FINANCIAL REVIEW

Divergence

Sinclair Noe — December 9, 2014

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

DOW – 51 = 17,801
SPX – 0.49 = 2059
NAS + 25 = 4766
10 YR YLD – .04 = 2.22%
OIL + .80 = 63.85
GOLD + 27.80 = 1233.00
SILV + .73 = 17.21

We’ll start with economic news.

The Labor Department reports there were 4.83 million job openings in October, up from 4.69 million job openings in September. The number of available jobs means workers are more likely to leave their current jobs in search of a better deal. The quit rate, the share of total employees opting to quit their jobs was 1.9% in October, roughly the same level it was just before 2007. With 9 million unemployed people in October, there were about 1.9 potential job seekers per opening. In October 2013, there were 11.14 million unemployed people or about 2.8 potential seekers per opening.

The Commerce Department reports wholesale inventories increased 0.4%, despite an energy price-related decline in the value of petroleum stocks. September’s wholesale stocks were revised up to show a 0.4% gain. This might indicate that third quarter GDP could be revised slightly higher.

The National Federation of Independent Business says small-business sentiment reached a seven-year high in November. The index rose 2 points to 98.1, the highest level since Feb. 2007, as expectations for business conditions in six months surged and expectations for real sales volumes also gained. While stocks have soared and GDP and employment figures have returned to pre-recession highs, small business has lagged in the recovery. But that’s changing. Small businesses added more than 100,000 jobs to their payrolls last month, accounting for almost half of the total gains in the private sector.

So the economic news in the US was pretty good today. No reason for a market selloff, but that’s how the morning started, with a 200 point decline on the Dow. Crude oil prices bounced a little higher but nothing outside the norm. Sure the Federal Reserve could put the brakes on a Santa Claus rally; the Fed FOMC meets next week, and they might make minor changes to their language to indicate a willingness to raise rates next year, or Fed policymakers might drop their assurance that short-term interest rates will stay near zero for a “considerable time” and replace it by saying they’ll be patient before moving rates. What’s the difference between “considerable time” and “patience”? Who knows?

And don’t forget that politicians in Washington could always throw a monkey wrench in the works. They’ve done it before. Congressional negotiators were nearing a deal on massive spending legislation that would avert a government shutdown and bring the 113th Congress to a close, but they can’t resist the temptation to add on bits of legislation not directly related to the spending bill. A vote is expected by Thursday. And even if the bill makes it out of the House, the Senate could take up and pass the spending bill shortly after it leaves the House, but only if all senators agree. And this might shock you but it doesn’t look like all senators are in agreement on the bill; which could mean a push for further debate, forcing a continuing resolution and pushing the matter into next week when most of the politicians are planning a trip home for the holidays.

Meanwhile, the rest of the world is having a hard slog. In China the day started with a hard selloff in equities as the country moves to rein in credit as part of a broader set of financial reforms. China’s securities clearinghouse issued temporary restrictions on using lower-rated or riskier corporate bonds as collateral for short term borrowing. Chinese stocks had been surging for months. The Shanghai Composite Index is up almost 50 percent since July. The rally has been largely fueled by individual retail investors, who have been piling into the market and increasingly resorting to margin financing, or short-term borrowing, to purchase shares. While welcoming signs of life in the country’s stock markets, Chinese officials have grown wary in recent weeks of the rising levels of debt that have fueled the rally, and they have cautioned investors against speculation. If the stock market’s credit line is not yet maxed out, the question for investors is whether Beijing is likely to pull the plug and kill the party. The Shanghai Composite index dropped 5.4% today. The Shenzen Exchange dropped 4.2%. That doesn’t mean the bullish trend is over, but it was a gut check.

Then international trading moved to Europe and the Athens stock market crashed, down 11.2% on the day. Greek Prime Minister Antonis Samaras announced that Greece’s presidential elections will be held on December 17, two months earlier than scheduled. And there are no candidates yet. The opposition party Syriza, best known for its opposition to the Eurozone’s bailout of Greece, said the government doesn’t have the votes needed to elect a president. If Greece does not elect a president on December 17, snap parliamentary elections will be called.

Also, a report from The Financial Times said that Greece and finance ministers in the Eurozone agreed to extend Greece’s bailout by two months after the government failed to adopt the economic reforms required to get the last of their rescue funds. And so while the European Central Bank deals with flagging economic growth and rapidly declining inflation, the Eurozone might have to respond to political unrest in Greece, too.

What exactly is the Syriza political party? Well, first, it isn’t a political party, it is a coalition; so they don’t exactly have a party platform. But generally speaking they are opposed to austerity. They are essentially good with sovereign debt default, or at least a haircut for bondholders; they want the ECB to directly purchase Greek bonds; they want to write off the bank debt of people who can’t afford to repay; they want to tax the rich; and in a country with 25% unemployment and 50% youth unemployment, they want the EU to fund a jobs program.

Now, just a quick refresher on Greece, back in 2010 they faced insolvency; the Euro Union and the International Monetary Fund stepped in and extended non-performing loans and pretended there was no problem. In 2012, they continued the “extend and pretend” strategy while extracting a pound of flesh in the form of austerity budgeting, essentially transferring the hundreds of billions in losses from the Greek bankers to the Greek taxpayers. Eventually, the vulture funds moved into Greece to pick over the remains in the Greek bond market. But now, Greek voters may be saying that they won’t play the game anymore and the Euro-crisis is back on the front burner.

So, as we head into 2015, we have a US economy showing signs of solid recovery with a consistently improving labor market; we have China trying to deal with market instability as they try to stabilize at lower growth rates than in recent years; and the Eurozone dealing with economic stagnation which has fueled social and now political disenchantment which bodes poorly for future investment prospects. Where this all ends up in 2015 is hard to guess, but it would be easy to see some extreme volatility if even one of these economies jumps the tracks.

Meanwhile, the Supreme Court is back in session and they are handing down rulings. Today, the Supremes ruled that warehouse workers who fill orders for retail giant Amazon don’t have to be paid for time spent waiting to pass through security checks at the end of their shifts. The unanimous decision is a victory for the growing number of retailers and other companies that routinely screen workers to prevent employee theft. The justices said federal law does not require companies to pay employees for the extra time because it is unrelated to their primary job duties. Writing for the court, Justice Clarence Thomas said the screenings are not the “principal activity” which the workers are employed to perform.

And that brings us to today’s edition of “Banks Behaving Badly”. Federal prosecutors in Manhattan have sued Deutsche Bank, claiming that the bank owes the United States government about $190 million in unpaid taxes, penalties and interest. Prosecutors contend the tax liability stems from a transaction that Deutsche Bank undertook 14 years ago. The bank had acquired a company that held shares of Bristol Myers Squibb, and when the bank sold those shares, they made a profit of about $100 million. Prosecutors say they did not pay tax on the gain. Deutsche Bank claims they made a deal with the IRS in 2009 and paid to settle. The bank did not release the payment to the IRS, but insiders are saying it was $6 million. Prosecutors say the bank used shell companies to artificially inflate the cost basis of the stock so it did not owe any capital gains on the appreciation.

Citigroup will record $2.7 billion in litigation expenses and another $800 million in repositioning charges in the fourth quarter, leaving the bank with a small profit for the quarter. The $800 million in repositioning charges is an interesting way to say they will be firing more workers and close branches. The legal costs stemmed from government investigations into possible manipulation of foreign exchange markets, rigging Libor interest rates, and violating money laundering rules. That’s right, Citi is a repeat offender.

Citigroup adjusted its third-quarter earnings lower on Oct. 30, two weeks after the numbers were initially reported. The company added a $600 million legal charge that it attributed to “rapidly evolving regulatory inquiries and investigations.” Last month the bank agreed to pay $1 billion to settle a probe into currency manipulation with three regulators in the US and the UK. Michael Corbat was named CEO of Citi 26 months ago. Under Corbat’s tenure, the bank has reported earnings of $21.8 billion over 8 quarters. In the past 26 months, Citigroup has had legal expenses and repositioning charges totaling $13.3 billion, or more than half the banks’ earnings.