FINANCIAL REVIEW

Net Neutrality

Sinclair Noe — November 10, 2014

 

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Financial Review

DOW + 39 = 17,613
SPX + 6 = 2038
NAS + 19 = 4651
10 YR YLD + .05 = 2.36%
OIL – 1.43 = 77.22
GOLD – 26.90 = 1152.60
SILV – .22 = 15.71

Record highs for the Dow Industrial Average and the S&P 500 index, plus new records for the Dow Transportation Average. We enjoy milk and cookies. The S&P 500 has rebounded 9.4 percent from a six-month low on Oct. 15.

We’re still a couple of weeks away from Thanksgiving but third quarter earnings season is wrapping up, and analysts are already looking to next year, anticipating earnings will rise another 7% or so to around $126. And while stock prices have been hitting highs, volatility has dropped; the VIX is back down to 12 or so, indicating a fair amount of complacency, even as stocks hit highs. Commodity prices have been scraping the bottom of the barrel, with oil and gold near multi-year lows; one exception is cattle prices. Live-cattle futures last week hit an all-time high on CME, and prices are unlikely to come down anytime soon. In addition to increasing demand for beef, the recent drought in Texas and Oklahoma dented cattle herds, which has forced farmer to undergo a lengthy cattle replacement process.

Stock market analysts aren’t the only ones looking to next year. The World Economic Forum is out with its new Outlook on the Global Agenda 2015. Deepening income inequality tops the list of economic trends to watch. The US tops the list of most unequal of the world’s rich nations, and has surged ahead of the rest mostly in the last 30 years. What should be done about inequality? The report doesn’t get into specifics, but it does say this: “We know what we need: inclusive economies in which men and women have access to decent employment, legal identification, financial services, infrastructure and social protection, as well as societies where all people can contribute and participate in global, national and local governance.”

After the financial crisis in 2007-2009, governments had to spend billions of dollars of taxpayer money to rescue banks that ran into trouble and could have threatened the global financial system if allowed to go under. Since then, regulators from the Group of 20 economies have been trying to find ways to prevent this happening again. The G-20 is meeting in Australia this week, and Mark Carney, the Bank of England governor and chairman of the Financial Stability Board has released a proposal to put an end to taxpayer bailouts of the “too big to fail” banks.

The proposal calls for the big global banks to have a buffer of bonds or equity equal to 16% to 20% of their risk weighted assets. The bonds could be converted to equity to help shore up a bank if it should falter (at least that’s the theory). The new buffer, formally known as total loss absorbing capacity or TLAC, must be at least twice a bank’s leverage ratio, a separate measure of capital to total assets regardless of the level of risk. Globally, the leverage ratio has been set provisionally at 3 percent but Fitch ratings agency said banks might end up with a buffer equivalent to as much as a quarter of their risk-weighted assets once other capital requirements were included. Analysts have estimated this could run to billions of dollars.

The new rule will apply to 30 banks the regulators have deemed to be globally “systemically important”.

The Financial Times reports Swiss bank UBS is close to a settlement to resolve allegations of improprieties in its precious metals trading business; this might also signal a settlement regarding to rigging forex markets. UBS had closely integrated its forex and metals trading.

US public pension funds performed worse in the third quarter than all other institutional investment plans. Public pensions lost a median 1% in the third quarter, compared with a median drop of 0.84% for all plans over the same period. Small public pensions with less than $1 billion of assets were down 1.07%. Larger corporate funds with more than $1 billion of assets had the best showing for the second quarter in a row, losing just 0.54 percent this past quarter.

President Obama today came out in favor of net neutrality, endorsing a proposal to empower the Federal Communications Commission to require internet service providers to treat all web traffic equally and not charge content providers for better access. Obama’s statement said: “We cannot allow Internet service providers to restrict the best access or to pick winners and losers in the online marketplace for services and ideas.”

The FCC is currently weighing whether ISPs, such as Verizon and Comcast, can choose to block or prioritize delivering traffic to certain websites; creating slow lanes of information delivery for much of the web, and high-speed lanes for a toll. Net neutrality is about what kind of traffic lanes we should have on the Internet. Supporters of net neutrality think all online information should be treated equally; everybody gets to travel at the same speed. Opponents argue that fast lanes and priority access would actually make the Internet better.

Imagine a world where big companies like Netflix and Google pay extra money to give their users faster service. How could a plucky upstart search engine or the next video streaming service hope to compete? To provide the same speed, they’d have to pay too. But being young and small they might not have the resources. Net neutrality puts all Internet companies on the same footing, and in that way it helps support innovation and promote entrepreneurship.

Public policy groups want tough regulations that guarantee all websites are treated equally and can be accessed by people increasingly reliant on the Internet. Companies led by Comcast, Verizon, and AT&T argue that only light regulation is needed to ensure providers don’t block or slow Web traffic, and they say strict rules would squelch investment. What really terrifies the telecoms is that they’ll have to justify the rates you pay under the new rules; if not now, then eventually.

Obama’s plan would reclassify ISPs as common carriers under Title II of the Telecommunications Act, treating the service as a public utility. Under that section, it’s illegal “to make any unjust or unreasonable discrimination in charges, practices, classifications, regulations, facilities, or services.” And just like access to telephones or access to electricity, everybody would have equal access. For instance, the FCC doesn’t allow phone companies to charge more than $6.50 for a single line, so that all Americans can afford access. Similar pricing rules are in place at electricity plants. If the internet is regulated under Title II, the government could come up with a similar cap on how much companies can charge for internet access.

Obama’s proposal asks for no blocking of websites, no slowing of Internet content, and no deals that let companies pay for faster delivery of their content. He said the FCC should use utility-style rules that give the agency powers that extend to rate regulation, and forebear from setting prices. FCC Chairman Tom Wheeler has been considering a plan that mixes the utility-style regulation Obama advocates with weaker regulatory powers, which may allow for companies to pay more for quicker content delivery or fast lanes.

And while the telecom companies oppose net neutrality, it has wide support from the public, which submitted to the FCC almost 4 million comments overwhelmingly in favor of net neutrality this summer. Whether FCC Chairman Tom Wheeler will adopt Obama’s plan remains in question.

Nearly two months before notifying federal regulators and the public that it was recalling cars with a dangerously defective ignition switch, General Motors placed an urgent order for 500,000 replacement switches with its supplier, Delphi Automotive. GM sent emails to Delphi on Dec. 18, 2013, a day after a committee met to discuss the switch issue but declined to order a recall. Despite the official inaction, a GM employee sent an email to Delphi the next day requesting the half-million replacement parts for “an urgent field action for our customers.”

The emails were turned over by Delphi during discovery in class-action litigation against the automaker. The defective switch can, if jostled or bumped, shift to off or “accessory” mode without warning, causing a moving car to stall in traffic. The loss of power can deactivate the airbag system and impede power steering and brakes. GM has repeatedly said that the cars are safe to drive if nothing but the car key is on the ring, but in not making the problem public when it ordered the replacement parts, GM did not disseminate that information. The defect led to the recall of 2.6 million vehicles earlier this year. So far, 61 claims have been deemed eligible for compensation, including 30 deaths and 31 injuries.

Wednesday, June 18, 2014 - Forecasts Are Subject to Change

Financial Review with Sinclair Noe

DOW + 98 = 16,906
SPX + 14 = 1956
NAS + 25 = 4362
10 YR YLD - .04 = 2.61%
OIL - .15 = 105.72
GOLD + 5.80 = 1278.50
SILV + .14 = 20.00

The Federal Reserve FOMC meeting wrapped up today. The Fed issued a statement that was almost a carbon copy of the April statement. The Fed said that growth “has rebounded in recent months” and the labor market indicators “generally showed further improvement.” The central bankers noted that business fixed investment had “resumed its advance” after saying that it “edged down” in April. The only negative comment was that the housing sector “remained slow.”

The Fed will hold interest rates steady for now, and probably well into next year; and they will continue to cut back on their large scale asset purchase program by another $10 billion per month. So, starting in July, the Fed will only buy $35 billion in Treasuries and mortgage backed securities.

The Fed statement was generally upbeat: "Economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually. Household spending appears to be rising moderately and business fixed investment resumed its advance."

Fed Chairwoman Janet Yellen held a press conference and the topic of inflation was brought up. The feeling is that the Fed wants to see solid signs of recovery, and inflation isn’t a concern; those inflation numbers are just “noise”, according to Yellen. Yellen said: “The data we’re seeing is noisy, inflation is rising in line with expectations.”

 So, when you pay 7.7% more for hamburger, or 4.2% more for milk, or 5.8% more for airline tickets, or 5% more for car insurance; don’t worry, it’s just noise. You might want to wear ear plugs the next time you fill up at the gas station.

Yellen figures the stock market valuations are not out of historical norms, so even though the markets are trading around all-time highs, there are no bubbles forming. And the low volatility is not due to complacency, which is the actual definition of low volatility.

The Fed has been forecasting stronger growth right around the corner, and that is still the long range outlook, but the first quarter threw a monkey wrench into the forecast; blame it on the weather, or whatever. They now forecast GDP to rise 2.1% to 2.3%, down from the 2.8% to 3% forecast in March. Once again, strong growth is just over the horizon, like a carrot dangling just in front of a horse.

The markets just love an accommodative Fed. The S&P 500 hit a record high close, the Dow rebounded for nearly a hundred point gain, bond prices move higher, even small caps got dragged along for the ride.

Recessions are often considered to be over when there have been two quarters in a row of positive growth. The euro zone hit that mark when it squeezed out annualized growth of 0.5% in the third quarter after growth of 1.3% in the second quarter. Not so fast, at least according to economists at the Center for Economic Policy Research; they say the Euro-recession is merely hibernating; growth is still too weak and unemployment too high to declare the recession over.

The research group says that economists and policy makers should look more broadly at other indicators, like the sustainability of growth and unemployment. Joblessness in the euro zone is 11.7%, just below a record. The recession that began in mid-2011 is the longest since the group began keeping track in 1970. A committee of the group said in a statement: “Since early 2013 the euro area has witnessed a prolonged episode of extremely weak growth in economic activity. Labor markets have shown little change over that period.”

The International Monetary Fund is warning that the legal defeat Argentina suffered Monday in its decade-long fight against holdout bondholders could ricochet around the world’s sovereign debt markets, saying: “We are concerned about possible broader systemic implications.”

Last year, the IMF warned that if Argentina lost its case against creditors, the case could set a precedent that gives holdouts outsized power over nations struggling to pay back their debts. That, the IMF warned, could undermine sovereign debt restructurings around the globe. Cutting the amount of debt owed to creditors is a last-chance emergency measure sometimes needed to prevent the collapse of entire economies.

The IMF, the Group of Seven leading industrialized economies and others will have to rethink their reliance on sovereign immunity for getting restructurings done and courts around the globe will be forced to resolve conflicts between the Argentina legal case and their own law on sovereign debt. Financial markets are being forced to write new contracts that avoid complicated fights that leave creditors and borrowers in legal limbo for years.

For its part, the IMF is  reassessing how it handles the debt of countries in crisis. If a country can’t pay its debts, the IMF has traditionally only considered forcing a debt restructuring as a condition for an emergency fund loan. Now, it is considering offering an alternative: extending bond maturities.

In the past the IMF said that while bail-in measures would be voluntary (ranging from rescheduling of loans to bond exchanges that result in long maturities), creditors would understand that the success of such measures would be a condition for continued Fund support for the adjustment measures. Later this week, the IMF plans to post its latest policy musings on the issue.

Meanwhile, lawyers for Argentina say they will meet with hedge funds in New York, later this week to negotiate with hedge funds that held out on a partial payment for bonds. Argentine President Cristina Fernandez Kirchner has labeled the holdout investors "vultures" for picking over the carcass of the broken economy in the wake of the 2001-2002 default. In a televised address to the nation yesterday she said Argentina was the victim of "extortion" by the holdouts, but that she was still open to negotiations and insisted she would continue to pay the more than 90 percent of creditors who accepted the restructuring terms in 2005 and 2010.

Mary Barra, chief executive of General Motors, came under renewed attack today from lawmakers who were not satisfied with the company’s investigation into its delayed recall of millions of cars and challenged her on whether its most recent recalls should have been made earlier.

On congressman produced a string of internal emails from 2005 that showed that one GM employee had experienced a stalling problem in a Chevrolet Impala. The employee said in an email that the Impala she was driving had inexplicably shut off when she hit a bump in the road.

“I think this is a serious safety problem, especially if this switch is on multiple programs,” she wrote in an email to another GM employee. “I’m thinking big recall.”

As early as December 2000, drivers of the Chevrolet Impala and the other newly recalled cars began lodging complaints about stalling with the National Highway Traffic Safety Administration. That vehicle, however, was not recalled until this week, when the Impala was among 3.36 million cars worldwide recalled for a faulty ignition key. Those vehicles recalled were in addition to the 2.6 million Chevrolet Cobalts, Saturn Ions and other small cars with a defective ignition switch that the automaker has linked to at least 13 deaths and 54 crashes.

Barra testified that she did not believe that recalls were routinely avoided in the past. “If there was a serious safety problem, a recall would have been done,” she said.

In the end, the panel said it would continue to investigate G.M., including the role of safety regulators, and may hold more hearings on the subject.

Send in the drones. Iraq has asked the United States for air support in countering Sunni rebels. General Martin Dempsey, the chairman of the US military's Joint Chiefs of Staff, gave no direct reply when asked at a Congressional hearing whether Washington would agree to the request. ISIS has essentially taken over a major oil refinery in northern Iraq, but the Maliki government says they have not lost the refinery and government troops are still holding on; but if they are holding on, it’s by a thread. The big oil companies are evacuating some of their employees from refineries in the south. Iraqi troops are holding off Sunni fighters outside Samarra north of Baghdad.

The stunning and unexpected victories by the Islamists are very worrisome. In a region that is no stranger to conflict, this one is particularly frightening and has far-reaching consequences, including the threat of spin-off groups similar to ISIS taking root in surrounding nations.

A militarily successful Islamist force straddling over parts of Iraq and Syria will pose a real threat to the security and stability of those countries’ immediate neighbors. Even Syria, where government forces are fighting their own civil war, has offered to send troops to Iraq.

What appears to be the most likely scenario at this point is that the rapid Sunni militant advance is likely to be stalemated at or north of Baghdad. They will probably continue to make some advances, but it seems unlikely that they will be able to overrun Baghdad and may not even make it to the capital. This scenario appears considerably more likely than the two next most likely alternative scenarios: that the Sunni militants overrun Baghdad and continue their advance south into the Shia heartland of Iraq; or that the Shia coalition is able to counterattack and drive the Sunnis out of most of their recent conquests. That’s what the markets are betting on right now, but forecasts are subject to change.