FINANCIAL REVIEW

Some Outcomes Are So Predictable

Sinclair Noe — November 18, 2014

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

DOW + 40 = 17,687
SPX + 10 = 2051
NAS + 31 = 4702
10 YR YLD – .02 = 2.32%
OIL – 1.34 = 74.32
GOLD + 9.80 = 1198.00
SILV + .07 = 16.31

Record highs for the Dow Jones Industrial Average (26th of 2014) and the S&P 500 Index (43rd of the year). While there are plenty of reasons for concern, the major stock indices have been climbing a wall of worry. Today, health care stocks pulled the market higher.

Wholesale prices in the US increased in October as higher costs for services and food outweighed a slump in energy. The Producer Price Index was up 0.2% compared to a 0.1% drop in September. Wholesale prices excluding food and energy rose 0.4 percent after no change a month earlier. Compared with 12 months earlier, producer prices rose 1.5% and the core index increased 1.8 percent in the year ended October. Prices for goods dropped 0.4 percent last month, the most since April 2013. Energy costs decreased 3 percent last month, the biggest decline since March 2013. Wholesale food costs climbed 1 percent as prices of vegetables, eggs and meats increased. The cost of services increased 0.5 percent in October, and this is a major reason why the overall index was higher. Now normally services don’t jump that much. What happened?

The nationwide average price of a gallon of regular unleaded gas was $2.89 on Nov. 16, its lowest level since the end of 2010. Oil prices have been falling fast but gas prices, the price at the pump, has not dropped as fast; there was a lag. At gas stations and other retail fuel vendors alone, margins jumped 26.1 percent, the most in more than four years; and that showed up in the inflation report under “cost of services”. It looks fairly clear that if gas stations had passed on lower prices faster, there would have been little of no increase in the PPI.

Gas stations aren’t the only ones who are refusing to pass along savings from lower fuel prices. In the 12-month period ending in September, U.S. airlines burned through nearly 16.2 billion gallons of fuel. They paid an average of $2.97 a gallon, down from $3.07 the prior year. That 10-cent drop saved the industry $1.6 billion. Fuel prices have since fallen further. United Airlines estimates it will pay $2.76 to $2.81 a gallon during the last three months of the year.

Are airfares falling? Well, of course not. The average domestic airline ticket during the 12-month period ending in September rose 3.5 percent to $372. That figure doesn’t include another $56 in taxes and fees that passengers pay. And if you want to check luggage, well, take out a loan. You may remember that when fuel prices were higher, the airlines responded by limiting the number of flights to fall just short of demand, giving them the power to charge higher fares.

What are the airlines doing with their newfound profits? They are buying more planes; 10,000 new orders for more fuel efficient jets in the past 5 years. In the first nine months of this year, US carriers spent $10.2 billion on capital improvements, or a little more than $1 billion a month.

The National Association of Home Builders/Wells Fargo gauge measures homebuilders’ confidence; a reading above 50 indicates confidence. The gauge rose four points to 58 in November. Confidence has not yet resulted in a building boom. Later this week the government will report on new-home construction, and economists expect that the pace of residential starts was just about unchanged in October.

Yesterday, Japan announced its economy contracted 1.65 in the third quarter, officially moving into another recession. Today, Prime Minister Shinzo Abe called an early election and delayed for 18 months a second planned sales-tax increase after the first installment in April led consumer spending to stagnate.

Clearly Japan is still struggling; the Eurozone likewise; and the emerging economies are getting clobbered by a downturn in commodities. China’s economy is still growing but at a much slower pace, and Russia is tumbling toward its own unique catastrophe. Here in the US, the economy looks moderately acceptable and the stock market is hitting record highs. So the big question is whether the US economy can carry the world, or if the world will drag down the US economy, or whether there will be a decoupling.

In today’s edition of “Banks Behaving Badly” we feature Bank of Tokyo-Mitsubishi UFJ, a familiar name; you may recall that last year the bank was fined $250 million by the New York Department of Financial Services for hiding information about transactions with Iran, Burma and Myanmar, countries that were under sanctions. The bank “misled” the department in reaching the 2013 settlement, with key information deleted from a supposedly objective report; and so now they face an additional $315 million fine for submitting a whitewashed report. PricewaterhouseCoopers, which produced the 2008 report for the bank, agreed in August to pay $25 million and refrain from certain work in New York for two years after the regulator accused the consulting firm of altering its findings under pressure from bank lawyers and executives.

Now, this is just crazy on several different levels. First, the bank hid information about transactions with countries on the sanction list; then they put together a report which hid information about how they hid information; and to do this, they had to bully their auditor. Then the regulator actually allowed the accused bank to put together a report explaining how they had violated the rules, and then the regulators were apparently shocked that the report whitewashed the bad behavior. This is something like have the crooks fill out the police report and serving as a consultant for the prosecutors. What could go wrong?

If you are wondering how regulators could be such puppets of the banks, we offer the case of JPMorgan. ProPublica reports that the Federal Reserve Bank of New York put a team of regulators in JPMorgan to supervise the nation’s largest bank, and then JPMorgan bankers blocked the investigators from investigating; and when the investigators complained, the Federal Reserve Bank of New York did …, pretty much nothing. And what followed was the London Whale trading scandal resulting in about $7 billion in combined losses and fines. The new report essentially says that if the investigators had been allowed to do their job, things might have turned out different.

A US Senate subcommittee report was more blunt, saying: “[T]he whale trades exposed a bank culture in which risk limit breaches were routinely disregarded, risk metrics were frequently criticized or downplayed, and risk evaluation models were targeted by bank personnel seeking to produce artificially lower capital requirements.”

Remember when JPMorgan’s CEO Jamie Dimon bragged about how clean JPMorgan was compared to all the other banks? Now we know that he really meant JPMorgan was better at hiding its dirt from investigators.

Some outcomes are so predictable.

Fortunately, there are still some great mysteries. And a little, dishwasher sized spacecraft has been trying to unlock the mysteries of the universe. The spacecraft is called the Philae, and it is the landing craft of the Rosetta craft that flew 300 million miles and then launched the Philae onto Comet 67P. The Philae bounced and landed a couple of times in the low gravity conditions, and then it came to rest on the side of a cliff, in darkness; it’s solar powered battery packs were unable to recharge. And you probably thought that was the end of the story. Not exactly. Before the batteries ran out, the Philae detected carbon-based, organic molecules.

It isn’t clear whether they included the complex compounds that make up proteins. One of the key aims of the mission is to discover whether carbon-based compounds, and through them, ultimately, life, were brought to early Earth by comets. Scientists are analyzing the data to see whether the organic compounds detected by Philae are simple ones, such as methane and methanol, or a more complex species such as amino acids, the building blocks for proteins. A drill on Philae also obtained some material from the comet’s hard surface, but data about organic molecules from that experiment have yet to be fully analyzed. The little unmanned spacecraft wrapped up its mission on the comet’s surface on Saturday after radioing back data from a series of experiments and then its battery ran out. And that is probably the last we will ever hear from this historic spacecraft.

The comet is now speeding toward the sun, where it may explode, or maybe the sun’s gravitational pull will slingshot the comet into the far flung reaches of the galaxy. And as the comet hurtles toward the sun, maybe, just maybe some light will hit the solar panel on the Philae, and the battery will recharge, and we will learn something that we never knew before.