Tuesday, August 12, 2014 - Hype is Hurting

Hype is Hurting

by Sinclair Noe

DOW – 9 = 16,560
SPX – 3 = 1933
NAS – 12 = 4389
10 YR YLD + .02 = 2.44%
OIL - .15 = 97.22
GOLD + .60 = 1309.50
SILV - .10 = 20.02

The Dow Industrial Average has now gone negative year-to-date. Seven of the 10 main groups in the S&P 500 declined, with energy companies dropping 0.7 percent to lead the slide as Brent crude settled at the lowest level since July 2013. The International Energy Agency said a supply glut was shielding the market against threats in the Middle East.

As we wrap up earnings season, 73% of companies have beaten earnings estimates, slightly above the 1-year average of 72%, but “beating estimates” this time doesn’t mean what it did in recent quarters. For the past few years, analysts have ratcheted down their estimates in the run-up to earnings season, setting the bar lower and lower—and setting up an easy beat. Companies are beating by an average of 4.2%, above the 1-year average of 3.2%. Q2 earnings growth is 8.4%, up from an expected 4.9% on June 30. This is the second-highest earnings growth rate since Q4 2011. Revenues are now up for 5 consecutive quarters and at all-time highs, and it now looks like revenues might be driving earnings. The strongest sectors for upside earnings surprises have been telecom services, health care (especially biotech), and information technology; while consumer staples is the weakest. US banks and thrifts had their second best quarter in 2 decades, with more than $40 billion in net income.

Profit margins have soared. Net profit margins more than doubled from 4.6% in March 2009 to 9.8% at the end of the first quarter. Margins could come in just shy of 10% when all the second-quarter results are in. The problem is that high margins tend to mark a peak rather than a normal level of profitability. In other words, it’s tough to keep the margins high, and there are several reasons: most of the fat has been cut and it is difficult to further improve labor efficiencies and that’s confirmed by last week’s productivity report showing that the real output of nonfarm business has been hovering around 3% year to year since Q2-2010, consistently higher than real GDP growth; capital spending has been low, but is likely to rebound; and with interest rates near all-time lows, companies will find it difficult to find better financing to boost margins. As margins stagnate or slip, the best defense is to look for companies that are growing revenues.

Actually, the best defense might be to discount analysts’ expectations; something that Wall Street is doing with greater frequency. The problem is that analysts issue glowing earnings growth expectations for the next few quarters, based on pro forma estimates, minus the bad stuff, and heavily adjusted; which in turn drives up share prices. Traders buy in. As the distant quarters get closer and closer, the analysts ratchet down expectations, making for a bar that is easy to hurdle, and again the traders buy in.

In its latest report on earnings expectations and reported earnings, FactSet found a startling change in how the market reacts to these fabricated earnings beats. Over the past five years, companies with upside earnings surprises saw their stock prices rise on average 1% from two days before the announcement to two days afterwards; and downside earnings surprises were punished with a 2.3% decline in stock price over the four-day window. So far in the second quarter earnings season, companies have been crushing earnings, and the market is languishing. FactSet found that this time around the market didn’t reward these juicy earnings surprises at all. Stocks of these companies actually dropped 0.1% over the four-day window. And downside earnings surprises got hit with a 3% decline. The hype is hurting.

The share of unemployed Americans competing for each open job hit a six-year low in June. The Labor Department's monthly Job Openings and Labor Turnover Survey, or JOLTS report, showed the number of unemployed job seekers per open job fell to 2.02 in June, the lowest level since April 2008. Job openings, a measure of labor demand, increased to a seasonally adjusted 4.67 million in June, the highest level since February 2001. At the same time, hiring reached its highest point since February 2008. Much of the increase in employment growth since the 2007-2009 recession ended had been driven by a sharp decline in the pace of layoffs, as opposed to a higher rate of hiring.

Job growth has topped 200,000 in each of the past six months, a stretch last seen in 1997. The unemployment rate has declined to 6.2 percent from 6.7 percent at the end of 2013. The JOLTS report shows some of the slack is coming out of the labor market, and the next sign of a tightening labor market is if we start to see wage growth. Meanwhile, a gauge of small businesses’ intentions to hire has also surged to a fresh post-crisis high, with 13% of respondents to a survey by the National Federation of Independent Business indicating their intentions to hire. That’s the largest percentage since September 2007. The problem is they aren’t actually hiring. The JOLTs hiring rate is nowhere near as buoyant as the job opening rates. The US hiring rate, hires as a share of total employment, hit 3.5% in June. You might expect businesses to intend to hire before they actually hire, but there is also a disconnect; and it might be in a skills mismatch or it might be in a wages mismatch.

During the Great Recession and its aftermath, the federal government acted to help victims of the severe downturn by funding programs that extended unemployment benefits—to up to 99 weeks in some cases, up from the standard 26 weeks. As the economic recovery continued, weak as it was for many in the working class, many lawmakers on the right began to believe that these extended benefits were a drag on employment—the theory being that government checks reduced the incentive for recipients to find a job, and that cutting off this lifeline would compel unemployed workers to look harder for work and perhaps take jobs they may not have accepted if the benefits had continued. Relying on this premise, Congress allowed the federally-funded Emergency Unemployment Compensation program to lapse last December.

Now, more than seven months later, data are available to test this idea. Coming from perspectives that diverge greatly along the ideological spectrum, scholars at both AEI and EPI, the Economic Policy Institute and the American Enterprise Institute, a couple of think tanks at opposite ends of the spectrum, have come to the conclusion that this “bootstraps” theory is incorrect—curtailing jobless benefits did not boost employment. Because unemployment benefits are contingent upon the people who receive them proving that they are looking for a job, receiving jobless benefits appears to make recipients at least just as likely, and certainly not less likely, to rejoin the ranks of the employed.

The US budget deficit was $95 billion at the end of July, down 3 percent from the same period last year. The fiscal year-to-date deficit at the end of July was $460 billion, the lowest level since the same period in fiscal year 2008, compared with a deficit of $607 billion for the same period in fiscal year 2013.

The National Association of Realtors released metro area home-price data for the second quarter, and it looks like growth in home prices is slowing, especially in the East. Nationwide, the median existing single-family home price in the second quarter was $212,400, up 4.4% from the second quarter of 2013. The median existing home price for the Phoenix area is $198,600, up 8.6% from one year ago.

The inventory of all existing homes for sale rose 6.5 percent in June from a year earlier to 2.3 million, an increase from a 13-year low of 1.8 million in January 2013. That’s a 5.5-month supply at the current sales pace, less than the six months that is considered equilibrium between buyers and sellers. Breaking it down further, inventory tightened at the market’s low end and grew at the top. The number of U.S. homes for sale in the bottom third of the market -- below $198,000 -- fell 17 percent in June compared with a year earlier, according to a Redfin analysis of 31 large U.S. metropolitan areas. The supply was up 3 percent in the middle market and jumped 15 percent at the top. The rising inventory of more expensive properties is giving a boost to sales. At the bottom of the market, first-time buyers, even those with the credit, savings and income to overcome tougher underwriting requirements, must face off against other bidders. First-time purchasers accounted for 28 percent of all sales of previously owned homes in June, down from about 40 percent historically.

A funny thing happened in New York yesterday; Manhattan prosecutors filed criminal charges against a dozen payday lending companies and their owner, accusing them of making payday loans that defied New York's limits on interest rates, or usury laws. The defendants in the case tried to cover their tracks with a maze of offshore corporations, to make it look like they weren’t doing business in New York. Under New York state law, the maximum interest rate that can be charged is 9 percent annually and the general usury limit is 16%, with a bunch of exemptions. The defendants in this case are accused of charging between 300% and 700% interest. Remarkably, most states still have usury laws on their books, but not all. In Arizona the legal rate of interest is 10%.

You may very well have a credit card that charges more than 10%, and the reason that is not considered usury is federal court decisions and statutes have virtually exempted credit card companies by allowing them to charge customers, regardless of their state of residence, the interest rates allowed by the state in which they are incorporated. This means that there are no limits on credit card interest rates in practice, even if certain limits remain on the books, the only exception being the 18 percent interest limit for federally chartered credit unions. And so it is a very rare event when anyone faces a criminal charge of usury.

Wednesday, June 11, 2014 - Nowhere to Hide

Nowhere to Hide

by Sinclair Noe

DOW – 102 = 16,843
SPX – 6 = 1943
NAS – 6 = 4331
10 YR YLD + .01 = 2.64%
OIL + .14 = 104.49
GOLD + .70 = 1261.60
SILV un = 19.30

The US posted a $130 billion budget deficit in May and the smallest shortfall for the first eight months of a fiscal year since 2008. The deficit last month was about $9 billion less than May of last year. For the fiscal year, which began Oct. 1, the government is running a budget deficit 30% smaller than it was a year earlier; or about $436 billion compared with $626 billion. Revenues for that period are 7% higher than a year earlier and outlays are 2% lower.

The Congressional Budget Office in April projected that the federal deficit will decline to $492 billion this fiscal year, the smallest in six years; down from $680 billion in 2013 and down from a record $1.4 trillion in January 2009. The CBO estimates that next year, the shortfall will decline further, to $469 billion. The 2014 deficit will be 2.8% of gross domestic product, compared with 4.1% of GDP in 2013.

The World Bank has cut its global growth forecast, predicting the world economy will grow 2.8% this year, below its previous forecast of 3.2% made in January. In its twice-yearly Global Economic Prospects report, the World Bank said tensions between Ukraine and Russia hit confidence worldwide.

The bank also cut its growth forecast for the United States to 2.1% from 2.8%, citing the bad weather at the start of the year that resulted in economic contraction in the first quarter. The good news is that the lower forecast is largely a result of things that have already happened, and the US economy appears to be rebounding.

The World Bank expects growth to quicken later this year as richer economies continue their recovery. It kept its global growth forecasts for the next two years unchanged at 3.4% and 3.5%, respectively. Provided the problems in Ukraine don’t get worse, or something else nasty doesn’t pop up.

In Ukraine, government forces and rebels claiming allegiance to Russia continue to clash in the east of the country. In Brussels today, the European Union served as broker for talks between Ukraine and Russia over future natural gas deliveries. Russia offered to supply gas for about 20% below the current price if Ukraine would settle its outstanding debts; Ukraine rejected that deal.

Maybe the World Bank is looking for trouble in the wrong place. Sunni rebels from an al Qaeda splinter group overran the Iraqi city of Tikrit; you remember Tikrit is Saddam’s hometown. The other day, the rebels captured Mosul, the second largest city in Iraq; now they’re closing in on the biggest oil refinery in the country.

The point is, we don’t know where the next black swan event will occur.

Maybe an app will backfire. Yesterday we told you about Uber, the ride-sharing app; now valued at $18 billion. Today, Uber brought the city of London to its knees. Actually, taxi drivers protesting Uber got fed up and parked their taxis on the streets, and London town suffered a massive case of gridlock. In Paris, taxis slowed traffic on major arteries into the city during the morning commute. Hundreds choked the main road to Berlin's historic center while commuters packed buses and trains, or just walked, to get to work in Madrid and Barcelona. Taxi drivers across Europe say Uber breaks local taxi rules, violates licensing and safety regulations and its drivers fail to comply with local insurance rules.

Mohamed El-Erian is the chief economic adviser at Allianz and the former co-chief investment officer of Pimco, and he says “investors might be surprised to learn that they have a lot riding on something that they pay very little attention to: macro-prudential regulation, or what central banks and other government agencies do to reduce the risk of systemic financial disasters.

“The aim of such regulation is to lower both the probability and potential costs of financial accidents. It does so by enhancing the resilience of the system, establishing circuit breakers to prevent problems in one area from contaminating others and, at the extreme, containing the detrimental impact on the broader economy when failures occur.

“Authorities around the world have imposed higher and more intelligent capital requirements, required financial institutions to value their assets more conservatively and to hold more easy-to-sell assets, placed constraints on allowable risk-taking, insisted on more stable funding, and demanded greater provisions against bad loans.

“The impact of the revamped regulation has gone far beyond the targeted banks and other financial companies. It has allowed central banks to be bolder in maintaining and evolving exceptional monetary and credit stimulus, which in turn has significantly bolstered the prices of stocks, bonds and other assets as a means of stimulating the economy.”

In other words, the Fed has pumped up financial assets in the hope it will trickle down to the rest of the economy and jumpstart consumer spending and jobs and wages and such. But what if the economic recovery doesn’t follow on the heels of the pumped up financial assets? This is the lasting question for investors. What to do when the prices of assets rise above what history and fundamentals warrant?

If you think that prices are too low, you can buy. But if you think prices are too high, what should you do?  One option is to sell short; borrow the security whose price you believe to be inflated, sell it and wait for the price to fall, then buy it back at a lower price and pocket the difference. That is a very dangerous move when the markets are trading at record highs. You might pick the exact top or prices may move higher for a while, and the markets can remain irrational longer than you can remain solvent.

Policymakers face a similar asymmetry.  It’s true that for a central bank, liquidity isn’t tied to solvency, so experiencing temporary losses is more a political than an economic or operational concern, but losses still matter. Central bankers can play with the value of a currency, making moves to keep a currency from falling or appreciating; happens all the time.

Sometimes policymakers are trapped in the box that they built. It is precisely investors’ belief in the commitment of policymakers that makes them willing to view some very risky investments so casually. However, when many such investments are made over an extended period without adequate compensation for risk, sharp investors expect a round of bubble trouble on the horizon.

One of the funny things that tends to happen in times like this is that investors rush into areas they think should be safe, looking for a place to hide. Largely ignored during much of last year's 30% rally in the S&P 500 Index, the stocks leading the US market this year rank among its usually sleepiest components.

The best sector in 2014 is utilities, including Consolidated Edison, about as staid a group as one can get. They're up 14.5% on a total return basis this year, compared with 6.4% for the S&P 500 as a whole.

What's happening is the opposite of what ordinarily happens in a moving market. It relates to an investing concept known as "beta," which refers to the amount of risk a particular stock adds to a portfolio. Stocks that tend to rise or fall with the market – but in a more pronounced way – are called "high beta." They generally outperform in up markets and fall the most in down markets.

Best Buy and Priceline, two discretionary stocks that were among the S&P's strongest in 2013, are good examples because their sales and profits rise along with the economy, and they led the way last year. This year, those stocks are lagging the more boring "low beta" stocks – those that tend to move less dramatically than the market. It's a signal that investors are worried about earnings growth and U.S. economic demand, and don't want to bet as heavily on the types of stocks that generally qualify as high beta – often cyclical names in the technology, discretionary and energy sectors.

To be sure, this may change if growth picks up, but after US GDP contracted in the first quarter for the first time in three years, investors are cautious. People are still scared. They're still more worried about protecting to the downside than accentuating the upside. That's helped drive equities' rotation into the more defensive, high-dividend paying names, also typically part of the low-beta camp.

So far this year, the 50 stocks in the S&P 500 with the lowest beta scores, a group that includes ConEd and McDonald's, are up on average by 12%. Meanwhile, the 50 highest beta stocks, which include Citigroup and Best Buy, are up an average of 7%. In 2013, the 50 highest-beta S&P 500 stocks rose an average of 51.4%, compared with 21.3% for the 50 lowest-beta stocks.

Investors who have pursued the high-beta contingent have suffered. Among them are hedge funds, which kept a heavy exposure to momentum-type names and the "beta" strategy. Hedge funds now have 3.8 times more net cyclical exposure to defensive stocks. In January, that measure was 4.7 times - bets that went sour as the market corrected through the first quarter. Once that trade began to break, that also accelerated a rotation back into more value-oriented names and sectors. So, what happens when these defensive plays get overvalued? I’m not saying it has happened; today was just one day after a string of record highs. I’m just posing the question.

Thursday, April 10, 2014 - Mr. Toad’s Wild Ride

Mr. Toad’s Wild Ride
by Sinclair Noe

DOW – 266 = 16,170
SPX – 39 = 1833 (-2.1%)
NAS – 129 = 4054 (- 3.1%)
10 YR YLD - .06 = 2.62%
OIL - .20 = 103.40
GOLD + 5.80 = 1319.10
SILV + .19 = 20.13

If you want to know why the stock market is up one day and down the next, and not just little moves but triple digit swings – I don’t know. If anybody says they know, they probably don’t. Maybe it’s the Fed, maybe it is earnings reporting season, maybe it’s a strong economy or a weak economy, or maybe the markets are just trying to imitate Mr. Toad’s Wild Ride. The one thing we know is that stock prices fluctuate, and over time a pattern or trend develops; right now things are wobbly.

In economic news, the Labor Department said that the number of people applying for unemployment benefits dropped to 300,000, the lowest level in nearly seven years.

The Treasury Department says the federal budget deficit for the first half of the 2014 fiscal year totaled $413 billion, down $187 billion from where it stood at this point last year, as tax revenue surged and spending sank.  In March, the Treasury collected $216 billion in taxes, up 16% from a year ago, helping reduce the deficit for March to $37 billion from $107 billion last year. 

Meanwhile, spending sank by 14%, or $40 billion; military spending has been cut, federal government jobs have been cut, and Fannie Mae and Freddie Mac are no longer a drain but rather a contributor to the Federal coffers. Tax receipts have been increasing as the stock market improved (not necessarily today but remember last year was strong). Also, the economy has been better, not great but better. 

The budget gap last month was the smallest deficit recorded for the month of March since 2000. Over all, the deficit is expected to equal 4.1% of gross domestic product in 2014, down from nearly 10% in 2009, during the depths of the recession. It is the fastest four-year reduction in deficits since the demobilization after World War II.

California is sinking. Scientists estimate that the Central Valley accounts for about 20% of the groundwater that is pumped in the nation. It's the lifeblood of the flourishing agriculture industry, producing crops from almonds to plums, nectarines and cotton. And the water to irrigate is pumped from aquifers that are not being replenished by rainfall.

The US Geological Survey published a study that found that 1,200 square miles of the Central Valley were sinking half-an-inch per year, but the rate is not consistent everywhere. The town of El Nido, just south of Merced sank almost a foot a year between 2008 and 2010. A foot a year is not sustainable. You can’t really mitigate against a foot a year.

Farmers are digging deeper wells, and as the water is pumped out of clay aquifers, the earth above falls to fill the void, and the clay compresses. It’s called subsidence. The land sinks and the compressed clay cannot hold as much water as it once did. Once subsidence happens there is no way to undo it.

About 30% of California’s water supply comes from underground supplies, more during droughts, and about 80% of state residents rely to some degree on groundwater. Some towns, cities and farming operations depend entirely on it. And it has been a problem for a long time. Three generations ago, so much groundwater was pumped from aquifers that half the valley sank like a giant pie crust, sagging 28 feet near Mendota and inflicting damage to irrigation canals, pipelines, bridges, roads and other infrastructure.

The sinking only stopped because of 2 massive government funded irrigation projects, the federal Central Valley project and the California State Water project, which flooded the region with water from distant mountains and relieved pressure on the natural underground water supply. Now, the drought and climate change have opened up a new era of groundwater pumping. The result is the ground is sinking and the land subsidence is perhaps the worst ever seen in California.

This causes multiple problems for infrastructure. Dams and irrigation canals rely on gravity to move water, but when the ground sinks, the water doesn’t always flow as expected.  Flood safety is another concern; flood control channels might not perform as expected as levees sink. Bridges sag; well casings fail; and then there is the issue of the state’s multi-billion dollar high-speed rail line plotted to run through an area that is sinking by about a foot a year.

While the San Joaquin Valley faces the worst problems of land subsidence, other regions of California are dealing with similar problems on a smaller scale. The USGS has been studying sinking ground in the Coachella Valley for years in conjunction with the local water district. In a 2007 USGS study, researchers determined that the ground had subsided up to 4 inches in parts of La Quinta, with smaller effects in parts of Palm Desert and Indian Wells, during a year-and-a-half period from 2003 to 2005.In the Coachella Valley, the ground has sunk in some places where groundwater levels have fallen. Uneven settling has cracked the foundations of houses and fractured walls, swimming pools and roads.

After years of drought, water tables are dropping fast. Well-drilling costs are soaring. The biggest problem is the gradual, irreversible compaction of the earth that occurs when aquifers are pumped to historic lows. It doesn’t make the aquifer unusable. It just reduces the amount of water that can be stored in it, now and in the future.

The Basel Committee on Banking Supervision released its final ruling on just how much derivatives traders have to hold in reserve to pay off on defaults. International regulators are trying to safeguard trades and bring more openness to a $700 trillion market, known for its secrecy.

Swaps are what investors use to help guard against risk (at least theoretically). They’re bought by pension plans and retirement funds to protect against fluctuations in interest rates, meaning they affect most people who own annuities. They’re used by the US government to limit exposure in the mortgage market and cut home-loan costs. Investors can also hedge an investment in a company by buying a swap that will pay them if a borrower stops paying its debts. They’re called swaps because investors and banks exchange, or swap, payments over time based on how interest rates move or how the creditworthiness of companies changes.

Think of it as a form of insurance, with a few major exceptions; swaps do not require an insurable interest. For example, you can buy life insurance for your spouse and your spouse can buy life insurance on you because you have an insurable interest in each other. Your doctor can’t buy a life insurance policy on your life because your doctor does not have an insurable interest. And when you think about it that is a good way to approach insurance. Otherwise, your doctor might buy an insurance policy on your life and then bet against you; which is essentially what many people did with swaps in the financial crisis; they bought insurance on mortgage debts betting mortgages would default.

More frequently, swaps dealers sold swaps to people or entities who didn’t need the swaps or didn’t understand the swaps; for example the city of Detroit or the nation of Greece; they bet interest rates would go one way, and then they took on more debt than was prudent and when rates turned, they lost everything. Swaps made bankers billions of dollars before helping to blow up the global economy in 2008.

The other significant difference between swaps and insurance is that insurance companies must have reserves to pay claims. Swaps dealers, not so much; and so when defaults happen, the swaps contracts have a nasty history of not covering the risks they are supposed to cover. In other words, they never paid their claims.

After the crash, regulators set to work to make them less dangerous, through changes that in the process would make them less profitable. Where swaps had been one-on-one deals before, now they would be backstopped by third parties in clearinghouses that ensure everyone can pay, with the aim of avoiding emergency bailouts and panic. And the new Basel Rules now applies a minimum 20% risk weighting to money deposited at clearinghouses, which are third parties that guarantee the transactions. Note that is not a 20% in actual reserves, just a 20% risk weighting on money deposited at clearinghouses; big difference.

Today’s edition of “Banks Behaving Badly” features a hedge fund, SAC Capital Advisors, run by Steven A. Cohen. A judge has accepted a guilty plea from the hedge fund firm as part of a $1.2 billion criminal settlement for insider trading. In total, SAC Capital has agreed to pay $1.8 billion to resolve criminal and civil probes into insider trading. The Department of Justice said that payout is the largest insider trading settlement in history. The judge said: "These crimes clearly were motivated by greed, and these breaches of the public trust require serious penalties."

Now here is the peculiar part; if these breaches of the public trust require serious penalties why would they not include prison time? The answer is that you can avoid prison if you can pay enough money. SAC Capital has lots of money. Manhattan U.S. Attorney Preet Bharara said: "Today marks the day of reckoning for a fund that was riddled with criminal conduct." Not exactly. Today marks the day SAC Capital writes a check and continues on; that does not constitute a day of reckoning.

Thursday, March 13, 2014 - White Smoke

White Smoke
by Sinclair Noe

DOW – 231 = 16,108
SPX – 21 = 1846
NAS – 62 = 4260
10 YR YLD - .07 = 2.65%
OIL + .25 = 98.24
GOLD + 3.90 = 1372.10
SILV - .15 = 21.28

Let’s start with some economic news, and then we’ll get to today’s anniversary (yes, we have another one to talk about).

The federal budget deficit narrowed in February, shrinking 5% from a year earlier as receipts jumped and spending only modestly rose. The shortfall was $194 billion for February, versus the $204 billion recorded in the same month a year ago. The deficit has been steadily improving in the past several years, dropping to $680 billion in fiscal 2013.

Retail sales increased 0.3% from January to February; December to January sales were revised lower by 0.4%; sales were up 1.5% from February a year ago. Retail sales excluding gasoline increased by 2.2% on a year to year basis.

Initial claims for unemployment benefits for the week ending March 8, decreased by 9,000 to 315,000.

Since federal unemployment insurance expired on Dec. 28, an estimated two million Americans have missed out on the benefits. Today, a bipartisan group of Senators reached a deal to extend federal long-term unemployment insurance for 5 months. The deal would be distributed retroactively to when benefits ended in December. The cost of about $10 billion would be offset by some tricky accounting known as “pension smoothing”. The bill still needs to clear a Senate vote, probably in late March; then it would go to the House of Representatives, where it would likely face a quick demise.

Earlier today President Obama signed a memo directing the Labor Department to rework the rules regarding overtime. The reforms are expected to raise the salary threshold that currently allows employers to exclude workers from overtime pay under the Fair Labor Standards Act. It hasn't been raised in more than a decade. The threshold was last raised in 2004 to $455 per week under Bush, less than half of what it was almost 40 years ago on an inflation-adjusted basis. Obama said businesses are classifying all kinds of employees as professional or administrative, including some who make as little as $23,660 a year, thereby exempting them from overtime requirements under current law.

The situation in Ukraine is still a mess. Russia is conducting military exercises near its border with Ukraine. German Chancellor Angela Merkel warns of a “catastrophe” unless Russia changes course. US Secretary of State John Kerry said serious steps would be imposed Monday by the US and Europe if a referendum on Crimea joining Russia takes place on Sunday as planned. The referendum will probably happen. The serious steps refers to trade sanctions, bans on visas, a freeze on assets.

The EU has offered Ukraine 11 billion euros in aid, except it isn’t really aid, it is actually loans; it includes acceptance of an IMF austerity plan. Remember how the IMF helped Greece turn a recession into a full blown depression? One thing the past few years have done is provide a proving ground for austerity, and the results appear conclusive; budget tightening results in economic contraction or at a minimum, stagnant growth. So, it appears the only yields from Putin’s intervention in Crimea will be much pointless suffering among Ukrainians and life for years to come in the smothering embrace of a Russian bear or the smothering belt-tightening of the IMF.

The escalating situation would hurt an already stagnating Russia, where the Russian stock market hit a 4 year low, down about 20% year to date. The EuroZone can probably survive if Russia turns off supplies of natural gas, because we are now moving into spring. Within the EU, Germany tends to trade with Russia more than other countries. German exporters would take a hit; the German economy has been the strongest in the EU and if it catches cold, the rest of the EU catches pneumonia. And then the Euro banks get involved. Russia has more than $700 billion in foreign debt, and just a small bit of that is sovereign debt, most of it is private debt owed by banks and corporations, largely controlled or owned by the Kremlin. Euro banks have lined their vaults with potentially toxic Russian debt.

The thing about debt is that it comes due; when that happens, the options are to pay it off, roll it over or default. If sanctions are imposed and in place for any length of time, default will be the likely result. At this point it is becoming clear that the best possible scenario is one where bombs are not flying.

Don’t worry about the US banks, they only have about $24 billion in Russian debt; just a drop in the bucket. The New York State comptroller yesterday released estimates that Wall Street pulled in $26.7 billion in cash bonuses last year; up 15% for a year earlier; it works out to $164,530 per person when split up among the industry’s 165,200 employees in New York. Of course that’s not how it’s split up; some get more, some get less.

To put it in perspective, the Institute for Policy Studies figures that Wall Street’s bonus cash is nearly double what the country’s 1.085 million full-time minimum wage workers earned all of last year, which works out to $15.1 billion. Here’s the bad news; they also looked at the multiplier effect of that $26 billion pile of bonus money. The Wall Street crowd is more likely to hold onto their bonuses, and so bonuses impact the economy to the tune of $10.4 billion, whereas minimum wage workers spend almost all of their money, impacting the economy to the tune of $32.3 billion.

And that brings us to today’s anniversary. This week we’ve noted the 5 year anniversary of the current bull market, the bear market of 2000, the 25^th anniversary of the WorldWideWeb, and the 3 year anniversary of Fukushima. One year ago, Jorge Bergoglio of Argentia was elected as Pope. In recognition of St. Francis of Assisi he adopted the title of Pope Francis, and like his namesake he has focused his attention on caring for the poor and marginalized.

Pope Francis moved quickly to offset the influence of the Curia by appointing a standing advisory council made up of eight Cardinals from around the world, a move that also signaled his interest in a more decentralized governance within the church. Pope Francis created the position of the Secretariat of the Economy to oversee the finances and administrative functions of the Holy See and appointed Australian Cardinal George Pell to head the Secretariat. The move weakens the power of the Vatican Secretary of State. The change is one more step in Pope Francis' campaign to transform the Curia with a special focus on the scandal plagued Vatican Bank.

The new Pope elevated 19 Catholic leaders to the level of cardinals, including 5 from Latin America, and one from Haiti and one from Burkina Faso, a couple of the poorest countries in the world.

Two weeks after he was elected, Pope Francis left the walls of the Vatican to visit a juvenile detention center where he washed and kissed the feet of 12 prisoners incarcerated in Rome as part of the traditional Holy Thursday rite. Last summer, the Pope went to Brazil where he conducted a mass before about 3 million people on the beaches of Copacabana; he also visited hospitals, prisons, and a favela, earning the nickname the “Slum Pope”.

On the plane back from Brazil, the Pope told a group of reporters, "Who am I to judge a gay person of goodwill who seeks the Lord?" and opened up a new conversation about gay rights within the Catholic Church. Since that first quote, Francis has continued to make statements on gays that amount to a shift in tone for the Vatican if not a change in doctrine.

Recently the Pope has encountered criticism for defending the church on the issue of sexual abuse. Pope Francis appointed a commission on sex abuse led by Cardinal Sean O'Malley, the archbishop of Boston, but as of yet has not met with any abuse victims. This is an issue that remains a stain on the church and will need to be addressed, but it was not the only controversial issue.

In November, Pope Francis published an apostolic exhortation titled “Joy of the Gospel” offering a platform for a good and faithful life. The papal pronouncement also condemned the “new tyranny” of unrestrained capitalism, causing income inequality and poverty, and calling on leaders to curb “the absolute autonomy of the marketplace and financial speculation,” to reject the “new idolatry of money”, and act “for the common good.” 

He noted that “the earnings of a minority are growing exponentially, so too is the gap separating the majority from the prosperity enjoyed by those happy few.”  He called for “more politicians who are genuinely disturbed by the state of society, the people, the lives of the poor,” and for the commitment of political and financial leaders to “ensure that all citizens have dignified work, education and healthcare.”

Francis warned that our economic systems will “devour everything which stands in the way of increased profits, whatever is fragile, like the environment, is defenseless before the interests of a deified market.”

Francis broadened the definition of the commandment “thou shalt not kill,” by saying, “today we also have to say ‘thou shalt not’ to an economy of exclusion and inequality. Such an economy kills.” In striking terms he asked “How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses 2 points?”  He repeated his warning that “Money must serve, not rule.”

Tuesday, May 14, 2013 -

Booms

by Sinclair Noe

DOW + 123 = 15,215
SPX + 16 = 1650
NAS + 23 = 3462
10 YR YLD + .03 = 1.95%
OIL - .94 = 94.23
GOLD – 5.00 = 1426.80
SILV - .24 = 23.51

So, we have record highs. I went back to check some of the earlier in the year predictions. Last December, Goldman Sachs was predicting the S&P 500 would hit 1625; sounded good, even a little bold back then. Of course, in the past week, we've blown past those numbers. Many experts are calling for a correction here. Maybe, maybe not. If your memory is still sharp, you'll recall a few weeks back I was talking about the “Sell in May” strategy; and if you're really sharp, you'll recall I said the way to play that strategy was to wait for a MACD sell signal for an exit, rather than just an arbitrary date on the calendar. We still haven't had the exit signal.

The market is in full melt-up mode, extending further above its longer-term moving averages every single day. The riskier stocks helped pushed the market higher over the past week or so. Technology names blasted higher. Materials broke out and helped lead the market to record heights. This shows that we are finally seeing investors beginning to believe in the market again.

In a recent Gallup survey, only 52% of folks said that they or their spouse own any stocks (that includes mutual funds). That's a jaw-dropping number if only for the fact that the S&P 500 has more than doubled since its 2009 bottom. The data shows that, left to their own devices, most individual investors sold into that 2009 bottom, and they kept selling stocks as the market recovered and pushed to new highs. So, there is a lot of money on the sidelines. If we do get a correction, it will probably happen right after Mom and Pop investor jump in.

The Congressional Budget Office just did a new series of baseline budget deficit projections and they're a lot lower than the old ones. The short-term deficit, in particular, is way lower; $200 billion lower; or a $643 billion deficit for 2013 rather than an $845 billion deficit. That's about half higher-than-expected tax revenues and about half higher-than-expected payouts from Fannie Mae and Freddie Mac. A big reason for the smaller-than-expected deficit is stronger economic growth.

The CBO is also revising the 10-year deficit forecast down by $618 billion, primarily because of the slowdown in health care spending. This doesn't mean the deficit problem is completely fixed. The current projection has the deficit shrinking for the next couple of years and then growing again. So, things will get better before they get worse, but that leaves us with a manageable 2024 deficit. The problem is that it's trending upward, and nothing in this revised projection changes that fact. There's no need to panic about the 2024 deficit, or for that matter, no need to strike a grand bargain. It is possible that we could start to control health care costs and do more to boost economic growth, and ten years from now, we might not have much of a problem at all. Key here is economic growth.

The Department of Labor reports US import prices fell in April due to a drop in oil costs, a positive sign for household finances that also pointed to benign inflation pressures. Import prices slipped 0.5 percent last month, the biggest decline since December. March's data was revised to show a 0.2 percent decline instead of the previously reported 0.5 percent drop. Stripping out petroleum, import prices dipped 0.1 percent.

The tame inflation environment should allow the Federal Reserve to stay on its ultra-easy monetary policy; so this flies directly in the face of those who are worried about the Fed “tapering off” of QE. At its policy meeting earlier this month the central bank decided to continue buying $85 billion worth of bonds every month to push long-term interest rates downward. At the same time, the economy has lately shown signs of resilience despite austerity measures.

The National Federation of Independent Business reports its gauge of confidence for small U.S. businesses rose in April to its highest in six months. Lower oil prices are also helping household finances. The United States imports much of the fuel it consumes. Last month, imported petroleum prices fell 1.9 percent. The Labor Department report also showed export prices fell 0.7 percent last month, the largest decline since June.

Meanwhile, there is a boom in North American energy that may be one of the biggest stories in the global economy, even though we haven't really felt the positive impact in the US; not yet anyway. The boom is related to the shale exploration in the US and the oil sands fields in Canada.

A new report from the International Energy Agency, the IEA, discusses the consequences of the boom, and they are looking at this as a boom. The report describes the US supply "shock" as that is sending "ripples" throughout the world, affecting every aspect of the market.

Here's the key part from the press release announcing the report:

The supply shock created by a surge in North American oil production will be as transformative to the market over the next five years as was the rise of Chinese demand over the last 15, the International Energy Agency (IEA) said in its annual Medium-Term Oil Market Report (MTOMR) released today. The shift will not only cause oil companies to overhaul their global investment strategies, but also reshape the way oil is transported, stored and refined.

According to the MTOMR, the effects of continued growth in North American supply – led by US light, tight oil (LTO) and Canadian oil sands – will cascade through the global oil market. Although shale oil development outside North America may not be a large-scale reality during the report’s five-year timeframe, the technologies responsible for the boom will increase production from mature, conventional fields – causing companies to reconsider investments in higher-risk areas.

In virtually every other aspect of the market, developing economies are in the driver’s seat. This quarter, for the first time, non-OECD economies will overtake OECD nations in oil demand. At the same time, massive refinery capacity increases in non-OECD economies are accelerating a broad restructuring of the global refining industry and oil trading patterns. European refiners will see no let-up from the squeeze caused by increasing US product exports and the new Asian and Middle Eastern refining titans.

“The good news is that this is helping to ease a market that was relatively tight for several years. The technology that unlocked the bonanza in places like North Dakota can and will be applied elsewhere, potentially leading to a broad reassessment of reserves. But as companies rethink their strategies, and as emerging economies become the leading players in the refining and demand sectors, not everyone will be a winner.”

While geopolitical risks abound, market fundamentals suggest a more comfortable global oil supply/demand balance over the next five years. The MTOMR forecasts North American supply to grow by 3.9 million barrels per day (mb/d) from 2012 to 2018, or nearly two-thirds of total forecast non-OPEC supply growth of 6 mb/d. World liquid production capacity is expected to grow by 8.4 mb/d – significantly faster than demand – which is projected to expand by 6.9 mb/d. Global refining capacity will post even steeper growth, surging by 9.5 mb/d, led by China and the Middle East.

Now, when you look at this energy boom, you might think this would be a real positive for US manufacturing. We just haven't seen it yet, and we might not. There has been talk about a renaissance in US manufacturing, and factory output continues to rise, but the truth is that manufacturing has dropped to just 9% of jobs, and in the last month, there were no new manufacturing jobs added. For every $1 of manufacturing output in a community, there’s another $1.48 of wealth created. And there has been a push for new manufacturing jobs which unfortunately has been hampered by austerity measures out of Congress. Any strength we've seen in manufacturing is probably just a short-term bounce reflecting more the relative weakness of Europe and Japan. Lower energy prices might help, but not yet. The ability to make things is fundamental to the ability to innovate things over the long term. When you give up making products you lose a lot of the added value.

Maybe we are on the leading edge of a new oil and natural gas boom in this country, but one thing we'll need to get there is water.

Water and energy are inextricably linked.

Power plants are the largest users of water in the United States, while substantial amounts of energy are needed to supply fresh water to homes, farms and factories and treat waste water prior to safe disposal.

Rising water consumption for hydraulic fracturing and production of biofuels, coupled with severe droughts across more than 60 percent of the continental United States in 2012, have propelled that link up the policymakers' agenda.

The threat to hydroelectric generation is obvious. But in 2007-2009, drought put the water supplies of 24 of the nation's 104 reactors at nuclear plants at risk.

The United States withdrew 410 billion gallons of water from aquifers, rivers and the ocean every day in 2005, of which 350 billion gallons were fresh water and 60 billion gallons were saline or brackish.

Cooling systems for nuclear plants and power plants that burned coal, gas and oil accounted for 41 percent of fresh water withdrawals and 49 percent of all water withdrawals. That put them ahead of irrigation (31 percent) and public supply to homes and offices (11 percent). The remaining uses including industry, mining, livestock and aquaculture accounted for less than 10 percent combined.

In addition to power plants, water used in growing crops for biofuels as well as for drilling and fracking oil and gas wells accounts for a rapidly increasing amount of total consumption.

The broader energy sector has been the fastest growing water consumer in the United States in recent years and is projected to account for 85 percent of the growth in domestic water consumption for the next 20 years.

Environmentalists and community groups cite water scarcity as one reason to ban or restrict fracking. Even in Texas, water conservation districts say they are considering introducing restrictions if reservoirs and the water table drop too low.

Most of the water employed in thermoelectric power stations is in the cooling system. In once-through cooling (OTC) systems, water is withdrawn from a source, normally a river or coastal location, circulated through heat exchangers, then returned to the surface water body. OTC systems withdraw large amounts of water but use comparatively little, returning most to the source.

Most thermal plants in the United States employ OTC systems. Net water consumption is therefore only 3 percent of the total, compared with gross withdrawals of almost 50 percent. The distinction between withdrawals and consumption is crucial. Water that is consumed cannot readily be used for another purpose.

Power plants need sufficient water at a low enough temperature to operate efficiently. Most states impose restrictions on the temperature at which water can be discharged back into rivers and the sea to prevent the animals and plants in the waterway from being cooked. If there is insufficient water or it is too hot, power plants may be forced to close or cut output.

In August 2012, the Illinois Environmental Protection Agency waived the normal environmental restrictions and allowed four coal-fired and four nuclear power stations to release hundreds of millions of gallons of hot water at nearly 100 degrees Fahrenheit into state lakes and rivers to keep the lights on.

On other occasions, low water levels forced power plants to turn down. During the 2003 heat wave in France, which was responsible for more than 10,000 deaths, nuclear plants had to reduce their output, worsening the crisis.

Nuclear and coal-fired power plants with OTC systems are especially vulnerable to droughts and heat waves because they rely on by far the largest volume of water withdrawals. Combined-cycle gas plants are much more efficient. And gas turbines, solar and wind generators use negligible quantities.

Options for reducing the power sector's vulnerability include switching the type of fuel from nuclear and coal to gas, solar or wind; switching to recirculating or dry and hybrid wet-dry cooling systems; or switching the water source from fresh water to saline or waste water.

The drawback is the capital cost and reduced efficiency of the plant.

Oil and gas extraction uses prodigious quantities of fresh water and produces large amounts of brackish waste water, which is normally reinjected far below the drinking water table. Drilling a conventional well uses relatively small quantities of water for drilling mud. Fracking uses vast amounts of water. A typical well drilled and fracked in the Eagle Ford uses 4.3 million gallons.

Pressure to reduce the amount of fresh water used in fracturing operations has led to interest in switching to saline or waste water, recycling water, or fracking with diesel or hydrocarbon gels, though all these systems are less efficient and remain experimental, and represent the threat of contamination to acquifers.

Biofuels present another problem. Huge amounts of water are being used to grow crops to produce ethanol.

Because biofuels need so much water for their growth, they are particularly vulnerable to droughts. Just as traditional agricultural crops are hindered in times of drought, so are energy crops.

We may be looking at a boom in energy production in this country, but it comes at a price.

Tuesday, February 12, 2013 - The Battles to Come

The Battles to Come

by Sinclair Noe

DOW + 47 = 14,018
SPX + 2 = 1519
NAS- 5 = 3186
10 YR YLD + .01 = 1.97%
OIL + .48 = 97.51
GOLD + 3.00 = 1652.30
SILV + .17 = 31.22

The all-time high in the S&P 500 index is 1565. The all-time intraday high in the Dow Industrials is 14, 198.10, reached in October 2007. We are close.

After years of acting like deer in the headlights, investors are now throwing cash at the stock markets. Meanwhile, insiders are selling. Google's CEO is selling more than 40% of his stock. He didn't sell hardly anything from 2008 through now. There is a thought that insiders are selling now and mom and pop investors are buying, and once we work through this exchange, the markets will tank. This theory is being called the grand rotation.

Ahead of tonight’s State of the Union Address, the White House has followed custom by leaking tidbits from the speech. It is expected the president will talk about North Korea testing a nuclear bomb; this, for the third time, and bigger than ever. Apparently Mr. Obama will also announce that 34,000 out of 66,000 troops will come home from Afghanistan by this time next year, which sounds better than it is. That means the Pentagon is roughly on pace to hand over security to the Afghans by the end of 2014, as Mr. Obama has long promised. It also means there will still be more than 30,000 troops in Afghanistan, and I'm not sure what will be accomplished. 

The most recent Medal of Honor recipient, Clint Romesha was invited to attend the State of the Union speech as a guest of the first lady. Apparently he will spend the evening with his wife and buddies from his former unit, Black Knight Troop, 3-61 CAV. Romesha and his wife are celebrating their wedding anniversary. I don't know whether they will watch the address or not. Viewership is down to 38 million or so, less than back in the 70's. Romesha's story is inspiring. He was wounded on the battlefield during what has been described as one of the fiercest fights in the Afghan war, but he fought on, rescued his comrades and managed to hold onto an outpost that was technically indefensible. The young Sergeant is amazing; he can spend his evening however he wants.

President Obama will have a fight on his hands as he proposes a second-term agenda that includes new government investments, limits on guns, a revamped immigration system and new initiatives to kick-start the economy for middle-class Americans. The president will propose government action in education, manufacturing, infrastructure and clean energy. The president is also expected to announce his intention to begin negotiations on a free trade agreement with the 27-member European Union.

Mr. Obama already faces stiff opposition from Republicans who control the House and have repeatedly blocked some of his top priorities. On Tuesday, Republicans began using the Twitter hashtag #notserious to describe Mr. Obama’s expected speech; and that's the gentler of the hashtags; the not-so-gentle tag is #youlie.

House Speaker John Boehner this morning gave his own preview of the State of the Union as he  repeatedly challenged the president's willingness to go against his own party on issues that include reforms to social programs and spending.

Speaking with a small group of reporters this morning, Boehner said: "I think he'd like to deal with it [fiscal problems], but to do the kind of heavy lifting that needs to be done, I don't think he's got the guts to do it. He understands there is a spending problem. He understands that we need changes and reforms, and we need to solve these problems." When pressed about the severity of that statement, he modified, saying the president does not have the "courage."

Washington is in the midst of yet another self-inflicted, artificial fiscal crisis, facing a political showdown over "sequestration," the self-imposed round of across-the-board spending cuts to domestic programs and the Pentagon. The sequester was supported by both the White House and Congress as a way to encourage lawmakers to find common ground. Instead, they have been mired in a stalemate, unable to find an equitable solution for both sides. The deadline is March 1^st. It doesn't look good.

The State of the Union wasn't the only big speech of the week but it certainly has been overshadowing a speech by Janet Yellen, vice-chair of the San Francisco Federal Reserve; she talked about how slow this recovery has been and why. One of the culprits for the slower recovery? Fiscal policy. Specifically? We're not spending enough. Government spending, which usually provides a boost to the economy in the quarters following the recession, has been a net drag this time because the government is spending less than it normally does.

After passage of the 2009 economic stimulus package, which helped save or create millions of jobs, Congress all but gave up providing support to the labor market. Instead, in the last two years, the nation’s deficits have been reduced by $2.5 trillion, with the overwhelming majority coming from spending cuts. Yellen described fiscal policy as a headwind for the recovery: “Discretionary fiscal policy hasn’t been much of a tailwind during this recovery. In the year following the end of the recession, discretionary fiscal policy at the federal, state, and local levels boosted growth at roughly the same pace as in past recoveries. But instead of contributing to growth thereafter, discretionary fiscal policy this time has actually acted to restrain the recovery.”

Everybody that’s tried austerity in a time of no growth has wound up cutting revenues even more than they cut spending because it results in a downward spiral and it drags the country back into recession. The experience of Europe should be showing US policymakers that cutting spending in a weak economy backfires, squashing economic growth, which causes debt to expand. But it doesn’t seem like that lesson is taking hold.

Today, the Treasury Department reported the federal government had a rare surplus for January and is on track to run its smallest annual budget deficit since  2008. The government took in a surplus of $2.9 billion in January. That's the first monthly surplus since April, a month that benefited from income tax payments. January's budget benefited from an estimated $9 billion in extra revenue from higher Social Security taxes. That helped lowered the deficit through the first four months of the budget year to $290.4 billion — nearly $60 billion lower than the same period a year ago. The budget year began on Oct. 1.

For the entire year the Congressional Budget Office is forecasting the deficit will total $845 billion. If correct, that would be first time government hasn't run an annual deficit in excess of $1 trillion since 2008.

The deficit is the amount the government must borrow when its expenses exceed its revenue. Each month's deficit is volatile and can be affected by calendar quirks that shift government spending or revenue from one month to another. The annual deficit is projected to be smaller this year because the government is collecting more revenue this year, mainly because of faster job growth and higher taxes. At the same time, the government is spending less on some programs. That's in part because of spending cuts that were enacted under a 2011 agreement to raise the federal borrowing limit. Also, the improved economy has reduced demand for unemployment benefits and some other government programs, or some people have just used up their benefits and fallen from the rolls.

The Congressional Budget Office is projecting even smaller annual deficits of $616 billion in 2014 and $459 billion in 2015.

This weekend the G-20 will meet in Moscow. Today, the G-7 broke into the European trading morning with its first statement on exchange rates since September 2011, in which it pledged to keep economic policies directed at domestic needs and disavowed targeting currencies. The G-7 acknowledged Japan isn’t driving a devaluation and that its monetary policy is aimed at ending 15 years of deflation.

But after the G7 statement, an unnamed official of the G7 told reporters in the United States that markets had misinterpreted the statement and that it was in fact aimed at Japan, that it's okay for Tokyo if a weaker yen is the result of policies aimed at driving the economy, but it's not kosher if policies are aimed specifically at devaluing the currency.

What the G7 appeared to be saying - before the unnamed official signalled it was a warning to Tokyo - is that currency devaluation can be a byproduct, rather than a goal, on the long, hard road back to a sustained recovery. The Federal Reserve's quantitative easing, for example, an asset-buying program, is negative for the US dollar, but is aimed at juicing the economy, not driving down the greenback; theoretically anyway.

So, the G-7 issued another statement that said: "We, the G7 ministers and governors, reaffirm our longstanding commitment to market determined exchange rates and... that we will not target exchange rates."

And now the thinking is that this means Japan won't be buying US Treasury bonds as part of its stimulus plan because that would further weaken the yen. This also means there is a global race to devalue currencies.

China has become the world's biggest trading nation in goods. China's customs administration said the combined total for imports and exports in Chinese goods reached $3.87 trillion last year, edging past the $3.82 trillion trade in goods registered by the US commerce department. The US economy is still twice the size of the Chinese economy, but apparently we are more self contained.

A new report from the Project on Government Oversight says that regulators at the SEC derailed last year's efforts to reform the $2.6 trillion money market fund industry, and that many of those regulators are now working in the private sector, and the “revolving door” policy may have impacted policy and enforcement decisions. Yea, we're all shocked.