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Wednesday, September 03, 2014

Another Glass of Kool-Aid

Financial Review with Sinclair Noe

DOW + 10  = 17,078
SPX – 1 =  2000
NAS – 25 = 4572
10 YR YLD – .01 = 2.41%
OIL – .36 = 95.18
GOLD + 3.50 = 1270.30
SILV + .02 = 19.27

The Commerce Department reports orders for goods produced in US factories rose 10.5% higher in July, mainly due to a big surge in contracts for commercial aircraft. Yet excluding transportation goods, factory orders fell 0.8% in July.

Meanwhile, auto sales rose to a seasonally adjusted annual rate of 17.5 million in August, up from 16.5 million in July. Recalls finally caught up with General Motors and sales declined 1%; Chrysler sales were up 20%; Ford sales were up less than 1%; VW slipped 13%; Nissan sales were up 12%; and Toyota gained 6%.

Tesla is expected to announce tomorrow that it has selected Nevada to be the home of its gigafactory, which will build batteries. Arizona, California, New Mexico, and Texas were also in the running for the $5 billion plant, a key part of Tesla’s plan to scale up its production and launch a mass-market car in the next couple of years. The factory is expected to employ more than 6,000 people.

The Federal Reserve gathers information from its districts two weeks before they get together for the FOMC policy meetings. They publish the information in a beige folder, and it is called the Beige Book; the information is not necessarily economic data or statistics, but rather opinions and anecdotes. They ask people what they see and think about different parts of the economy. So the Beige Book, which was released this morning, usually includes some vague and fuzzy terms; for example the economy has been expanding at a modest to moderate pace. The Beige Book describes manufacturing, job growth, the housing market, and consumer spending as modest, moderate or mixed. Auto sales and tourism remain bright spots. Demand for residential mortgages was less robust. The Fed described the labor market and hiring trends as generally modest. Employers, however, increasingly are struggling to find skilled employees. Wage and price pressure were little changed. That might be one of the more interesting findings. If employers can’t find skilled workers, one answer is to pay better.

The OECD, the Organization for Economic Cooperation and Development reports that high unemployment rates in the developed world are mainly the result of a tepid economic recovery rather than a lack of appropriate skills in the work force.

Today the S&P 500 index hit an intraday high, and the Dow nearly set an intraday high. Financial markets have been downright giddy for the past couple of years; we’ve seen 32 record high closes for the S&P 500 this year. Meanwhile, the Fed looks around and the consensus is that the economy is moderate to modest, not robust or booming. If it seems there is a disconnect between the market euphoria and the underlying economy, well, don’t worry, have another glass of Kool-Aid. That disconnect worked for a while. The financial markets were correct to dismiss the contraction in the first quarter GDP. After all, the second quarter GDP snapped back with 4.2% growth, which must be proof positive that the first quarter was a one off fluke. Meanwhile, the gap between exuberant markets and a moderate economy is filled with longer-term risks.

Some of those risks have been with us for quite a while. Regulators are just now getting around to issuing rules for banks to hold enough liquid, or easy-to-sell assets, to keep them afloat during a crunch, such as back in 2008. The Federal Reserve said big U.S. banks would need to hold a total of about $2.5 trillion in highly liquid assets by 2017, and that they would have a shortfall of about $100 billion if that threshold applied today. The regulators also proposed rules determining how much money – or margin – swaps buyers and sellers must set aside when they do trades outside central clearing houses, which makes them more risky than cleared derivatives trades.

What is considered liquid? Well, cash, treasuries, and other securities are considered liquid. What are those other securities? They’re still working on that. The idea is that it is some sort of asset that can be easily converted to cash. Of course, when there is a crunch or a freeze, it means that securities can’t be converted. Easy to sell assets are only easy to sell when you can sell them.

Medicare provides health coverage for people over age 65 and for people with disabilities. Spending per Medicare patient has almost always grown more rapidly than the economy as a whole, often by a wide margin. This year, Medicare will spend about $ 11,200 on average for every person enrolled in the program. By comparison, it spent $12,000 three years ago, in inflation-adjusted dollars. The Congressional Budget Office forecasts that the number will fall below $11,000 by 2017 and stay below this year’s number until 2020.

Medicare spending is dropping for two main reasons: first, the baby boomers are entering the program and in the short-term it skews toward a slightly younger and healthier population; second, over the last few years, Medicare patients have been using fewer expensive medical services, particularly hospital care and prescription drugs. The budget office is increasingly persuaded that such a pattern is going to last for a while.
NATO meets tomorrow to try and figure out what to do about the Ukraine-Russia situation. Russian president Putin has said that Russians aren’t actually fighting in Ukraine. Today he proposed a ceasefire plan to end the conflict, which Russia is not a party to.

Meanwhile, President Obama was in Estonia, which is a member of NATO and he hinted that NATO might now be willing to provide military assistance to Kiev. Obama said that any assault on the Baltic States would be met by force. “We’ll be here for Estonia. We’ll be here for Latvia. We’ll be here for Lithuania. You lost your independence once before. With NATO, you will never lose it again.” Estonia is a former Soviet republic just like Ukraine, but unlike Ukraine, Estonia is a member of NATO. Ukraine says it would like to become a member of NATO.

European leaders are contemplating a fourth, harsher round of sanctions against Russia, with France announcing that it was suspending the delivery of a new Mistral warship to Russia. For months, French officials have deflected and deferred any discussion about a controversial deal to supply two advanced warships to Russia. Even after several rounds of sanctions, travel bans, and asset freezes, this is perhaps the harshest penalty that any country in Western Europe has taken against Russia so far. It is only a suspension, rather than a cancellation, but the financial hit to France’s defense industry could be significant. To date, EU sanctions against Russia have covered only future business, leaving existing contracts untouched. If any European country was going to voluntarily endanger current business deals, instead of things at some unspecified time down the line, few would guess that it would be France.

Of course there are creatures with far less backbone, and far looser scruples than even France. I’m talking about politicians. Specifically, two former US senators. Gazprombank GPB is a subsidiary of Gazprombank, the third largest Russian bank; the same Russian bank already targeted with sanctions. Former Senators Trent Lott of Mississipppi and John Breaux of Louisiana have signed on as lobbyists for Gazprombank. This is bipartisan slime; Lott is a republican and Breaux is a democrat.

NATO is looking to the US to shore up energy security, particularly as tensions rise with gas-rich Russia over the Ukraine crisis. At this week’s NATO Summit, European allies will likely press President Obama for accelerated gas exports and a lift of the US oil export ban as a counter to Russian influence.

Latvian President Andris Bērziņš said, “We wish to develop a real transatlantic bond between Europe and the U.S. on energy. Recent developments in Ukraine are the further proof of the urgency to reduce dependency on one supply here. Thereby, the U.S. involvement is very important for our efforts to make strong energy security and develop integrated energy markets in the region.”

The US is the world’s largest natural gas producer thanks to recent drilling innovations, and the US rivals Saudi Arabia and Russia in oil production. Countries across the globe would rather do energy trade with the US than with less stable energy superpowers, but US law largely prohibits oil exports and limits natural gas exports.

On another front, Obama announced that the United States now has a plan for dealing with the Islamic State, or ISIS, or ISIL, or whatever you call it. The plan is to destroy and degrade them. It will take time because of the power vacuum in Syria and the importance of building coalitions, including with local Sunni communities. Obama told a news conference, “The bottom line is this, our objective is clear and that is to degrade and destroy ISIL so that it’s no longer a threat not just to Iraq but also the region and to the United States.”

Vice President Joe Biden used a little more powerful language in a speech in New Hampshire, saying, “They should know we will follow them to the gates of hell until they are brought to justice. Because hell is where they will reside.”

At some point, somebody will look around and figure out that most of the bad actors on the global stage get their funding from oil; until then, have another glass of Kool-Aid.

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