Financial Review

Knock On

Sinclair Noe — November 16, 2015

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

Subscribe: iTunes | Android | RSS

DOW + 237 = 17,483
SPX + 30 = 2053
NAS + 56 = 4984
10 YR YLD – .01 = 2.27%
OIL + 1.32 = 42.06
GOLD – 1.80 = 1083.10
SILV – .03 = 14.35

World leaders wrapped up G-20 meetings in Turkey with a vow to boost intelligence-sharing, cut off terrorist funding and strengthen border security in Europe, as they sought to show resolve and unity following the deadly terror attacks in Paris. This year’s G-20 agenda also included efforts to hasten global economic growth, with a particular focus on addressing the effects of China’s economic slowdown. French warplanes launched an assault on ISIS targets in Raqqa, Syria. Meanwhile, the authorities in France announced that they had conducted sweeping police raids around the country overnight, detaining two dozen people.

ISIS released a video today saying they will strike Washington. The Department of Homeland Safety said it had no “specific credible information of an attack on the U.S. homeland.” CIA Director John Brennan said he would be surprised if the group doesn’t have additional attacks in preparation.

Markets across the globe are still processing the weekend’s coordinated terrorist attacks in Paris. Asian exchanges traded lower overnight. European shares reversed early losses and closed in positive territory. The euro dropped, as investors scrambled for safe-havens like the U.S. dollar.

French President Hollande declared that France is at war. Hollande urged lawmakers to approve a three-month extension of the nation’s state of emergency, new laws that would allow authorities to strip the citizenship from French-born terrorists, and provisions making it easier to deport suspected terrorists.

The attacks are also likely to hit France’s economy, which has the largest number of tourists in the world. The sector accounts for almost 7.5% of the country’s GDP. The specific wording by President Hollande is of note, because of course it opens up a can of worms about NATO, the EU, and various agreements for open borders in the EU. This means likely restrictions on import-export activity.

It is nearly impossible to calculate the side effects of the Paris attacks. A couple of quick thoughts include an increase in surveillance. UK Prime Minister David Cameron has already announced the Brits will hire 1,900 new spies to deal with ISIS. The CIA is surely going to place a few ads as well. This will drive the tech heads in San Jose even crazier.

Next, think about the role of Russia in Syria and then expand it out to the role of Russian oil and Saudi Arabian oil vying for global market share. The oil market has been bound up with geopolitics and the threat of conflict for a century, and today’s trading in the oil patch is far from the final word on the direction of those markets.

White House officials confirmed Putin and Obama met privately at the G-20 in Turkey and agreed to “a Syrian-led and Syrian-owned political transition.” These are delicate positions in the dangerous dance between Sunni and Shia playing out in the deserts of Syria and Iraq.

The major stock indices in the US started in negative territory, but then rallied. There were some interesting theories bandied about for the recovery. One story talked about the increase in oil stocks as investors looked for safe havens; although the story didn’t go so far as to suggest that increased military action in the Middle East threatens oil supply routes or even that cutting off ISIS black market oil trading removes a small chunk of supply.

Another story mentioned the travel and tourism industry had a bad day, but then explained that previous terror attacks have taught investors that it doesn’t make financial sense to panic. And then the idea that citizens steadfastly refuse to allow terrorists to dictate how we will live our lives because terrorism won’t succeed in the long run.

I missed a good discussion on whether traders felt the terror attacks might push the Fed to pass on a rate hike in December. Nor was there much discussion about the probability of the stock markets’ bullish affection to war. I don’t know why the markets moved higher. Maybe after a lousy week last week, the shorts closed out positions because it was just time for an up day.

The response in the US has been to fly French flags at football games. The NYSE and Nasdaq observed a minute of silence at 9:25 AM Eastern, before the opening bell. And already, nine states (at last count) have said they would shut their doors to Syrian refugees, in direct violation of the Pottery Barn Rule. The governors of Florida, Alabama, North Carolina, Texas, Arkansas, Louisiana, Indiana, Illinois, and Massachusetts all said they would not accept refugees fleeing the Syrian conflict; go ahead and connect the dots.

There has yet to be a single Syrian refugee resettled in Alabama to date, even though there is  a US State Department-approved refugee processing center in Mobile. And it is uncertain whether any governor would have the power to ban refugees from a given country, as resettlement is handled at the federal level. The State Department said this morning that the US still plans to try to admit 10,000 Syrian refugees into the country in the coming year; final destination to be determined.

Marriott International said that it had agreed to buy Starwood Hotels and Resorts Worldwide for $12.2 billion in cash and stock, creating the world’s largest hotel company. The timing of this acquisition was just exquisite. Under the terms of the deal, Marriott will pay $72.08 a share in cash and stock for Starwood, whose brands include Westin, the W, Sheraton and St. Regis. Starwood shareholders would own 37 percent of the combined company. Combined, the companies operate more than 5,500 hotels with 1.1 million rooms worldwide in 30 countries, with 300,000 employees.

For the first time in at least a decade, imports fell in both September and October at the three busiest seaports in the US. The three – Los Angeles, Long Beach, and New York harbor – handle more than half of the goods coming into the country, and saw imports fall just over 10% between August and October; typically known as peak shipping season. The slowdown in imports is likely an adjustment from a sizable inventory build-up earlier this year.

S&P 500 earnings are on track to close their first season of negative growth since 2009, with more than 90% of components having already reported results, S&P 500 earnings are down 0.9 percent in the third quarter. Estimates call for sub-zero growth in the current quarter as well setting up for a bona fide ‘earnings recession’ (two consecutive periods of declines). According to FactSet, this already occurred in the second and third quarters. All this comes as the Fed prepares to hike rates for the first time in almost a decade – a move that could weaken corporate earnings even further.

Japan has unofficially entered recession. Japan just booked two consecutive quarters of negative gross domestic product. GDP contracted at an annualized pace of 0.8% in the third after a 0.7% pace of contraction in second quarter. The Nikkei 225-share index dropped 1 percent.

The average price of crude sold by OPEC fell below $40 a barrel for the first time 2009. The daily OPEC Basket Price fell to $39.21 a barrel on Nov. 13. The basket, an average of export grades from each of the group’s 12 members, typically trades below international oil futures as some OPEC nations pump denser or higher-sulfur crude that’s less profitable to refine. OPEC’s annual revenues may be curbed to $550 billion at current prices from an average of more than $1 trillion in the last five years.

 The number of oil wells in North Dakota that have been drilled but not fracked has topped 1,000 for the first time in September, as producers wait for prices to recover before turning them on. As a result, more than 8% of oil wells in North Dakota are now sitting idle, harming the industry’s ability to grow production; daily output in the state fell 2% in September to about 1.16 million barrels a day.

The nation’s second largest for-profit college, Education Management Corporation, will forgive nearly $103 million worth of student loan debt to settle claims that it violated consumer protection laws; specifically, misleading students about the benefits of a degree from its schools, and misrepresenting job placement numbers.

In a separate action, the company agreed to pay an additional $95 million to settle four whistleblower lawsuits that claimed it misled the government about its recruiting strategy. EDMC operates a network of 110 under the names: Art Institute, Argosy University, Brown Mackie College, and South University. EDMC did not admit to any wrongdoing.

Constellation Brands, the maker of Robert Mondavi wines and Svedka vodka, agreed to acquire Ballast Point Brewing & Spirits for $1 billion to add to its beer portfolio. The deal is expected to be completed this year and will be financed with cash and debt.

Ericsson said it has not engaged in any merger talks with Cisco Systems, despite rumors Cisco was actively pursuing the Swedish maker of networking equipment.

Blackstone  has reportedly agreed to sell its facility management group GCA Services unit for about $1 billion to Goldman Sachs  and Thomas H. Lee Partners.

Canadian Pacific CEO Hunter Harrison met with Norfolk Southern CEO James Squires, proposing a possible merger, which was coolly received by the Norfolk boss.

The Supreme Court refused to be drawn into the debate over Planned Parenthood, rejecting an appeal by abortion opponents who said they had a right to see some of the group’s internal documents, including its medical-standards manual. The appeal by New Hampshire Right to Life sought the disclosure of information related to a 2011 federal grant made to the Planned Parenthood chapter in northern New England.

Friday, June 20, 2014 - Wall Street’s Midsummer Night’s Dream

Financial Review with Sinclair Noe

DOW + 25 = 16,947
SPX + 3 = 1962
NAS + 8 = 4368
10 YR YLD un = 2.62%
OIL + .83 = 107.26
GOLD – 5.60 = 1315.70
SILV + .12 = 20.98

Both the Dow and the S&P closed at new records, with the Dow hitting an intraday high of 16,978. For the week, the Dow was up about 1 percent, the S&P 500 was up 1.4 percent and the Nasdaq was up 1.3 percent.

Today is the last day of spring. The solstice will occur tomorrow morning at 6:51 AM Eastern time, so tomorrow is technically the first day of summer, and the longest day of the year, or at least the day with the most daylight. For the western states, we’ll have solstice at 3:51AM, so there really will be some Midsummer Night’s Dreams. The markets have been drifting in and out of fantasy and reality this week.

On Wednesday, Federal Reserve Chairwoman Janet Yellen said the Fed would keep doing what the Fed does, and all the markets heard “buy, buy, buy.” Wall Street traders opened their eyes from a Midsummer Night’s Dream and fell in love with the first trade they saw.

Yellen said inflation was just “noisy” and interest rates could stay "well below longer-run normal values at the end of 2016." Yellen nonetheless cited reasons for optimism about the economy, including resilient household spending and an improving jobs market, even as the Fed lowered some of its economic forecasts. This is a recurring theme. The Fed’s forecasts for economic growth in 2014 have resembled a downward slope. They cut their forecast on Wednesday from the range of 2.8% - 3.0% down to 2.1% -2.3%. Back at the start of 2012, the Fed thought this year, we would see 4% growth. At the start of this year, they expected 3.5% growth.

Meanwhile, the IMF is warning government officials around the world to prepare for the time when the Fed and other advanced economy central banks do raise interest rates. Not that rates will rise soon or fast, but eventually they will rise, and the IMF hopes to prolong that time, even if it risks fueling asset price bubbles. The long lead time before Fed rate increases should give governments around the world more time to get their economic houses in order. However, it also may encourage undisciplined governments to put off reforms. The IMF believes disruptive market volatility is one of the biggest risks in the years ahead.

And then there’s the question of how the Fed will actually exit QE. At the beginning of 2007 the Fed held assets totaling about $880 billion. Today, the balance sheet stands at about $4.3 trillion, including $2.4 trillion in treasuries and $1.7 trillion in mortgage backed securities. This was the Fed’s attempt to drive down actual rates on actual loans to people and businesses, with the idea that lower rates would stimulate demand. The Fed can set a target for the Fed funds rate, but that’s just a target.

Anyway, all those bond purchases worked, sort of; long term rates dropped relative to short term rates and risky obligations. The best guess is that long term interest rates dropped about 25 basis points for every $600 billion in bond purchases. And buying mortgage backed securities helped push down mortgage rates, which was helpful in putting a floor under housing prices, and likely spurred some construction, although the housing market seems to be stalled right now.

The Mortgage Bankers Association yesterday lowered its forecast for combined new and existing home sales in 2014 to 5.28 million; a decline of 4.1% that would be the first annual drop in four years. The group also cut its prediction on mortgage lending volume for purchases to $595 billion, an 8.7% decrease and the first retreat in three years. The big housing rally wiped itself out because prices increased too quickly for buyers to keep up. The pool of eligible new buyers is collapsing because of stagnant incomes and lack of credit. This revealed one of the biggest problems for the Fed’s stimulus plan; they could indeed lower rates, but they couldn’t direct distribution.

Could the Fed get back to pre-crisis balance sheets? Probably not, but they can just hold the bonds to maturity. There really doesn’t seem to be any viable option, and if the Fed continues to hold those securities, it’s a safe bet they won’t be trying to push rates too high too fast. At the same time, however, the Fed reinvests billions of dollars from maturing securities, about $16 billion each month this year, to maintain the size of its holdings.

The Fed once planned to stop reinvesting, allowing its holdings to dwindle, soon after it ended the expansion of the portfolio. In 2011, the Fed said this would be its first signal that it was winding down the stimulus campaign. But there is growing support among Fed officials to preserve the portfolio’s size instead.

Fed officials generally argue that the effect of bond buying on the economy is determined by the Fed’s total holdings, not its monthly purchases. In this view, reinvestment would preserve the effect of the stimulus campaign. Not everyone agrees with this assessment; some people believe the flow of funds is more important than the size of the balance sheet. The Fed in recent years has almost completely replaced its inventory of short-term government debt with longer-term securities that do not begin to mature until 2016.

And the composition of the balance sheet means that the Fed will have a whole bunch of paper maturing in early 2016. What they do then will be important. Reinvesting will have a fairly significant jolt for the economy. Many in the Fed have come to accept the bond holdings as a fact of life. In 2011, when the Fed first described its exit plans officials believed that reducing the Fed’s bond holdings was a necessary step to maintain control of inflation. Maybe that’s why Yellen can dismiss inflation as being nothing more than noise. So, even as the Fed reduces purchases, the overall balance sheet remains large, and reinvestments will be significant, and their feeling is that raising the target on interest rates will only provide flexibility with monetary policy.

It all sounds good on paper, but I still think the process will be a bit painful, with unintended consequences.

Let’s get you up to date on the situation in Iraq. Ayatollah Ali al-Sistani, an Iraq cleric considered one of Shia Islam's leading voices, has called for creation of new government that avoids past mistakes; so it looks like prime Minister Maliki is in trouble. Sistani called for national unity. The Pentagon says it has seen evidence of "small numbers" of Iranian troops in Iraq but no sign of a major deployment by Tehran.

Obama said yesterday he was prepared to send up to 300 military advisers to help the Iraqi security forces. The special forces troops will work in teams of around 12 and be based mainly at the headquarters of the Iraqi military, with some deployed to individual brigades. The Pentagon said today that the first couple of teams will be made up US troops already in Iraq at the embassy but that as of now no additional units had been sent.

UN Secretary General Ban Ki-moon has effectively endorsed Barack Obama's decision to hold off from ordering air strikes in Iraq, saying that any such action would likely be futile or could even backfire: "Military strikes against ISIS might have little lasting effect or even be counter-productive if there is no movement towards inclusive government in Iraq."

The oil refinery in Baiji, in the north of Iraq, has reportedly fallen to the ISIS rebels. And fighting continues, with most of the battles being won by the rebels. If you are still unclear about the events on the ground in Iraq, you are not alone. According to a Newsweek report, US intelligence has lost virtually all its local assets to be left effectively blind in the country:

“The “surprising” collapse of the Iraqi army and the defection of key Sunni tribal leaders to al-Qaeda-inspired insurgents has largely stripped the CIA of spies in … country. As a result, according to a US intelligence official, the CIA is mostly relying on “technical means”—electronic intercepts of all kinds—and the support of friendly regional secret services, like Jordan’s, to monitor the rapidly deteriorating situation.

Oil prices have inched up but not as much as some feared they would, considering that Iraq is the second largest producer in OPEC. If its supply was completely disrupted, it would take all of the world’s surplus production capacity to replace it.

Gasoline prices typically fall in the weeks following Memorial Day, after supplies increase enough to fill up the cars of the nation's vacationers as summer approaches. This year, drivers are paying more. The national average price of $3.67 a gallon is the highest price for this time of year since 2008, the year gasoline hit its all-time high.