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Friday, February 12, 2016

Nobody Knows Normalization

Financial Review

Nobody Knows Normalization

DOW + 313 = 15,973
SPX + 35 = 1864
NAS + 70 = 4337
10 Y + .10 = 1.75%
OIL + 2.77 = 28.98
GOLD – 9.40 = 1238.00

The Nikkei Stock Average finished down 11% for the week, its biggest weekly percentage drop since October 2008. For the day, the index ended off 4.8% at 14,952, the lowest since October 2014. The Nikkei is down 21% year-to-date.

Japanese Prime Minister Shinzo Abe held a meeting with his top financial diplomat today, as well as the BOJ’s governor, following a report that the “architect of Abenomics” called for a Group of 20-wide response to the recent market rout. Friday’s high-level gathering came as the country’s stock markets plunged again and the yen hit highs not seen since October 2014. Speculation is also rampant that Tokyo could conduct yen-selling intervention.

The Hang Seng China Enterprises Index of mainland Chinese companies trading in Hong Kong fell 2% Friday and was off 6.8% for the week. Trading was halted on the Kosdaq, the smaller cap, tech focused exchange in South Korea as the index dropped by more than 8%.

Here in the US, we’re not quite in bear territory for the major indices: The Nasdaq dropped 18% from last summer’s high; the S&P 500 dropped 15% from last year’s high.

And then we bounced today, not enough for weekly gains, but a bounce off the lows, as expected. For the week the Dow lost 1.4%, the S&P lost just under 1% after hitting a two-year low yesterday, and the Nasdaq lost just over a half a percent for the week. I’m just glad the markets will be closed Monday.

So, the very, very bad start to the New Year in the markets has carried over into February, and everybody is looking for a market bottom. And maybe yesterday marked a low; we can never really know until after the fact, but one day does not confirm a trend reversal. Add Bank of America to the list. The firm’s research team is the latest on Wall Street to lower expectations for the U.S. stock market in 2016, after one of the worst starts to a year on record wiped out more than $2 trillion in value.

The bank now expects the Standard & Poor’s 500 Index to end the year at 2,000. While the bank’s new target implies a 7.7 percent advance from the current level, it’s 9 percent lower than the prior target of 2,200. It would also mean a small annual loss. Of course, nobody knows where stocks will finish the year. You don’t know, Bank of America doesn’t know, I certainly don’t know, and the central bankers of the world have no clue.

So far, all attempts by central bankers to respond to the situation have not been working out. The People’s Bank of China has been selling dollars and substituting derivatives to prop up its balance sheet; a strategy that seems likely to result in devaluation of the Chinese currency.  Japan is fumbling around for answers and the yen has been getting stronger.

Europe has joined Japan with negative interest rates and it isn’t stimulating the economy, it is just leading banks, businesses and individuals to hoard cash. And Eurobanks are looking especially vulnerable right now. Deutsche Bank’s problems came into focus this week. The yield on Deutsche Bank’s 6% Contingent Convertible bonds, or CoCos, rose to more than 13% from 7.5% at the start of the year. The bank’s shares were down 40% in the same period.

When the debt of Germany’s biggest bank is trading like junk, it should catch your attention. As a side note, it would be high irony if Germany had to go begging to the EU to save its banking system. But Deutsche Bank is not the only Eurobank with problems.

Janet Yellen tried to normalize interest rates and instead the yield curve flattened. Fed Chair Janet Yellen wrapped up her testimony before Congress yesterday, stressing that the central bank was not on a “preset” path to return policy to “normal” and “wouldn’t take negative rates off the table.”

Yellen told lawmakers this week she was studying ways to “be prepared” in the event the current slide in world stock markets, concern about financial sector stress, and slowing economic growth all translate into a recession or another financial crisis. The growing consensus is that the Fed can’t raise rates again and a majority of money managers are calling for cuts.

What are the central banks going to do when another wave of bad news breaks over the markets? And will whatever they do work? The idea of the central bank “put” seems to be losing its punch, or even worse, backfiring. While the recent market volatility might just be an overblown response to the December rate hike by the Fed, you also have to question how one tiny little rate increase could cause this much damage, and if the real problem goes much deeper?

Retail sales rose 0.2% in January, as consumers boosted purchases of new cars as well as groceries and shopped more online. Sales in December were sharply revised higher to show a 0.2% gain instead of a 0.1% decline. Sales at gas stations dropped 3.1% in January.

Core sales – excluding autos, gas, building materials and food – rose an even stronger 0.6%. In an early sign of lackluster spending, Retail Metrics, a private research firm, said sales at stores open at least a year fell 0.9 percent in January from a year earlier. Meanwhile, business inventories climbed a seasonally adjusted 0.1% in December. To put it simply, sales are not strong enough to clear the shelves.

The University of Michigan’s preliminary February reading on consumer sentiment dropped to 90.7 from 92.0 in January. The expectations component fell from 82.7 to 81.0 during the month. The gauge of current conditions was down less, falling from 106.4 to 105.8. Consumer views of their financial situations improved, but largely because they expect lower inflation. In fact, respondents anticipated the lowest inflation rate on record in the January survey.

Sure enough. The Labor Department said import prices dropped 1.1% last month after decreasing 1.1% in December. Import prices have decreased in 17 of the last 19 months, reflecting the strong dollar and plunging oil prices.

A new report from the New York Federal Reserve shows older Americans have been ramping up their debt while younger Americans have not. In real terms, debt in the hands of Americans between 50 and 80 years of age has increased by 59% since 2003. At the same time, the aggregate debt of those age 39 and younger has dropped by 12%.

This is mainly a result of the housing market. Home-secured debt, per capita, has surged 47% for those age 65, for an increase of $11,191, while it’s dropped 28% to $8,195 for those aged 30. The same trend played out for auto loans as well; on a per-capita basis, auto debt is up 29% for those 65 years old, but it’s down 6% for those 30 years old. Overall, balances owed by households grew $288 billion in 2015, slightly less than the $306 billion increase seen in 2014.

Major world powers have agreed to a cessation of hostilities in Syria set to begin in a week and to provide humanitarian assistance to besieged areas, but failed to secure a complete ceasefire or an end to Russian bombing. The U.S., Russia and more than a dozen other nations also reaffirmed their commitment to a political transition when conditions on the ground improved, following a marathon meeting in Munich aimed at resurrecting peace talks.

Meanwhile, Saudi Arabia says it is willing to commit ground troops to fight ISIS in Syria; exactly how or when they might deploy, and what they intend to do if they deploy, and the extent of US involvement in any Saudi deployment – those are still open questions.

Oil prices were on a 6-day slide from February 4 until this morning; prices went from a high of 33.60 to a low of 26.05; or a 22% bear market in 6 days. Needless to say, there were some big bets on the short side, and when news of a hint of OPEC production cuts hit the wires, the shorts cashed in, which caused prices to pop, which squeezed the remaining short positions.

A big move up in oil prices today (10.5% and 12.3% intraday) but for the week, oil was down 4.7%. Most of the volatility in oil right now is due to speculators. At the same time, stocks have been moving in lockstep with oil; that correlation is not based on fundamentals; stocks and oil will disconnect eventually, just not today.

Christine Lagarde is set to win a second term as managing director of the International Monetary Fund, after a nominee deadline passed with no new candidates to challenge her. In a statement released Thursday, Treasury Secretary Jacob Lew said the U.S. supports her for a second term.

A full 76% of S&P 500 companies have reported fourth quarter earnings through early Friday. And the picture is not pretty. FactSet data show expectations for first-quarter per-share earnings have fallen to a decline of 6.3%, far wider than the decline of 5.5% they were showing as recently as Monday.  Back in September, that forecast was for growth of 4.8%.

By the end of December, it had fallen to growth of just 0.8%. The energy sector is looking worst, but all 10 S&P 500 sectors are facing lower expected earnings-growth rates for the first quarter than at the end of September

In case you missed it, Burger King announced this week that it will add hot dogs to its fast food menu. Proof positive that there is still some common sense in this world.

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