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Monday, October 10, 2016

3Q Earnings and Political Uncertainty

Financial Review

3Q Earnings and Political Uncertainty


DOW + 88 = 18,329
SPX + 9 = 2163
NAS + 36 = 5328
OIL + 1.39 = 51.20
GOLD

Today is Columbus Day. Even though stock markets were open today, bond markets were closed, the majority of banks and credit unions were closed, and most federal and local government offices are closed for the holiday. (In case you were wondering why the mail wasn’t delivered.)

Oil prices rose to their highest in a year after Russia said it was ready to join a proposed deal to cap oil production. The Organization of the Petroleum Exporting Countries (OPEC), of which Russia is not a member, aims to agree an output cut by the time it meets in late November. Russian President Vladimir Putin said an output freeze or even a production cut were likely the only right decisions to maintain energy sector stability.

Analysts at ABN Amro took a more cautious view on an OPEC deal, saying previous hints by the group on output cuts have always failed to be followed up by action. Iraq, OPEC’s second biggest producer, had already poured cold water on expectations, saying over the weekend that it wants to raise output further in 2017.

Further complicating OPEC output caps is that inventory levels in the US have reached record highs since the oil-price collapse in 2014. This surplus supply is a major factor keeping oil prices low. Current inventories are 45 million barrels higher than 2015 levels, which were more than 100 million barrels higher than the average from 2010 through 2014. Until the present surplus is reduced by almost 150 million barrels down to the 2010-2014 average, there is little technical possibility of a sustained oil-price recovery.

The Federal Reserve’s September meeting was contentious. The Fed extended its stimulus campaign, but three officials voted to raise rates, the largest bloc of dissenting votes in several years. On Wednesday, the central bank will release an account of the meeting that may reveal more about the lines of conflict. Fed chair Janet Yellen said at a news conference after the meeting that the majority of officials saw no reason to rush ahead with a rate increase. The dissenters say the Fed is playing a dangerous game by dragging its feet. On Friday, Yellen will have another chance to explain her own views when she addresses a conference in Boston.

The publication of Alcoa Q3 results tomorrow after the closing bell, will mark the beginning of Q3 earning season for major US companies. According to FactSet consensus estimates, profits are likely to decline by 2.1% y/y, the sixth consecutive quarterly decline. Earnings should drop despite the expected 2.6% increase of sales. On June 30, analysts estimated a 0.3% increase of profits in Q3.

The decline in corporate profits should be mainly driven by the energy sector, whose earnings are expected to tumble by 67% y/y. Industrial and real estate should also record falling earnings, at -7.8% and -6.3% respectively. On the opposite side, utilities should post the highest earning growth rate (+5.3%), followed by consumer discretionary at +5%. According to FactSet consensus, corporate profits should return to a positive growth rate in Q4, with a 5.6% y/y increase.

During earnings reporting season, companies publish what passes for the results of the prior quarter and they also have the chance to explain their successes or failures. We tend to hear plenty of excuses such as a “strong dollar” or “Brexit” or the old standby “bad weather”.

The excuse for poor third quarter results is likely to be uncertainty related to the presidential election.  People aren’t buying enough potato chips – political uncertainty. Companies aren’t buying new computers – political uncertainty. Consumers aren’t buying new cars – political uncertainty. Recent measures of consumer confidence have exceeded or neared post-financial-crisis highs, and consumer spending remains one of the bright spots of the US economy. So, when you hear the excuse of “political uncertainty” you can be fairly certain that is not the answer.

The British pound resumed its decline as investors waited for clues about the cause of last week’s flash crash and on whether Britain is truly headed for a hard Brexit. U.K. Prime Minister Theresa May will meet with foreign leaders this week in a bid to build understanding for her negotiating position ahead of this month’s EU summit. Meanwhile, officials are still trying to figure out what triggered last week’s flash crash in the pound. Sterling remains the world’s worst-performing major currency this year.

British-born Oliver Hart and Finland’s Bengt Holmstrom won the Nobel Economics Prize today for work that addresses a host of questions from how best to reward executives to whether schools and prisons should be privately owned. Their findings on contract theory have implications in such areas as corporate governance, bankruptcy legislation and political constitutions. Hart is an economics professor at Harvard University while Holmstrom is a professor of economics and management at the Massachusetts Institute of Technology.

Hart’s research work has included a damning assessment of America’s private prisons. He showed that the pressure to cut costs was too great, leading to an unacceptable drop in quality. At the core is the issue of “incomplete contracts” – the fact that contracts are not detailed enough to cover every small point.

Holmström is known for pioneering research into executive pay. His work on employment contracts has considered a range of professions from teaching to management and whether they should be paid fixed salaries or work on the basis of performance-related pay.

A group of nuns and other religiously-affiliated investors have lost faith in Wells Fargo and filed a shareholder resolution calling on the bank to report on the root causes of a fake accounts scandal that led to a $190 million settlement struck with regulators last month. The faith-based investors say they also want the report to cover improved controls after revelations bank employees opened as many as 2 million checking, savings and credit card accounts without the customers’ permission in order to meet sales quotas. The resolution is one among a series filed recently at Wells Fargo. Other resolutions call on Wells Fargo to study a breakup and to split the roles of chairman and chief executive officer.

Deutsche Bank CEO John Cryan was in Washington over the weekend for the International Monetary Fund and World Bank’s autumn meetings. Reportedly while there he met with Justice Department officials but was not able to negotiate down the $14 billion fine they have demanded. Deutsche Bank is expected to issue new shares, sell assets, or both, once it knows the scale of the fine, to ensure that its capital ratio remains within regulatory limits.

Mylan has agreed to pay the U.S. government $465 million in a swift settlement over how it charged Medicaid for its allergy shot EpiPen. The U.S. Centers for Medicare and Medicaid Services, or CMS, said in a letter this week that Mylan had misclassified EpiPen as a generic drug, while the government has said it was a brand-name product and that Mylan should have given states and the U.S. bigger rebates. The agreement with the Justice Department and other agencies resolves all potential rebate liability claims by federal and state governments. There was no admission of wrongdoing by Mylan or its employees.

Negotiators from Unifor and Fiat Chrysler will not be with their families today celebrating Canadian Thanksgiving. The union has set a strike deadline of midnight for its 9,750 members employed by the automaker, and is looking for a contract similar to the one it signed last month with General Motors Canada. Among other things, that deal traded pension benefits for shortening the time it takes newly hired employees to reach full wage rates.

Chicago’s public schools and its teachers’ union make the final push to avert a looming strike on Tuesday. Pensions are among a key sticking point. The district would like to phase out the 7 percent of annual salary that it contributes each year to teachers’ pensions. Unions want to keep the pension contributions and ink a new, three-year contract that would give teachers 2 percent raises in the second and third years. The state, the city and the school district have all had their credit ratings cut to junk, or just above it. The impasse and the threat of the strike would affect nearly 400,000 students.

Samsung has reportedly stopped production of its Note 7. The temporary production halt comes after five reports of fires in replacement phones, suggesting replacement Galaxy Note 7 devices remained plagued by the same faulty battery problem that occurred in the original device. Samsung’s decision came after major mobile carriers in the U.S., including AT&T and T-Mobile, said they would stop issuing Note 7s over safety concerns.

After five years of litigation, the U.S. Supreme Court will hear arguments on Tuesday in the patent dispute between the world’s two top smartphone manufacturers over the amount Samsung should pay Apple for copying the iPhone’s distinctive look. The justices’ ruling, due by the end of June, could have a long-term impact for designers and product manufacturers going forward because the Supreme Court, if it agrees with Samsung, could limit the penalties for swiping a patented design.

A jury found that Samsung had violated an Apple design patent by mimicking the iPhone’s round corners and grid of icons. The question for the justices is whether that means Samsung must turn over all its profits from the infringing phones or just those attributable to the disputed features. The court has not heard a design patent case in over a century.

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