Tuesday, May 06, 2014 - Quickly Aging Here

Quickly Aging Here
by Sinclair Noe

DOW – 129 = 16,401
SPX – 16 = 1867
NAS – 57 = 4080
10 YR YLD  - .02 = 2.59%
OIL + .38 = 99.86
GOLD – 1.80 = 1308.90
SILV - .04 = 19.65

There was a pretty broad selloff on Wall Street today. AIG posted lousy earnings late yesterday, and today they dragged down most of the financials. Twitter proved a drag on the tech stocks. Twitter reached the 6 month expiration of a lock-up period that had restricted sale of about 82% of its outstanding stock. Share prices dropped about 18% today, but home prices in Silicon Valley are likely to move a bit higher in the next month. After the close, Disney posted better than expected earnings.

Let’s start with economic data; the trade deficit narrowed in March, down 3.6% to $40.4 billion. March exports came in at about $193 billion and imports were around $234 billion, resulting in a $40 billion shortfall. Exports are 17% above the pre-recession peak, while imports are about 1% above the pre-recession peak. Exports of capital goods, industrial supplies and materials, and automobiles increased in March. Exports of services hit a record high, while those of non-petroleum goods were also the highest on record. Exports to Canada, South Korea and Germany all touched all-time highs in March. Imports of food and non-petroleum products hit record highs in March.

Last week we saw the estimate for first quarter gross domestic product showing 0.1% growth; that estimate worked with an assumption that the trade deficit for March would come in at $38.9 billion, not the $40.4 billion reported today. So, this implies that the GDP number could be re-estimated by two-tenths, which would mean a negative -0.1% GDP for the first quarter, or maybe just a bit worse. There will be other data considered in the final GDP number, but it now looks like a negative number. And most economists are calling for a bounce back in the second quarter.

Corelogic reports home prices nationwide, including distressed sales, increased 11.1% in March 2014 compared to March 2013. This change represents 25 months of consecutive year-over-year increases in home prices nationally. On a month-over-month basis, home prices nationwide, including distressed sales, increased 1.4% in March 2014 compared to February 2014.

Excluding distressed sales, home prices nationally increased 9.5% in March 2014 compared to March 2013 and 0.9% month over month compared to February 2014. So, home price increases are slowing, and this might also prove a drag on GDP, but it doesn’t necessarily mean the housing market is in the dumps. One of the bright points in the report is that there are fewer distressed sales, that means there is also less inventory, and there is less negative equity.

A separate report from Black Knight Financial, a mortgage research firm finds the number of mortgages on which lenders initiated foreclosure in March fell to the lowest level in more than 7 years. Banks initiated foreclosure on 88,000 properties in March, down more than 27% from a year ago, and well below the high of more than 316,000 in March 2009.

Foreclosures should continue to trend down because the share of mortgages that are behind on their payments is also declining. Around 2.1% of all loans were in some stage of foreclosure in March, the lowest level since late 2008, and another 5.5% of all borrowers were 30 days or more past due on their loans but not yet in foreclosure, the lowest since late 2007. Both of those are still well above pre-crisis levels but they are down sharply from a few years ago.

Growth in the services sector accelerated in April, rising at the fastest pace in eight months as new orders jumped and overall activity quickened by the most since early 2008. The ISM said its services sector index rose to 55.2 in April from 53.1 in March, topping expectations for a read of 54.1. The data provides further evidence that economic activity is regaining momentum after lagging through much of the winter.

Today is the anniversary of one of the scariest days in market history. On May 6, 2010, the Dow plunged nearly 1,000 points in a matter of minutes in what became known as the flash crash. The crash wiped out $1 trillion in wealth in the blink of an eye, only to recover, kinda, sorta. High-frequency computerized trading was believed to at least be part of the cause of the technical breakdown. And the regulators have not figured it out to this day, and yes it could happen again.  

Last week, SEC Chair Mary Jo White testified before Congress that the markets were not rigged. Today, the SEC announced they have sent out subpoenas demanding records from brokerage companies to try and figure out how customers’ orders are routed, and how firms are being paid for order flow. The good news is the SEC is investigating; the bad news is that dark pool and high frequency trading has been going on for years and the SEC appears totally clueless.

Institutional Investor released its Rich List, a list of the 25 top income generating hedge fund managers. David Tepper of Appaloosa Management topped the list with $3.5 billion in earnings. Second on the list was Steven Cohen of SAC Capital, who might have fared better if his firm hadn’t been guilty of insider trading. Just for reference, $3.5 billion works out to $400,000 an hour.

I also ran across an article that puts the Fed’s QE into perspective. The Federal Reserve has spent approximately $3.2 trillion in the post-Crisis era, with most of the money being dropped from helicopters hovering over Wall Street banks. The Fed mainly bought Treasuries and mortgage backed securities, but they could have mailed a check for $10,223 to every person in the US; they could have bought back all the US debt owned by China, Japan, and Belgium; they could have created 12.8 million jobs in 2009, each paying $50k a year, and still be making payroll for them today – which actually would have met their mandate. And that’s just based upon large scale asset purchases under QE; by some estimates the Fed has dished out my than $17 trillion to prop up the financial order. A trillion here, a trillion there, pretty soon it adds up to real money.

The Census Bureau released a report on the demographic makeup of the US; the population is aging rapidly; about 1 in 5 Americans (21%) will be 65 years old and up by 2050, compared with just 13% in 2010 and less than 10% in 1970. It sounds like a lot of old people, but it seems less so when compared with other countries. In 2050, around 40% of Japan’s population will be 65-plus, up from 24% in 2012. In Germany, Italy, Spain, and Poland over 30% will be 65 plus. China will have about 26% of its population over the age of 65, which amounts to more old people in China than the entire population of the US.

The concern with an aging population is that there will be a much slower economy: less spending, less saving, lower economic output, and slower growth; fewer working age people paying taxes, less money going into social programs like Social  Security and Medicare, and more money coming out of those programs. But the Census report also finds that the working age population will increase, mainly due to immigration.

The White House today released the 2014 National Climate Assessment, written by 300 climate experts and reviewed by the National Academy of Sciences. The full report, at more than 800 pages, is the most comprehensive look at the effects of climate change in the US to date. Don’t worry, they also provided a Cliff Notes version that weighs in at a mere 137 pages, thereby killing fewer trees. The short and sweet is that we’re all going to fry; it’s too late, climate change is here and now, and it will just get worse and worse.

Average temperatures in the US have increased 1.3 degrees to 1.9 degrees Fahrenheit (depending on the part of the country) since people began keeping records in 1895, and about 80% of that warming has come in the past 20 years. The period from 2001 to 2012 was warmer than any previous decade on record, across all regions of the country. And it will keep getting hotter. If we really get very serious about cutting emissions, temperatures will rise by 3 to 5 degrees, depending on location, over the next 80 years; if we keep going the way we’re going, temperatures will rise 5 to 10 degrees, and maybe by 15 degrees in some places. That means 115 degree days in the desert southwest could be 125 to 130 degrees.

In addition to extreme heat, you can add wildfires, and drought, and hurricanes, and extreme downpours – real gulley washers, plus rising sea levels. The report says that in much of the US, especially the Midwest and Northeast, more rain is falling in short-duration, heavy bursts, leading to more flooding. The Northeast and Midwest may continue to get wetter, while the Southwest becomes even more parched, raising water supply and energy concerns there.

The report warns the Southwest to prepare for major disruptions ahead due to climate change: "Increased heat and changes to rain and snowpack will send ripple effects throughout the region’s critical agriculture sector, affecting the lives and economies of 56 million people –- a population that is expected to increase 68% by 2050, to 94 million. Severe and sustained drought will stress water sources, already over-utilized in many areas, forcing increasing competition among farmers, energy producers, urban dwellers, and plant and animal life for the region’s most precious resource."

The report says the Southwest will be plagued by drought, which is not really uncommon, but the droughts will be hotter and drier and longer and will lead to a big increase in wildfire activity, which has already started to take place.

The report notes that American society and its infrastructure were built for the past climate, not the future. It highlights examples of the kinds of changes that state and local governments can make to become more resilient. One of the main takeaways is that you don't want to look at the weather records of yesteryear to determine how to set up your infrastructure.

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.