Morning in Arizona

Morning in Arizona

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Tuesday, May 16, 2017

A Tale of Two Markets

Financial Review

A Tale of Two Markets


DOW – 2 = 20,979
SPX – 1 = 2400
NAS + 20 = 6169 (record)
RUT + 0.76 = 1394
10 Y – .01 = 2.33%
OIL – .35 = 48.31
GOLD + 6.30 = 1237.70

Another record high close for the Nasdaq Composite, with minor losses for the other major indices. The safe play appears to be mega-cap tech plays.

A rally in the euro was reinforced by dollar losses, prompted by allegations that President Trump disclosed highly sensitive intelligence information to senior Russian officials. Late yesterday, White House National Security Adviser H.R. McMaster rejected the conclusions of a Washington Post article which claimed the president had revealed sensitive classified information to Russia’s top diplomat during an Oval Office meeting last week.

McMasters said the story “as reported is false”. Then this morning, Trump took to Twitter and confirmed reports by the Washington Post and other media outlets that he gave sensitive information to Russian officials, tweeting he had the “absolute right” to do so. Questioned about the report in the early afternoon, Trump simply said he had a “great meeting” with the Russians.

The disclosures add to concern over the administration’s chances of passing legislation, including tax reform, that has partly been priced in by financial markets. Sen. Majority Leader Mitch McConnell said, “I think we could do with a little less drama from the White House on a lot of things so that we can focus on our agenda,” “I think we could do with a little less drama from the White House on a lot of things so that we can focus on our agenda.”

Well.., not today – NBC News has just reported that Trump allegedly asked ousted FBI Director James Comey to “let go” of the investigation into former national security advisor Michael Flynn. According to Comey’s account of events, the conversation happened the day after Flynn resigned.  Stock markets continue to hit new highs, even as new headlines out of Washington reflect what appears to be a profoundly dysfunctional White House.

Stocks remain supported by the strongest earnings season for S&P 500 components since 2011. There are mostly two markets, tech and everything else. S&P 500 tech valuations, as measured by price/cash flow, have struggled to break above the 15x threshold that served as valuation floor during the 2002-07 bull market.

The 60%-plus gain in the S&P 500 Technology Index since the end of 2013 has occurred with that price/cash flow ratio hovering at a 15 multiple. The tech trade may be crowded but it still doesn’t look like a bubble at these valuations. The mega-cap tech trade is a different beast. Amazon.com trades at 144x 2017 EPS consensus, 85x 2018 EPS consensus. Netflix trades at 155x 2017 EPS consensus, 84x 2018 EPS consensus. Tesla doesn’t have positive expected EPS for 2017 or 2018.

China‘s latest efforts to curb risky debt levels are not only shocking local markets but raising worries globally about another market shock. As a result, China has replaced Europe as the top worry for global money managers, according to the latest Bank of America Merrill Lynch survey published today. Thirty-one percent of the 184 respondents consider Chinese credit tightening the biggest “tail risk” for markets.

The second worry is a crash in the global bond market, at 19 percent, followed by trade war, at 16 percent. The China worries also feed into existing worries about expensive stocks. The BofAML survey found that 37 percent of respondents think global equity markets are overvalued. That’s the most since January 2000, just before the burst of the tech bubble.

 The Commerce Department said  housing starts ticked down 2.6% to a 1.17 million annual pace, and stood just 0.7% higher than in the same month last year. Permits fell 2.5% to a 1.23 million pace in April. That was 5.7% higher than a year ago. Starts have been 6% higher in the first four months of this year than in the same period last year, and the pace of permit authorizations is over 10% higher, pointing to stronger growth in the future.

Housing starts remained strong but the more volatile multi-family sector dropped. This should be expected. Apartment construction bounced backed more quickly after the recession and may have peaked. More of the action should now be in the single-family component, which continues to gain traction. Given under-building in many markets, there seems to be plenty of room for continued growth in that sector.

The Federal Reserve said that industrial production grew 1% in April. This is the fastest pace of growth since February 2014. Compared with a year ago, production was up 2.2%. Manufacturing was hurt by the strong dollar in 2015 and 2016 but business investment has picked up this year.

In April, manufacturing output grew 1% after a 0.4% increase in the prior month. This is also the fastest rate since February 2014. One point to watch is the improvement in automobile assemblies. Given tepid auto sales, this may add to inventories and ultimately place downward pressure on car prices.

The US economy is forecast to expand at a 4.1 percent annualized pace in the second quarter, according to the Atlanta Federal Reserve’s GDP Now forecast model.

Investors shrugged off reports Ford plans to cut about 10 percent of its salaried workforce in North America and Asia. Ford does not plan any cuts to its hourly workforce or production capacity. Ford plans to offer financial incentives to convince salaried employees to depart voluntarily, including generous early retirement offers.

In 2016, Ford cut hundreds of white-collar jobs in Europe to cut costs by $200 million annually. The focus of the new cost-cutting effort is on North America and Asia. Ford has about 30,000 salaried U.S. employees.

It seems like the U.S. automakers are in an odd spot. A secular shift toward electric, driverless, or some other automotive technology paradigm seems possible. We also can’t rule out a cyclical downturn, considering a recent flattening in auto sales. Meanwhile, shareholders are clamoring for cost reductions, making it hard to double down on growth projects.

Home Depot’s first-quarter profit and same-store sales topped estimates as customers spent more on expensive items such as appliances and flooring and roofing materials. The company’s shares rose about 2 percent to hit a record high. Sales at stores open for more than a year rose 5.5 percent, topping estimates.

The company also raised its earnings forecast for the year ending January 2018. Home Depot’s results contrast with falling sales at department stores such as Macy’s and JC Penney, which are struggling with lower customer spending on apparel and growing competition from online and off-price retailers.

Shares of Staples jumped 3.5% in premarket trade but then lost 3.5% in regular trade as the retail sector struggled. The office supply retailer beat same-store sales expectations, while matching on profit and coming up short on revenue. The net loss for the quarter to April 29 was $815 million, or $1.24 a share, after a profit of $41 million, or 6 cents a share, in the same period a year ago.

TJX, the owner of T.J. Maxx and Marshalls stores, posted its slowest comparable-store sales growth in more than 10 quarters and forecast a disappointing current-quarter profit. Shares dropped about 5%.

Urban Outfitters became the latest major retailer to report dismal first-quarter results, with key metrics missing on all fronts. Same store sales fell 3.1%. Revenue decline 0.2%. Gross profit margins fell.

Another one bites the dust… retailer Rue21, owned by Apax Partners, has filed for Chapter 11, as shoppers shift their spending online and away from teen fashion trends. Rue21 entered into a Restructuring Support Agreement with certain stakeholders and expects to continue normal operations throughout the Chapter 11 process.

There’s a blame game brewing over the massive cyberattack that infected hundreds of thousands of computers. Microsoft is pointing a finger at the US government, while some experts say the software giant is accountable, too. The hack used a technique purportedly stolen from the US National Security Agency to target Microsoft’s market-leading Windows operating system.

The attack started Friday and has affected computers in more than 150 countries, including severe disruptions at Britain’s National Health Service. The hack effectively takes the computer hostage and demands a $300 ransom, to be paid in 72 hours with bitcoin. Microsoft blamed the NSA’s practice of developing hacking methods to use against the U.S. government’s own enemies.

The problem is that once those vulnerabilities become public, they can be used by others. In 2014, Microsoft ended support for the highly popular Windows XP, released in 2001 and engineered beginning in the late 1990s, arguing that the software was out of date and wasn’t built with modern security safeguards.  The company had already been supporting it longer than it normally would have because so many customers still used it and the effort was proving costly.

Microsoft released a patch for the flaw in March after hackers stole the exploit from the NSA, but some organizations didn’t apply the updates. Businesses that failed to update Windows-based computer systems that were hit by the WannaCry ransomware attack could be sued over their lax cyber security, but Microsoft likely enjoys protection from such lawsuits.

Hackers claim to have stolen an upcoming Disney movie for a ransom, and will release the film if the company doesn’t transfer the fee via bitcoin. It is believed that the movie is the latest installment in the Pirates of the Caribbean series.  CEO Bob Iger said he’s not paying, but is working with the FBI on the matter.

The issue is reminiscent of Netflix’s recent troubles with Orange is the New Black, which had most of its new season released online by hackers.

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