Thursday, June 19, 2014 - Market Hits Record Highs and Supreme Court Hands Down More Decisions

Financial Review with Sinclair Noe

DOW + 14 = 16,921
SPX + 2 = 1959
NAS – 3 = 4359
10 YR YLD + .01 = 2.62%
OIL + .48 = 106.07
GOLD + 42.80 = 1321.30
SILV + .86 = 20.86

Taking a look at economic data, weekly claims for jobless benefits fell 6,000 to 312,000; the labor market still has plenty of slack but still shows signs of modest improvement. The Philly Fed manufacturing index was up to its highest reading since last September. And the Conference Board's index of leading economic indicators rose 0.5% to 101.7 in May.

President Obama said today that the United States would deploy up to 300 military advisers to Iraq to help its Iraqi government forces fend off Sunni militants. Obama emphasized again that he would not send combat troops to Iraq, although there seems to be a fine line between combat troops and advisers; he said the United States would help the Iraqis “take the fight” to the militants, who he said pose a threat to Iraq’s stability and to American interests, because Iraq could become a sanctuary for terrorists who could strike the United States or its allies.

Secretary of State John Kerry will go to Europe and the Middle East this weekend to build support among Iraq’s Arab neighbors for a multisectarian government in Baghdad.

Markets were in negative territory most of the day, nothing big, then we recovered near the end of the session, nothing big; the S&P 500 hit its 21^st record high close of the year. This market is just slowly scratching and clawing its way higher, and that’s a good thing. When the markets go on a sharp move higher, sometimes called a parabolic run, it usually ends with a nasty fall. For now, the markets are moving higher but staying within the channels of standard deviation.

There are plenty of geopolitical hotspots, and a boatload of economic uncertainty, but the US equity markets are as constant as you could want. The past 44 consecutive sessions of the Standard & Poor's 500 index have fluctuated upward or downward by less than 1 percent. To put that streak in context, the S&P 500 hasn't seen this little movement since 1995, when the index didn't change by a full percentage point for 95 days. All the while, stocks have been steadily ticking up. The S&P 500 is up 6% year-to-date.

There always seems to be a crisis somewhere and maybe investors and Wall Street traders are just crisis weary, even if it is a little dangerous to wait for the next hotspot to implode. Ukraine hasn’t resulted in disaster, at least not for the US. We’ve been dealing with a mess in Iraq for more than 10 years, so there’s no reason to freak out now. The full impact of recent world events is still unclear, so just keep trading. Compared with past conflicts in the Middle East, America has reduced its dependence on oil in the region and thus may not be feeling the effects of the current crisis as strongly.

The Federal Reserve’s QE policy has been a tremendous success for Wall Street, even if it hasn’t trickled down to Main Street. Impressive corporate earnings growth may be outweighing any effects that world events are having on the markets. Earnings of companies in the S&P 500 are expected to growth by a rate of 5.4% in Q2 2014, with nine of the ten sectors in the index projecting higher growth than last year.

Yesterday, Fed Chairwoman Janet Yellen dismissed inflation as nothing more than noisy. Wall Street traders loved the dismissal of rising prices as an indication that the Fed would not be swayed from their ongoing accommodative policy. Still, you have to wonder where the Fed is going as they try to oversee an uneven recovery and a benign exit from QE.

Like the Fed, the Bank of England has kept interest rates in the near zero range for the past 5 years. Last week, BOE Governor Mark Carney indicated that economic liftoff might come sooner than the markets think. Unemployment in Britain has been falling faster than expected, even though there is still considerable slack in the labor market. British GDP has steadily risen over the past year and is now just 0.6% below its pre-crisis peak. The improving picture could nudge the BOE toward a rate increase sooner rather than later. And so the BOE has its own form of forward guidance, stressing that the timing of the first rate increase is less important than the idea that once rates increase, the degree and pace of increases will be gradual and limited; in other words, a soft and gentle slope.

The Supreme Court is handing down decisions this week. Today they issued a unanimous ruling on Alice Corp v. CLS Bank International, a case that deals with patents. Alice Corporation, an Australian company developed a method for mitigating settlement risks among multiple parties. In its Supreme Court brief, the company said the method was eligible to be patented largely because it involved shadow records updated in real time that “require a substantial and meaningful role for the computer.”

The patents were challenged by CLS Bank International, which says it clears $5 trillion in foreign exchange transactions a day using methods to ensure that both sides performed. The bank said that Alice Corporation’s patents merely recited “the fundamental economic concept of intermediated settlement of escrow.”

A trial court invalidated Alice’s patents and then a court of Appeals affirmed the lower court ruling. Writing for the Supremes, Justice Clarence Thomas said that was “a patent-ineligible abstract idea,” and “Merely requiring generic computer implementation fails to transform that abstract idea into a patent-eligible invention.”

The case had been closely watched by the software industry. Patent claims over the way ideas are incorporated into computers, cellphones and other devices have become a challenge for many high-tech companies. Justice Thomas indicated that the decision posed no threat to the concept of software patents, writing: “There is no dispute that many computer-implemented claims are formally addressed to patent-eligible subject matter.”

The Supremes were also unanimous in ruling on United States v. Clarke; in this case the Court held that a taxpayer may conduct an examination of IRS officials in response to a summons for information and records if the taxpayer can point to facts or circumstances that could raise an inference of bad faith on the part of the IRS.

Another unanimous ruling says the First Amendment protected an Alabama whistleblower. In Lane v. Franks, the high court ruled that Edward Lane's First Amendment rights protected him from job retaliation when he testified in the public corruption trial of then state Rep. Sue Schmitz in 2010, who was accused of being on the payroll at the college but failed to actually show up for work. Schmitz’ bogus job was uncovered and detailed, along with many other cases of corruption in the state's two-year college system as part of a two-year investigation of the system by The Birmingham News in 2006-07.

 Lane was fired by the two-year college he worked after his testimony. Lower courts had ruled against Lane, finding that he was testifying as a college employee, not as a citizen. Writing for the court, Justice Sonia Sotomayor said Lane's testimony was constitutionally protected because he was speaking as a citizen on a matter of public concern, even if it covered facts he learned at work. The decision is a win for whistleblower advocates, who said it could encourage more government workers to cooperate with prosecutors in public fraud cases without fear of losing their livelihoods.

Meanwhile, there is still some fallout, and uncertainty surrounding a Supreme Court decision earlier this week involving sovereign debt of Argentina. Argentina defaulted on nearly $100 billion of debt in 2002. Because some of the debt was sold under New York law, it faced a court challenge after it settled with only some creditors in 2005 and 2010. A few “hold out” creditors sought better repayment terms, specifically, some hedge funds bought the debt after the 2002 default for pennies on the dollar and then demanded full payment. The president of Argentina has called the hedge funds, “vultures” The Supreme Court has given the vultures a victory.

In the next 10 days, we’ll see if Argentina will succeed in defying the United States courts. On June 30, there is a scheduled interest payment on a set of Argentine bonds that its government wants to pay. But the courts say that interest may not be paid unless the country pays all it owes on bonds it defaulted on years ago, something Argentina says it cannot and will not do.

Argentina’s plan is to convert the bonds on which it wants to make payment into new bonds that would not be subject to New York law. Several banks and other financial institutions were willing to accept a partial payment but now that might risk the ire of American courts.

There is no equivalent to bankruptcy law for sovereign debtors. There is no legal procedure to resolve debts of destitute countries. There is no court to approve a restructuring plan that will wipe out some debts and convert others to equity, as there is for companies. Instead, troubled countries negotiate with lenders to restructure the debts. That restructuring could involve reducing the amount owed, lowering the interest rate, extending the maturity of the debt or some combination of the three.

The IMF would typically work with poor countries by offering emergency money contingent on financial reforms for the country; the IMF money was understood to rank above the old debts. Bondholders could, and did, hold out for full payment, but they faced the risk that the restructuring would go through and those who agreed would get partial payouts, while the holdouts got none. Now it has changed, at least for countries that issue bonds under New York law. The hand of holdouts has been strengthened immensely. Financial market service providers are now sovereign debt enforcement agents.

What would happen then? In a brief submitted to the Supreme Court, Joseph Stiglitz, the Columbia University professor who was formerly chief economist of the World Bank, offered a warning: “Unable to restructure, governments that default would be permanently shut out from the debt market, with consequential adverse effects on development and economic growth prospects.” In other words, a modern day debtors’ prison for countries with oppressive debt.

We’ll see how this one unfolds.

Wednesday, May 14, 2013 - Crumbs and Curds

Financial Review with Sinclair Noe

DOW – 101 = 16,613
SPX – 8 = 1888
NAS – 29 = 4100
10 YR YLD - .07 = 2.54%
OIL + .37 = 102.07
GOLD + 11.00 = 1306.70
SILV + .22 = 19.85

The days of milk and cookies can be fleeting; one day the world seems sweet and creamy, and the next day you’re left with nothing but crumbs and curds. The Russell 2000 index of small and mid-caps, dropped 1.6% falling below the 200 day moving average; since hitting a high in March the Russell is down 8.7%. The Dow Jones Internet Index has plunged 17% from a 13-year high in March.

There is a strong tendency among the Wall Street hype-sters to “buy the dip”, with the pitch being that if stocks plunge, it’s really just a buying opportunity if you are patient. What they don’t say is that it is almost impossible to be patient if you run out of capital, but putting that aside, the stocks will all come roaring back someday. Yea, I’m not going to tell you that. Some stocks will recover. Some stocks don’t come back.

Here’s a quote from a Citigroup analyst’s note to clients: “We believe the recent pullback represents a particular opportunity among large cap Internet stocks, with multiples having retraced to levels not seen for more than two years, with no/little change in fundamentals, and with investment profiles that sync well with what portfolio managers are seeking in today’s market.”

Among the favorite downtrodden internet stocks: Facebook, down 18% from its high; LinkedIn, down 43%; and AOL, down 31%, seriously I was surprised to learn that AOL still trades. I would have thought that anybody who lived through 1999 would have shunned AOL permanently. Did we learn nothing from the dot.com days? Certainly the Wall Street analysts learned nothing; they rode the market all the way down back in the day, all the time screaming “buy, buy, buy.” I’ll say the same thing I said back then, you can’t go broke taking a profit.

Treasury bonds rallied. The yield on the 10-year Treasury note touched 2.523% at one point, its lowest level since Oct. 31. While today’s move had all the markings of a short squeeze, the storyline is that the European Central Bank will pump more liquidity into the economy next month. Bank of England Governor Mark Carney signaled there is no rush to raise interest rates after the bank left its growth and inflation forecasts broadly steady in its latest inflation report. And Federal Reserve Chairwoman Janet Yellen said last week that the Fed would continue to keep interest rates near zero for a considerable period to support the economy and inflation remains low. Yellen is scheduled to speak tomorrow.

Today we had a report on inflation at the wholesale level. The Labor Department’s Producer Price Index, or PPI, increased 0.5% in March. The PPI was overhauled in January for the first time since 1978, largely to include services such as retail, health care and financial advice. Previously the index only looked at the price of goods: food, energy, housing and the like. That makes sense, but it has also lead to some wicked wild spikes and dips in the PPI. More likely the CPI, prices at the retail level, are more accurate, running in the range of 1.5% annualized rate.

There’s just something about the bond market that doesn’t feel right. Rates should not be dropping if the economic recovery is really underway. If the first quarter was a weather related aberration, and the second quarter is bouncing back, rates should not be dropping.

After ending 2013 at 3.03%, 10-year Treasury yields have declined 50 basis points year to date. Sovereign yields have collapsed throughout Europe and have generally fallen around the globe. What's behind the decline? Are there potential ramifications for stocks and the global economy? These are critical questions, especially considering the bullish consensus view of accelerating US and global growth.

The Ukraine crisis likely marks an unfortunate end to an era of global cooperation (of a sort) and a return to Cold War tensions and risks. Geopolitical risks exacerbate the vulnerabilities of financial market excesses. And the global central bankers’ response to the collapse of 2008 has resulted in trillions upon trillions of dollars of mispriced financial assets and ever greater leveraged speculation. When the Fed was pumping $85 billion a month into the markets - that was not de-leveraging. With QE winding down, there is impetus for the leveraged speculators to take more risk averse positions; toss in a geopolitical flare-up and greed transforms to fear.

Former Fed Chairman Alan Greenspan was speaking at a financial summit in Washington today and he said that current calculations of the federal government's budget deficit and fiscal outlook understate the risk of long-term trouble, because they do not take into account such "contingent liabilities" as the risk of a major Wall Street bank collapsing. Typically, deficit hawks invoke the phrase "contingent liabilities" to call for cuts to Social Security and Medicare, arguing that official government accounting understates the long-term taxpayer costs of such programs. But Greenspan didn't make a hard pitch on entitlement cuts, focusing instead on the risk of bank bailouts.  

Bond prices are going up nonetheless because the big money is seeking a safe haven in a gathering storm.

Europe’s highest court Tuesday gave people the means to scrub their reputations online, issuing a ruling that could force Google and other search engines to delete references to old debts, long-ago arrests and other unflattering episodes. Embracing what has come to be called “the right to be forgotten,” the Court of Justice of the European Union said people should have some say over what information comes up when someone Googles them.

The decision was celebrated by some as a victory for privacy rights in an age when just about everything, good or bad, leaves a permanent electronic trace. Others warned it could interfere with the celebrated free flow of information online and lead to censorship. The ruling stemmed from a case out of Spain involving Google, but it applies to the entire 28-nation bloc of over 500 million people and all search engines in Europe, including Yahoo and Microsoft’s Bing.

Google is already getting requests to remove objectionable personal information from its search engine. Europeans can submit take-down requests directly to Internet companies rather than to local authorities or publishers under the ruling. If a search engine elects not to remove the link, a person can seek redress from the courts.

The criteria for determining which take-down requests are legitimate is not completely clear from the decision. The ruling seems to give search engines more leeway to dismiss take-down requests for links to webpages about public figures, in which the information is deemed to be of public interest. But search engines may err on the side of caution and remove more links than necessary to avoid liability. Google has said it is disappointed with the ruling, which it noted differed dramatically from a non-binding opinion by the ECJ's court adviser last year. That opinion said deleting information from search results would interfere with freedom of expression.

Some limited forms of a “right to be forgotten” exist in the US and elsewhere, for example, in regard to crimes committed by minors or bankruptcy regulations, both of which usually require that records be expunged in some way.  And some things probably are better off forgotten.

In 1897 silver and gold dealers-slash-bankers in London began gathering each day to post their metals prices. They would meet in a basement and compare prices and then average prices and come up with something called the “fix”. There was a morning fix and an afternoon fix for both gold and silver. This became the price for precious metals. There has long been speculation that the bankers who set the fix might occasionally alter the prices to suit their own trades, in other words the fix was rigged and manipulated.

The basic price setting formula worked well for the bankers and it was adopted by the Libor and the Forex and the ISDA and others who liked the idea of controlling prices for a major market. Turns out the Libor and the Forex and other markets were indeed manipulated, and investigations are ongoing. And then the regulators got the bright idea that if all those markets were rigged, maybe the original, the gold and silver fix, maybe they were rigged. Investigations are underway. 

And so Deutsche Bank has decided they don’t want to be part of the London silver fix. They have announced they are resigning their post effective as of August 14, 2014. That leaves just two primary dealers to set prices for silver, HSBC and Bank of Nova Scotia; not enough to matter; and so the London Silver Fix will close down. The London Gold Fix will continue for now, but by the middle of August there will be no more London Silver Fix. And all of the banks that continue to trade in silver will have to find new ways to rig the market.

People used to think price manipulation in major markets never occurred. More evidence today, Bloomberg reports on a research paper that uncovered evidence that some traders got early news of Federal Reserve rate announcements and then traded on it during the Fed’s media lockup. The paper, covering September 1997 through June 2013, detected abnormally large price movements and imbalances in buy and sell orders that were “statistically significant and in the direction of the subsequent policy surprise.” The moves occurred during the window between when Fed announcements were supplied to the news media and when they were permitted to be released to the public.

The researchers calculate that the traders made off with somewhere between $14 million and $250 million in aggregate profits. A spokesperson says the Fed “enhanced its media release security procedures” last October “to better protect the information against premature release.”

Thursday, May 08, 2014 - Monetary Policy Is Not A Panacea

Financial Review with Sinclair Noe

DOW + 32 = 16550
SPX – 2 = 1875
NAS– 16 = 4051
10 YR YLD + .01 = 2.60
OIL – 01 = 100.24
GOLD - .10 = 1290.80
SILV - .15 = 19.25

Stocks were mostly lower today. The closing numbers looked quiet but it was a roller coaster ride with the Dow Industrials up about 150 points. The Nasdaq also squandered early gains to finish in negative territory. The Nasdaq ended lower for a third straight session, its longest losing streak since early April. A late selloff in utilities and energy, among the best performing sectors recently, dragged the S&P 500 lower. Of 445 companies in the S&P 500 that have reported earnings, 68.2% beat expectations, above the 66% beat rate for the past four quarters. Profits are expected to rise 5.3% this quarter.

The number of people who applied for new unemployment benefits last week fell to the lowest level in a month. Initial jobless claims dropped by 26,000 to a seasonally adjusted 319,000.

The federal government had a budget surplus of $114 billion in April. That is $1 billion more than a year ago and would be the biggest April surplus since 2008. For the fiscal year to date, CBO estimates the deficit to be $301 billion, down $187 billion compared to the same period in 2013.

Retailers posted modestly higher sales in April. Results from March and April are generally viewed together because of the shifting nature of Easter, which fell about three weeks later this year and moved into April from March last year. For the two-month period, retailers reported 3.4% growth, down from 3.5% a year earlier.

Consumer credit balances increased by $17.5 billion in March to a total of $3.141 trillion. The gain was a bigger increase than the $15.5 billion expected by economists. This was the biggest month-over-month growth rate since February 2013. Nonrevolving debt like college and auto loans grew by $16.4 billion. Revolving debt like credit cards increased by $1.1 billion.

At 4.21%, the 30-year fixed-rate mortgage is at its lowest since the week of November 7, 2013, so says Freddie Mac in their new weekly report on national mortgage rates. Last week, it averaged 4.29%. A year ago, it was 3.42%. Since the housing market crashed, the Federal Reserve has used extraordinarily easy monetary policy to keep interest rates like mortgage rates low in its effort to bolster the housing market and stimulate the economy.  Lately, various housing-market metrics such as existing-home sales, new-home sales, and mortgage applications have all been flagging. Last week, we learned that the US homeownership rate was at a 19-year low, and some experts think it'll never come back.

Yesterday, Fed Chair Janet Yellen said, "One cautionary note, though, is that readings on housing activity—a sector that has been recovering since 2011—have remained disappointing so far this year and will bear watching. The recent flattening out in housing activity could prove more protracted than currently expected rather than resuming its earlier pace of recovery." That was the big takeaway from Yellen’s Congressional testimony yesterday.

Fed Chair Janet Yellen was back on Capitol Hill today for a second day of testimony. She appeared before the Senate Budget Committee.  Yellen’s favorite new line is, “Monetary policy is not a panacea.” That pretty much says it all.

There are a couple of trends that concern Yellen; long term unemployment; there are about 3.5 million workers who haven’t found a job for at least 6 months. Also, income inequality is pulling down spending and slowing the economy. Yellen would like to do something about these disturbing trends, but you know, “Monetary policy is not a panacea.”

Meanwhile, the European Central Bank was meeting to determine monetary policy for the Euroland; they decided to leave interest rates unchanged at 0.25%. ECB President Mario Draghi’s favorite line is “whatever it takes” and he’s been saying it for a couple of years. Euroland is slogging along with persistently low inflation and high unemployment. Draghi says something should be done, but he did not say what; and the ECB might address stimulus of some sort or another next month or so.

Perhaps Draghi is waiting to see how the situation in Ukraine plays out; right now the picture is smoky and very gray. Rebels in eastern Ukraine say they will proceed with a referendum this weekend seeking autonomy even though Russian President Putin appeared to withdraw his support for the vote. Putin yesterday presided over nationwide army drills, a day after he softened his tone by promising to withdraw troops from the border. The government in Kiev says a referendum would be illegal. Putin also indicated he would pull Russian troops from the Ukrainian border, but satellite images show that probably isn’t happening. The situation involving the tug of war between the West and Russia regarding Ukraine has steadily worsened over time and now involves outright economic warfare; sanctions on one side and the threat of energy shortages on the other.

Even former Treasury Secretary Tim Geithner is coming out of exile to hawk a new book. Geithner says there had been talk about nationalizing banks back in the crisis days. On the legacy of the bailouts, Geithner rejects criticism that the Troubled Asset Relief Program benefited the rich rather than ordinary Americans. And yet he acknowledges that the too big to fail banks are bigger and more dangerous than ever.

Have you ever seen a boxer knocked out? The devastating blow is the one you don’t see coming. Mark Carney, governor of the Bank of England and head of the Financial Stability Board, an international watchdog set up to guard against future financial crises, was recently asked to identify the greatest danger to the world economy. He answered shadow banking. It is huge and growing fast, and little understood, and even less transparent. We don’t even know exactly what counts as shadow banking; basically, it refers to lending by non-bank institutions and it involves more than $70 trillion in assets, up from about $25 trillion ten years ago.

A broader definition, however, would include any bank-like activity undertaken by a firm not regulated as a bank: it could be bond trading platforms set up by technology firms, or payment systems offered by Paypal or financing offered by a retailer such as Sears, or peer-to-peer lending, or money market funds, or who knows what. At the core is the concept of credit and lending. Shadow banking fills a void left by traditional banks, which have become miserly with lending.

Yet shadow banking is poorly or non-regulated. Think of the structured investment vehicles, a legal entity created by banks to sell loans repackaged as bonds. These were notionally independent, but when they got into trouble they pulled in the banks that had set them up. Or money market funds, which seemed like a nice safe place to park cash as a stop-gap measure; they seemed conservative, nearly risk free, until they suffered a run.

Banks must now incorporate structured investment vehicles on their balance-sheets. Money-market funds must hold more liquid assets, to guard against runs. Limits on leverage have been imposed or are being considered for many forms of shadow banks. American regulators are still allowing some money-market funds to create the impression that an investor can never lose money in them. The problem for banks is that they are involved in shadow banking, either in the form of loans to shadow banks, or because the banks buy the products created by shadow banks.

One of the biggest paces for concern is China. Banks there are banned from expanding lending to certain industries, and from luring deposits by offering high returns. So they do both of these things indirectly, through shadow banks of various sorts. Some firms are setting themselves up as pseudo-banks. It is hard to imagine that all the shadowy loans to unprofitable steel mills and overextended property developers will pay off. At which point the Chinese government will likely step in a take control, but there will be a cost.

Nouriel Roubini, the New York University professor and chairman of Roubini Global Economics is known as something of an economic pessimist, and now he thinks we’re on the verge of a bubble, but not a collapse. Roubini says the Federal Reserve will keep its key lending rate low even after it lifts off from near zero, where it has rested for the few years. That slow process of normalization will keep the spigot of borrowing flowing, helping support the economy. But it will also lead to risky lending practices. Hence, a bubble is inflating that could eventually pop.

Roubini cited the return of some of the key characters associated with the period before the last financial collapse: Lots of low quality bond sales, debt without strong protections for bondholders. Roubini says: “All the risky things that were happening back in ’06 and ‘07 are back again to the same level, if not more. So we are in the beginning of a credit bubble, but just the beginning.”

Nonetheless, Roubini doesn’t see the reversal happening immediately, citing money that continues to rush into the market. For now, credit investors appear to be stuck in an uneasy equilibrium.

He’s by no means the first person to make this claim: the question of financial stability is one of the key criticisms of the Fed’s accommodative policies. Roubini didn’t criticize the central bank, so much as say that the Fed is damned-if-you-do, damned-if-you don’t.

Yeah, well, we’ve all learned that monetary policy is not a panacea.