Financial Review

Thoughts on Oil

Sinclair Noe — December 7, 2015

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DOW -117 = 17,730
SPX – 14 = 2077
NAS – 40 = 5101
10 YR YLD – .07 = 2.20%
OIL – 2.37 = 37.60
GOLD – 15.10 = 1072.20

Crude prices fell again in the first trading session after OPEC said over the weekend that it would maintain production at the current levels and made no decision on a new target ceiling. An oil glut has cut prices by more than 60% since June 2014. Abandoning an official output ceiling effectively codifies what OPEC has already done for the past year: ignore its previous target of 30 million barrels a day. The cartel produced 31.4 million barrels per day in October. Indonesia also rejoined OPEC on Friday (after being inactive since 2008), boosting the group’s participants to 13 members. Oil prices today dropped to levels last seen in 2009.

There has been an ongoing battle between OPEC and US shale producers with each side pumping massive amounts of oil in the hopes the other would cut production once crude became too cheap. The world isn’t going quite the way Saudi Arabia expected when it led OPEC to declare a pricing war against US shale drillers last year by flooding the market with crude oil. Far from being a quick kill, shale drillers have stubbornly held on, and OPEC has suffered along with them.

Cheap oil has already affected global markets and economies in countless ways, from disrupting Venezuelan politics to sinking the Russian ruble and introducing the world to “low-flation.” In a note to clients, Citi suggested that one of the only things propping up oil prices has been ETF holders thinking that they’ve gotten in at the bottom, even as larger money managers have increasingly given up on forecasting longer-term prices amid greater volatility.

The Labor Department last Friday said U.S. created 211,000 jobs in November after a nearly 300,000 gain in October, keeping the unemployment rate at an eight-year low of 5%. Against the backdrop of a steadily improving labor market the Federal Reserve is gearing up to raise its benchmark short-term interest rate, now near zero, for the first time since 2006. The Fed is expected to pull the trigger after its Dec. 15-16 meeting.

Federal funds futures imply a 76 percent probability of liftoff in December, and the U.S. two-year Treasury has risen by more than 30 basis points over the past two months. The dollar index moved higher following on the heels of its largest one-week loss since May. In the wake of November’s solid non-farm payrolls report, the conversation has now shifted towards how fast the Fed will have to raise rates and to what eventual level.

Venezuelan voters on Sunday delivered a heavy blow to the socialist party of President Nicolas Maduro by granting the opposition a considerable majority in the national assembly. Venezuela’s opposition leaders say they captured two thirds of the seats in congress in Sunday’s election, a super-majority that offers them a powerful mandate for profound change, including the ability to fire ministers, change the constitution, reshape the judiciary and electoral commission and start a process to recall the president. Nicolas Maduro. The official tally has the opposition far ahead but not yet with the crucial two-thirds margin.

Meanwhile, in France, the right-wing National Front party led by Marine Le Pen performed well in the regional elections held on Sunday. The party, which opposes immigration and the country’s membership in the euro currency union, more than doubled its share of the national vote compared to the 2010 election.

Germany is on pace to take in one million asylum-seekers this year. In the last 11 months, the country has taken in 964,574 new migrants, including more than 200,000 just in November; about 484,000 migrants came from Syria. Germany has accepted the largest number of asylum-seekers of all European countries, according to the UN High Commissioner for Refugees. Chancellor Angela Merkel said in September, “Germany is doing what is morally and legally obliged. Not more, and not less.”

It’s extraordinary also because it’s larger than the total number of refugees that the US—with a population of 320 million to Germany’s 80 million—has accepted in the last 10 years. Since 2005, the US has accepted a total of 675,982 refugees from regions all over the world, according to data from the Refugee Processing Center, an arm of the US Department of Justice’s Bureau of Population, Refugees and Migration.

Beijing issued its most severe smog warning for the next 3 days – the first time the municipal government has issued a so-called red pollution alert. Local authorities upgraded the air pollution alert to red from orange. Some industrial companies must stop or limit production, outdoor construction work will be banned and primary schools and kindergartens are advised to cancel classes. Even healthy people should try to avoid outdoor activity and choose public transportation. The particulates, which reached “very unhealthy” or “hazardous” levels in 28 cities in northern China in November, are caused to a large extent by man-made pollution, including the burning of fossil fuels.

China is the biggest consumer of coal in the world, by a long way. As for the coal-fired power stations? They’re still running, with thousands more planned to be built in the coming years. At a climate conference in Paris, where China is negotiating with the rest of the world on emissions, that strategy is getting harder to argue for. After this week, the idea may be harder to sell in Beijing, too.

Keurig Green Mountain said it has agreed to be acquired by an investor group led by JAB Holding in a deal with an equity value of about $13.9 billion. As part of the deal, JAB will pay $92 in cash for each Keurig share outstanding, which represents a 78% premium to Friday’s closing price of $51.70. The deal is expected to close during the first quarter of 2016. The Coca-Cola Co. which is Keurig’s largest shareholder with a 17% stake, is supportive of the deal. JAB Holding is the investment arm of the secretive Reimann family.

JAB owns a stake in Reckitt Benckiser. It also has a luxury arm which houses investments in Jimmy Choo, Belstaff and Bally, and owns perfume maker Coty. JAB struck a deal in 2013 to buy D.E. Master Blenders 1753, and later agreed a deal with Mondelez International to combine their respective coffee businesses. That created Jacobs Douwe Egberts, which describes itself as the biggest pure-play coffee company in the world; they also control Caribou Coffee and Peet’s. Overall, the company’s retail value would lag behind Nestlé’s which controls about 23% of the coffee market.

General Electric has abandoned plans to sell its appliance business to Electrolux. Both companies were being sued by the Justice Department to stop the deal, which would have combined the number two and three domestic appliance makers in the U.S.

We may be seeing a bidding war for Pep Boys. Carl Icahn has offered $15.50 a share. That bid was 3.3 percent more than the $15-a-share proposal from Bridgestone Corp. that Pep Boys agreed to in October. Philadelphia-based Pep Boys closed at $16.06. Investors are betting that Icahn, Bridgestone or someone else will be willing to pony up for a well-known brand with 800 locations in 35 states.

Yahoo shareholders still do not know how – or if – the company’s board plans to restructure the technology giant. The firm’s directors ended three days of deliberations on Friday without announcing whether they will proceed with plans to spin off its stake in Alibaba, sell its core business, shake up management, or do something else entirely. The big question on the Alibaba spinoff is the tax implications. The big question if Yahoo sells off its core business – what would be left?

Chipotle Mexican Grill is struggling to contain the damage from an E. coli outbreak at its restaurants. Chipotle fell in early trading after rescinding its 2016 forecast and projecting its first quarterly same-store sales decline as a public company. Sales at locations open at least 13 months plunged as much as 20 percent in the days after the illnesses were reported and may fall 8 percent to 11 percent for the fourth quarter as a whole. That would be the first drop since Chipotle went public in 2006.

The Arizona Regional Multiple Listing Service reports overall sales in Phoenix in November were up 6.5% year-over-year. Cash Sales (frequently investors) were up slightly at 29.1% of total sales. Active inventory is now down 8.8% year-over-year. After sluggish price increases off 2.4% in 2014, prices are already up 4% through September.

Last summer I went to Hawaii and visited Pearl Harbor and the Arizona Memorial. Oil still leaks from the tanks of the sunken Arizona. They don’t try to drain the tanks because they are in a precarious way and also because the Arizona is considered hallowed ground. They say the tanks will empty the last drops of oil when the last veteran of Pearl Harbor passes away.

Financial Review

The Greek Unknown

Sinclair Noe — July 1, 2015

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

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DOW + 138 = 17,757
SPX + 14 = 2077
NAS + 26 = 5013
10 YR YLD + .09 = 2.42%
OIL – .02 = 56.94
GOLD – 4.30 = 1169.30
SILV – .12 = 15.65

Let’s start today with some economic data. ADP reports private-sector hiring picked up in June, as employers added 237,000 jobs. The monthly jobs report from the Labor Department will be released tomorrow; it includes private sector plus government jobs. The consensus guestimate is for about 225,000 new jobs last month.

Construction spending rose 0.8% in May to a seasonally adjusted $1.04 trillion. Spending rose 0.3% for residential projects, and 1.5% for nonresidential projects. The Commerce Department revised April’s result to 2.1%.

Manufacturers grew in June at the fastest rate since the start of 2015. The Institute for Supply Management said its manufacturing index rose to 53.5% last month from 52.8% in May, matching its highest level of this year. Readings over 50% indicate more companies are expanding instead of shrinking. The employment gauge jumped 3.8 points to 55.5%. The ISM’s new-orders index edged up to 56.0% from 55.8%.

The second and final Markit reading of U.S. manufacturing conditions in June was revised up to 53.6 from a preliminary 53.4, but the index was still at its lowest level since October 2013.

Overnight, Greece defaulted on its $1.8 billion debt payment to the IMF. That failure means the Greek bailout package has expired. But markets rallied this morning on reports that Greek Prime Minister Alexis Tsipras, in a letter to the country’s creditors, said he was willing to accept the terms presented in a proposal made at the weekend as the basis for more talks. For now, the July 5 referendum is still scheduled, even though the terms to be voted on have been taken off the negotiating table. And then Tsipras addressed the Greek nation saying they should vote no on the referendum, so it doesn’t sound like Tsipras made any real concessions.

European stocks and bonds rose today. The Stoxx Europe 600 index rallied 2.2 percent. Yields on debt from Italy, Spain and Portugal all fell and the euro weakened 0.8 percent to below $1.106.

Now, we hear a lot of speculation about how the Greeks will vote on the referendum on Sunday. The simple answer is that we don’t know. A poll released today shows 47% to 43% in favor of a “Yes” vote; but keep in mind the polling was done by a German polling company.  The referendum was thrown together so fast that there hasn’t been anything that could be considered reliable polling to tell us how the vote will play out. If anyone speculates, it is just that – speculation. Beyond that, we don’t know the consequences. I have heard reports that if Greece votes no, they will be kicked out of the Eurozone. Not so fast.

From a legal standpoint Greece would still be a member of the European Union; even if they start printing drachmas. Greece might want to take control of its own monetary policy and not be bound to contracts denominated in euros. Even if a country violates the treaty, there’s no mechanism for kicking it out. That would create a host of legal and administrative headaches for both Athens and Brussels. Trouble is, there’s no clear legal path for a country to exit the Eurozone without leaving the EU first. EU treaties describe the Eurozone as “irrevocable.” A country can leave the EU, however. Under Article 50 of the EU treaty, a country can withdraw its EU membership. Since euro membership is only open to EU countries, Greece would automatically fall out of the currency area if it left the political union. But here too, there’s a catch: Article 50 stipulates that countries engage in a two-year negotiation with Brussels before they can leave, time Greece doesn’t have.

Now, there may be some legal trickery that could be applied, such as a referendum of all 28 euro countries, or perhaps an agreement outside the framework of the EU treaty. The problem with all of these scenarios is that Europe would tacitly be acknowledging that euro membership is revocable, and that makes the euro a revolving door. Further Greek defaults will leave European taxpayers holding the bag for more than €200 billion-euro in aid. Weigh that against market losses that can grow to the trillions in the flash of volatility like we saw on Monday. Now, weigh that against the optics of elderly Greek pensioners begging for food in modern day Europe, and remember the words of Ghandi, who said: “Poverty is the worst form of violence.”

So, when you hear pundits saying they can tell you how the Greek situation will play out, or how the Greeks will vote on the referendum, or that there will be a Greek exit, realize that nobody knows how this will be resolved.

One lesson we have learned: as economies crumble, so does the viability of the digital infrastructure that so much of the world has come to take for granted as the way money moves. The harder an economy is hit, the more valuable cash becomes. Basically the economy returns to cash trading as merchants refuse to accept payment with plastic as they have to take the receipts to be cleared at a bank. The less faith you have in the bank’s ability to clear those receipts, the more likely you are to lean on cash. That’s how a modern day bank run works. And in Greece the banks are closed so plastic is worthless, and the ATMs are empty. A reminder that you can’t stuff “ones” and “zeroes” under your mattress; and when times get tough, cash is still king.

Meanwhile Puerto Rico’s junk-rated power utility said it made a full $415 million bond payment due today and reached an agreement to continue negotiations with creditors to restructure its $9 billion of debt. Its bonds rallied.

The Puerto Rico Electric Power Authority, called Prepa, made the principal and interest payment by selling $128 million of short-term debt to the companies that insure its bonds, including Assured Guaranty. It also tapped reserves and used $153 million from its general fund. The utility extended a forbearance pact with creditors until Sept. 15, which will keep discussions out of court. It must negotiate a plan to overhaul its debts by Sept. 1 to keep the deal in place. The talks with creditors may advance the utility’s effort to pare its debt load. There is still a major problem of $72 billion of debt owed by the Commonwealth of Puerto Rico.

And next on the list is Ukraine; they could suspend debt payments almost immediately if an important meeting with creditors ends in stalemate. Ukraine is asking its foreign bondholders to accept a 40 percent write down or “haircut” on the $23 billion of debt they own, but so far they have not agreed.

Meanwhile, gas negotiations between Russia and Ukraine have fallen apart, after the two failed to agree on a pricing plan at talks in Vienna. The European Commission, which mediates the negotiations between Gazprom and Naftogaz, issued a statement Tuesday evening saying the two sides were “still far apart” on a deal. Ukraine has now stopped receiving gas from Russia, but transit supplies to Europe are continuing at the usual rate.

China’s vast manufacturing sector remained lackluster in June, fueling calls for additional stimulus measures to boost the world’s number two economy. The Shanghai Composite, which entered a bear market on Monday, ended the day down 5.2%.

The U.S. and Cuba have reached an agreement to restore diplomatic relations and reopen embassies in each other’s capitals, the biggest step yet toward ending a half century of enmity between the two countries. The historic deal will be proclaimed in a White House statement today, and follows the two countries’ landmark announcement to normalize relations last December. A U.S. economic embargo against Cuba will still remain in place, and only Congress can lift it.

General Motors sales fell 3 percent in June. Nissan reported June’s biggest gain so far with a 13 percent increase. Fiat Chrysler said U.S. sales rose 8.2 percent in June. Ford Motor missed estimates with a 1.5 percent light-vehicle sales gain; sales of Ford’s F-Series pickups fell 8.9 percent last month. Vehicle prices also climbed in June, with the average transaction price up 1 percent from a year earlier to $31,948.

Swiss insurance giant ACE Ltd. will buy property insurer Chubb Corp for $28.3 billion. The deal will create the world’s biggest property and casualty insurer by underwriting income. The deal is expected to close in the first quarter of 2016.

General Electric expects to accelerate the pace of GE Capital asset sales in the third quarter as the U.S. conglomerate retreats from the banking industry. Since the landmark announcement on April 10, GE Capital has announced asset sales totaling $23 billion in ending net investment, and anticipates $100 billion in sales in 2015.

The US government sued to block Electrolux AB from taking over General Electric’s appliance business, warning that the $3.3 billion deal would leave millions of Americans vulnerable to price increases for ranges, cooktops and wall ovens, products that serve an important role in family life and represent large purchases for many households.

By a 2-1 vote, a federal appeals court has upheld a 2013 decision finding Apple liable for conspiring with publishers to fix e-book prices. Apple is now set to pay $450 million to e-book consumers and lawyers through a settlement originally announced last year.

AT&T’s proposed $48.5 billion acquisition of DirecTV is expected to get U.S. regulatory approval as soon as next week. The Department of Justice has completed its review of the merger and is waiting on the FCC to wrap up its own. The move could create the country’s largest pay-TV company, giving DirecTV a broadband product and AT&T new avenues of growth beyond wireless service.