Earnings, Kitchen Sinks, Whining

By Sinclair Noe

DOW + 84 = 13,596
SPX + 8 = 1480
NAS + 18 = 3136
10 YR YLD +.05 = 1.88%
OIL + .94 = 95.18
GOLD + 7.10 = 1688.10
SILV +.24 = 31.83

The Dow Jones Transportation Average logged a record high today, ending the day up 37.44, or 0.66%, at 5,681.28. The transports average logged its best opening 15 days in January in more than a quarter century. The Dow Jones Industrial Average is still well off its October, 2007 all-time high of 14,164.53. So Dow Theory purists will have to be patient for a while yet. The Nasdaq still has a way to go. But Silicon Valley is back on top. Is it 2000 all over again?

The Best Performing Cities Index from the Milken Institute may have a familiar ring to it. The country's top metro area in 2012, based on jobs, pay and technology—is San Jose, Calif. It has been over a decade since the region ranked first on the index. Coming in second place on the index is Austin, Texas, another hub for tech innovation. The Milken Institute reported that for every job added to the tech sector, five outside jobs were created.

The number of Americans filing new claims for unemployment aid hit a five-year low last week and residential construction increased in December. Initial claims for state unemployment benefits fell 37,000 to a seasonally adjusted 335,000, the lowest level since January 2008. It was the largest weekly drop since February 2010 and ended four straight weeks of increases. The jobless-claims report suggests that we’re likely to see nonfarm payrolls expand at perhaps a better rate than we’ve seen in recent months.

A separate report from the Commerce Department showed housing starts jumped 12.1 percent last month to their highest level since June 2008. Permits for future home construction were also the highest in about 4-1/2 years. Digging into the housing report, 30 percent of all housing starts in 2012 were of multi-family apartments. That is the highest share in over 20 years. In December alone, multi-family starts jumped 23 percent month to month, seasonally adjusted, and are up nearly 166 percent from December of 2011. Compare that to single family gains of 8 percent month-to-month and 18.5 percent from a year ago. The housing starts number would indicate a shift in strategy. Developers are rushing to increase supply of multi-family apartments; this even as single-family rentals continue to gain market share. Continued uncertainty in the housing market, tighter mortgage underwriting and weaker consumer wealth has pushed ever more Americans to rent; the foreclosure crisis forced others. Still, the report indicates improving health in the housing sector. The labor and housing figures were really quite compelling and exceeded expectations rather handily in both cases.

Today, the American Bankers Association's held a economic conference to complain about tax increases and continued uncertainly among government policy makers; they say it will slow economic growth and job creation significantly early this year and threaten to tip the economy back into a recession. The tax hikes already put into place following this month's fiscal cliff deal in Congress will subtract 1.25 percentage points from gross domestic product growth this year, and additional government spending cuts--or continued uncertainty--would cause the economy to grow even slower than the tepid 2.0% pace. Those lackluster projections assume a relatively orderly resolution to the debt-ceiling debate in Congress.

It's earnings reporting season; still too early to declare the fourth quarter a success or a failure. And we've been sifting through some numbers. Extending the climb in corporate profits this year is expected to grow more challenging as labor costs rise with increased hiring. CEOs say they also face uncertainty over new health-care rules and taxes. Washington’s repetitive political confrontations threaten to further lengthen their odds. The debt-limit fight comes as the economy likely is growing at an annual rate of just 1.5 percent in the first quarter, although it will probably expand 2 percent during the year.

Despite the whining from the bankers, corporate profits are outstanding. Bloomberg reports US corporations’ after-tax profits have grown by 171 percent under Obama, more than under any president since World War II, and are now at their highest level relative to the size of the economy since the government began keeping records in 1947. Profits are more than twice as high as their peak during President Ronald Reagan’s administration and more than 50 percent greater than during the late-1990s Internet boom, measured by the size of the economy. The S&P 500 index is up 80% over the past 4 years and is now at a 5 year high.

Corporations are holding more than $1.7 trillion in liquid assets; essentially, they are parked in cash reflecting uncertainty over future policies. They’re investing in capital projects only 80 percent of their available internal funds. Though that figure is up about one-third from late-2009, that ratio has been below 80 percent only once since the end of 1958. Companies have squeezed profits out of this horrible economy by making it even more horrible, laying off workers and slashing costs. 

No sector has complained more than the banks, which have been reporting profits this week, and no sector has been making more money than the biggest, most oppressed banksters. JPMorgan Chase made $21 billion last year; it would have been more except for the $6 billion in losses by the London Whale. Today, Citigroup reported it was hit by charges for layoffs and fines to the tune of $2.3 billion in the last quarter; they still managed to posted net income of $1.2 billion. More alarming, Michael Corbat, Citi’s new CEO, had the audacity to blame regulatory costs for the bank’s performance — as if it were operating under some especially onerous rules that others weren’t.

Even with these “special” and “one-time” circumstances stripped out, these banks continue to be black boxes. Investors’ only choice is whether to trust the junk they spew forth.

Bank of America really has something to whine about; the bank reported a widely expected 63 percent drop in fourth-quarter profit after making huge payments to settle legal claims over its mortgage business. The bank’s earnings, a slim $732 million, amounted to 3 cents a share. For the entire year, profit jumped to $4.2 billion. The bank’s recent legal settlements also weighed on its results. Bank of America had warned investors that it deducted $2.5 billion to settle with regulators over claims of foreclosure abuses. The bank last week also struck an $11 billion agreement to resolve claims that it sold troubled mortgages to the government-controlled housing finance giant, Fannie, which experienced deep losses from the loans. The bottom line is that, quarter after quarter, these banks turn in financial reports that are impenetrable and full of what analysts politely call “moving parts.” It’s nearly five years since the dark days of the financial crisis, yet it’s still not clear if these banks are digging out or deeper. Methinks they doth protest too much. Why, it's almost as if the banks are trying to hide something.

Consumer advocates have complained that mortgage lenders are getting off easy in a deal to settle charges that they wrongfully foreclosed on many homeowners. Now it turns out the deal is even sweeter for the banks than it appears: Taxpayers will subsidize them for the money they're ponying up. The Internal Revenue Service regards the lenders' compensation to homeowners as a cost incurred in the course of doing business. Result: It's fully tax-deductible.

Regulators reached agreement this week with Goldman Sachs and Morgan Stanley. Last week, the regulators settled with 10 other lenders: Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, MetLife Bank, PNC Financial Services, Sovereign, SunTrust, U.S. Bank and Aurora. The settlements will help eliminate huge potential liabilities for the banks. Under the deal, 12 mortgage lenders will pay more than $9 billion to compensate hundreds of thousands of people whose homes were seized improperly, a result of abuses such as "robo-signing." Companies can deduct those costs against federal taxes as long as they are compensating private individuals to remedy a wrong. By contrast, a fine or other financial penalty is not tax-deductible.

Elsewhere in the world;  International Monetary Fund chief Christine Lagarde says the threat of financial collapse in the global economy appears to have eased, but she warned that developed economies still need to follow through on financial reforms and debt reduction. LaGarde said:

"We stopped the collapse. We should avoid the relapse. And it's not time to relax." Lagarde said that big economic powers, including the United States and European countries, had taken important steps to shore up their financial systems but have a lot of work left to do. She warned that there are signs of a waning commitment to regulate the financial sector. She said that reforms have been delayed and diluted, and she worries that banks are pushing back against necessary reforms. Wonder where she got that idea?

On the United States, Lagarde said any cuts should be aimed at allowing time for an economic recovery to play out. In Europe, Lagarde said she sees a lot of progress on reform. She said the European Union has a lot of new tools to deal with financial crisis. "And yet, firewalls have not yet proven operational," she said. She added that the EU still has work to do on its banking union in order to prevent future problems. On Greece, which has seen the most acute collapse of all the EU countries and which many believed would have to leave the currency union, Lagarde said recent reforms appeared to have restored confidence.

"This time it's different," she said. I think I've heard that line before.

Monday, October 8, 2012 - The 11th Anniversary

The 11^th Anniversary

by Sinclair Noe

DOW – 26 = 13,583
SPX – 5 = 1455
NAS - 23 = 3112

10 YR YLD
OIL+.30 = 89.63
GOLD – 5.80 = 1776.50
SILV - .53 = 34.08
PLAT -12.00 = 1699.00

Due to the Columbus Day holiday, US bond markets were closed and there was no interesting data to speak of. Trading volume was on the lighter side. After equity futures opened the day 5 points lower in the S&P 500, stocks drifted slightly higher on the day. This was also an important anniversary; yesterday actually. When the Taliban refused to give up the al-Qaida leaders who orchestrated 9/11, the US invaded Afghanistan on Oct. 7, 2001.

With any luck our troops will be out of there by the end of 2014. When the Soviets withdrew from Afghanistan in the 1990s, the country fell apart and eventually fell under the control of the Taliban. In time we'll learn how the country will manage after the US leaves. The Afghan people already view their government as weak and corrupt and those doubtful of a peaceful future say that if the upcoming presidential election is rigged and yields an illegitimate leader, civil war could erupt between ethnic groups backed by neighboring countries trying to influence Afghanistan's future.

We don't speak much about war. We have had very little public discourse on the longest war in US history. War, for some, is a business. And across this country we have a strong infrastructure of military industries that produce instruments of war, or are involved in financing war. As of last week, we have lost 2,000 in Afghanistan and tens of thousands have been injured. Last Saturday, Sgt. 1st Class Riley G. Stephens, 39, was shot and killed by an Afghan National Army soldier at a highway checkpoint in Wardak Province. The Airborne Special Forces member had three children and a wife. Residents in his tiny hometown, Tolar, Texas, gathered on the local high school football field, burning candles in his honor. Sargeant Stephens was number 2,000. I don't know the name of the guy who was 1,999. I apologize. I mean no disrespect. Someone whose life story and profound sacrifice may get far less acclaim. Meanwhile, the first casualties of the conflict get shoved deeper into the nation's collective memory.

Obviously somebody was just killed in action there and that person should be remembered and celebrated. But we’ve also got to remember there are widows who have been dealing with this since 2001. They still need support and their families need care and their kids need to figure out how they’re going to school. The price those families pay impacts generations.

We have a huge disconnect in this country. You probably don't think about Afghanistan unless you have a family member serving there. You probably don't know what to do about Afghanistan when you do think about it. So, what you do is you remember the fallen, you remember the families, you remember the soldiers that return, and you absolutely honor their service by keeping our oath that we will take care of them and their families. And never forget.

Political pressures are rising again in Europe. Political pressure, riots, and protests are part and parcel to hard times. These developments change nothing of significance in the calculus concerning the eventual success of the Eurozone crisis response.

After a quiet few weeks, political pressures are rising again in Europe. Molotov cocktails exploding in Athens and news reports of mounting support for the rightist Golden Dawn party bring into questions the durability of the summer stabilization in the Euro-Zone.

In fact the only example of public outrage having an impact recently has come in Portugal, where protests spread spontaneously against the government’s new proposal to shift social security contributions from firms to workers. The furor forced the government to withdraw this step, which had been aimed at increasing competitiveness by an ‘internal devaluation’.

Today, the European Central Bank urged euro-zone states to implement further “major” reforms of their labor markets in order to combat rising unemployment and bolster growth. The ECB report says: “Major labor market reforms in euro area countries are essential to foster job creation, bring down unemployment and restore competitiveness, while also lowering the risks of a permanent decrease in potential output growth.” We'll see who's buying it.

As German Chancellor Angela Merkel travels to Greece tomorrow for her first visit since the turmoil began in 2009, European finance ministers gathered in Luxembourg today to discuss Spain’s overhaul effort. Spain doesn’t need an assistance program. That’s what the Spanish government is saying again and again. But there seems to be insistence to put a program in place.

Joseph E. Stiglitz says the Fed and ECB can’t revive the economy on their own. “For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending. The current downturn, already a half-decade long, will not end any time soon. That, in a nutshell, is what the Fed and the ECB are saying. The sooner our leaders acknowledge it, the better.”

To better calculate the true idleness and “wasted youth” phenomenon in advanced economies, the OECD calculates the share of youth “not in employment, education, or training” among the total in the 15- to 24-year-old age group. This is the so-called NEET ratio, which comprises “idle youth” in the labor force (looking for work, but unable to find it) and outside the labor force (inactive). Idle youth are associated with long-term scarring effects; the euro area peripheral countries look less bad than other OECD countries. Yes, there have been significant increases in Ireland and Spain during the crisis, but the Q1 2011 NEET ratio of these two countries was still only 2.8 percentage points higher at 17.6 percent than the corresponding 14.8 percent in the United States.”

Robert Shiller writes about the social epidemic behind housing. “People waiting to buy a home may be waiting for a sense that prices have a rosy long-term future. Home prices in the United States have been rising for several months, and that is generating some optimism that now is the time to buy. However, the social waves also carry other, less encouraging stories that compete with such optimism — for example, foreclosures, unemployment, Europe’s troubles and the Asian slowdown. Will optimism about real estate emerge as a leading story?”

A single mysterious computer program that placed orders - and then subsequently canceled them - made up 4 percent of all quote traffic in the U.S. stock market last week. Still don't know what was behind it.

The program placed orders in 25-millisecond bursts involving about 500 stocks, according to Nanex, a market data firm. The algorithm never executed a single trade, and it abruptly ended at about 10:30 a.m. Friday. Just goes to show you how just one person can have such an outsized impact on the market. Exchanges are just not monitoring it.

Maybe, the ultimate goal of many of these programs is to gum up the system so it slows down the quote feed to others and allows the computer traders (with their co-located servers at the exchanges) to gain a money-making arbitrage opportunity. The scariest part of this single program was that its millions of quotes accounted for 10 percent of the bandwidth that is allowed for trading on any given day. Regulators are trying to see how they can rein in the practice, which accounts for 70 percent of trading each day. Think transaction tax.

This quarterly earnings season, which kicks off in the US with aluminum producer Alcoa’s figures on tomorrow night, will be the first since 2009 in which the profits of corporate America are forecast to turn negative compared with the same quarter a year ago. With China slowing, a “fiscal cliff” of towering tax rises looming in the US and the eurozone crisis little closer to resolution, it is hard to believe chief executives will up their earnings guidance for the near future, either.

At the start of July, Wall Street analysts predicted the S&P 500 companies would post quarterly earnings up 1.9 per cent on a year ago, according to FactSet. Now the consensus shows a 2.7 per cent drop. The S&P 500 has risen 7.3 per cent over the same period. What gives?

Maybe, just maybe, weak demand has finally caught up with chief executives who previously found other ways to boost earnings. Earnings cannot keep growing faster than revenues. The latest data shows productivity plunged, which means that all the fat has already been cut. Profit gains earned through job cuts and factory closings in the absence of a global economic recovery are starting to reach their limit. A lot of the earnings growth that we’ve seen has been related to cost reductions. Now many of those cost reduction efforts have run their course. Without revenue growth, there is no room for profit to expand further.

Materials companies, metals producers and miners, in particular, are among those expected to post the worst earnings drops because of crumbling demand in Asia, along with energy companies suffering from falling natural gas prices.

Almost anything could be driving recent price swings, with the macro backdrop still playing a dominant role — QE3, heightened expectations of stability in Europe, better economic indicators in the US. And although third quarter earnings are expected to contract, analysts are expecting a decent rebound in the fourth quarter. Global growth is slowing, but the US recovery appears to be on sounder footing than was widely understood even at the start of the summer, when there was sporadic talk of possibly falling back into recession. Maybe companies have been too dire in their earlier guidance. Maybe not. We'll see soon.

Expectations for both margins and revenue growth in 2012 have been falling all year. Morgan Stanley strategists sent out a research report:

Many have asked us if there can be an earnings recession without an economic recession, and today’s environment answers the question. Roughly, 50% of the companies are expected to experience YoY contraction in net margins during the quarter, including heavyweights like CVX, MFST and GOOG. While revenue growth expectations have largely held up, earnings estimates for the quarter have seen sharp downward revisions in the last two months hurt by the highest ratio of negative-to-positive guidance any time in this cycle.

A different sampling of analysts performed by Convergex arrived at a different conclusion:

The upcoming earnings season will have the 30 companies of the Dow Jones Industrials showing an average revenue decline of 0.7%.

Analysts have been cutting their top line expectations for the companies of the Dow every month for the last half-year. Back in January, for example, they thought revenues could grow at a very healthy 4%. By May, the analyst community began to realize that macroeconomic conditions were going south pretty quickly and cut expectations to 3%. Starting in August, analysts’ financial models pointed to an average decline for the Dow companies. The most recent numbers, as of Friday, now show that 0.7% average decline.

Among the reasons for the slowdown in revenue growth per share are slowing emerging markets growth and recession throughout Europe.

Earnings trends have been a good barometer of market valuations but a relatively poor reflection of broader US economic health since the crisis, and that probably hasn’t changed.