Thursday, March 27, 2013 - Certain Assumptions

Certain Assumptions

by Sinclair Noe

DOW – 4 = 16,246
SPX – 3 = 1849
NAS – 22 = 4151
10 YR YLD - .03 = 2.67%
OIL + 1.02 = 101.28
GOLD – 14.10 = 1292.70
SILV - .05 = 19.79

Stocks fell for the fourth time in 5 sessions. This year's first quarter, which ends Monday, isn't nearly as bullish as last year, when the benchmark Standard and Poor's 500 stock index soared 10% in the first three months of the year on its way to a 29% gain. The broad market is unchanged in 2014.  The losing sectors today included banks and biotech. The Nasdaq Biotechnology Index, up 304% in the last five years, has fallen 11% since the end of February, while the Russell 2000 gauge of smaller companies has slipped 2.7% after rallying more than 230%.

If you really want a great investment, it's hard to beat collecting $7,250 for every $1 you spend. That's the benefit Boeing will reap from a ramped-up lobbying push in Washington state that ended with a massive $8.7 billion tax subsidy. A new analysis of lobbying data shows the tax break came as part of a deal to keep production of a new jet, the 777X, in the Seattle area.

Lobbying data is notoriously difficult to parse because matching individual dollars to specific legislative priorities is often impossible. It's plausible that the company could have achieved the same result with a single phone call, given how terrified state officials were that the company might ship high-paying jobs elsewhere. The governor's office had estimated that Washington would lose an estimated 20,000 jobs and more than $20 billion in economic activity if Boeing took production of the new jets elsewhere.

But the new analysis of the lobbying data shows that Boeing didn't leave anything to chance in pursuit of its goal: that it went about getting what it wanted the old fashioned way, by spending gobs of money on lobbyists to follow lawmakers around, to call them incessantly and otherwise convince them that tax revenue isn't really all that important anyway. Boeing spent about $1.3 million to lobby state lawmakers from 2011 through 2013, according to the findings from the nonprofit National Institute on Money in State Politics. In the previous three-year period, the company spent $450,000. (The $7,250 - to - $1 calculation assumes every lobbying dollar was spent to win the tax subsidy).

About a week ago we reported on the Federal Reserve’s Stress Tests for the 30 biggest US banks. Zions Bank failed. Last week’s test was to determine if banks have sufficient capital to absorb losses and support operations during adverse economic conditions while using a standardized set of capital action assumptions.

 Yesterday, we got the results from the second part of the Stress Tests; to determine if banks could pass the test and expand buybacks and/or dividends, in other words, if the assumptions hold up. There were 5 failures out of 30, including: HSBC North America, RBS Citizens Financial, Santander Holding USA, Zions, and Citigroup. The official punishment is no stock buybacks and no dividend increases. It’s the second time the Fed has failed one of Citigroup’s capital plans. The last rejection came in 2012.

Meanwhile, Bank of America will spend $9.3 billion to resolve a dispute over mortgage securities with the Federal Housing Finance Agency, the regulator that oversees Fannie Mae and Freddie Mac. The FHFA sued 18 financial institutions in 2011 over their sales of toxic mortgage securities to Fannie and Freddie, alleging false representation of the mortgage loans behind the securities. Bank of America said that it will make cash payments of roughly $6.3 billion and also purchase securities from Fannie and Freddie worth more than $3 billion.

Separately, New York's attorney general announced that Bank of America and its former chief executive Kenneth Lewis reached a $25 million settlement to end an investigation into their actions in the 2008 acquisition of Merrill Lynch. The civil fraud lawsuit accused them of failing to disclose Merrill losses and bonuses before the deal closed.

 Credit card companies charge retailers a fee, called a swipe fee, whenever a customer pays with plastic. These fees are determined by the card networks. Wal-Mart has filed a $5 billion lawsuit against Visa, saying the credit card company passed along unreasonable fees when shoppers used credit or debit cards at its stores.

In the lawsuit, Wal-Mart alleged that Visa's swipe fees went against antitrust regulations, and in turn churned up more than $350 billion for issuers over the course of nine years, claiming:  "The anticompetitive conduct of Visa and the banks forced Wal-Mart to raise retail prices paid by its customers and/or reduce retail services provided to its customers as a means of offsetting some of the artificially inflated Interchange Fees.  As a result, Wal-Mart's retail sales were below what they would have been otherwise."

There is a certain amount of irony in Wal-Mart filing a lawsuit based on antitrust regulations.

Applications for unemployment benefits dropped last week to a 6 month low.

The seasonally adjusted pending home sales index dropped 0.8% to 93.9. The index has fallen 10.5% over the past 12 months. Contracts to purchase previously owned homes fell in February for an eighth straight month; the housing data this week has been weak. Higher mortgage rates, rising prices and a limited supply of homes have slowed sales since last summer. Average fixed-rate mortgages edged up slightly from last week; 30-year fixed-rate mortgages averaged 4.40% up from 4.32% on March 20.

The Commerce Department released its third and final estimate of fourth quarter Gross Domestic Product. The earlier estimate was that the economy grew at a 2.4% pace; the revised estimate was increased to 2.6% growth. Consumer spending increased at a 3.3% annual pace, partly on stronger health care outlays, up from the previous 2.6% estimate. Also, state and local government spending and exports rose more rapidly than initially thought.

Business equipment expenditures, a key gauge of companies' appetite for capital spending, also picked up more than previously estimated. A negative behind the growth is that much of the fourth quarter expansion was related to businesses stockpiling inventory; that was followed by bad weather, which means much of the inventory stayed on the shelves, and there will likely not be strong demand in the first quarter. Most estimates for first quarter GDP are coming in around 2%.

Earnings reporting season kicks into gear in about 2 weeks; it could be ugly. Earnings rose 8% in the fourth quarter of 2013, but first quarter earnings are expected to drop to 0.9%. The slashing of earnings forecasts for the first quarter are starting to ripple into the rest of the year. Investors now think earnings will only grow 7.7% for the full year of 2014. That's down from the 10% growth expected at the start of the year.

These rapid decreases in earnings projections leave investors with less reason to pay up with current stock valuations, much less push the market up higher still. Of course, there is a big difference between earnings estimates and earnings reports; there is a game played between companies and analysts, where companies ratchet down expectations and then try to beat diminished expectations.

More than 6 million people have now signed up for private insurance plans under Obamacare. The last-minute boost has exceeded the nonpartisan Congressional Budget Office's estimate that 6 million people would sign up in the program's first year, down from earlier expectations of 7 million enrollees because of problems with websites. It's unclear how many of the more than 6 million signups are people who did not previously have insurance. Also unclear is how many people have paid for their policies, a step necessary for the plans to take effect. Bottom line is that a lot of people signed up and you can’t un-sign all those contracts, so Obamacare is here to stay.

President Obama is in Italy today meeting with Pope Francis at the Vatican, after wrapping up a summit with European leaders. Meanwhile, Russian President Putin announced plans for a G-1 meeting in Sochi in June.

The US Senate and House passed separate bills today imposing additional sanctions on Russian officials for the nation’s annexation of Crimea from Ukraine. The Senate bill, approved on a voice vote, includes about $1 billion in loan guarantees and authorizes $150 million in direct assistance to Ukraine. The House legislation would impose additional asset freezes and visa bans on senior Russian officials and corporations.

The International Monetary Fund announced a $14-18 billion standby credit for Kiev in return for tough economic reforms that will unlock further aid from the European Union, the United States and other lenders over two years, effectively pulling Kiev closer to Europe; in a smothering, debt soaked embrace.

Obama said in Rome today that additional sanctions on Russia would inevitably also hit the economies of the US and Europe. The US and its allies are looking at Russia’s military, energy and finance industries as possible targets if it moves deeper into Ukraine.

Top Ukrainian security officials say that Russia now has 100,000 troops on its side of the Russia-Ukraine border. Other estimates put the number much lower, around 30,000, but still enough to overpower the undermanned and undersupplied Ukrainian armed forces. CNN reported that US intelligence assessments have increased the likelihood that Russia will invade Ukraine in the past week. This has been based on a number of worrying indicators about the Russian military buildup on the Ukrainian border.

Thursday, March 20, 2014 - Stress Tests and Such

Stress Tests and Such
by Sinclair Noe

DOW + 108 = 16331
SPX + 11 = 1872
NAS + 11 = 4319
10 YR YLD un = 2.77%
OIL - .27 = 98.63
GOLD – 2.10 = 1329.50
SILV - .34 = 20.37

More sanctions for and from Russia; President Obama today expanded sanctions against Putin’s inner circle, now banning visas and freezing assets of 20; the blacklist now includes a commodity broker with a brokerage based in Switzerland, plus Bank Rossiya with about $10 billion in assets.

In response, the Russian Duma, the lower house of parliament ratified the annexation of Crimea, and Putin announced sanctions against US oligarchs, including Senators John McCain and Harry Reid, and House Speaker John Boehner. McCain said he would have to cancel his plans for Spring break in Siberia.

There is an EU summit underway, and it remains to be seen if European leaders will get tough with sanctions. German Chancellor Angela Merkel has been talking tough but the Euro-economy is still fragile, and it is doubtful sanctions will serve as a strong deterrent. This is not to say that sanctions won’t have an effect. Some of Russia's largest companies are registered abroad where they may benefit from lower tax rates.

You might not have caught this next bit of news, after all there was a lot going on today with the Russian sanctions and the breaking news on the missing plane and the basketball brackets and such; anyway, in Florida today, after talking about sanctions, President Obama called for legislation requiring equal pay for equal work.

Obama said: “Women with college degrees may earn hundreds of thousands of dollars less over the course of her career than a man at the same educational level, and that’s wrong. This isn’t 1958 -- it’s 2014.”

This is clearly a blatant attempt to draw in more female voters in the mid-term elections; still it’s true.

California is facing wildfires "outside of any normal bounds" as a historic drought turns drying brush and trees into a perfect tinderbox. Fire officals say the state recorded 665 wildfires from the start of the year through March 8, about three times the average of 225 for this time of year. Cal Fire officials warn that each day without heavy rain deepened the risks of a catastrophic fire season and made it hard to deal with more wildfires if and when they broke out. And the fires are bigger.

Even before this year's drought, forest officials were reporting a longer fire season, and more catastrophic mega-fires, in California and other western states. Half of the worst fires in recorded Californian history have occurred since 2002. This is usually the time of year when much of the state is greening up. We haven't even got into the months that historically are the worst in California – late August, September and October – so that's a big red flag right there.

The number of Americans filing for jobless benefits hovered near three-month lows last week. Initial claims for state unemployment aid increased 5,000 to a seasonally adjusted 320,000 last week.

In a separate report, the Philadelphia Federal Reserve Bank said its business activity index rebounded to 9.0 in March from -6.3 in February. Any reading above zero indicates expansion in the region's manufacturing. There was a rebound in new and unfilled orders at factories in the region. Shipments also bounced back, but inventories fell. Employers opted to increase hours for existing workers rather than expand payrolls.

The National Association of Realtors said existing home sales slipped 0.4% to an annual rate of 4.60 million units. That was the lowest level since July 2012. Inventory levels are low, while prices have been moving higher. The median price for a previously owned home rose 9.1% in February from a year earlier.

The Conference Board's leading economic index rose 0.5% in February, after a 0.1% rise in January and a 0.1% decline in December.

The Federal Reserve submitted the stress test results on the 30 biggest US banks; 29 passed, one failed. Zions Bank does not have enough capital reserves; this is not a surprise; Zions is resubmitting its capital plan after taking a charge on bank trust preferred securities which Zions tried to claim as Tier 1 capital, but the Fed did not accept that.

Anyway, the Fed figures that if the economy falls off another cliff, the banks would lose $501 billion, but they would be able to survive. The Fed defines falling off a cliff as a bad recession where unemployment spikes to 11.25%, the stock market drops 50%, and home prices drop 25%. Most sane people would call that a depression.

Previous stress tests were used to reassure investors that the big banks were not a hot mess and were financially strong, even in tough times. The problem is that the tests aren’t very realistic. Unfortunately, the Fed’s approach ignores a lot of the horrible things that actually happen in nasty downturns. For example, banks’ borrowing costs tend to rise, killing profits that could offset their losses; trouble at one bank can spread as investors wonder which others will be affected; credit freezes can force financial institutions to sell assets at a loss, setting in motion downward spirals in which falling prices and banks’ woes reinforce each other. If you start thinking about all those things, we’d be lucky if one bank could pass the test. Of course, that wouldn’t inspire much confidence, and so…

Remember not so long ago when the markets were upset about emerging markets and a slowdown in China? Just in case you forgot, Morgan Stanley has just issued a report on China. Here are some of the key points:

Morgan Stanley analysts…, “believe China’s twin excesses (excessive investment funded by excessive debt) will inevitably unwind, causing a substantial slowdown in China’s economy, significantly below market expectations. In recent weeks, a trip to the region and further research into China’s shadow banking system have convinced Morgan Stanley analysts  that China is approaching its “Minsky Moment,” which increases the chances of a disorderly unwind of China’s excesses. (that reference to “Minsky moment” refers to an economist named Hyman Minsky, from the 1930, who basically claims that the more you prop up an economy, the more likely it will eventually become unstable) The efficiency with which credit generates economic activity is already deteriorating, as more investments are made in non-productive projects and more debt is being used to repay old debts.

Based on the Morgan Stanley analysis, their baseline case is that China may slow from the current level of 7.7% Gross Domestic Product (GDP) growth to 5.0% over the next two years. A disorderly unwind could take Chinese growth down to 4% in a shorter time frame with potentially disastrous consequences for levered Chinese assets (banks, property) and the entire commodity supply chain (commodity stocks, equipment stocks, commodity-sensitive countries and their currencies).

The consensus is more optimistic and expects China’s economy to grow by 7.4% in 2014 and 7.2% in 2015. Most market participants have concluded that the Chinese economy, despite its excesses, will slow only moderately as the government successfully manages to “soft-land” the credit and investment boom and that, as a result, the impact on global GDP growth could be moderate and is not likely to derail the global developed-market-led expansion. However, one of the more controversial conclusions of their analysis is that global economic growth could be impacted severely enough to cause a global earnings recession.

They suspect China’s economy has arrived at that unstable state where speculative and Ponzi finance appear to dominate. From a macroeconomic perspective, very few economies have ever created as much debt as China has in the past five years. China’s private sector debt has increased from 115% of GDP in 2007 to 193% at the end of 2013. That 80% increase over five years compares to the U.S.’s 26% in 2000-2005. In recent years, only Spain and Ireland have achieved debt growth greater than China’s. Every year, China is now adding $2.5 trillion of private sector debt to a $9.7 trillion GDP.

There is evidence that this debt growth has become excessive and non-productive. It now takes 4 renminbi (RMB) of debt to create 1 renminbi of GDP growth from a nearly 1:1 ratio in the early and mid-2000s. After the massive stimulus and more than doubling of new bank loans in 2009, the government attempted to stabilize credit growth, but the growth of the shadow banking system exploded instead. Shadow banking now accounts for more than a fifth of total credit in China—or about 40% of GDP from a base of 12% just five years ago. The shadow banking system funnels credit to borrowers who can no longer get loans from the formal banking sector.

Defaults or near-defaults have begun to occur with regularity over the past three months and are likely to pick up in quantity significantly over the next year. As it is becoming more clear that investors may not get all of their money back, interest rates on trust products, wealth management products (WMPs), corporate bonds, and bank loans have risen by roughly 200 basis points in the last year.

The unwind of this credit boom is likely in progress, and they expect it to pick up speed over the coming months and quarters. It will likely involve a steady drip of defaults and near-defaults as insolvent borrowers finally become illiquid. Market rates for all assets except central government bonds and central bank bills will likely continue to rise, reflecting increasing market fears of default by shaky borrowers. Asset values will likely begin to deteriorate as stressed borrowers attempt to sell assets to stay afloat. As a result, banks and other financial entities could begin to increase provisioning for bad debts and to reduce credit availability by gradually tightening credit standards. This could lead to a credit crunch where credit to the economy is choked off for all but the safest borrowers. Most other analyses concludes that China could slow more than currently expected by the consensus, but that the global economy is well-positioned to withstand such a slowdown. And the Morgan Stanley report concludes that they are  a bit more pessimistic.