Tuesday, August 13, 2013 - Metric Disconnects

Metric Disconnects

by Sinclair Noe

DOW + 31 = 15451
SPX + 4 = 1694
NAS + 14 = 3684
10 YR YLD + .11 = 2.71%
OIL + .42 = 106.53
GOLD – 15.90 = 1322.40
SILV + .03 = 21.56

Retail sales rose 0.2% in July, following an upwardly revised 0.6% increase in June; retail sales are now up for 4 consecutive months. The retail sales report is important because consumer spending accounts for about 70% of the economy. We've heard that so frequently that it sounds like a cliché, but when we spend, that money circulates through the economy and it is the vital life blood of the economy. Areas showing gains included restaurants and bars, grocery stores and sporting goods outlets. Within general merchandise, department stores showed a 0.6 percent increase in sales last month

Another Commerce Department report today showed inventories at US companies were little changed. Merchants had enough goods on hand to last 1.29 months at the current sales pace in June.

Atlanta Federal Reserve bank President Dennis Lockhart says he thinks policy makers should move cautiously this year to scale back its bond buying program. Lockhart says the Fed might make its first reduction before the end of the year, maybe as soon as September, and that it should be thought of as a cautious first step. So, Lockhart was a bit more dovish than other Fed policy makers of late, and as he made the comments, small losses on Wall Street gave way to modest gains.

The equity markets have come to play an outsized role in the US from a policy and practical level. It’s never a good idea to try to assess complex phenomena with a single metric, yet for much of the public and the officialdom, the level and trend of the stock market is a proxy for the health of the economy. Fed policymakers now have a vested interest in keeping the stock market up, both to boost confidence and maybe out of personal vanity; if the stock market were to fall, that would mean they’ve done a bad job. Can’t have that!

Equity is a residual claim: payments to shareholders come after paying suppliers and employees, bondholders, leases and licenses, legal claims, and taxes. But our new ideology is that the last should come first. And to achieve that, companies in the US have abandoned the model of sharing the benefits of productivity gains with workers. Once upon a time increases in productivity moved up in tandem with increases in wages, but that changed in the 1970s. Since the end of World War II, productivity has increased by 254%, but real hourly compensation has only increased by 113%. As I say, they used to move in tandem; the disconnect happened about 40 years ago.

According to Bloomberg data, trailing 12-month earnings per share for the S&P 500 are 16 per cent above their level of October 2007 (when both earnings and share prices peaked before the financial crisis). On the same basis, earnings for the MSCI EAFE index, covering the rest of the developed world, are down 37 per cent. Those for the FTSE-Eurofirst 300 are down 42 per cent.

Earnings for the MSCI emerging markets index are up since October 2007 – but by only 13 per cent, having peaked and started to decline two years ago.

Look closely at the raw numbers for the US and they turn out to be less inspiring. S&P 500 companies are on course to increase earnings by 3.6 per cent year on year for the second quarter. But they have declined by 1.3 per cent once financials are excluded. During those 12 months, bear in mind, the S&P gained 18 per cent, and its financials index gained 33 per cent.

Companies are not generating that much in revenues but, over the past 12 months, they returned a record amount of it to investors. This is an admission that they see few opportunities to invest for growth. But, in an environment where investors take little on trust and are desperate for a yield from anywhere, it has helped the rally keep going. This is not a strategy that can last forever. At some point, companies must start generating more revenues and profits with which to make these payouts.

And if you still think its safe to jump back in;Apparently FINRA is looking into whether sell-side research analysts are doing some naughty things, which is an evergreen topic. It’s hard to tell if the analysts are doing naughty things but, probably, right? Basically the analysts are meeting with potential issuers before those issuers’ IPOs, which is fine. But at those meetings, which tend to be arranged by “so-called I.P.O. advisers” they might be talking about the IPO and the analysts’ views of the issuers, which is not fine. 

Yep, the IPO market is back in a big way. Initial public offerings are up 40% from a year ago; 126 companies have raised $27.1 billion, on track to $43 billion for the full year. Mark Hulbert at Marketwatch writes: "When companies are rushing to sell their shares, it often means that the overall stock market has become not just fairly valued, but actually overvalued.”

As Hulbert points out, companies aren't selling you stock out of the goodness of their hearts, but to make their executives, employees and bankers rich. What better time to get rich than when you think your stock is probably overpriced? The last big IPO boom featured dumb money chasing quick riches on first-day stock pops, a game that was heavily rigged in favor of insiders.

Hulbert's own inflation-adjustment of the IPO data suggests the market is on pace for the biggest dollar amount of IPO issuance since 2000, just at the popping point of the dot-com bubble. Estimates like these are going to vary depending on what sort of method you use to adjust for inflation; suffice to say there are a lot of IPOs these days.

IPOs may be back in fashion but mergers just took a hit.

The Department of Justice and several states has sued to block the proposed merger of American Airlines and US Airways. Arguing the combined airline would reduce competition for air travel in key markets. European regulators recently approved the deal after the companies agreed to give up two daily slots at London’s Heathrow Airport.

The airlines claim the merger would cut costs by streamlining operations and scaling back on unprofitable routes. They claim this would be good for customers because it could result in lower costs. However, the merger would also create a monopoly in several areas, such as nonstop service between Miami and Philadelphia or Nashville and Washington DC. The combined airline would also dominate some key hubs.

If not challenged by DOJ, the merged American would surpass United to become the largest U.S. passenger airline by several measures. While US Airways and American overlap on only 12 nonstop routes, no other nonstop competitors exist on 7 of those 12. The merger would also mean less competition along 1,665 other routes within the United States, while boosting competition along just 210 routes. According to the Justice Department, If the US Airways-American merger went through, the four biggest airlines would control more than 80 percent of the domestic air-travel market.

This doesn't mean the merger won't happen; it is still a possibility, but there would likely be some major concessions as talks continue.

Have you experienced a power outage lately? We had one at the studios about a week ago. It happens, and it is happening with greater frequency. The Department of Energy has a new report that shows the power grid is suffering more blackouts, a lot more over the past 20 years.

The report notes that “thunderstorms, hurricanes and blizzards account for 58 percent of outages observed since 2002 and 87 percent of outages affecting 50,000 or more customers.” The rest are caused by things like “operational failures, equipment malfunctions, circuit overloads, vehicle accidents, fuel supply deficiencies and load shedding — which occurs when the grid is intentionally shut down to contain the spread of an ongoing power outage.”

The report estimates that over the past 10 years, weather-related outages have cost an average of about $18 billion to $33 billion per year, adjusted for inflation. So, is severe weather the cause of the blackouts, or is the problem related to old infrastructure? Yes. The grid is old; there's been almost no new construction in the past 25 years, and that makes it vulnerable to severe weather. Grid resilience is increasingly important as climate change increasesthe frequency and intensity of severe weather. Greenhouse gas emissions are elevating air and water temperatures around the world. Scientific research predicts more severe hurricanes, winter storms, heat waves, floods and other extreme weather events being among the changes in climate induced by emissions of greenhouse gasses.

The Energy Department report says the grid should be modernized and made to tougher standards especially where severe weather may be a problem. Yes, it would be expensive to upgrade the grid, and it would be more expensive to wait.

Yesterday, we reported that a couple of lower-level traders at JPMorgan might face the possibility of arrests in connection with the London Whale trades. It doesn't look like Bruno Iksil, the actual London Whale will be arrested; he's cooperating with the investigators.

Almost everyone, from President Obama to his ideological foes in the Republican Party, wants the government out of the business of guaranteeing almost every mortgage loan made in the U.S. That's all well and good, but there is no reason to think that private investors will be willing to fund the types of mortgages people expect at rates they consider "affordable" in the absence of government guarantees. The government could help assuage investor fears by proving that it is committed to upholding the rule of law and punishing individuals who commit financial fraud.

The government, in turn, has shown almost no interest in charging individuals with criminal conduct. Somehow one of the most destructive and widespread frauds in recent history happened without anyone causing it; except for Fabrice Tourre, and that was a civil suit, not criminal. Bank shareholders have certainly spent money on settlements, but the actual perpetrators, whoever they were, have gone unscathed. Given this backdrop, who would pour money into a rejuvenated "private-label" MBS market in sufficient size to offset a large decline in government support?

From the perspective of investors, lying about the quality of the loans they were packaging into securities wasn't even the worst thing the banks did. In many cases, banks failed to ensure that the securities they were selling were even legal. And it now appears that many of the mortgage backed securities weren't really backed by mortgages, maybe more than $1 trillion dollars worth of the stuff.

Of course, the lack of proper documentation didn't prove much of an obstacle to banks that wanted to foreclose on delinquent (and current) borrowers -- they just forged the paperwork they needed.These fraudulent foreclosures harmed investors and the broader economy, although they boosted the earnings of the big banks.

State attorneys general and the Department of Justice eventually settled with the big banks over this practice. None admitted wrongdoing, and no individuals were punished. Far less money actually reached the victims of these fraudulent practices than was expected -- and many had to endue long delays before getting what little they were owed, and then many people received a check in the mail and it bounced; yep, the settlement checks sent out by the banks, bounced. As if that weren't bad enough, the court-appointed settlement monitor says that many of the banks are still breaking the rules. 

The government's failure to prosecute wrongdoing has created an environment of legal doubt that keeps investors away. Not only are investors unable to trust the government to enforce the law -- they can't even trust the government to tell them how bad a job it has done enforcing the law. It all leaves you wondering why anyone would buy private-label MBS until that changes. 

Friday, 15 February, 2013 - February 15th - An Historic Date

February 15th - An Historic Date

by Sinclair Noe

DOW + 8 = 13,981
SPX- 1 = 1519
NAS – 6 = 3192
10 YR YLD +.01 = 2.01%
OIL – 1.23 = 96.08
GOLD – 24.30 = 1611.10
SILV - .60 = 29.90

Today marks the 10^th Anniversary of the largest single coordinated protest in history. Roughly ten to fifteen million people (estimates vary widely) assembled and marched in more than six hundred cities: as many as three million flooded the streets of Rome; more than a million massed in London and Barcelona; an estimated 200,000 rallied in San Francisco and New York. From Auckland to Vancouver to the streets of New York and Los Angeles—and everywhere in between—tens of thousands came out, joining their voices in one simple, global message: No to the Iraq War.

And there it was. We failed. Slightly more than a month later, the U.S. was shocking and awing its way through Iraqi cities and Saddam Hussein’s defenses and bedding in—though it didn’t know it yet—for a near decade-long occupation. The protests, which by any measure were a world historic event, were brushed aside. The UN Security Council was bypassed. Congress rubber stamped the war. The media was little more than a puppet. The U.S. spent nearly a trillion dollars on a pre-emptive war that didn’t need to happen and a nation-building exercise that has achieved only fragile, uncertain gains. Far from a “Mission Accomplished,” the American adventure in Iraq has become a cautionary tale of hubris and poor planning.

February 15^th was a global day of protest; the biggest ever.

For the week, both the Dow and Nasdaq fell 0.1 percent while the S&P rose 0.1 percent in its seventh straight week of gains, a period during which the index rose 8.4 percent. The last such seven-week run was between December 2010 and January 2011.

Wall Street dealmakers are off to a busy start to 2013, as some of corporate America’s most recognizable names have become involved in multi-billion-dollar mergers and acquisitions. Check this article from Christopher Matthews: Just yesterday, American Airlines and US Airways announced they would be merging in an $11 billion deal, to form the world's largest inconvenience, or airline.

Private equity firm 3G and Warren Buffett‘s Berkshire Hathaway announced a $28 billion joint acquisition of  food conglomerate H.G. Heinz. That private euqity firm is from Brazil. American private equity firms look for something much sexier than ketchup. The Brazilians are looking for profit.

And these two deals follow hard upon $24.4 billion leveraged buyout of Dell by private equity firm Silver Lake Partners and the firm’s founder, Michael Dell.

US companies have spent $219 billion on mergers and acquisitions so far in 2013, a sharp increase from 2012, when firms spent just $85 billion during the same period. And US firms are on pace to have the biggest year in M&A activity since 2000.

While all this activity will be surely benefit shareholders of acquired firms — as well as lots of Wall Street investment bankers — what does it say about the health of the economy? Since the late 19th century, mergers and acquisitions have tended to come in waves, spurred by the availability of credit, changes in government policy, or bursts of private-sector innovation. Deregulation, for instance, motivated a wave of mergers in the airline industry in the 1970s and the consolidation of the banking industry in the 1990s. But perhaps the most important factor in motivating these bursts of M&A is economic conditions, particularly the strength of the stock market. Mergers in particular are often financed with stock, and high stock values give companies the resources with which to make purchases.

But the stock market has been doing pretty well for a few years now, with the S&P 500 up more than 138% since its bear-market lows of 2009. So why are we only now seeing the first glimmer of an M&A boom?

Surely one reason is that today’s market is heavily fortified by quantitative easing. The Federal Reserve has taken unprecedented action to keep interest rates low in both the short and long term, and those efforts have kept stock prices high despite the weak economy. In other words, given central bank stimulus, a rising stock market isn’t quite the indicator it used to be. We can see this in GDP growth figures as well.

In addition to predicting M&A activity, the stock market is also considered a leading indicator of economic growth, meaning increases in GDP generally follow bull markets.  This is because stock prices reflect investors expectations for a company’s future income. A high stock price today represents investors’ belief in big profits tomorrow. Taken in the aggregate, a surging stock market index is a predictor of increases in GDP down the line.

But, just as we’ve seen the link between rising stock prices and M&A severed, the huge gains we’ve seen in stock prices since 2009 have also not been followed by robust economic growth. Again, this is probably because Fed action has done more to promote stock price increases than economic fundamentals. But this is exactly why we should be encouraged by this fast start to M&A activity in 2013, especially if it keeps up in the coming months. It may mean that recent stock market gains are once again reflecting confidence about future profits, and not just central bank stimulus.

What makes this plausible is the fact management won’t seek out — and boards won’t sanction — expensive acquisitions if they’re not confident about future growth. And given the fact that corporate profits have been strong while unemployment remains high and wage growth stagnant means the corporate sector will eventually have to start spending if economy is to recover fully.

So while high profile M&A deals are often times more about CEO empire building than creating real shareholder value, this boom may be a positive sign for the economy nonetheless. It may finally be that rising stock prices are actually telling us something about the real economy around us — and perhaps more important, that corporate leaders are finally feeling frisky once again.

The Group of 20 is meeting this weekend and they are acting like they won't throw Japan under the bus; in other words, they say they won't target Japan over policies that have weakened the yen. The yen initially fell on a draft communique prepared for G20 leaders at their meeting in Moscow. The draft omits part of this week's Group of Seven statement declaring fiscal and monetary policy may only be used for domestic economic aims. The yen has reversed early gains and is now the weakest major currency on reports the language of the G20 statement may differ from that of the G7 countries. The G20 is expected to urge members to avoid competitive devaluation, but not echo the G7 view that exchange rates should not be a target of policy. That's a new phrase: “competitive devaluation”.

Federal Reserve Chairman Ben Bernanke said the United States is acting in line with the position of the G7 nations by using domestic policy tools to boost growth and reduce unemployment.

A new study published by the Government Accountability Office says the 2008 financial crisis cost the US economy more than $22 trillion. The GAO report says: "The 2007-2009 financial crisis, like past financial crises, was associated with not only a steep decline in output but also the most severe economic downturn since the Great Depression of the 1930s." The agency said the financial crisis toll on economic output may be as much as $13 trillion -- an entire year's gross domestic product. The office said paper wealth lost by homeowners totaled $9.1 billion. Additionally, the GAO noted, economic losses associated with increased mortgage foreclosures and higher unemployment since 2008 need to be considered as additional costs.

The GAO report concludes that an ounce of prevention is worth a pound of cure: "If the cost of a future crisis is expected to be in the trillions of dollars, then the act likely would need to reduce the probability of a future financial crisis by only a small percent for its expected benefit to equal the act’s expected cost."

In other words, Wall Street and its many allies and lobbysists have been complaining about the cost of regulation and reform but they never mention that it was Wall Street’s reckless investments and trading that caused the biggest financial collapse since the Great Crash of 1929 or the trillions of dollars in costs they inflicted on our country. That economic wreckage can still be seen from coast to coast in unemployment, foreclosed and underwater homes, lost retirements and educations and so much more.

Another quarter of data shows that the austerity solution has not been working in Europe. A deepening recession in the 17-nation eurozone revealed evidence that the problems of the single currency’s crisis-hit periphery were spreading northwards to affect monetary union’s core economies of Germany and France.

Despite an easing of financial tensions in the second half of the year, gross domestic product in the members of the monetary union dropped by 0.6% in the final three months of 2012, a heftier decline than the markets had been expecting. The US grew by 2.2% in 2012 and Japan by 1.9%, while GDP in the eurozone contracted by 0.5%.

The Treasury Department said Friday that foreign holdings of U.S. Treasurys rose 0.3 percent in December from November to $5.56 trillion. It was the 12th consecutive monthly gain. China, the top foreign holder, increased its holdings 1.7 percent to $1.2 trillion. Japan, the second largest holder, boosted its investment 0.2 percent to $1.12 trillion.

Demand kept rising in December even as Congress approached a deadline to raise the government's $16.4 trillion borrowing limit. In January, Congress approved a measure to temporarily suspend the borrowing limit until May 19. That has allowed the government to take on more debt while the debate continues.

 Remember how Congress managed to delay the fiscal-cliff and debt-ceiling fights? That's right, they kicked the can down the road. What's left of that mess, a big round of spending cuts called "sequestration," takes effect on March 1 and will shave about $85 billion from government spending this year, with more to come in the years ahead. And it is almost universally agreed that sequestration would hurt the economy if it happens; it would nip potential growth in the bud; just nip it. And the economy is, how do you say, not so good! In fact, it shrank in the fourth quarter of 2012.

When the going gets tough, the wimps leave town. Congress has recessed, and the recess is scheduled to end with four full days to fix the sequestration problem. They couldn't fix it in two years, but they have four days to clean it up after their vacation. A new survey indicates that 94% of Americans have no problem with Congress taking a vacation right now, as long as they all take a vacation together on a Carnival Cruise.