Tuesday, March 04, 2014 - Everybody Clap Your Hands

Everybody Clap Your Hands

by Sinclair Noe

DOW + 227 = 16,395
SPX + 28 = 1873
NAS + 74 = 4351
10 YR YLD + .08 = 2.69%
OIL – 1.57 = 103.35
GOLD – 15.90 = 1335.40
SILV - .27 = 21.24

Ukraine has not exploded. The situation has not escalated, nor has it de-escalated. Apparently Russia and the West have both figured out that conflict has the potential for mutually assured destruction, not along the lines of the old nuclear Cold War, but potentially painful for both sides; and so today, everything is on hold. Vlad Putin said he sees no immediate need to invade Ukraine; the Obama administration is trying to put together $1 billion in loan guarantees.

Secretary of State John Kerry visited Kiev and there is still talk of sanctions if things don’t de-escalate. Putin says sanctions would be cause for retaliation. The Ukrainian military has shown remarkable restraint, adopting a Gandhi-like non-violence stance in the face of overwhelming firepower. And for the moment, there is a standoff but not a truce. That could change tomorrow.

A story in Politico today says the Russians no longer respect or fear Western leaders. Why?

“Russia thinks the West is no longer a crusading alliance. Russia thinks the West is now all about the money.”

Quite so. More specifically,

“Putin’s henchmen know this personally. Russia’s rulers have been buying up Europe for years. They have mansions and luxury flats from London’s West End to France’s Cote d’Azure. Their children are safe at British boarding and Swiss finishing schools. And their money is squirrelled away in Austrian banks and British tax havens.

“They have seen firsthand how obsequious Western aristocrats and corporate tycoons suddenly turn when their billions come into play.

“They know full well it is European bankers, businessmen and lawyers who do the dirty work for them placing the proceeds of corruption in hideouts from the Dutch Antilles to the British Virgin Islands.

“We are not talking big money. But very big money. None other than Putin’s Central Bank has estimated that two thirds of the $56 billion exiting Russia in 2012 might be traceable to illegal activities. Crimes like kickbacks, drug money or tax fraud.

“The Kremlin thinks it knows Europe’s dirty secret now. The Kremlin thinks it has the European establishment down to a tee. The grim men who run Putin’s Russia see them like latter-day Soviet politicians. Back in the 1980s, the USSR talked about international Marxism but no longer believed it. Brussels today, Russia believes, talks about human rights but no longer believes in it. Europe is really run by an elite with the morality of the hedge fund: Make money at all costs and move it offshore.”

Wall Street went to work today, and it seems they were heartened by the fact that Ukraine had not exploded and possibly a few traders looked at a map and discovered the Ukraine is about 4,000 miles from the corner of Wall and Broad; and Ukrainians don’t buy enough iPhones to move the needle. Keep calm and carry on.

So, it was back to the bull market behavior that got us here. Everything is copasetic. Corporate profits are absolutely smashing; the systemically important big banks posted profits of about $76 billion last year, just a smidge off their pre-crisis bubble era peak. There’s a small cap rally underway. Take a look at the Russell 2000, which was screaming for the month of February. There’s a biotech bubble; it’s enough to take your breath away, but they have a new drug for that; 11 of this year’s 14 best performing Russell 2000 stocks are biotechs, 7 of the top 8. The Nasdaq biotech index has gained 18%, since the start of the year.

That’s cool but not as cool as Tesla, which has doubled since Thanksgiving. One analyst recently said that Tesla’s pursuit of commercializing battery packs and cheaply storing green energy is a game changer, but the Elon Musk scheme to make a self-driving car is utopia. I always thought we’d have flying cars in utopia, but the future never unfolds exactly as we imagine.

Merger and acquisition activity is exciting again and it’s creating liquidity events. Apps are selling for $19 billion. Home thermostat companies bring in a cool $3.2 billion. Warren Buffett is on the prowl for something as good as Heinz catsup. Google is buying a company called Deep Mind, which does something in the way of artificial intelligence, which means that in the near future we won’t even have to think anymore.

Stocks are challenging all-time highs. The S&P 500 is hitting new highs. Almost every sector is moving up, with the possible exception of Bitcoin. Global central banks are printing money with abandon. Corporate bonds and junk bonds and Treasury bonds are all moving higher. Precious metals are moving higher. Greek stocks are moving higher. And the big winner so far this year, in terms of performance and the ability to attract investors, is not the bond market or the stock market; it’s commodities. To everything there is a season. Commodity ETFs are up $887 million in inflows for February.

And the valuations in the S&P 500, well, everybody seems to think they’re still more or less fairly valued; it’s not like it was in the late 90s; this time it’s different (lol), especially if the economy grows, which everybody seems to think will happen one of these days.

The latest guesstimate is that the US economy will grow this year at the fastest pace since 2005; that, in turn, will help reduce the annual average unemployment rate for a fourth straight year. So says the White House in forecasts accompanying its 2015 budget plan released today in Washington.  Gross domestic product will expand 3.1% in 2014 after rising 1.9% last year.  The jobless rate will average 6.9% this year, compared with 7.4% last year, and average 6.4% in 2015.

The $3.9 trillion budget anticipates an accelerating economy that’s boosting employment while moving up inflation to levels that would hardly change the pulse rate of the most hawkish Federal Reserve policymakers. The estimates in the budget plan showed the annual average yield on 10-year Treasuries will advance to 3 percent in 2014, from 2.3 percent last year, and increase to 3.5 percent in 2015.

In addition to rosy economic prognostications, the budget plan for 2015 proposes raising about $100 billion in revenue over the next decade through new taxes and restrictions on US multinational companies. The changes would affect digital goods, deductions for “excessive” interest, and hybrid arrangements that can lead to income that isn’t taxed in any country. Obama also wants to make it tougher for US-based companies to move to other countries.

The tax portion of the budget plan also would expand the earned income tax credit for low income workers, exclude Pell grants from income and establish automatic enrollment in individual retirement accounts. Further it would tax private equity managers’ carried interest as ordinary income, limit deductions for high income taxpayers, and end certain subsidies for oil and gas companies.

Most of the proposal will never see the light of day. However this idea on the earned interest carry trade might be something. The money taken in by this would be enough to pay for the Earned Income Tax Credit. Today, Warren Buffett said the tax break for low  income Americans aimed at encouraging work, would actually be the most direct way to help the working poor, with the fewest negative side effects; a better choice than raising the minimum wage. The IRS claims the tax break helped lift 6.6 million people out of poverty in 2011, the most recent year for which full data is available. Currently the credit does significantly more for families with children. Obama’s proposal would expand the EITC for workers without kids.

A July study from the Center on Budget and Policy Priorities estimated that expanding the EITC by lowering the age of eligibility for childless workers would lift an additional 300,000 Americans out of poverty. Expanding the EITC would help reduce poverty in two ways. First, it would give childless low-income Americans who are already working an income boost. And expanding the credit would encourage more people to work.

The White House signaled last month that its new budget would not extend the olive branch to Republicans that was offered in its proposal a year ago. Actually, there is some bipartisan support for some things. For example, the idea of closing the carried interest loophole, which would tax fund manager pay at 35% instead of the current 15% rate, which is somehow based on capital gains because fund managers don’t earn income, just capital gains. But wealthy fund managers pay an awful lot of money to politicians to encourage them to keep the loophole closed. Wealthy fund managers get very, very angry about any effort to take away a tiny bit of their billions. Blackstone Group co-founder Stephen Schwarzman, who made $465 million in 2013, declared in 2010 that Obama's idea of raising taxes on him and his buddies was just “like when Hitler invaded Poland in 1939”. That’s a quote. He went on to say, “It’s a war.”

A reminder that the budget proposal is coming from the White House and is being sent to the Congress, both of which are located in Washington DC, where tax policy has a tendency to become deadlocked in partisan disputes between  the lobbyists who actually write the laws.

By the way, the number one song in America is by Pharrell Williams and the title is “Happy”; the chorus is: “Clap along if you feel happiness is the truth.” It’s a nice song. Go ahead, clap along. 

Tuesday, January 08, 2013 - Thank You, America

Thank You, America

DOW – 55 = 13,328
SPX – 4 = 1457
NAS – 7 = 3091
10 YR YLD -.03 = 1.87%
OIL +.06 = 93.25
GOLD + 13.20 = 1661.10
SILV + .24 = 30.50

Some people have debated what we should do if the banks get into trouble again; should they be bailed out? The Too Big to Fail Banks of 2008 are even bigger today, and if one collapses, then there would likely be a cascading effect through the global financial system. So, if a big financial institution gets into trouble, should there be a bailout, or do we just say “tough luck”? You probably have an opinion, and reasonable people can debate the issue, or at least there could be room for reasonable debate, until now. As of today, there is no more debate.

If you go to Webster's Dictionary and look up the word “ingrate”, you will find a picture of Maurice “Hank” Greenberg; the guy who founded American International Group, AIG, the huge insurance company that in 2008 accepted a $182 billion dollar bailout from the Treasury. Hank Greenberg, the former CEO of AIG is contending in a lawsuit that the government treated the company’s shareholders too harshly when carrying out its 2008 rescue of the insurance giant. AIG is weighing whether to join the lawsuit, filed by Mr. Greenberg’s investment firm, Starr International Company, which owns about 12% of AIG. In addition to founding AIG, Greenberg gained notoriety for a high profile fraud case in 2005 that pushed him out of his CEO role at AIG. Greenberg was accused of using sham transactions to mask the company's financial position.

So far, AIG has not joined in the suit with Greenberg. The choice is not a simple one for the insurer. Its board members, most of whom joined after the bailout, owe a duty to shareholders to consider the lawsuit. If the board does not give careful consideration to the case, Mr. Greenberg could challenge its decision to abstain. Should Mr. Greenberg snare a major settlement without A.I.G., the company could face additional lawsuits from other shareholders. In other words, the board of directors may have a fiduciary duty to sue the government.

One of Starr International’s major arguments is that AIG’s bailout terms were far tougher than those granted to other large financial firms. Greenberg has accused the New York Fed of using the rescue to bail out Wall Street banks at the expense of shareholders, and of being a "loan shark" by charging exorbitant interest of 14.5 percent on the initial loan. 

The Treasury did force AIG to do things which were against their very nature. AIG was forced to pay full settlement on credit default swaps; one-hundred cents on the dollar, to the tune of more than $12 billion to Goldman Sachs alone. Now remember these credit default swaps were a form of insurance but they weren't insurance, and they were and remain largely unregulated. CDS is not like insurance in that it does not require reserves be held to pay off claims. The whole idea behind CDS was to collect premiums without ever paying claims. To force AIG to make full payment on a CDS claim was unprecedented and now Greenberg claims it was cruel and unusual punishment.

AIG’s cash needs and internal failings were in many ways far more serious than those of other institutions. In fact, the company was in such dire straits after the rescue that the government eased up on the terms. The concessions were considerable.

In early 2009, the Federal Reserve cut the interest rate on a big loan to AIG, saving the company about $1 billion a year in interest. Then the Treasury exchanged $40 billion of preferred shares for new ones that effectively paid no cash dividends to taxpayers. If it had paid the originally agreed 10 percent dividend on all these and other preferred shares, the insurer would have paid roughly $20 billion from the beginning of 2009 to the end 2012. Instead, the preferred shares were converted into common stock, which the government later sold, purportedly turning a profit of about $22 billion.

The bailout eventually worked out for AIG. After losing half its value in 2011, the stock rose more than 52 percent in 2012, tripling the gains of the broader S&P insurance index. Things worked out so well for AIG that they are now running a television ad campaign called “Thank You, America” in which it offers its gratitude for the bailout.

Mark Twain was right; truth is stranger than fiction because fiction is obliged to stick to possibilities.

Seriously, thank you, America.

There has been a lot of talk about breaking up the big banks, cutting them down into smaller banks that don't threaten the global financial system. The Dallas Federal Reserve has called for breaking up the biggest banks. Texas Republican Jeb Hensarling, the new Chairman of the House Financial Services Committee has expressed concern about the Too Big to Fail banks. Elizabeth Warren was elected in Massachusetts and she will sit on the Senate Banking Committee. Even Sandy Weill and John Reid, co-founders of Citigroup, which originally pushed through legislation which destroyed Glass-Steagall; they are now proposing that Glass-Steagall be reinstated and the biggest banks be broken up. The timing would seem to be right. Don't hold your breath.

The bank lobby will fight any attempts to break up the banks. Eventually, we will come back around to a big bank or insurance company on the verge of collapse and begging for a bailout; it's inevitable; the banksters continue to gamble in the derivatives markets, and eventually all gamblers lose, and when they lose.., please, please remember the story of Hank Greenberg and AIG.

Alcoa has kicked off the fourth quarter earnings reporting season by posting a profit of $242 million, or 21 cents per share, compared with a net loss of $191 million, or 18 cents per share, in the year-ago period. Excluding one-time items, net income was $64 million, or 6 cents per share, in line with average analysts' expectations of 6 cents.

Alcoa is supposed to provide clues about earnings, but I've never found a good correlation. Instead the earnings season has become little more than an exercise in obfuscation. Take the phrase “excluding one-time items”; that means the cost of doing business. Lucy Kellaway at Financial Times has come up with what she calls the Golden Flannel Awards, a mock celebration of corporate malarkey. Here's an example from one annual report: “In the wholesale channel, Burberry exited doors not aligned with brand status and invested in presentation through enhanced assortments and dedicated customised real estate in key doors.” I don't know what that means, but it might surprise you to learn that Burberry sells raincoats and they don't manufacture doors. Another company, called Record, does manufacture doors, which they call “entrance solutions”.

Sometimes companies create new words, such as: solutioneering, sustainagility, or innovalue. Sometimes, companies say things that are just designed to hide reality; for example, Citigroup issued a press release that talked about “optimizing the customer footprint across geographies,” which means they fired 1,100 workers. Citigroup also got the top prize by declaring that from now on they would offer “client-centric advice”. Sounds good until you think about what they've been offering up to now.

I still think it will be hard to top AIG's “Thank you, America.”

Anyway, welcome to earnings reporting season.

So, I was away on vacation over the holidays, but I'm catching up on the fiscal cliff deal. It has some interesting provisions; lots of little and not so little special deals, especially in the form of tax breaks. For a bunch of lawmakers who were supposedly so busy and so involved in "negotiations," they were remarkably productive when it came to special interests.

There's $9.7 billion over the next 10 years on additional subsidies for student loans or $5.6 billion for adoptions, although both those figures seem like a lot considering that employer-provided childcare is getting only $209 million. More money is at stake in subsidies for various businesses, $46 billion, and $18 billion for alternative energy. 

There's a special 50% tax credit for maintaining railroad tracks is projected to cost $331 million over the next two years.

Tax benefits for certain motorsport racing track facilities, such as Nascar, will cost more than $100 million over the next seven years.

Business property on Indian reservations will receive $660 million in tax breaks over the next three years. Indian employment tax credits will total $119 million over the next four years. Tax breaks for Alaskan Natives receiving trust income will add up to $46 million over 10 years.

More favorable deductions for contributions of food to charities will cost $314 million over two years. For contributions of property, the benefit will be $225 million over a decade.

Film and television production got the last-minute extension of tax write-offs worth $430 million over the next two years.

Businesses in Puerto Rico will receive $358 million over the next two years. In addition, a temporary increase in the excise tax rebate on rum production will give Puerto Rico and the U.S. Virgin Islands $222 million, much of which will go to benefit local rum distillers.

Regulated Investment Companies, such as mutual funds and real estate investment trusts, are to receive $211 million in tax benefits over the next two years. Some of that pertains to dividends paid to foreign investors.

Over the next two years, additional economic development credits for American Samoa will cost $62 million.

Over the next three years, $7 million will go to expand credits for plug-in electric vehicles to include motorcycles. That's a 10% rebate, up to $2,500 for buying an electric scooter.

$59 million in credits for fuel made from algae and expanding benefits for certain other biofuels.

Tax credits for renewable diesel fuel and small agricultural producers of biodiesel will total $2.2 billion over the next five years.

Asparagus growers will get $15 million.

There’s a provision that allows workers to convert conventional 401(k)s into Roth 401(k)s at a cost of $12.2 billion over the coming decade.

There were big breaks for private equity firms and hedge funds, including the

the continuation of the “carried interest” which in effect allows sophisticated investment managers to postpone their earnings from a deal and then often pay taxes at capital gains rates that are lower than the rates for fee income.

And a $9 billion tax break for big banks and manufacturers related to "active financing." Active financing is a special transaction tax break that specifically allows multinational companies to avoid paying US taxes on foreign earnings if those profits resulted from "actively" financing a deal or activity on foreign soil. Not surprisingly, big businesses claim it helps them be more competitive abroad.

Thank you, America.