FINANCIAL REVIEW

Monday.

Sinclair Noe — October 27, 2014

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

DOW + 12 = 16,817
SPX – 2 = 1961
NAS + 2 = 4485
10 YR YLD – .02 = 2.26%
OIL – .52 = 79.92
GOLD – 5.90 = 1226.10
SILV – .10 = 17.21

In economic news: the National Association of Realtors reports pending home sales rose 0.3% in September, hitting the second highest level for this year. The index of pending home sales reached a seasonally adjusted 105 in September, compared with 104.7 in August. Slower price growth and more homes for sale are likely supporting pending home sales. Pending sales typically close within 2 months, and so this gauge augurs well for actual sales.

Financial data firm Markit said its preliminary or ‘flash’ services sector purchasing managers index slipped to 57.3 last month, the lowest reading since April, from 58.9 in September. A reading above 50 signals expansion in the services sector. The index has been gradually declining for 4 months. The October readings would indicate fourth quarter GDP slowing to about 2.5%.

Goldman Sachs analysts revised their price outlook for oil; they are decidedly more bearish, predicting $75 a barrel for the first quarter and second half of next year. The thinking is that US shale oil will be enough to keep prices down, and non-OPEC countries will continue to provide plenty of supply, so even if OPEC wants higher prices, they will find it difficult. Oil prices hit a 28 month low today, breaking a key area of support at $80 a barrel. So, that started a big debate over how low oil can go. One of the more interesting arguments comes from Dennis Gartman, publisher of the Gartman Report, who says the era of oil is over. At one point, Gartman went so far as to compare crude oil to whale oil, which became obsolete following the advent of crude in the early 20th century.

This week’s economic calendar includes reports on durable goods orders and also consumer confidence tomorrow. The durable goods report has been all over the place, so we’ll try to smooth out those numbers; companies probably increased spending and investment in September, after stripping out the volatile airline and auto sectors. Consumer confidence is projected to move from 86 to 87. Friday brings reports on consumer spending and consumer confidence and the core PCE inflation numbers. Wednesday brings the first estimate of third quarter GDP; look for 3% growth, which would be down from 4.6% second quarter GDP growth, but still pretty good. Just the kind of sluggish, mediocre growth that has characterized the recovery. There is a very good chance that 2014 GDP will come in just under 2.5%. One area of concern for the GDP number is whether the strong dollar has hurt exports. Also, there will likely be a little less spending on automobiles, which enjoyed a big sales boom in the second quarter. And lower oil prices actually might trim GDP.

Of course the markets will be following the Federal Reserve FOMC meeting on Tuesday and Wednesday. The Fed will issue a statement on Wednesday but there will be no press conference or economic forecasts. And so we should expect the expected. The Fed will likely announce the end of QE3 bond buying, as previously announced. The Fed will likely say that raising interest rates won’t happen for a considerable time. They will likely say they are still concerned about low inflation. And they will probably say something to appease the financial markets. Do not expect the Fed to say much of anything they haven’t said before.

There were a few interesting developments over the weekend, including stress tests and elections. The European Central Bank conducted stress tests of 130 banks; 25 failed. Some failed by a little, some failed by more, at least 9 failed banks were in Italy. Also, the ECB looked at the assets held on the books of 123 banks, a variation on the stress test known as the Asset Quality Review. The ECB found €136 billion in troubled loans banks had not already confessed to owning, bringing the European total to €879 billion ($1.1 trillion). Now, you may remember Dexia, the Belgian bank that failed a few years ago, after it had passed one of the first ECB stress tests; so, there is some concern about how much these tests actually reveal about the soundness of Euro banking.

The good news is that more than 100 Euro banks passed the test, but it doesn’t mean they will start lending anytime soon. In the US, it has been a long slow climb. Overall US bank lending has grown at a modest 1.9% annual rate during this recovery and commercial and industrial loan growth has grown at a 3.6% rate. Only recently, five years after US stress tests, have total bank lending and business lending started to pick up in earnest. In September total bank loans were up 6.3% from a year ago, the best performance since 2008, and commercial industrial loans were up a robust 12.3% from a year ago. And Ben Bernanke still can’t get his mortgage refinanced.

The bad news is that the tests were designed to show that Euro banks were strong enough to weather another financial crisis. And the fact that many banks are not ready, means that a cascading effect would probably topple the banks that passed. So, if the idea behind the test was to reassure markets, well, probably not.

US banks will undergo another stress test in January, and the banks are already getting ready. Wall Street’s biggest debt dealers have been dumping speculative-grade securities, or what most people call junk bonds, at the fastest pace on record ahead of annual stress tests by the Fed. They reduced their holdings by 68 percent in the week ended Oct. 15. US junk bonds dropped 2.1 percent in September, their worst month since June 2013. They’ve gained 1.1 percent in October as some investors return to the debt to chase higher yields. The 22 primary dealers that trade with the Fed pared their high-yield bonds to a net $2 billion dollars on Oct. 15 from $6.26 billion the week before. The Fed and the Office of the Comptroller of the Currency have been heightening their scrutiny of leveraged lending, too, leading the biggest banks to back away from funding some takeovers financed by the debt. They’ve warned banks that rising levels of such risky loans on their balance sheets may require more capital held against them.

Of course, there is more to economic recovery than sound banks. Thinking that lending somehow can lead GDP is an illusion. Businesses need to believe in an increase in the demand for their products before asking for credits, and if that external demand growth is no longer there, then there is a need for additional stimulus, which has been tried by the Fed, and has helped to prop up the banks, but has not propped up broader demand; to do that we need to improve jobs and wages.

Elections over the weekend in Ukraine showed voters supporting pro-Western parties. President Petro Poroshenko hailed the vote as a mandate to end a rebellion in the country’s east and to steer the country further away from Russian influence.

In Brazil, incumbent Dilma Rousseff defeated challenger Aecio Neves. Dilma represented the Workers Party, which rose to power 12 years ago under Lula da Silva. Aecio represented the Social Democracy party, considered the conservatives in the campaign. Brazilian markets have been erratic and mostly lower leading to the election, and today. The country has experienced a recession. Economic growth has slowed from 7.5% in 2010 to 2.5%. The Brazilian equity markets were down about 2.8% today, and are in bear territory. The currency, the real, was down 1.9% today to a 9 year low. And that’s just the beginning of troubles for Brazil. You may remember the protests that brought millions of Brazilians to the streets to deal with the issue of inequality; it still hasn’t been addressed. Then there are issues of political and judicial corruption; environmental impacts of development projects; and pretty much everything else in Brazil is screwed up, with the possible exception of the beaches.

And Brazil matters. It is the fifth largest country in the world, both by geographical area and population; and the seventh largest economy, and the largest economy in Latin America. At its core, the election was between two opposing ideologies, one supporting business and stabilizing the economy through privatization and tighter fiscal policies; and the other promoting anti-poverty programs, social welfare, and education. The latter won. The question now is what Rousseff will do to consolidate her position.

And it is still earnings season.

Twitter posted 3Q results. Sales of $361 million, better than estimates. EPS of $.01, which Twitter nailed. Down 10% in after-hours trading.
(By the way, I did that in 140 characters.)

Amgen reported higher-than-expected third quarter earnings and revenue, even as net profit fell due to a hefty restructuring charge, and the company raised its full-year forecast and the number of job cuts it expects to make. Excluding items, Amgen earned $2.30 per share, exceeding analysts’ average expectations by 19 cents. Amgen was up about 1%.

Merck beat third-quarter earnings forecasts but disappointing sales of its Gardasil cervical cancer vaccine and other big products sent its shares about 2 percent lower. Merck said it earned $895 million, or 31 cents per share, in the quarter. That compared with $1.12 billion, or 38 cents per share, in the year-earlier period.

Kohl’s, the department store retailer, warned its earnings for the year will likely hit the low end of its previous guidance as October sales have been soft.

The big earnings report tomorrow will be Facebook, after the close.

Elon Musk, the guy behind Tesla, delivered a speech at MIT on Friday, in which he called artificial intelligence the greatest existential threat to our existence. I don’t know. It sounds a bit far-fetched.

But on a related note, Charles Schwab says that it will introduce free automated investment plans picked by computer algorithms in the first quarter of 2015. Investments are allocated by computer algorithm to some 20 asset classes ranging from U.S. stocks and bonds to commodities and emerging markets securities. Robo-advisors, what could go wrong?