FINANCIAL REVIEW

Third Quarter Wrap

Sinclair Noe — September 30, 2014

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Financial Review

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DOW – 28 = 17,042
SPX – 5 = 1972
NAS – 12 = 4493
10 YR YLD + .02 = 2.51%
OIL – 3.14 = 91.43
GOLD – 6.30 = 1209.70
SILV – .49 = 17.07

We wrap up the third quarter of 2014.

The Dow Jones Industrial Average is up 3.4% year to date; and it is up about 11% from the lows of February. Ten of the 30 Dow stocks are up more than 10% year to date. Eight of the Dow stocks are in negative territory for the year, even after adding in divdends. The best performing Dow stocks are Intel (up 37% ytd) and Microsoft (up 28% ytd). The worst performing Dow stocks are Boeing (down 5% ytd) and United Technologies (down 6% ytd).

The Dow lost 55 points, or 0.3%, for the month, and for the third quarter the Dow added 217 points or 1.3%. The S&P 500 dropped 31 points, or 1.5% in September, and added 12 points for the quarter; and that was good enough for the seventh consecutive quarterly gain, the best run for the S&P 500 since 1998. The Nasdaq Composite lost 87 points, or 1.8%, for the month, but added 85 points for the third quarter. The Russell 2000 index of small cap stocks lost 69 points, or 5.8% in September; and posted a loss of 98 points, or 8.1% for the third quarter.

In other markets: Oil prices dropped from $105.51 to $91.43 per barrel, a decline of more than $14 for the quarter. Gold is down $122 for the quarter. Silver is down almost $4.

The yield on the ten year Treasury note finished the quarter essentially unchanged, but it was a wild ride; one month ago the 10-year yield had dropped to 2.34%. Sovereign bonds around the world beat corporate debt this quarter by the most in three years as consumer-price gains slowed in the U.S. and disinflation threatened Europe. Government securities returned 1.4 percent from the end of June through yesterday, while company debt earned 0.3 percent. But don’t forget the dollar rally; even if you made money in foreign stocks or sovereign debt, you likely have a loss when you try to bring the gains home and have to re-price into dollars.

The dollar index of major currencies rose 0.4% to 85.95. The index has gained 7.7% over the last three months, the biggest quarterly gain since 2008 and a record-breaking 11 successive weeks of gains. Of course a stronger dollar is not always a good thing; it could lead to weaker trade performance, less exports, and more imports. Supposedly a strong dollar is indicative of a strong economy as spending switches from US goods toward foreign goods it will likely result in less output and lower employment than it otherwise would be in the absence of dollar appreciation. In other words, a strong dollar might reduce GDP by almost 0.5%.

Of course a weak currency can be problematic as well, just look at Russia. The ruble is down almost 17 percent against the dollar this year and weakened to a record low this week. The dollar-denominated RTS stock index is in a bear market and yields on government ruble bonds due in 2023 have jumped 1 percentage point since June to 9.42 percent, more than the yield on similar-maturing debt securities sold by Greece.

Net outflows from Russian assets totaled $75 billion in the first half of 2014, compared with $61 billion in all of last year. The Russian central bank is reportedly considering capital controls to limit the outflows. Yuan-ruble trading is growing faster than any other pair of currencies on the Moscow Exchange, and the Russians would like to increase the Chinese currency’s role in local money markets. Some doom and gloomers think that spells the end of the US dollar, but what it actually means is that sanctions are working. The dollar is strong and it dominates world markets.

The S&P/Case-Shiller US National Home Price Index, which covers all nine U.S. census divisions, recorded a 5.6% annual gain in July 2014. The 10- and 20-City Composites posted year-over-year increases of 6.7%. Although all cities but one gained on a monthly basis, 17 saw smaller increases in July as compared to last month.

For those worried that home prices have gotten too high, consider this: In many major cities, prices are still below bubble peaks. In 18 of 20 major US cities, home prices in July were between 3% and 42% below the bubble peaks that were hit in the local markets. Las Vegas is still down 42%, and Phoenix has the second worst recovery, with prices still 35% below the peak. In the most recent Case-Shiller report, Phoenix posted a gain of 5.7% for the past 12 months, and a gain of just 0.3% from June to July.

Consumer confidence fell in September for the first time in five months. The Conference Board, an industry group, said its index of consumer attitudes fell to 86.0 in September from a upwardly revised 93.4 the month before. Consumer confidence was hurt by concerns over the job market and expectations that economic growth will slow in coming months. A variety of factors are impacting consumers. Employers appear to be picking up hiring and laying off fewer employees, but workers are still concerned about their career prospects. Home prices are on the rise, but many households are wary of taking on too much debt, with Americans’ credit-card balances recently hitting the lowest tally in more than a decade. According to the sentiment report: “Tiny wage gains meant that nearly half of all households anticipated declines in inflation-adjusted incomes during the year ahead.”

Even as the U.S. economy reached a milestone in May with employment exceeding the prerecession peak, 29 of 50 states have yet to match that accomplishment. Bloomberg recently compiled Labor Department data shows the weakest jobs rebound has been in the states central to the 2002-2006 housing bubble and the subsequent price collapse. Nevada, Arizona and Florida are among those furthest from their peak employment during the December 2007-June 2009 downturn. The energy industry is driving the economic expansion in 12 of the 13 states leading growth since the recession ended. Leaders include Texas, North Dakota, Oklahoma and Louisiana, with Oregon the only non-energy state among the standouts. Oregon has been boosted by technology manufacturing and fast growth in exports.

Median household income is now 8 percent below what it was in 2007, adjusted for inflation. It’s 11 percent below its level in 2000. It used to be that economic expansions improved the incomes of the bottom 90 percent more than the top 10 percent. Since the current recovery began in 2009, all economic gains have gone to the top 10 percent. The bottom 90 percent has lost ground. We’re in the first economic upturn on record in which 90 percent of Americans have become worse off. And this month, that was reflected in the confidence figures.

Next week the International Monetary Fund hosts a gathering of the top finance officials from around the world. The IMF plans to again revise down its outlook for the global economy next week. Central banks have tried to rev up growth with cheap cash, but printing money can only go so far. The IMF has been arguing for a while that governments must restructure their economies to make them more competitive and capable of consistence growth. Next week they are expected to say that the best idea for many governments is to spend more on infrastructure and invest in roads, bridges, power plants, ports, and other big, expensive projects.

The IMF argues that taking advantage of low borrowing costs to finance infrastructure can boost near-term growth with cash injections and long-term output by increasing the efficient flow of commercial goods. If projects are carefully chosen, that public investment can add two percentage points to growth in industrialized economies, cut debt levels by up to 8% of gross domestic product and increase private investment by a half-percentage point of GDP. The extra debt from financing the projects would be more than offset by the growth returns.

A follow-up on the story about the New York Fed, which is supposed to serve as a banking regulator. ProPublica ran a story about a former New York Fed bank examiner, who noted that her ex-bosses weren’t willing to stand by her claims that Goldman Sachs didn’t have any conflict-of-interest policies, or at least a version that could pass muster. They fired her, but she made secret recordings before she was fired, and now she’s suing. The day this all broke, last Friday, Goldman issued a new conflict-of-interest policy that prohibits investment bankers from trading individual stocks and bonds. That wouldn’t have anything to do with the fact that, like Goldman Sachs itself, one of its investment bankers was on both sides of Kinder Morgan’s acquisition of El Paso, would it? Steve Daniel, a Goldman banker, had an undisclosed $340,000 personal investment, and Goldman Sachs had a $4 billion stake, in Kinder Morgan while both were selling El Paso advice on the deal. And of course there are multiple examples of when Goldman made bets against their clients.

The first case of deadly Ebola diagnosed in the U.S. has been confirmed in Dallas, in a man who was traveling in Liberia and arrived in the U.S. on Sept. 20. The man is being kept in isolation. He had no symptoms when he left Liberia, then began to show signs of the disease on Sept. 24; he was admitted to the hospital on September 26; he is now critically ill. At the same time, another suspected case is being evaluated at a National Institutes of Health facility, the 13th such possible infection in the U.S. All others have tested negative.

There is no approved treatment for Ebola, though drugmakers are attempting to develop vaccines or medicines that could be used in this or a future outbreaks. Current care involves isolating the patient so they can’t infect others, and providing supportive treatment such as intravenous fluids and antibiotics to fight opportunistic infections. There are some drug companies that are working on Ebola vaccines and treatments, and yes, they saw their stock prices jump today. Here’s a quick rundown: NewLink Genetics, an Ames, Iowa, company working on an Ebola vaccine, up 14% today; Tekmira Pharmaceuticals, up about 20 percent; BioCryst Pharmaceuticals, up 12 percent; and Sarepta Therapeutics, up 7 percent.