Financial Review

The Yellen Rally

Sinclair Noe — March 30, 2016

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

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DOW + 83 = 17,716
SPX + 8 = 2063
NAS + 22 = 4869
10 Y + .01 = 1.83%
OIL + .02 = 38.30
GOLD – 17.60 = 1225.30

Federal Reserve Chair Janet Yellen said a lot of what markets wanted to hear at her speech to the Economic Club of New York yesterday. Yellen said global and financial uncertainties posed risks to the domestic economy. She emphasized that rate hikes by the Fed would be gradual while spelling out what she means by data dependence. Market-implied odds of a rate rise at the April FOMC meeting fell to zero following her speech.

World stocks are flying higher as investors welcomed Fed Chair Janet Yellen’s “cautious” stance on raising U.S. interest rates. The dollar plunged as Yellen started speaking yesterday and is now headed for its worst month since 2010. Oil futures rose 3 percent this morning, rallying in reaction to a weaker dollar. Equity markets rallied across the globe.

On Wall Street, both the Dow and S&P 500 have closed at 2016 highs two consecutive days and have more than completely wiped out losses from the worst start to a year ever for stocks. With one trading day left in the first quarter, the Dow is up 1.7% for 2016 and the S&P 1.0%. Only the Nasdaq remains in the red for 2016, down 2.8%. This is a stark turn from the dark days of early February, when the three major U.S. indexes had 2016 losses ranging from 10% to 15% when the market hits its low for the year.

Japan missed out on the global rally, however, after announcing that industrial output dropped 6.2% in February due to sluggish demand both at home and abroad. The month-on-month fall marks the biggest drop since March 2011, when a devastating earthquake in Japan crippled the country’s supply chain. Japanese factory activity is closely monitored by market watchers as a proxy for the trend of the national economy. Nikkei -1.3%.

Huge industrial overcapacity will drag on China’s growth this year, according to the Asian Development Bank, which cut its growth outlooks for the world’s second-largest economy. The ADB’s new forecast sees GDP growth slowing to 6.5% this year and 6.3% in 2017, compared with Beijing’s expectations of between 7% for 2016 and an average of 6.5% over the next five years.

The Brazilian Democratic Movement Party – the country’s largest – has left the governing coalition of President Dilma Rousseff, sharply raising the odds she could be impeached in a matter of months. While not totally unexpected, the loss of this key ally will likely lead other parties to follow suit.

ADP’s monthly report on private sector employment shows companies took on 200,000 workers in March; the increase in employment followed a revised 205,000 gain the prior month. The government releases their monthly jobs report on Friday; most estimates are running just above 200,000 new jobs in March.

Confirming earlier reports, Boeing says it will eliminate about 4,000 jobs in its commercial airplanes division by the middle of this year, and another roughly 550 jobs in a division that conducts flight and lab tests. The job cuts will include hundreds of executives and managers, but will not be executed through involuntary layoffs.

Lawmakers in Washington have revealed legislation that would give Puerto Rico the ability to restructure some of its $70 billion debt, weeks before an expected crippling default of the island’s de facto finance authority. Although it wouldn’t grant access to Chapter 9, the plan would award the territory some of the legal tools found in bankruptcy as long as it first jumps through a number of hoops. The restructuring process also calls for putting Puerto Rico’s finances under a presidentially appointed oversight board.

Is Novartis in more hot water? An anonymous whistle-blower has accused the Swiss drug maker of paying bribes in Turkey through a consulting firm to secure business advantages worth an estimated $85M. The alleged benefits include getting medicines added to drug lists approved for prescription in government-run hospitals, and avoiding price cuts in other countries by changing the names of two drugs. Last week, the U.S. asked Novartis for records of 80K “sham” doctor events.

A jury has rendered a verdict in a General Motors case involving a defective ignition switch; the switch was defective but it did not cause the accident in question. This was the first trial to reach a verdict since the company recalled millions of vehicles with the part. The eight jurors, who deliberated less than a day following a two-week trial in Manhattan, found that the ignition switch made the 2007 Saturn Sky involved in the crash on a New Orleans bridge unreasonably dangerous and that GM failed to warn about its safety risks. But the cause of the crash was icy road conditions and not the switch, and so they awarded no damages.

Takata has estimated that a comprehensive callback of its airbag inflators could total about $24 billion, that is about $7 billion more than a recent projection by analysts, sending its shares tumbling by a fifth to an all-time low. Bloomberg reports that the worst-case recall scenario would involve 287 million airbag inflators.

A District Court has ruled that MetLife isn’t so important after all, striking down a designation made by financial regulators that MetLife should be consider a systemically important financial institution, of SIFI. The designation as a SIFI requires a financial institution to hold extra reserves to insure against collapse. At the heart of the case is whether the government can designate non-banks as systemically important.

The 2010 Dodd-Frank Wall Street reform law authorized the U.S. to designate banks as ‘systemically important’ after AIG received a government bailout of $182 billion during the 2008 financial meltdown. MetLife argued in court that the Financial Stability Oversight Council (FSOC) used a secretive and flawed process when, in 2014, it determined that a collapse of the insurer could devastate the U.S. financial system just as much as failure of a major bank.

Last week the Supreme Court heard arguments in the Zubik v Burwell case, also known as the Little Sisters of the Poor case, which involves a challenge by religious nonprofit organizations to federal regulations requiring that employer-provided health insurance plans include contraception for women at no additional cost to the employee. The Little Sisters, a Roman Catholic order of nuns, operates homes for the elderly. Other plaintiffs include Catholic Charities and the Most Rev. David Zubik, the bishop of Pittsburgh.

The nonprofits argue that Obamacare is violating the Religious Freedom Restoration Act by requiring them to indicate in writing that they object to providing birth control to female employees, a bureaucratic step that allows the coverage to be provided and paid for by insurance companies or third-party administrators.

Yesterday the court issued an order asking lawyers on both sides to submit supplemental briefs, requiring the two parties comment on an imaginary workaround that would allow religious objectors to the Affordable Care Act’s contraception mandate to notify their insurers that they object to providing birth control, but in an even more subtle fashion than the workaround already given them.

First, the nonprofit will go to its insurer and say, in no uncertain terms, “We want insurance for our employees with no coverage for contraception.” They would not have to send in any government form or pay for any insurance they did not ask for. The insurer, the order suggests, would then send a notice to the employees saying that “the insurance company will provide cost-free contraceptive coverage, and that such coverage is not paid for by petitioners and is not provided through petitioners’ health plan.” If this sounds like a distinction without a difference, you might actually be qualified to be a supreme court justice, but don’t worry because you could never be confirmed.

Capping weeks of drama and intense negotiations, Foxconn Technology has finally clinched a deal to take over Sharp, but with a lower price tag than their original agreement. The Taiwanese firm will pay about $3.5 billion for a two-thirds controlling stake in Sharp, nearly $900 million less than its initial offer. Foxconn is reportedly planning to overhaul Sharp’s management including replacing its CEO.

Alphabet’s Google Fiber is introducing a home phone service, Fiber Phone, in addition to its existing high-speed internet and cable TV offerings (and potentially a triple play package). The service is set to provide unlimited local and nationwide calls for $10 per month, while adopting the same international calls rates as Google Voice. According to the company, a user’s Fiber number “lives in the cloud,” allowing them to use it on any phone, tablet, or laptop.

Microsoft’s Build 2016 kicks off today. Chief executive Satya Nadella addressed developers at the three-day conference in San Francisco, where the focus will be on HoloLens, an augmented-reality headset. Tweaks to the newish Windows 10 operating system will also get attention. Nadella kicked off the conference with a vision of the future filled with chatbots, machine learning and artificial intelligence.

Nadella said “Bots are the new apps,” and if you’re wondering what bots are, well, it involves “People to people conversations, people to digital assistants, people to bots and even digital assistants to bots. That’s the world you’re going to get to see in the years to come.” If you still don’t’ know what bots are, ask Cortana or Siri.

More than 80 years after the Hindenburg disaster, airships are poised for a comeback. Straightline Aviation has signed a letter of intent to acquire 12 new Lockheed Martin hybrid airships – 280 feet long, able to carry 20 tons of cargo – in a deal valued at about $480 million. The company plans to use the massive blimps to run air operations for oil-and-gas companies, transporting their equipment and commodities to and from remote locations.

Financial Review

That’s Her Story

Sinclair Noe — February 10, 2016

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

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DOW – 99 = 15,914
SPX – 0.35 = 1851
NAS + 14 = 4283
10 Y – .02 = 1.70%
OIL – .64 = 27.30
GOLD + 8.00 = 1197.80

Fed Chair Janet Yellen delivered her semi-annual Humphrey-Hawkins testimony in Washington today in her first major appearance since the Fed’s rate hike last December. In prepared testimony, Yellen said there are good reasons to believe the United States will stay on a path of moderate growth that will allow the Fed to pursue “gradual” adjustments to monetary policy.

Family incomes and wealth are rising, domestic spending “has continued to advance,” and business investment outside the oil sector accelerated in the second half of the year, she said. Yellen said she expects the labor market to continue to improve and inflation eventually rise towards the Fed’s target despite a recent drop in inflation expectations.

Yellen said that financial conditions “have become less supportive to growth.” If these conditions persist, they could weigh on the economy. In addition, Yellen said there are “downside risks” largely stemming from uncertainty about the health of the Chinese economy. “Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken and financial market conditions could tighten further.”

The Fed chairwoman did not come out and say anything about the U.S. central bank’s own forecast, made in December, that it would raise interest rates four times in 2016. She stressed the Fed was not in automatic tightening mode. Yellen said, “Monetary policy is by no means on a preset course.”

With Wall Street off to an ugly start to the New Year, there has been some speculation the Fed might have to reverse course and cut rates; Yellen addressed this in her Q&A session, saying: “I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy. I don’t think it is going to be necessary to cut rates.” Rather, she said she expected continued US growth would allow the Fed to pursue its plan of “gradual” rate hikes.

To boil it down for you, Yellen essentially said that we won’t see a rate hike in March and we won’t see 4 rate hikes in 2016. Tomorrow, Yellen will repeat the story before the Senate.

Treasury 10-year note yields fell two basis points, or 0.02 percentage point, to 1.70%. Two-year note yields rose one basis point to 0.70%. The difference between two- and 10-year note yields fell to the lowest on an intraday basis since January 2008; just 100 basis points. A shrinking gap is known as a flattening yield curve.

The decline in longer term yields probably doesn’t signal the expectation that short term rates might go even lower, but rather, it signals that bond market participants are seeing the possibility of rates going higher as diminishing. The upside, which in this case is a healthy economy with a healthy demand for money, is being perceived as less likely.

A possible side effect is that low rates equate to cheap money. Now that doesn’t mean that interest rates are dropping everywhere; corporate bond rates have not been dropping, largely because quality has been dropping. And don’t expect to see lower rates on credit cards in the foreseeable future; but mortgage rates are cheap.

Calculatedriskblog reports mortgage applications increased 9.3 percent from one week earlier; purchase applications are up 25% year-over-year; and refinancing applications increased 16% from the previous week. The average contract interest rate for a 30-year fixed rate conforming mortgage dropped to 3.91%, the lowest level since April 2015.

We had a similar flight to safety causing Treasury bond rates to plunge during the Euro-crises of 2012 and early 2013. Those low rates gave rise to the biggest increases in housing construction and jobs during the entire US expansion.

Japanese stocks extended a heavy selloff today, the Nikkei dropped 2.3%, closing in the red for six of the past seven sessions, despite a festive atmosphere across East Asia for the Lunar New Year holiday. Japanese Prime Minister Shinzo Abe defended BOJ Governor Haruhiko Kuroda’s handling of the economy, and said it was up to the central bank to decide what policy instruments to use.

The Supreme Court temporarily blocked the administration’s effort to combat global warming by regulating emissions from coal-fired power plants. The order was not the last word on the case, which is most likely to return to the Supreme Court after an appeals court considers an expedited challenge from 29 states and dozens of corporations and industry groups.

But the Supreme Court’s willingness to issue a stay while the case proceeds was an early hint that the program could face a skeptical reception from the justices. The 5-to-4 vote was unprecedented; the Supreme Court had never before granted a request to halt a regulation before review by a federal appeals court.

The challenged regulation, which was issued last summer by the Environmental Protection Agency, requires states to make major cuts to greenhouse gas pollution created by electric power plants, the nation’s largest source of such emissions. The plan could transform the nation’s electricity system, cutting emissions from existing power plants by a third by 2030, from a 2005 baseline, by closing hundreds of heavily polluting coal-fired plants and increasing production of renewable, clean energy.

Though the first emission reduction obligations do not take effect until 2022, the states said they had already started to spend money and shift resources; and any judicial review will be completed well before 2022.

The Treasury Department reports the federal government ran a budget surplus of $55 billion in January, compared with a deficit of $18 billion in the same month a year ago. Including the monthly surplus, the government is running deficit of $160 billion for the fiscal year to date. That’s 17% less than the first four months of the last fiscal year, which ended in September.

Deficit hawks shouldn’t get too excited by the lower year-to-date number, however. The Congressional Budget Office is projecting a deficit of $544 billion for fiscal 2016, which would be more than $100 billion above the shortfall for 2015. The CBO pegged that expected bigger deficit partly on some tax breaks being made permanent.

China has confirmed its first case of the Zika virus in a man who recently traveled to Venezuela. The World Health Organization declared Zika a public health threat on Feb. 1, and raised the possibility that there could be up to 4 million cases of the virus in the Americas alone.

Deutsche Bank shares recovered about 5% today, leading a surge in European bank shares. Deutsche Bank is considering a bond buyback to help ease investor concerns about its debt. The stock remains down over 30 percent since the start of 2016.

HSBC has been sued by the families of U.S. citizens murdered by drug gangs in Mexico, claiming the bank let cartels launder billions of dollars to operate their business. HSBC already paid nearly $2 billion in penalties in December 2012 to resolve charges that it failed to stop hundreds of millions of dollars in drug money from flowing through the bank from Mexico.

Just last week, the Justice Department announced that it had reached a $470 million settlement with HSBC related to mortgage lending and foreclosure fraud that led to the economic collapse of 2008.

MetLife, the same insurance behemoth that advertises how it is a huge international powerhouse, now says that it really isn’t so big after all, and to prove it, they sued the US government over whether regulators can designate non-banking firms as “too big to fail.” Today, the case went to trial.

Non-bank firms designated systemically important must hold more capital and comply with rules intended to stave off the need for a federal bailout should they fail. The rules have yet to be finalized. Last month, MetLife said it plans to split up due to the “regulatory environment” and pressure is mounting on other firms to also shrink and shed the “too big to fail” designation.


A significant barrier to Google’s plan to put driverless cars on the roads has been removed, after the NHTSA supported its interpretation that a robot could meet the legal definition of a driver. Do they get a driver’s license?

Google has also filed for another potential use of its artificial intelligence system in a patent award that described an “autonomous delivery platform” for trucks. The driverless transport vehicle would carry several lockers that could only be opened by the recipient of a package, using a PIN code or credit card.

Time Warner reported a bigger-than-expected drop in quarterly revenue as subscription revenue for its cable channel HBO and Turner television network disappointed. Time Warner dropped about 4% on the day.

Cisco Systems reported its second-quarter earnings rose to $3.1 billion from $2.4 billion in the same quarter last year. Revenue was flat at $11.9 billion. Cisco beat estimates on the top and bottom line. Shares moved higher in after-hours.

Whole Foods Market said profit declined in its latest quarter, same store sales were down and gross margin continued to deteriorate, but they still topped estimates. Shares moved higher in after-hours.

Twitter said it had 320 million average monthly active users in the quarter, lagging a forecast for 323 million users from RBC Capital Markets. Revenue rose 48% to $710 million in the quarter. Twitter posted earnings of 16 cents per share, versus estimates of 12 cents. But the takeaway is that user growth stalled. Shares moved lower in after-hours.

Tesla reports it will be cash flow positive in 2016, and will turn a profit. Just not today. Tesla posted a loss of $320 million, its 11th straight quarterly loss. But good times are right around the bend. Tesla shares moved higher in after-hours.

Financial Review

Sideways

Sinclair Noe — November 19, 2015

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

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DOW – 4 = 17,732
SPX – 2 = 2081
NAS – 1 = 5073
10 YR YLD – .02 = 2.25%
OIL – .24 = 40.51
GOLD + 11.30 = 1082.30
SILV + .04 = 14.32

The biggest rally in stocks in 4 weeks fizzled today. The S&P is up 2.9% so far this week. The S&P 500 has surged almost 12% from its August lows, including an 8.3% gain in October. Treasuries rose and the dollar fell. The MSCI Emerging Markets Index rallied 1.9%, heading toward the biggest weekly gain since the period ended Oct. 9. Equity gauges in South Korea, India and South Africa jumped more than 1%. Oil touched the lowest level in almost three months.

The number of Americans filing for unemployment benefits fell last week. Initial claims for state unemployment benefits slipped 5,000 to a seasonally adjusted 271,000 for the week ended Nov. 14. Claims have now held below the 300,000 threshold for 37consecutive weeks, the longest stretch in years, and are not too far from levels last seen in the early 1970s. Claims below this level are usually associated with a healthy jobs market.

Other data showed a slight pick-up in factory activity in the mid-Atlantic region in November after two straight months of declines. In a separate report, the Philadelphia Federal Reserve said its general activity index rose to 1.9 this month from -4.5 in October. It was the first positive reading in three months.

Arizona gained a net 33,800 jobs in October, dropping Arizona’s unemployment rate to 6.1% from 6.3%. Even so, the state remains well behind the nation’s 5% unemployment rate. In October, Phoenix had 1.9 million workers, about 3,000 fewer than it had in the same month eight years earlier.

Rebuilding the US energy industry to substantially reduce reliance on carbon-based fuels may result in a net gain of 2 million jobs by 2050 while increasing disposable household income, according to a new study sponsored by a nonprofit that advocates clean energy. The report found that a large-scale shift to renewable sources for generating electricity could increase U.S. employment by 1 million jobs by 2030 and 2 million by 2050, even after accounting for job losses related to fossil fuels. The transition would also provide between $300 and $650 in additional disposable income per household annually in 2050. A majority of the 2 million new jobs would be in the construction, utility and manufacturing industries.

Two IPOs came to market today: Square and Match. Both IPOs were underpriced, although the market will probably adjust in time. Square raised less than it had sought in its initial public offering, selling 27 million shares for $9 each, totaling $243 million. The price realized is well below the offer price of $11 to $13 a share and puts the company’s market value at about $2.9 billion, less than half the $6 billion valuation it had in its latest financing. In trading, the price popped to a high of $14.78.

Match Group, the owner of online-dating services Tinder, Match and OkCupid, priced its shares in its IPO at the bottom end of a $12 to $14 per share offering. The sale gives the company a market value of $2.9 billion. The price jumped as much as 24% in the first day of trading, valuing the company at $3.57 billion.

The U.S.’s biggest health insurer is considering pulling out of Obamacare, a month after saying it would expand its presence in the program. UnitedHealth Group is scaling back marketing efforts for plans it’s selling this year under the Affordable Care Act, and may quit the market entirely in 2017, because the business has proven to be more costly than expected. It’s an abrupt shift from October, when the health insurer said it was planning to sell coverage in 11 new markets next year, bringing its total to 34. The company also cut its 2015 earnings forecast.

MetLife, the largest U.S. life insurer, said the Financial Industry Regulatory Authority’s staff has indicated the agency will seek a “significant fine” from the company’s broker-dealer unit as part of a probe into possible violations tied to variable annuities. MetLife said in its quarterly regulatory filing that the company is cooperating in this investigation. MetLife said in the filing that the probe focuses on potential violations “regarding alleged misrepresentations, suitability, and supervision in connection with sales and replacements of variable annuities and certain riders on such annuities.”

Wall Street’s private stock markets would have to reveal whether they favor any particular users including high-frequency traders under a proposal approved Wednesday by the Securities and Exchange Commission. Many of the new disclosure requirements sought by the SEC mirror those currently reserved for public markets such as The New York Stock Exchange.

The regulatory effort follows a series of enforcement actions in which Investment Technology Group and UBS Group paid tens of millions of dollars to settle allegations they misled investors about how their dark pools worked. The proposal would require dark pool operators to make a new public filing that spells out their conflicts of interest, including whether an affiliate trades in the dark pool. If the dark pool creates advantages for any particular users, it would have to reveal that in the filing.

Japanese exports fell for the first time in more than a year in October. Exports slumped 2.1% last month, while imports fell 13.4%, hit by soft demand in China and other Asian economies. Despite the weakness, the Bank of Japan held its current pace of monetary stimulus steady at its policy meeting today.

Volkswagen is expected to announce substantial spending cuts on Friday, the day the carmaker must inform U.S. regulators of how it plans to bring its diesel cars into compliance with air-quality standards. VW is facing class action lawsuits around the globe. Volkswagen has also disclosed that 120,000 U.S. owners have signed up for its $1,000 goodwill package – or about one quarter of the 482,000 vehicle owners covered by the emissions scandal.

Meanwhile, Reuters is reporting that federal prosecutors with the Department of Justice are examining whether Bosch, the world’s largest auto supplier, knew or participated in Volkswagen’s years-long efforts to rig diesel emissions tests. Bosch built key components in the diesel engine used in six Volkswagen models and one Audi model. Federal authorities are also investigating how deeply the scheme permeated VW’s hierarchy. The probe is at an early stage and there is no indication that prosecutors have found evidence of wrongdoing at Bosch.

A proposed four-year labor contract between Ford and the United Auto Workers appears to be in trouble after more than half of those voting so far have rejected the pact and only two days remain for workers to cast ballots. Newer UAW members are providing the most resistance over the length of time it takes for younger workers to reach the top wage level. Older workers feel they gave up too much in earlier contracts. Results of voting are due on Saturday.

Pfizer is in advanced talks to buy Allergan  for as much as $380 per share in a deal that would value the Botox maker as high as $150 billion. The companies might announce an agreement as soon as Monday. Shares in Ireland-based Allergan had dropped due to plans by the U.S. Treasury Department to deter tax inversions, a major motivation behind Pfizer’s pursuit of the company.

The US Treasury Department will release new “targeted guidance” this week designed to reduce the tax benefits available to US companies that move their tax addresses overseas. Treasury Secretary Jack Lew informed lawmakers of the coming announcement in a letter on Wednesday. The administration previously has said it was examining “earnings stripping,” a practice by which companies load up their US operations with deductions and effectively push profits to low-tax countries.

In September 2014, the Treasury Department announced rules against inversions, including limiting companies’ ability to use their offshore profits to finance a deal. That change caused AbbVie to abandon a planned inversion, but other companies moved ahead. The Treasury hasn’t yet issued the formal regulations it promised last year, and congressional efforts to revamp the international tax system have stalled.

The September 2014 announcement included a warning that rules against earnings stripping might be retroactive to inverted companies. That means the Treasury announcement coming later this week could affect companies such as Medtronic and Mylan that finished their inversions in the past 14 months, plus a half dozen more deals that haven’t closed yet.

Cutting Pfizer’s tax rate to 15% would save $2.1 billion in 2017 based on analysts’ estimates. At a multiple of 10, that’s worth just over $20 billion. At the reported deal price, Pfizer would be paying a premium of more than $35 billion for Allergan based on its undisturbed price. If Pfizer can’t get the deal done, it might face a breakup fee of 2 to 3%. And the more companies try to weasel out of taxes through inversions, the greater the likelihood there will be legislative change, which could make any savings short-term or even non-existent.

The attacks in Paris may have finally spurred a brand change for Isis Pharmaceuticals, a drug maker that until now has held on to its name despite the terrorist group’s rise in the Middle East. Named after Isis, the Egyptian goddess associated with good health, the company has had the moniker since its founding 26 years ago. Its ticker symbol is also under review.

The House of Representatives has easily passed a bill to restrict the admission of Iraqi and Syrian refugees to America by requiring extra security procedures. The American Security Against Foreign Enemies Act of 2015, or the American SAFE Act of 2015, would require the secretary of Homeland Security, the head of the FBI and the director of national intelligence to sign off on every individual refugee from Iraq and Syria, affirming he or she is not a threat.

It’s unclear whether the Senate will take up the legislation. President Obama has already said he would threaten such a bill, and the perfect venue for a veto would be directly in front of the Statue of Liberty.

Financial Review

How to Eat a Bank

Sinclair Noe — April 10, 2015

 

Podcast: Play in new window | Download (Duration: 13:14 — 6.1MB)

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DOW + 98 = 18,057
SPX + 10 = 2102
NAS + 21 = 4995
10 YR YLD – .01 = 1.95%
OIL + .99 = 51.78
GOLD + 13.80 = 1208.30
SILV + .34 = 16.59

For the week, the Dow is up 1.6 percent, the S&P is up 1.7 percent and the Nasdaq is up 2.3 percent. Both the Dow and S&P notched their second straight week of gains.

Oil posted its fourth consecutive weekly gain. The oil rally coincided with a stronger dollar, which weighs on dollar denominated commodities. In March, the prices the U.S. paid for imported goods and services fell for the eighth time in the last nine months, even though the cost of foreign oil actually rose for the second straight time. Import prices dropped 0.3% last month, or an even steeper 0.4% excluding fuel.

The sharply lower cost of imported goods is a double-edged sword. We may pay less for commodities and all sorts of goods such as cell phones and electronics; and that can stretch paychecks. Next Tuesday the Commerce Department reports on retail sales and we’ll find out if shoppers are in a spending mood or a savings mood. A strong dollar is also great if you plan to travel abroad; they say April in Paris is pretty nice. Yet the strong dollar also makes US goods and services more expensive for foreigners to buy, reducing demand for American-made exports. That’s cutting into corporate profits and could even cost American jobs, potentially slowing the nation’s pace of growth. The Labor Department will report on both producer and consumer prices next week, prices at the wholesale and retail levels. Economists expect both the CPI and the PPI to be up in March compared to February, but maybe not enough to move into positive territory.

Earnings season kicked off this week. The corporate earnings outlook for 2015 is ugly, as first-quarter earnings for the S&P 500 index are expected to come in 4.7% lower , while second-quarter earnings are expected to be 2.1% lower, according to FactSet. Meanwhile, Thomson Reuters says profits of companies on the S&P 500 are projected to have declined by 2.9% in the first quarter. So, that should give you a range.

The big banks start reporting earnings next week, with JPMorgan and Wells Fargo posting results on Tuesday. Mortgage lending is expected to prop up bank earnings, as lower mortgage rates have spurred applications to refinance home loans. Financials have the best outlook among sectors, with analysts projecting first-quarter 2015 earnings to have surged 10% from a year ago, according to Thomson Reuters data. Meanwhile, energy is expected to be the worst performing sector; companies may see first-quarter earnings plummet 64% from the same quarter a year ago.

If you were hoping to be one of the first people to sport the new Apple watch, yea, that ship has already sailed. At one minute after midnight, Apple started taking orders for delivery of the watches in June. Within 6 hours they were sold out. It’s hard to believe we’ve all survived so long without one of those watches.

Also this coming week, we might see a plea deal in the long running investigation into manipulation of the London Interbank Offered Rate, or Libor. The NY Times reports Deutsche Bank is close to a deal with New York financial regulator, federal prosecutors, plus regulators in Washington and London to pay a penalty (somewhere in the neighborhood of $1.5 billion) and accept a criminal guilty plea. The bank also faces investigations into currency manipulation and violations of United States sanctions against countries like Iran. Several other banks have already reached settlements on interest rate rigging, but Deutsche was a holdout.

General Electric plans to sell most of its $30 billion real estate portfolio over the next two years as it gets back to its industrial roots; GE also set a share buyback plan of up to $50 billion – the second-largest ever. Blackstone Group and Wells Fargo are buying most of the assets of GE Capital Real Estate in a deal valued at about $26 billion. GE said it had letters of intent to sell an additional $4 billion of commercial real estate to other buyers that it did not identify. The total deal is the biggest in the commercial property market since Blackstone’s acquisition of office landlord Equity Office Properties Trust in 2007 for $39 billion.

GE’s deal to sell off real estate and get out of most of the finance business will result in an after-tax charge of $16 billion in the first quarter, and up to $4 billion worth of taxes on repatriated earnings. Right now, US-based multinationals are not taxed by the US government on what they earn overseas, until they repatriate or bring that money back to the US. According to a report in March by Credit Suisse, the cumulative earnings parked by S&P 500 companies overseas is over $2 trillion, and there’s at least $690 billion in overseas cash. It’s not like the money is lost overseas; it is sometimes used for foreign acquisitions; another trick is to borrow against the cash pile to pay for dividends or share buybacks; not exactly a path to productive, organic growth.

To console investors about the costs, GE authorized one of the largest buybacks ever, second only to Apple’s $90 billion buyback plan. General Electric has the potential to return more than $90 billion to investors through 2018 in the form of dividends, buybacks and other measures. The exit of most of GE Capital businesses is expected to release about $35 billion in dividends to GE, which would be allocated to its planned $50 billion share buyback.

CEO Jeff Immelt has been scaling down GE Capital since the financial crisis, when GE Capital almost wiped out the entire company. What was once seen as a way for GE to help finance sales to its own clients had grown into a financial behemoth that stretched into subprime lending among other areas. For years, Jack Welch had used reserves that GE Capital maintained against problem loans to smooth out the books at GE; adding to reserves in strong quarters and reducing them in weak quarters, when the income was needed. GE Capital became a black box of financial complexity that baffled even experts but allowed Welch to “deliver” remarkably consistent earnings, almost as if he could produce numbers out of thin air. At the same time it managed to suck the life out of research and development at the parent company. Who needs research and development and innovation on the industrial side when you can cook the books on the financial side?

In September 2008, GE Capital was on the verge of collapse, only revived by an infusion of cash and confidence from Warren Buffett (and yes, Warren pulled down a sweetheart deal). That seems to have been the point where Immelt recognized the need for a new direction, back to its industrial roots. The only financial operations to be retained will be the leasing operations that are directly tied to GE’s manufacturing businesses, which make equipment ranging from aircraft engines to medical scanners. GE anticipates that the industrial operations will generate 90% of revenue by 2018.

The finance arm still has $500 billion in assets, making GE Capital the country’s 7^th largest bank; that position also earned GE Capital the designation of a “systemically important financial institution” or SIFI. The designation as a so-called “SIFI” brings with it tougher oversight by the Federal Reserve. GE wants to lose the designation and the regulatory oversight that goes with it. They will still have a financing arm, but it will be greatly scaled down.

So far four non-bank firms, including GE Capital, have been designated as a SIFI. The others are insurers American International Group, Prudential Financial, and Metlife.   Metlife is suing the federal government over the label. Just yesterday, Jamie Dimon of JPMorgan bemoaned the burdens of regulation. Some of the SIFI firms have privately griped that regulators haven’t provided them with a clear path on how to shed the designation. The Wall Street Journal calls it the “Hotel California” of Fed oversight; it’s a clever line, and I wouldn’t be surprised if the marketing team at Metlife or JPMorgan came up with it, but it is also incredibly stupid and a lie. It is easy to drop the SIFI designation; all a bank has to do is get smaller; sell off parts, spin off parts – simple. And the path was laid out in the Brown-Vitter bill. The legislation presented the mega banks “with a clear choice: Either have enough of your own capital to cover your own losses or downsize until you are no longer a risk to taxpayers.” The banks managed to squash that legislation because they still like the old business model of privatized profits and socialized losses.

For Metlife the whole idea of SIFI regulations was just too much to bear. When the insurer was designated too big to fail, they sued; because nothing says you are not big like taking on the entire US government. The Metlife argument might be better if the company didn’t tout, in its own advertising that it is indeed a huge, global company with tens of billion in revenue and trillions in life insurance in force. They just don’t want to be forced to hold extra capital in reserve because it might bring down their profits. So, Metlife thinks that is terrible. But the government thinks it might be a good idea to have some reserves just in case something goes wrong; it would be like a cushion against a catastrophe, some type of safeguard against disaster, some protection from a meltdown, you might even call it insurance.

So, what today’s deal shows is that there is a way out of the “too big to fail” problem with the mega banks; just cut them into small bite sized pieces that can be easily digested, and the American taxpayer need never be forced to choke on bailouts again. That is how you eat a bank. In that regard, the GE deal might be the most important restructuring of the American banking system to happen under the Dodd-Frank Wall Street reform law.

FINANCIAL REVIEW

One Thing Is One Thing

Sinclair Noe — January 13, 2015

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

DOW – 27 = 17,613
SPX – 5 = 2023
NAS – 3 = 4661
10 YR YLD – .02 = 1.89%
OIL – .03 = 46.04
GOLD – 2.30 = 1232.10
SILV + .43 = 17.14

The stock market went south so fast. We started the day with a triple digit gain, up more than 250 points, then down by more than 100; there was a 425 point swing from high to low.

It is earnings reporting season. Shares of home builder KB Homes fell 16% after reporting softer demand in the fourth quarter hit gross margins, which will continue to lag prior-year results for some time.

CSX, the railroad company, today announced record fourth-quarter 2014 net earnings of $491 million, a 15 percent increase from $426 million for the same period last year. The company also generated record fourth-quarter earnings per share of $0.49, up 17 percent from $0.42 per share in 2013.
Tomorrow, JPMorgan and Wells Fargo will report earnings; Bank of America reports on Thursday, and Goldman Sachs on Friday.

MetLife wants the government off its back. The US’s biggest life insurer is going to sue to challenge its designation as “systemically important”. The institutions that receive the designation are expected to bolster their capital and liquidity and to submit to heightened monitoring by the Federal Reserve under the 2010 Dodd-Frank Act to prevent another financial crisis. MetLife is the first to sue.

The Justice Department and more than a dozen states attorneys general have accused Standard and Poor’s Credit Rating Agency of handing out, for a fee, highly inflated credit ratings to mortgage investments that then collapsed and helped to spur the financial crisis. The government is looking for a settlement of $1 billion. Still, S&P mounted a two-year campaign to defeat civil fraud charges, portraying them as retaliation for cutting the credit rating of the United States. But it turns out that one thing is one thing and the other thing is the other thing. S&P never really had a defense; there are hundreds of emails and memos and phone recordings clearly indicating that S&P was creating bogus ratings, for a fee. So, now S&P is looking to settle for $1 billion, which represents about one year’s profit.

Let’s take a look at today’s economic data. The federal government ran a budget surplus of $2 billion in December. The December figure brings the government’s budget deficit for the first three months of fiscal 2015 to $177 billion, which is 2% higher than the first quarter of fiscal 2014. The government spent $333 billion in December, up 44% from December 2013. Total receipts were $335 billion, an increase of 18%.

The World Bank cut its outlook for global growth, saying a strengthening US economy and falling oil prices won’t be enough to offset deepening trouble in the Eurozone and emerging markets. The drop in oil has bolstered the US recovery by giving consumers more money to spend, leading the bank to revise up its growth projection for the world’s largest economy by 0.2 percentage point to 3.2%. And the World Bank says the global economy is being pulled by a single engine, the US economy.

The copper market is saying that won’t be enough to eliminate a supply glut that’s lasted at least two years. Because of the drop in oil, there is just a general avoidance of raw materials. Falling oil prices also reduce mining companies’ energy costs, giving the producers an incentive to continue mining the metal, even as demand drops. Copper also may have been hit by technical selling when the price reached $2.72 a pound, which equals $6,000 a metric ton on the London Metal Exchange. The bottom fell out when we broke $6,000, and it’s been down ever since. Today, March copper dropped .12 to $2.60.

The Labor Department reports there were 4.97 million job openings in November, the highest level since early 2001, and up from 4.83 million in October. With 9.07 million unemployed people in November, there were about 1.8 potential job seekers per opening. The Job Openings and Labor Turnover Survey, or JOLT survey, shows the number of separations, such as quits and layoffs, fell to 4.62 million in November from 4.86 million in October. Meanwhile, the total number of hires declined to 4.99 million from 5.1 million. Now, let’s break it down; when workers are confident they can switch jobs, they are more likely to quit. Get a new job with more pay. We are starting to see that a little more than in the past 4 or 5 years, but workers generally lack the confidence to make that transition. Workers’ reluctance to quit means that employers don’t have to quickly ramp up pay for employees.

The Friday jobs report showed unemployment dropping to 5.6% but the problem is that wages also dropped. People aren’t quitting their jobs for better paying jobs, but there may be hope for better wages. ADP reports that people who stayed in their jobs in the third quarter scored an average 2.8% raise during the prior year, and that’s adjusted for inflation. The Labor Department’s employment cost index says much the same thing. The wage and salary part of the index, which excludes benefits, rose 1.6% for private-sector workers in the six months ending in September. And we are seeing some industry sectors paying more wages: restaurant workers got 3.3%, hotel workers 3.5%, construction workers 2.9%. Those numbers are not inflation adjusted and they are not big increases but they are increases. The next employment cost index, or ECI, which won’t be published until the end of the month, but the ECI has been rising throughout 2014. The third quarter ECI wage numbers were much stronger than the hourly earnings data. And that’s how it starts.

Meanwhile, the NFIB small-business-optimism survey rose to 100.4 in December, the highest reading since October 2006; and the report showed that 25% of firms reported compensation increases over the past three months, while 17% expected to increase compensation over the next six months. And the ECI tends to track with the NFIB’s optimism survey.

Of course, as the unemployment rate drops, it is not a guarantee that wages will go up. The thinking is that once we do get closer to full employment the picture for wages will change and the long awaited acceleration in labor compensation will finally materialize. The truth is that wages have been stagnant for more than 30 years, and we’ve had extended periods of low unemployment during that time. Inequality has been increasing for over three decades, and during that time we have been at or near full employment many times. Yet, wages over this time period have been flat. As noted by the Economic Policy Institute, “Since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline, even though decades of consistent gains in economy-wide productivity have provided ample room for wage growth.” The idea that market forces alone will increase wages sufficiently to offset increasing inequality is not supported by the evidence from these years.

Yields on Japanese government bonds hit record lows today. The yield on the five-year government bond hit zero for the first time, while the benchmark 10-year yield fell to a record low 0.25%. The Bank of Japan remains the dominant force in the domestic bond market, buying ¥8 trillion to ¥12 trillion a month of Japanese government bonds and driving yields lower as it seeks to flood the economy with cash to defeat more than a decade of deflation. Few investors are willing to bet against Japanese government bonds with the Bank of Japan buying at that volume. Also, last year the Swiss National Bank introduced negative interest rates on bank deposits; that followed a similar move by the European Central Bank. So, the central bank has been joined by foreign investors, who plowed a net ¥8.7 trillion last year into medium- and long-term Japanese debt, mostly government bonds.

It’s no secret that Europe is slowing down and that more stimulus is necessary. Euro zone government bond yields fell on the prospect of looser ECB policy and many Eurozone countries sold debt to lock in ultra-low borrowing costs. The euro dropped to a 9 year low against the dollar. The euro has fallen in seven of the last eight sessions and is on pace for a sixth straight week of losses. The ECB is expected to launch its own quantitative easing at next week’s meeting, as data out of the euro zone has become bleaker and bleaker by the day. Data from Greece showed its economy was mired in deflation while engineering orders in Germany fell 10 percent year-on-year in November.

Yes, oil was falling again today. Prices are down nearly 60% since peaking in June 2014—US crude futures for February touched $44.20 per barrel at one point today. Today’s drop was thanks to the UAE’s oil minister reiterating that OPEC has no plans to cut production, though all OPEC countries are losing money.

Remember the manufacturing renaissance? The idea was that China’s rising labor costs would make it more economical to keep manufacturing operations in the US, and maybe even some companies that had sent jobs offshore would send them back; they call it reshoring. Makes sense. Especially when you add in the idea of increased energy production in the US adding to lower production costs. And some of that has happened. Labor costs did rise in China, or at least some of the large, urban, coastal cities, such as Shenzhen. Some companies have already shifted facilities further inland in China, or even left China for Vietnam, Cambodia or (in the case of textiles) Bangladesh – just not back to the US. Energy costs have dropped, as we are all well aware. Both energy costs and shipping costs are volatile, and shipping costs only have a small impact on most manufacturers.

And there are examples of a renaissance. Dow Chemical does plan to invest $4 billion to expand its chemicals production on the Gulf coast; in the past two years, the aluminum industry has announced $2.3 billion of new manufacturing investments in the US. The US auto industry is alive and well. In 2014, 16.5 million vehicles were sold nationwide, making it the industry’s best year since the Great Recession, when sales plunged to hit a low of 10.4 million vehicles in 2010. And manufacturing has seen four straight years of growth, and we’ve added 520,000 new manufacturing jobs in the last 3 years. But we have to remember that we lost 2.5 million manufacturing jobs between 2007 and 2009. And we might never again employ the same numbers of people in manufacturing, in part because manufacturing is changing, and automating.