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Friday, July 14, 2017

Complacency Abounds

Financial Review

Complacency Abounds

DOW + 84 = 21,637 (record)
SPX + 11 = 2459 (record)
NAS + 38 = 6312
RUT + 3 = 1428 (record)
10 Y – .03 = 2.32%
OIL + .52 = 46.60
GOLD + 11.10 = 1229.40
BITCOIN – 3.39% = 2156.96 USD
ETHEREUM – 5.51% = 187.69

Washington is in gridlock and the White House faces scrutiny. Valuations are at the highest levels since the financial crisis. There’s been straight months of outflows from the biggest exchange-traded fund tracking the S&P 500.

So, what happened today? Record highs for the Dow, S&P 500, and Russell 2000. The Nasdaq is within 10 points of a record. The CBOE Volatility Index ended at 9.51, a 24-year low, falling 15 percent.

We start with economic data. The Commerce Department said retail sales fell 0.2 percent in June as Americans curtailed spending at restaurants, department stores and gasoline stations. That followed a 0.1 percent drop in May. Most retail segments posted weaker results in June.

Sales at gas stations posted the biggest drop, down 1.3%, reflecting lower prices at the pump. Sales also fell at grocers, restaurants, book stores, sporting-goods stores and department stores. Auto dealers reported a small increase in sales, but they are not moving new cars off the lots as quickly as they were a year ago.

Meanwhile, the Labor Department said consumer prices were flat in June, the latest evidence that inflation remains muted. All told, inflation has climbed just 1.6 percent from a year ago. In June, energy prices sank 1.6%. Americans paid less for gasoline, natural gas and electricity. The cost of food leveled off in June after five straight increases.

The core rate of inflation that excludes the volatile food and energy categories rose 0.1% in June. Grocery prices have declined in the past year, but the cost of takeout and eating out has risen sharply. Over the past 12 months the core CPI is up 1.7%, unchanged from the prior month.

The University of Michigan’s sentiment index slipped to 93.1 in July from 95.1 in June. The index has fallen from a 13-year high of 98.5 in January. Americans feel plenty confident in the economy right now, but seem convinced we’re all headed for hell in a handbasket.

An index that measures current conditions rose to 113.2 to set a 10-year high, but a gauge that looks out six months fell to 80.2 from 83.9. The outlook of consumers is now back to where it was before the November election.

Industrial production rose 0.4% in June, a touch ahead of expectations and the fifth straight month of increases, as mining output surged 1.6%; mining includes the oil and gas sector. The Federal Reserve reported utilities output as flat and manufacturing output edged up 0.2%.

Economic forecasts are revising estimates for second quarter GDP lower, to the range of 1.9% to 2.5%. At the start of the second quarter estimates topped 3% growth. The economic data confirms a lack of inflation and a sluggish economy that fits with dovish statements from the Federal Reserve policymakers this week.

At this rate, we may have seen the last rate hike from the Fed for this year. The Fed still wants to trim its balance sheet, but 1.6% inflation and weak retail sales is hardly justification to hike rates.

The dollar dropped lower and treasuries rallied. Oil gained 1% today and 5% for the week.

Earnings season kicked off in earnest, with JPMorgan Chase, Citigroup and Wells Fargo all posting better-than-expected profits. Even though the bottom line was solid, they still faced challenges.

JPMorgan Chase reported a better-than-expected quarterly profit on Friday due to strong loan growth and higher interest rates, but said net interest income for the year would be lower than expected, sending its shares down about 2 percent.

JPMorgan earned $26.5 billion in profit over the past 12 months, the most ever by any major U.S. bank.

While trading results were worse than analysts’ estimated, second-quarter earnings set a record. The bank said that net interest income will probably climb $4 billion this year, less than the $4.5 billion it previously projected.

One area of weakness is mortgages, where the market may shrink and competition is stiff. JPMorgan said its markets revenue fell 14 percent in the second quarter. At Citigroup, trading revenue was down 7.2 percent.

On a conference call, JPMorgan CEO Jamie Dimon had a few choice words about Washington politics, choice as in four letter words we can’t repeat in print. Dimon also had trepidation about the Fed’s plans to unwind its balance sheet, saying: “We’ve never had QE like this before, and we’ve never had unwinding like this before.Obviously, that should say something to you about the risk that might mean, because we’ve never lived with it before.”

The Fed will likely announce the kick-off this year, possibly at its September meeting. The Fed’s plan calls for a phase-in period. It will unload $10  billion the first month and raise that to $50 billion over the next 12 months. Then it will continue at that pace to achieve its “balance sheet normalization.”

Just like the Fed “created” this money during QE to buy these assets, it will “destroy” this money at a rate of $50 billion a month, or $600 billion a year. It’s the reverse of QE, with reverse effects. QE had the intended effect: inflating asset prices. Unwinding QE, once it starts in earnest, is likely to pull asset prices in the opposite direction.

But given of how leveraged assets are, and to the enormous extent they have been used as collateral, Dimon – the banker who is concerned about collateral values – hit the nail on the head. It’ll be “a very different world.”

Citigroup posted earnings per share of $1.28 on revenue of $17.9 billion, topping analyst expectations on the top and bottom lines. That’s compared to earnings of $1.24 per share on $17.5 billion in revenue in the year-ago period.

Wells Fargo beat earnings expectations, as it benefited from higher interest rates, though revenue was lower than expected at $22.1 billion. At Wells Fargo, new car loans dropped by almost half in the second quarter, while its automotive portfolio fell to the lowest level in two years after the bank tightened underwriting standards.

Another cause for celebration earlier this week: court approval of a $142 million settlement of a class-action lawsuit between the bank and victims of its fake account scandal of 2016. The fiasco, you might remember, included claims that Wells Fargo employees opened up to 2 million bank and credit-card accounts without customers’ permission to boost sales numbers. Multiple class action suits followed, and the bank expects them to all fold into this settlement.

However, the bank’s first response was to veto the class action and send it to mandatory arbitration, which is an alternate form of resolving a dispute using an appointed independent party instead of the court system. It’s an option banks and financial institutions have written into contracts with consumers, and they use it to prevent consumers from joining together to pursue relief. Only after public pressure did the San Francisco bank agree to face the suit.

The big 3 banks all beat on the bottom line. There was a bit of disappointment on the guidance but overall, it’s been a good start to the earnings season.

Look for S&P 500 earnings in the range of 7%. Analysts have high hopes for earnings. Companies in the S&P 500 will earn $130 per share at year-end, compared with current trailing 12-month comparable earnings of about $120, according to data compiled by Bloomberg. That $10 spread is the widest between past and future earnings since 2001.

Expectations for tech profits have steadily climbed throughout the year, with analysts now calling for a 15 percent jump in the group’s bottom line.

Senate majority Leader Mitch McConnell has planned for a vote next week on revised healthcare legislation, unveiled yesterday, and he has his work cut out for him in the coming days to get the 50 “yes” votes needed for passage.

Republicans control the Senate by a 52-48 margin and cannot afford to lose more than two from within their ranks because of united Democratic opposition, but two Republican senators already have declared opposition. A dozen more Republican senators have expressed concern or remain noncommittal.

A major test for McConnell’s legislation expected early next week is an analysis by the nonpartisan Congressional Budget Office, which last month forecast that the prior version of the bill would have resulted in 22 million Americans losing insurance over the next decade.

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