Wednesday, April 16, 2014 - What is Really Plausible

What is Really Plausible

by Sinclair Noe

DOW + 162 = 16,424
SPX + 19 = 1862
NAS + 52 = 4086
10 YR YLD + .01 = 2.63%
OIL + .05 = 103.81
GOLD - .20 = 1303.20
SILV + .07 = 19.73

Let’s start with some earnings news and then we’ll move over to economic data.

Google posted $3.4 billion in net income, or $5.04 per share, in the three months ended March 31, compared to $3.3 billion, or $4.97 per share, in the year-ago period. Revenue rose 19% to $15.4 billion, but analysts had estimated $15.5 billion, and the shares were getting clobbered in late trades.

IBM reported its lowest quarterly revenue in five years; IBM reported revenue of $21.7 billion for the quarter, but that marks the eighth consecutive decline in quarterly revenue. The company has been restructuring its business by cutting jobs and selling its low-end server business. This is not what you would call a growth model.

Also, from the faulty business model file: Bank of America posted a $276 million loss for the most recent quarter. The financial results included a pre-tax expense of $6 billion, or approximately 40 cents a share after tax, to cover litigation costs as the bank moved to resolve mortgage-related litigation fallout from the financial crisis that began in 2007 and other issues; far worse than the $3.7 billion investors had braced for. The bank today agreed to a $584 million settlement of litigation over nine residential mortgage-backed securitizations insured by the Financial Guaranty Insurance Company. The FGIC said the securitizations were sponsored by Countrywide, which Bank of America bought in 2008.

Since the 2008-2009 financial crisis, Bank of America has logged some $50 billion of expenses for settlements of lawsuits and related legal costs, before taxes. Without those charges, its income before taxes would have been about three times higher. When does it end? How do you factor this when you try to value shares of a company? The simple answers: it ain’t over yet, and don’t even try.

In economic news: China reported that its economy grew at its slowest pace in 18 months at the start of 2014, but the increase was better than expected and showed some improvement in March.

From the Census Bureau: privately owned housing starts in March increased 2.8% from February to a seasonally adjusted annual rate of 946,000; single family housing starts increased 6% from the month before at an annual rate of 635,000. Building permits authorized were down 2.4% from February at a seasonally adjusted annual rate of 990,000, but it’s still 11.2% higher than March of last year.

The Federal Reserve reports industrial production increased 0.7% in March, following a 1.2% advance in February; for the first quarter industrial production moved up at a 4.4% pace. The increase in industrial production, which beat economists' expectations for a 0.5% gain, reflected in part a 0.5% rise in manufacturing output. There were also hefty increases in production at mines and utilities.

The Federal Reserve has just released its April Beige Book, a collection of anecdotes on economic conditions from business contacts across each of the 12 Fed districts. Economic growth increased and consumer spending rose, at least for people who weren’t completely snowed in. The Fed seemed quite fascinated with the weather, mentioning it more than 100 times; it’s like they had never seen snow before, and they seemed amazed that it makes actual work difficult for some people.  

Transportation, manufacturing, financial services, and auto sales all improved, though the reports on residential housing markets were “varied.” The Beige Book also talks of delays to crop plantings and shipments of commodities, as well as a pig virus that hurt hog farming. Labor market conditions continued to slowly improve with minimal wage pressure, and prices were generally stable or slightly higher.

Fed Chair Janet Yellen delivered a speech to the Economic Club in New York. She said the economy is improving, it will continue to improve, and by 2016 it will be normal, and then it will all be good. Yellen said: “I find this baseline outlook quite plausible.”

Yellen laid out 3 questions that will guide the Fed policymakers: Is there still significant “slack” in the labor market? Is inflation moving back toward 2 percent? What factors may push the recovery off track?

Is there still significant “slack” in the labor market? Why yes, yes there is. The unemployment rate is at 6.7% and Yellen would prefer to see it closer to 5.2% or 5.6% and she thinks it will take about 2 more years to get there. Further slack exists in the share of the workforce working part time and the long term unemployed and the low level of participation in the workforce. Toss in almost no wage pressure.

Is inflation moving back toward 2 percent? Yellen said inflation significantly persisting below 2% was more likely than inflation moving substantially above 2%. At the moment, the Fed’s favorite measure of inflation is less than 1%, well below the Fed’s annual inflation target of 2%.Inflation is likely to gradually move back toward the central bank’s target. Yellen said that to some extent, the low rate of inflation seems to be due to factors that are likely to be temporary, including lower consumer energy prices and a drop in import prices.

What factors may push the recovery off track?  Yellen says there can be a lot of ‘twists and turns’ in the economy” and the central bank has no “fixed idea” about what will come to pass. The Fed will try to set the course and Yellen said the central bank’s new forward guidance can serve as an “automatic stabilizer” that helps investors from overreacting to “twists and turns” the economy may take.

She cited the ongoing fiscal drag on the economy. This is a recurring theme; we heard Bernanke talking about this for a long time. Allow me to translate from Fedspeak to plain language. The Federal Reserve is responsible for monetary policy; Congress handles fiscal policy. So fiscal drag means that the policies laid out by Congress have hurt the economy. The Fed has tried to stimulate the economy, much like stepping on the accelerator while the Congress has been applying the brakes. That’s a bit simplistic because there are other factors at work. The Fed is stepping on the gas, the Congress is stepping on the brakes, and we’ve got rotten, ill-behaved bratty children in the back seat, reaching over and grabbing the steering wheel and threatening to drive into a brick wall; in this example, the bratty kids in the back seat are the banksters.

Just a little reminder of a story from the Summer of 2013; when we learned that Goldman Sachs was in the aluminum business. Goldman had 27 industrial warehouses in the Detroit area, where they stored aluminum. Goldman also had an interest in the financial markets for aluminum; they bet on price movement in the commodity; and they exploited pricing regulations set up by an overseas commodities exchange, which essentially allowed them to keep aluminum in storage longer than allowed, which keeps it off the market and out of production, which jacks up prices, based upon simple supply-demand, and then they bet on those higher prices. They literally had trucks moving aluminum from one warehouse to another, all around Detroit, but they wouldn’t ship it out for production. The move cost consumers more than $5 billion over the last 3 years.

The inflated aluminum pricing is just one way that Wall Street is flexing its financial muscle and capitalizing on loosened federal regulations to sway a variety of commodities markets. The maneuvering in markets for oil, wheat, cotton, coffee and more have brought billions in profits to investment banks like Goldman, JPMorgan Chase and Morgan Stanley, while forcing consumers to pay more every time they fill up a gas tank, flick on a light switch, open a beer or buy a cellphone. Federal regulators were also looking at JPMorgan and 3 other banks for rigging electricity prices.

Using special exemptions granted by the Federal Reserve and relaxed regulations approved by Congress, the banks have bought huge swaths of infrastructure used to store commodities and deliver them to consumers. After hearing of all the abuses by the banks, some people thought it might be good to rethink these policies. And about 9 months have passed, and finally 2 senators, Sherrod Brown and Elizabeth Warren, have sent a letter to the Fed, suggesting that "As a general matter, [big banks] should be prohibited from owning physical assets like warehouses, pipelines, and tankers."

Aluminum prices have continued to rise not necessarily because the commodity has become more valuable or scarce, but simply because the wait times for physical delivery have steadily grown longer. In some cases, the wait has lasted more than a year. Meanwhile, commodity traders have come up with a unique solution to banks hold physical commodities in warehouses to manipulate prices. The London Metals Exchange will give traders the ability to hedge aluminum prices, as the commodity continues to rise due to lengthy delivery times that have thrown a wrench in a number of supply chains.

Here are a few facts for your consideration: roughly one-third of everything we buy goes to interest; the interest goes to private banks; at the height of the financial crisis over 40% of US corporate profits went to the financial industry, up from 7% in 1980. The simple reality is that I we could just get those crazy banksters under control, we would have at minimum a couple of trillion extra dollars floating through the economy, and we wouldn’t have to worry (as much)  about the Fed and Congress and monetary policy versus fiscal drag, and we would all be talking about the phenomenal economic recovery. And that is not only plausible, but that’s a fact.

Tuesday, July 23, 2013 - Woman Gives Birth to a Baby

Woman Gives Birth to a Baby

by Sinclair Noe

DOW + 22 = 15,567
SPX – 3 = 1692
NAS – 21 = 3579

10 YR YLD + .02 = 2.51%
OIL + .09 = 107.00
GOLD + 12.50 = 1348.70
SILV - .05 = 20.59

The Dow Industrial Average hit a new record high close. The S&P 500 was down slightly after four straight gains, including a record high yesterday. It's still earnings reporting season, and the big report today came after the close of trade. Apple reported better than expected sales and profits. Generally, we're seeing revenues are coming in pretty lackluster and profits seem to be doing a little better than gains in sales.

In the first quarter of 2013, we saw an interesting and unexpected development. While the corporate earnings of S&P 500 companies were better than expected, their revenues weren’t nearly as impressive.  Just 46% of S&P 500 companies reported revenues above estimates. And the second-quarter corporate earnings might be similar, if not worse. Keep in mind that before second-quarter earnings season began, we had 87 S&P 500 companies issue negative earnings guidance. The information technology and consumer discretionary sectors of the S&P 500 had the largest number of companies issuing negative guidance about their corporate earnings relative to their five-year average.

Many stock advisors are staying optimistic and not taking into consideration the reliability of corporate earnings. Consider the Investors Intelligence Advisor Sentiment index. It has been increasing for three consecutive periods and is closing in on highs made in mid-May of 2012.

Big-cap companies are still trying their best to boost their corporate earnings through other means—call it financial engineering. Take Yahoo!, for example. In the past few quarters, the company purchased $3.65 billion worth of its own shares back, and in its first-quarter corporate earnings announcement, the company was very clear that it plans to purchase another $1.9 billion worth of its own shares back.

These anemic revenues mean that companies are not really selling more, and deteriorating earnings combined with key stocks heading higher continues looks like an effort to lure retail investors into a topping market. I'm not saying the market has topped here, and I'm not trying to sound bearish; that would be foolish while we have record highs. Just reminding you that a trend can reverse.

The Senate Financial Institutions and Consumer Protection subcommittee convened a hearing to explore whether financial companies – the big banksters like Goldman Sachs, JPMorgan Chase and Morgan Stanley – should control power plants, warehouses and oil refineries. 

Although Congress removed post-Depression era barriers that separated commercial banking and traditional commerce in the late 1990s, a group of bipartisan senators has lately been advocating the reinstatement of those walls in part to impose tighter regulation on such actions.

The ability of those banks, or more accurately their subsidiaries to gather nonpublic information on commodities stores and shipping also could give the banks an unfair advantage in the markets and cost consumers billions of dollars. And there is particular concern because the giant banks receive the benefit of low-rate borrowing from the Federal Reserve. That could leave taxpayers on the hook for losses caused by a collapse in commodities prices or in the event of an environmental disaster like the Deepwater Horizon oil spill.

Meanwhile, the Federal Reserve is reviewing the decades old decision to allow banks to be involved in physical commodities transport and storage. Yes, the Federal Reserve, in addition to printing money out of thin air, they serve as a banking regulator.

The 1999 Gramm-Leach-Bliley Act added exemptions for certain commodities units that previously weren’t allowed under the 1956 Bank Holding company Act. One was for businesses that the Fed could determine were complementary or incidental to the bank’s financial activities. The first of those decisions came in 2003, when the Fed allowed Citigroup to continue dealing in physical commodities.

The other exception was for firms that became banks after 1999 and had physical commodities businesses that predated Sept. 30, 1997. That rule is relevant because Goldman Sachs and Morgan Stanley converted to bank holding companies during the 2008 financial crisis. The Fed gave them five years to divest businesses that didn’t comply with the Bank Holding Company Act.

Morgan Stanley said in its 2012 annual report that it was in talks with the Fed over whether the company’s physical commodities businesses would be given a grandfather exemption or if it would have to sell any units by the end of the five-year grace period. Goldman Sachs faces the same deadline if any of its investments are deemed noncompliant.

This issue came to the forefront with a New York Times article over the weekend detailing how Goldman Sachs has been operating an aluminum warehouse operation in Detroit; the main job of the warehouse seems to be delaying delivery of the metal, crimping supplies and running up prices. We've been hearing more and more about banks trying to manipulate prices, whether through warehousing practices or manipulation of interest rates in the Libor rate rigging scandal, or the ISDAfix scandal, or the oil price scandal in Europe, or electricity scandal involving JPMorgan and Barclays. And at this point, we are accumulating more and more evidence that the banks are rigging pretty much everything.

By the way, we just marked the third anniversary of the Dodd Frank Financial Reform Act. They're now saying the thing might actually make it into law by the end of the year; so far, ti's just been bits and pieces of the legislation that has been enacted. Sort of like the road killl that's left after the lobbyists have finished with it. Since the summer of 2010, bank and financial industry lobbyists and attorneys have met with regulators more than 3,100 times to argue their positions. Reform representatives have met with regulators about 150 times. Guess who's winning?

Yesterday, we talked a bit about the problem in Detroit. I said the underfunded pensions weren't really a problem. That is true, but I should qualify. The underfunded pensions are problematic, but we could fix the problems. It would cost money. It would require hard work. That's not the path that Detroit is on. Rather, Detroit is turning into a test case for destroying pension funds and if it catches on, it will spread to other cities, and that might be a problem.

Bankruptcy or not, Detroit's emergency manager, Kevyn Orr, says the city simply can't afford the pensions it has promised tens of thousands of retired and current city workers, many of whom are counting on the checks to make ends meet.

So how much money do Detroit's retirees actually get? On average Detroit's firefighters, police officers and other city employees receive pension checks that are similar or slightly smaller in size than the national average of $30,000 a year. In Dallas Texas, the average annual police pension is around $47k, in Los Angeles it's about $58k. For different jobs the pensions vary, but a general city employee who retired in 2011 with an average ending salary of $60,000 and 40 years of service could receive around $45,000 a year.

Regardless of whether Orr's proposed cuts go through, pension checks for younger employees will be less generous. Current workers have already agreed to pension cuts. For example, in 2011, Detroit police and firefighters agreed to a roughly 15% cut for pension benefits accrued from future years of service.

While retired Detroit firefighters and police officers receive more generous pension checks than auto workers -- checks averaged almost $30,000 a year in 2011 compared to about $18,000 for UAW retirees they often don't receive the added bonus of Social Security payments. So apparently the plan is to slash the pensions, and since they aren't eligible for Social Security because they were on the city plan, ...they get nothing?

The birth of the as yet un-named prince-child of Kate and William in London has been making enormous headlines. The best headline I've seen is: “Woman Gives Birth to Baby”. The accompanying story provided details: A married woman of childbearing age has given birth to a baby boy. The event followed nine months of pregnancy. "Both mother and baby are doing well," a spokesman for the woman said. It is now expected that the baby will grow up.

Finally, a good use of austerity, at least as it applies to words.

It's been a while since we've followed up on austerity, so let's see how it's holding up. In the UK, austerity has shaved 6 percent from that country's gross domestic product over the past three years, according to estimates from Oxford economist Simon Wren-Lewis. This amounts to $143.5 billion in lost income during that time, or nearly $5,400 per British household.

Debt hawks  might argue that a little bit of economic pain now is worth it if you can avoid a government-debt blowup in the future. That was the gist of Harvard economists Carmen Reinhart and Kenneth Rogoff's oft-cited paper, "Growth In A Time Of Debt," which argued that government debt above 90 percent of GDP led to sharply lower economic growth. Reinhart and Rogoff followed up their paper with op-ed articles and even testifying before Congress to help convince governments here and in Europe to hurry up and cut government debt sooner rather than later. The only problem is that their research paper was riddled with errors and omissions, and problems with the Excel spreadhseet calculations.

The trouble is, austerity has not worked to lower government debt burdens. It has only made them worse.

Surprise, surprise: it turns out that slashing government spending and raising taxes in the midst of a recession/depression actually lowers tax revenue and raises the cost of government services for the poor and unemployed, which makes government finances even worse.

The struggling European countries that undertook their own austerity programs, as a condition of receiving bailout funds from the austerity fanatics holding the purse strings, are still seeing their debt loads rise.  In 2011 German Finance Minister Wolfgang Schäuble wrote that “austerity is the only cure for the Eurozone”; In Ireland, Greece, Spain, Italy, and Portugal, government debt as a percentage of GDP has increased since the beginning of 2011. The debt problem is worse than before the belt tightening. Public debt levels are rocketing in almost every country of the eurozone periphery. Debt ratios are already crossing the point of no return in Portugal and Italy and are nearing the danger zone in Ireland.

The latest figures from Eurostat are shocking even to those who never believed that combined fiscal and monetary contraction – made worse by bank curbs – could have any other result than a faster rise in debt trajectories.

Portugal’s debt has just blown through the upper limits set by the EU-IMF troika, reaching 127% of GDP in the first quarter of 2013. This is 15 percentage points higher than a year ago – the bitter fruit of austerity overkill. The Portuguese people have suffered year after year of cuts only to find themselves sinking deeper into a debt swamp. The finance minister resigned. Yields on 10-year bonds jumped briefly above 8%.The IMF warned last month that the debt outlook remains “very fragile” and that any external shock could push the country over the edge.

Italy’s debt has hit 130% – compared with 123% a year ago – rapidly spiralling beyond the safe threshold for a country without its own sovereign currency and central bank.

In Ireland, public debt has jumped by 18 points to 125% in a single year. This is partly “pre-funding” to cover borrowing needs for 2014 but a slide back into recession accounts for a big chunk.

The former head of the IMF’s team in Ireland, Prof Ashoka Mody, has called for “a complete rethinking” of the austerity strategy. He confirmed what the Irish trade unions and others have said all along, that fiscal overkill is self-defeating, especially if compounded by tight money.

Rogoff and Reinhart made errors when they guessed that 90% debt to GDP was the level that resulted in catastrophic meltdown, but you've got to think that anything over 125% debt to GDP can be problematic; certainly, it presents the bond market vigilantes with the hint of blood in the air. The current course is untenable. Markets may tolerate EMU debts of 130% for a while but they are unlikely to tolerate levels nearing 140%, or even any prospect of it.

The harsh reality is that the EU failed to clean up its problems. You can blame the mess on the periphery if you wish, or you can blame it on the belt tightening failed policies of the northern states, but the simple reality of the day is that austerity has not worked. Contractionary policy has needlessly pushed southern Europe into a double dip recession, or in some cases, just out and out depression.

Meanwhile, the big headline from across the pond: Woman Gives Birth to a Baby.