FINANCIAL REVIEW

Before the Flood

Sinclair Noe — December 11, 2014

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

DOW + 63 = 17,596
SPX + 9 = 2035
NAS + 24 = 4708
10 YR YLD + .01 = 2.18%
OIL – 1.22 = 59.72
GOLD + 1.30 = 1228.40
SILV + .04 = 17.20

We have a lot to cover. Let’s start with the economic news. The government reported early this morning that retail sales in November expanded at the fastest pace in eight months, rising 0.7%. A wide variety of retailers reported healthy sales last month. Retail sales growth hit 1.7% for autos, the most since August; and 1.2% for clothing, the most since April. Sales at building material and garden equipment stores jumped 1.4%, the most since April; while online or non-store retailers saw a 1% sales gain.

The Commerce Department reports business inventories rose 0.2% in October, as building material and clothing stores both built stocks heading into the holiday season. That represents a 4.8% gain from October 2013.

The number of people who applied for unemployment benefits hit the lowest level in three weeks, as employers continued to lay off very few workers. Initial claims for regular state unemployment-insurance benefits inched down by 3,000 to 294,000 in the week that ended Dec. 6.

The prices paid for imported goods fell 1.5% in November, the largest drop since June 2012, dragged down by lower fuel prices. Excluding fuel, import prices declined by 0.2% last month. The price of US-made goods exported to other nations, meanwhile, fell by 1% in November, the biggest decline since April.

Household wealth in the US dropped $140 billion from July through September, or 0.2% from the previous quarter to $81.3 trillion. The Federal Reserve used to call this report the flow of funds survey. Survey says the net worth of households dropped because of stock market weakness over the summer; the value of financial assets, including stocks and pension fund holdings, held by American households decreased by $315 billion in the third quarter. So the drop may be temporary, as stocks have rebounded in the fourth quarter. Household real-estate assets climbed by $214 billion.

The OECD, the Organization for Economic Cooperation and Development has ranked 43 nations on various economic measures. The typical American is even poorer than his or her equivalent in Greece. The median Australian is four times wealthier. The Canadians are twice as wealthy. The US continues to lead the world in billionaires (571 in 2014, with China a distant second at 190). But Americans rank 26th in median wealth (defined as assets owned, minus debts owed for the person on the middle rung of the wealth ladder).

Oil prices continued to crumble. I thought $60 would be an important level of support, but the price cut through that level like a hot knife through butter, to settle at 59.72, the lowest closing price since July 2009. Oil prices are now down 39% year to date. There are several reasons for the drop in oil prices. First, the US has been producing more oil, including shale oil, and yesterday the US Energy Information Administration reported that supplies had increased 1.5 million barrels for the week ended December 5th. Meanwhile, OPEC has not cut production as they try to maintain market share against the shale producers. Also, there is some geopolitical positioning as Saudi Arabia plays hardball with Russia and Iran over Syria. This makes any rapid recovery of oil prices unlikely, especially as additional supply looks set to reach the market from northern Iraq and Libya. Next, the Chinese economy is slowing slightly and the Eurozone is stagnant. The International Energy Agency estimates global oil demand for 2014 will now average 92.4 million barrels per day, reflecting the weakest growth in 5 years. OPEC predicts that demand for its oil will drop by about 500,000 a day in 2015. Also consider that oil is purchased in dollars and the dollar is strong; as the dollar increases in value relative to other currencies, it means you can buy more oil with each dollar. Oil’s price plunge started not long after the dollar rally began to accelerate; if the dollar rally falters, look for oil to find support, but it hasn’t happened yet.

As oil prices have dropped, the yield on junk bonds has been climbing because there are a bunch of junk bonds financing oil development projects; prices on high-yield bonds have declined 2.4% this month and 5.7% since the end of August, even as US equities have climbed to new highs. The divergence may signal junk-bond traders are picking up on a fundamental problem of overvalued energy companies in frothy markets. The energy sector accounts for 22% of US high-yield issuance and 16% of loan issuance through December. Some analysts are predicting a wave of defaults in the next couple of years. New York-traded oil futures around $60 a barrel would push energy companies with a riskier credit profiles to a level that would imply a 30% default rate.

Treasury Secretary Jacob Lew said today it was “premature” to talk about risks of contagion in US financial markets from the drop in oil prices. Asked for his reaction to the fact that many leveraged loans are tied to the energy sector, Lew said in general there will be winners and losers from the drop in energy prices. Overall, he said the drop in oil prices was like “a tax cut for the economy.” It may be premature to talk about contagion but don’t expect Secretary Lew to ring a bell when contagion is no longer premature.

In Washington, the politicians are wrangling over a spending bill to fund the government. A vote was supposed to take place today, but so far no vote. Then the vote was pushed back to 8PM Eastern, but that may or may not happen. The reason is that they aren’t sure they can muster enough votes for passage. Both Republicans and Democrats are opposed to the funding bill for different reasons that are not directly related to funding the government. Some Republicans are upset that the spending bill would delay any action to confront Obama over immigration. Some Democrats are upset about provisions that would scrap parts of the Dodd-Frank Financial Reform Law regarding federal insurance of some banks’ derivatives trades, plus a provision that would loosen campaign finance restrictions. The omnibus appropriations bill also combines a continuing resolution, and the whole thing is reportedly 2871 pages. I haven’t read it. The politicians that may or may not vote on it, have not read it. This is no way to run a government, which may shut down at midnight.

Can you name the worst performing global stock market in 2014? If you answered Russia’s RTX Index, you are correct; it is down 43% year to date. The Russian central bank raised interest rates again today, the fifth rate increase this year; rates now stand at 10.5%. It didn’t work. The Russian ruble fell 1.6% today.

Can you name the second worst performing stock market this year? The answer is the ASE Index, or the Athens Stock Exchange in Greece, which has been dropping like a rock this week, down 7.9% today, and down 29% year to date. The ASE had rallied to an almost three-year high in March. Greece’s government said this week it would start the process of electing a new president early, like next week early, even though they haven’t even figured out who the candidates will be.

A US appeals court has overturned the convictions of 2 former hedge fund managers for making illegal insider trades. The court held that defendants can only be convicted of insider trading if the person trading on confidential information knew the original tipper disclosed it in exchange for a personal benefit. So, if you were wondering how to get away with insider trading, the courts have now laid out the secrets. You cannot ask for a specific insider tip, pay for that insider information, and then trade and profit from that information. You can ask for specific insider tips but you must not pay for it directly; you can provide indirect compensation such as meals, travel, hookers, cocaine, box seats to a basketball game or even future compensation at some unspecified future moment in time; then you can trade on that information and profit from that information. So, apparently the courts have ruled that insider trading is acceptable as long as the trader is not blatant about directly paying for the insider information.

Insider trading is still cheating, of course. And it hurts the honest traders on Wall Street; and it hurts regular everyday investors; and it erodes the integrity of Wall Street, which I must admit is an oxymoron; and it further diminishes the integrity of the legal system, which is currently pretty low.

If you’re planning on traveling to California, think again. The Golden State is getting pounded by the Pineapple Express, a massive Pacific storm that is causing flooding and high winds and power outages. The storm is still centered out at sea but it is expected to bring up to 6 inches of rain to some areas near San Francisco and 4 feet of snow to the Sierra Nevada Mountains. We’ll get some remnants of the storm in Arizona over the next few days. The term Pineapple Express refers to a warm, moist air mass that brings rain to the Pacific. It’s called a Pineapple Express because the moisture stream comes from near Hawaii where pineapples are grown. Another way to think of the Pineapple Express is a river of water in the sky. In 1862, a Pineapple Express hit California and reportedly dumped up to 8 feet of rain on some places, leading to the worst flooding in recorded history of California, Oregon, and Nevada. Known as the Great Flood of 1862, both the Sacramento and San Joaquin valleys flooded, and there was extensive flooding and mudslides throughout the region. Nowadays, the extensive waterways and earthen dams from San Francisco to Sacramento would be demolished by that kind of flooding.

There is another round of storms expected to hit the coast next week, but it is nothing like the great storm of 1862, and it is not enough to end the drought in California, which some scientists say has been the worst drought in California in more than 1,000 years. Meteorologists say we would need to see 5 more storms like this before they would consider the drought to be ended. Meanwhile, much of the rain from this storm will wash away, leaving some landslides in its wake.