FINANCIAL REVIEW

Double Irish With a Side of Knowledge Box

Sinclair Noe — October 14, 2014

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Financial Review

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DOW – 5 = 16,315
SPX + 2 = 1877
NAS + 13 = 4227
10 YR YLD – .08 = 2.20%
OIL – 3.76 = 81.98
GOLD – 4.90 = 1233.20
SILV – .11 = 17.49

The Dow was down slightly, while the S&P and Nasdaq snapped a 3 day slide, but this was almost a quiet day; call it neutral. A follow-up on yesterday’s discussion of the 200 day moving average. The S&P 500 dropped down to the 200 day moving average on Friday (right around 1905), and then fell right through the trend line yesterday. We talked about the possibility of a bounce; and I don’t think today’s minor move qualifies as a bounce, even though it was a positive move. So, we are still waiting for a possible bounce. The 200 day moving average is a lagging indicator, and so for now, the trend line is still moving higher; which increases the prospects for a bounce. When the price drops below a declining 200 day moving average, it is considered extremely bearish and the probability of a bounce is very low. So, we wait for confirmation.

It is earnings reporting season, and today’s reports feature the banks. We start with JPMorgan Chase, the nation’s largest bank by assets, reporting third quarter net income of $5.6 billion, or $1.36 per share, a big improvement from the same period last year, when the bank’s legal bills caused it to lose $380 million. JPMorgan Chase missed profit expectations of $1.38 per share, but the bank beat revenue expectations by reporting third-quarter revenue of $25.1 billion, as opposed to estimates of $24 billion.

CEO Jamie Dimon talked about the cyber threat, saying there is a need for greater coordination between banks and the government, and also saying, “It’s going to be an ongoing battle, and unfortunately battles will be lost.” Indeed, the mere act of reporting earnings is an example of a lost battle. JPMorgan Chase’s earnings release was posted earlier than scheduled this morning on the Internet site that hosts the bank’s earnings documents. Oops.

And a side note on cyberattacks; a hacker claims to have stolen 7 million usernames and passwords for Dropbox, the cloud based file storage and sharing service. Dropbox says their servers have not been hacked, but you might want to change your passwords. I’m just saying.

Wells Fargo, the nation’s largest bank by market capitalization, reported net income of $5.7 billion, compared with year-earlier profit of $5.5 billion. Per-share earnings were $1.02 versus 99 cents a year earlier. The quarter marked the 17th consecutive period of year-over-year profit growth. Earnings matched estimates. Revenue increased 3.6% to $21.2 billion.
Wells Fargo, the country’s No. 1 mortgage originator, said it made $48 billion in new home loans in the third quarter, up slightly from the prior quarter, and down 40% from the year-earlier period. Meanwhile, JPMorgan Chase, the second-largest mortgage lender, said its third-quarter originations hit $21 billion, up from $17 billion in the second quarter, and down 48% from a year earlier.

Mortgage originations have dropped over the past year for lenders across the country as interest rates rose, which dried up refinancing applications. Now the mortgage market is increasingly driven by borrowers who want to buy a home.

JPM – .17 = 57.99. WFC – 1.37 = 48.83.

Citigroup reported third quarter net income increased to $3.4 billion or $1.07 a share on revenue of $19.9 billion, beating estimates. And in addition to the earnings report we also get today’s edition of “Banks Behaving Badly”. Citi revealed that the private-security unit in its Mexican bank engaged in illegal and unauthorized activities that included working for people outside of the bank and using intercepted phone calls. The fraud at Banamex began around 2000 and continued through last year, and included misreporting of gasoline expenses to inflate reimbursements from the bank, and shell companies were used to launder proceeds. The fraud amounted to about $15 million. Citi has disbanded the group. The disclosure marks the latest setback for Citigroup in Mexico, where separate incidents involving fraud have cut earnings by $400 million.

After the close, Intel reported a third-quarter profit of $3.3 billion, or 66 cents a share, compared with $3 billion, or 58 cents a share a year ago. Revenue for the quarter rose to $14.6 billion. Intel beat expectations.

CSX, the railroad company reported third quarter earnings of 51 cents per share on revenue of $3.2 billion, topping estimates. Yesterday, CSX said it had been approached by Canadian Pacific Railway about a possible merger. A CP-CSX deal would give rise to an industry giant with a combined market value of about $62 billion and, potentially, an increased ability to exploit the North American energy boom. CSX-controlled rails run from the Midwest to refineries on the East Coast, but the railroad lacks direct access to North Dakota oil fields. CP does have access to North Dakota oil-loading terminals. A deal would potentially create a single railroad operator that could haul crude from oil fields all the way to fuel-making plants in the Northeast.

The National Federation of Independent Business‘s small-business optimism index fell to 95.3 in September from 96.1 in August. The report said, “Optimism can’t seem to get out of second gear.” The decline can be traced to steep drops in two components. The subindex covering hard-to-fill job openings fell 5 percentage points last month to 21%, while the capital outlays subindexes tumbled 5 points to 22%. In addition, small business owners are cautious about their sales activity. The positive earnings trend declined 2 points to -19%, while the sales expectation subindex fell 1 point in September to 5%.

And today’s disconnect comes from a survey by the New York Fed that shows most consumers are optimistic about income growth; the median household income growth expectations rose to 2.9% in September from 2.5% in August. That said, the same group didn’t plan to spend their anticipated wealth; median household spending expectations fell to 4.4%, the lowest level since at least June 2013, when the survey started.

The Swiss bank Credit Suisse issued a report on global wealth. The ratio of wealth to household income in the US is the highest it has been since just before the Great Depression. In the 64 page report the bank warned that “This is a worrying signal given that abnormally high wealth income ratios have always signaled recession in the past.”

The wealth to income ratio typically runs around 4 or 5; in other words, wealth is about 4 times greater than annual income, but sometimes the country’s wealth stockpile surges to even greater heights; right before the Great Depression, the ratio jumped to 7, and right before the dot-come and housing bubbles it jumped up to 6. Now, the ratio is about 6.5. The ratio tends to get out of whack when bubbles of one sort or another have been built up, and the correction usually takes the form of a recession. No guarantees.

The collapse in crude-oil prices continues. The International Energy Agency cut its forecast for oil demand growth. The IEA projects demand this year to rise by 700,000 barrels a day, down from its previous estimate of 900,000 barrels a day. Chinese crude oil imports plummeted by 63% over the last five months, from 800,000 barrels a day in April to 290,000 in September. Meanwhile, supply from the US and Libya has surged; Libyan production is up by more than a third since August, to 810,000 barrels a day, and the country aims to reach 1 million barrels a day by the end of the year. At the same time, America’s oil boom is well documented. Shale oil production has grown by roughly 4 million barrels per day since 2008.

A couple of weeks ago a leading Saudi oil official said US shale requires $90 a barrel prices in order to stay profitable. This morning’s report from the IEA, says oil prices could go as low as $80 a barrel and barely put a dent in US shale production: from 2.8 million barrels a day this quarter, shale oil production would fall to 2.7 million barrels, a drop of 4%. The IEA forecasts drillers globally would only slightly cut back high-cost projects, reducing worldwide production by just 2.8%. There is of course, the political side of the oil story; low oil prices hurt Russia even more than sanctions.

Germany cut its official growth forecasts to 1.2 percent for 2014 from a previous 1.8 percent, and to 1.3 percent in 2015 from 2.0 percent, blaming crises abroad, notably with Russia, and moderate global growth. Chancellor Angela Merkel says Germany will stick to its budget and will not spend more to try to stimulate growth.

Ireland moved closer to closing a tax loophole known as the “Double Irish” that allows corporations like Apple and Google and about 1,000 others to avoid paying taxes in the US. The change was included in Ireland’s budget, which was released today and for the first time in 7 years did not include new austerity measures. Apple pioneered a method of skirting taxes by funneling its money through small subsidiaries set up in states or countries with low tax rates. A 2012 report in the New York Times documented how an Apple office in Reno, Nevada saved it millions that it would have owed to California. Subsidiaries in Ireland, the Netherlands, Luxembourg and the British Virgin Islands, meanwhile, helped save the company billions of dollars.

The European Commission has issued a preliminary finding that a special deal Ireland negotiated with Apple to cap the company’s tax rate violates the common market’s rules about illegal domestic subsidies; if the final ruling agrees, billions in fines could follow. The new rule, which will take effect in January, won’t affect companies currently employing the tax structure until 2020. So, there is about 5 years to figure out some new way to avoid paying taxes, but we don’t have to wait that long. Even as Irish officials announced the closing of one loophole, they announced the opening of another: the country plans to develop a special tax regime for intellectual property (IP), called a “knowledge box.” Essentially, it will give a special, lower corporate tax rate to companies on profits derived from IP.