FINANCIAL REVIEW

One Thing Is One Thing

Sinclair Noe — January 13, 2015

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

DOW – 27 = 17,613
SPX – 5 = 2023
NAS – 3 = 4661
10 YR YLD – .02 = 1.89%
OIL – .03 = 46.04
GOLD – 2.30 = 1232.10
SILV + .43 = 17.14

The stock market went south so fast. We started the day with a triple digit gain, up more than 250 points, then down by more than 100; there was a 425 point swing from high to low.

It is earnings reporting season. Shares of home builder KB Homes fell 16% after reporting softer demand in the fourth quarter hit gross margins, which will continue to lag prior-year results for some time.

CSX, the railroad company, today announced record fourth-quarter 2014 net earnings of $491 million, a 15 percent increase from $426 million for the same period last year. The company also generated record fourth-quarter earnings per share of $0.49, up 17 percent from $0.42 per share in 2013.
Tomorrow, JPMorgan and Wells Fargo will report earnings; Bank of America reports on Thursday, and Goldman Sachs on Friday.

MetLife wants the government off its back. The US’s biggest life insurer is going to sue to challenge its designation as “systemically important”. The institutions that receive the designation are expected to bolster their capital and liquidity and to submit to heightened monitoring by the Federal Reserve under the 2010 Dodd-Frank Act to prevent another financial crisis. MetLife is the first to sue.

The Justice Department and more than a dozen states attorneys general have accused Standard and Poor’s Credit Rating Agency of handing out, for a fee, highly inflated credit ratings to mortgage investments that then collapsed and helped to spur the financial crisis. The government is looking for a settlement of $1 billion. Still, S&P mounted a two-year campaign to defeat civil fraud charges, portraying them as retaliation for cutting the credit rating of the United States. But it turns out that one thing is one thing and the other thing is the other thing. S&P never really had a defense; there are hundreds of emails and memos and phone recordings clearly indicating that S&P was creating bogus ratings, for a fee. So, now S&P is looking to settle for $1 billion, which represents about one year’s profit.

Let’s take a look at today’s economic data. The federal government ran a budget surplus of $2 billion in December. The December figure brings the government’s budget deficit for the first three months of fiscal 2015 to $177 billion, which is 2% higher than the first quarter of fiscal 2014. The government spent $333 billion in December, up 44% from December 2013. Total receipts were $335 billion, an increase of 18%.

The World Bank cut its outlook for global growth, saying a strengthening US economy and falling oil prices won’t be enough to offset deepening trouble in the Eurozone and emerging markets. The drop in oil has bolstered the US recovery by giving consumers more money to spend, leading the bank to revise up its growth projection for the world’s largest economy by 0.2 percentage point to 3.2%. And the World Bank says the global economy is being pulled by a single engine, the US economy.

The copper market is saying that won’t be enough to eliminate a supply glut that’s lasted at least two years. Because of the drop in oil, there is just a general avoidance of raw materials. Falling oil prices also reduce mining companies’ energy costs, giving the producers an incentive to continue mining the metal, even as demand drops. Copper also may have been hit by technical selling when the price reached $2.72 a pound, which equals $6,000 a metric ton on the London Metal Exchange. The bottom fell out when we broke $6,000, and it’s been down ever since. Today, March copper dropped .12 to $2.60.

The Labor Department reports there were 4.97 million job openings in November, the highest level since early 2001, and up from 4.83 million in October. With 9.07 million unemployed people in November, there were about 1.8 potential job seekers per opening. The Job Openings and Labor Turnover Survey, or JOLT survey, shows the number of separations, such as quits and layoffs, fell to 4.62 million in November from 4.86 million in October. Meanwhile, the total number of hires declined to 4.99 million from 5.1 million. Now, let’s break it down; when workers are confident they can switch jobs, they are more likely to quit. Get a new job with more pay. We are starting to see that a little more than in the past 4 or 5 years, but workers generally lack the confidence to make that transition. Workers’ reluctance to quit means that employers don’t have to quickly ramp up pay for employees.

The Friday jobs report showed unemployment dropping to 5.6% but the problem is that wages also dropped. People aren’t quitting their jobs for better paying jobs, but there may be hope for better wages. ADP reports that people who stayed in their jobs in the third quarter scored an average 2.8% raise during the prior year, and that’s adjusted for inflation. The Labor Department’s employment cost index says much the same thing. The wage and salary part of the index, which excludes benefits, rose 1.6% for private-sector workers in the six months ending in September. And we are seeing some industry sectors paying more wages: restaurant workers got 3.3%, hotel workers 3.5%, construction workers 2.9%. Those numbers are not inflation adjusted and they are not big increases but they are increases. The next employment cost index, or ECI, which won’t be published until the end of the month, but the ECI has been rising throughout 2014. The third quarter ECI wage numbers were much stronger than the hourly earnings data. And that’s how it starts.

Meanwhile, the NFIB small-business-optimism survey rose to 100.4 in December, the highest reading since October 2006; and the report showed that 25% of firms reported compensation increases over the past three months, while 17% expected to increase compensation over the next six months. And the ECI tends to track with the NFIB’s optimism survey.

Of course, as the unemployment rate drops, it is not a guarantee that wages will go up. The thinking is that once we do get closer to full employment the picture for wages will change and the long awaited acceleration in labor compensation will finally materialize. The truth is that wages have been stagnant for more than 30 years, and we’ve had extended periods of low unemployment during that time. Inequality has been increasing for over three decades, and during that time we have been at or near full employment many times. Yet, wages over this time period have been flat. As noted by the Economic Policy Institute, “Since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline, even though decades of consistent gains in economy-wide productivity have provided ample room for wage growth.” The idea that market forces alone will increase wages sufficiently to offset increasing inequality is not supported by the evidence from these years.

Yields on Japanese government bonds hit record lows today. The yield on the five-year government bond hit zero for the first time, while the benchmark 10-year yield fell to a record low 0.25%. The Bank of Japan remains the dominant force in the domestic bond market, buying ¥8 trillion to ¥12 trillion a month of Japanese government bonds and driving yields lower as it seeks to flood the economy with cash to defeat more than a decade of deflation. Few investors are willing to bet against Japanese government bonds with the Bank of Japan buying at that volume. Also, last year the Swiss National Bank introduced negative interest rates on bank deposits; that followed a similar move by the European Central Bank. So, the central bank has been joined by foreign investors, who plowed a net ¥8.7 trillion last year into medium- and long-term Japanese debt, mostly government bonds.

It’s no secret that Europe is slowing down and that more stimulus is necessary. Euro zone government bond yields fell on the prospect of looser ECB policy and many Eurozone countries sold debt to lock in ultra-low borrowing costs. The euro dropped to a 9 year low against the dollar. The euro has fallen in seven of the last eight sessions and is on pace for a sixth straight week of losses. The ECB is expected to launch its own quantitative easing at next week’s meeting, as data out of the euro zone has become bleaker and bleaker by the day. Data from Greece showed its economy was mired in deflation while engineering orders in Germany fell 10 percent year-on-year in November.

Yes, oil was falling again today. Prices are down nearly 60% since peaking in June 2014—US crude futures for February touched $44.20 per barrel at one point today. Today’s drop was thanks to the UAE’s oil minister reiterating that OPEC has no plans to cut production, though all OPEC countries are losing money.

Remember the manufacturing renaissance? The idea was that China’s rising labor costs would make it more economical to keep manufacturing operations in the US, and maybe even some companies that had sent jobs offshore would send them back; they call it reshoring. Makes sense. Especially when you add in the idea of increased energy production in the US adding to lower production costs. And some of that has happened. Labor costs did rise in China, or at least some of the large, urban, coastal cities, such as Shenzhen. Some companies have already shifted facilities further inland in China, or even left China for Vietnam, Cambodia or (in the case of textiles) Bangladesh – just not back to the US. Energy costs have dropped, as we are all well aware. Both energy costs and shipping costs are volatile, and shipping costs only have a small impact on most manufacturers.

And there are examples of a renaissance. Dow Chemical does plan to invest $4 billion to expand its chemicals production on the Gulf coast; in the past two years, the aluminum industry has announced $2.3 billion of new manufacturing investments in the US. The US auto industry is alive and well. In 2014, 16.5 million vehicles were sold nationwide, making it the industry’s best year since the Great Recession, when sales plunged to hit a low of 10.4 million vehicles in 2010. And manufacturing has seen four straight years of growth, and we’ve added 520,000 new manufacturing jobs in the last 3 years. But we have to remember that we lost 2.5 million manufacturing jobs between 2007 and 2009. And we might never again employ the same numbers of people in manufacturing, in part because manufacturing is changing, and automating.