Financial Review

Aggressively Flat

Sinclair Noe — June 1, 2016

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

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DOW + 2 = 17,789
SPX + 2 = 2099
NAS + 4 = 4952
10 Y + .01 = 1.84%
OIL – .22 = 48.88
GOLD – 2.30 = 1213.70

It turned out to be an aggressively flat day on Wall Street. The Dow kicked off the morning with a 120-point drop and the S&P 500 index posted an early 22-point slide, followed by clawing and scratching back to slightly positive territory.

Manufacturing activity grew in May but at a very slow pace that suggests the sector is unlikely to speed up anytime soon. The Institute for Supply Management said its manufacturing index rose to 51.3% last month from 50.8% in April. Readings over 50% indicate more companies are expanding instead of shrinking.

The index has been above the cutoff mark for three straight months after slipping below 50% for five straight months. The big improvement came in how fast companies delivered goods to buyers and replenishing of inventories, a sign that demand may have picked up a bit.

JPMorgan’s Global Manufacturing Purchasing Managers’ Index (PMI), produced with Markit, came in at 50.0 last month, right on the level that separates growth from contraction, compared to 50.1 in April.

Construction spending dropped 1.8% in April. The monthly data followed an upward revision to March data of about 1.5%. Weakness in April was widespread. Residential construction declined 1.5%, while public construction spending fell 2.8%. Outlays for highways were down 6.6%. Many categories are stronger than they were a year ago, however, and overall all spending is 4.5% higher than in April 2015.

The U.S. auto industry looks set for another record year, even as May new-vehicle sales showed a decline. General Motors, the largest U.S. automaker, reported a 14.3 percent drop. Ford Motor said its sales fell 6 percent. Fiat Chrysler said sales rose 1 percent. In 2015, vehicle sales were a record 17.47 million vehicles. Overall, sales hit an annualized sale pace of 17.45 million units in May.

Toyota, Fiat Chrysler, Volkswagen and Mitsubishi are still selling new vehicles with defective air bags that will eventually have to be recalled. According to a report from the Senate Commerce Committee, the automakers confirmed they are continuing to sell some vehicles with ammonium-nitrate inflators without a drying agent.

The vehicles are legal to sell but must be recalled by 2018. The report also said that 11 automakers have replaced more than 2.1 million older Takata airbags with newer versions that would also need to be replaced. It just seems so incredibly stupid.

Prime Minister Shinzo Abe is postponing an increase to Japan’s sales tax (from 8% to 10%) by two-and-a-half years until 2019. Additionally, Abe will announce a new stimulus package in the fall aimed at sparking private demand and accelerating infrastructure projects. The decision marks an about-face for Abe, who already pushed off the hike once, and repeatedly said that only an economic shock on the scale of the Lehman Brothers collapse or a major earthquake would prompt another delay.

The OECD, which has a history of cutting its growth outlooks, has done it again, warning global policymakers of a self-fulfilling “low-growth trap” where ultra-loose monetary policy risks doing more harm than good. The organization lowered its world growth forecast by some 0.3%, predicting the global economy to expand by 3% in 2016 and “by only” 3.3% in 2017.

Looking at other major events on the calendar, tomorrow the ECB and OPEC meet, separately of course. The European Central Bank is not expected to announce any new stimulus measures. OPEC is expected to talk about caps on output but OPEC is not expected to announce an actual freeze on production.

Saudi Arabia has already said it won’t freeze production unless Iran freezes production, which Iran says it won’t do. Six months after OPEC left its high-production policy in place, some of the cartel members who called loudest for output cuts are feeling the most pain.

Friday brings the monthly jobs report, and we are looking for a repeat of the April numbers, somewhere around 160,000; any numbers significantly below 150,000 or above 200,000 could change the outlook for Federal Reserve decisions on interest rate policy; the FOMC meets on the 15^th.

One week later, there is a referendum in the UK and voters will decide whether to stay in the Euro Union or exit. Right now the Brexit is a toss-up. The official scolding seems to be backfiring.

Two weeks before a FOMC meeting, the Federal Reserve publishes the Beige Book, an anecdotal collection of observations on the economy from the 12 Fed districts. Today’s Beige Book noted tight labor markets in most districts despite modest job growth, growing price pressures. More generally, the Fed reported modest or moderate economic growth in the majority of its 12 districts.

Consumer spending was “up modestly on balance” in many regions. Reports on the factory economy were mixed, and banks generally saw higher demand for loans. Crop conditions were described as “promising in many districts,” though “low commodity prices continued to put pressure on agricultural incomes.”  The energy sector “remained weak” (no surprise) and everything else is good news for American workers.

Also today, we learned that Fed Chair Janet Yellen will deliver her semiannual testimony before Congress on June 21, about a month earlier than usual. This means we’ll hear from Yellen on June 6, June 15, and June 21. So, plenty of Fedspeak from the most important member of the FOMC ahead of a July 27 policy announcement that could include the Fed’s next rate hike.

Or the Fed could hike rates in June, and Yellen could try to explain how the Fed has been hacked at least 50 times in the past 4 years. The disclosure of breaches at the Fed comes at a time when cybersecurity at central banks worldwide is under scrutiny after hackers stole $81 million from a Bank Bangladesh account at the New York Fed.

French commuters are facing more travel disruptions as rail workers go on strike and President Hollande seeks to contain the labor unrest that caused many gas stations to run dry over the past week. About half of the nation’s train services have been canceled across the country, and there are concerns that the Euro 2016 soccer tournament, which France hosts from next week, may be disrupted.

Michael Dell and Silver Lake Partners underpriced their 2013 $24.9 billion buyout of Dell by about 22 percent and may have to pay tens of millions to investors who opposed the deal for the computer maker. The court ruling applies to about 5.5 million Dell shares. Dell shareholders claimed the Dell buyout took advantage of a dip in the company’s stock price and its board never determined the intrinsic value before negotiating. A Delaware judge was asked to make an appraisal of the fair value of the deal.

Cloud-based software maker Salesforce.com said it would buy Demandware, whose software is used by businesses to run e-commerce websites, for about $2.8 billion, or a 56 percent premium to Demandware’s Tuesday closing. The deal will help Salesforce open a new front as it looks to take away more market share from traditional software providers such as Oracle and SAP, both of which already offer cloud-based e-commerce services.

The Demandware deal follows Salesforce’s formula: Buy fast-growing companies that have the dual benefit of propping up Salesforce’s growth rate and opening new business lines. Salesforce is paying about 11 times Demandware’s revenue in the past year – more than double the median multiple offered in similar transactions over the last decade.

Who knows, maybe Salesforce will actually turn a profit someday. Meanwhile, consider that Salesforce and Google went public about the same time in 2004, and even though Salesforce has trouble posting earnings, the share price has outperformed Google.

Freeport McMoRan has wrapped up the sale of a 13% interest in its Morenci unincorporated joint venture to its Japan-based partner, Sumitomo Metal Mining Co for $1 billion in cash.  Freeport is taking aggressive actions, including asset sales and deferral of capital spending in an effort to cope with the weak commodity pricing environment.

Boeing has secured a more than $3 billion U.S. Air Force contract for Joint Direct Attack Munitions tail kits that use GPS to make conventional bombs into precision-guided weapons. Boeing’s contract was raised from an initial $1.75 billion awarded in October 2014, due to warfighter demand and the need to replenish depleted inventories.

Doctors at Hackensack University Medical Center in New Jersey have confirmed the birth of a child suffering from Zika-linked microcephaly, a condition wherein the child’s brain and head are partially developed. Reports indicate she is the first baby born with complications from the virus in the tri-state area. The mother is said to have contracted Zika while in Honduras and was admitted to Hackensack while vacationing in the U.S.

Following the lead of Britain and Australia, Canada is making plain packaging of cigarettes compulsory in a bid to cut the rate of smoking. Although the country already obliges firms to slap large graphic warning labels on cigarette boxes, the new measures would require a uniform, standardized color and font on packs and restrict the use of logos and trademarks.

The Food and Drug Administration proposed voluntary guidelines for the food industry to reduce salt. Though the guidelines are not mandatory, consumer advocates said they are meaningful because they will serve as a benchmark by which companies can be measured.

Americans eat almost 50 percent more sodium than what most experts recommend. More than 70 percent of sodium consumed is already in food before it reaches the table, according to the Centers for Disease Control and Prevention, and health advocates say the guidelines could help reduce that.

Financial Review

Flip Flop Fedspeak

Sinclair Noe — February 18, 2016

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

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DOW – 40 = 16,413
SPX – 8 = 1917
NAS – 46 = 4487
10 Y – .06 = 1.76%
OIL – .12 = 30.54
GOLD + 22.30 = 1231.70

After spending 2015 calling for rate hikes St. Louis Fed President James Bullard said Wednesday evening in a speech on monetary policy that it would be unwise for the Federal Reserve to continue raising interest rates given declining inflation expectations and recent equity market volatility.

Bullard, who is a voting member of the Fed’s rate-setting committee this year, said he now feels key assumptions supporting higher rates have been undermined. Bullard’s big concern is inflation expectations, and inflation has been trending lower, and Bullard believes stock market expectations have a big impact on inflation. In contrast to Fed Chairwoman Janet Yellen or Fed Vice Chairman Stanley Fischer, Bullard doesn’t think labor market conditions have much impact on inflation as the traditional “Phillips curve” suggests.

Today, San Francisco Fed President John Williams gave a speech in LA, where he said the economy “is, all in all, looking pretty good.” Williams said his views of the economy haven’t changed much from December: “When I look at my December forecast and compare it with my outlook for unemployment and core inflation today, there’s virtually no change” Williams said he was aware of potential risks facing the economy but added that that watching a stock ticker “isn’t the way to gauge America’s economic health.”

The Federal Reserve’s next policy move is much more likely to be a rate hike than a rate cut, although over the next two years a return to zero rates is a rising possibility – that according to a New York Fed survey of primary dealers. The regular monthly survey of 22 primary dealers, or those that do direct trading with the Fed, see about a 75 percent chance that the Fed’s next policy move will be a rate hike, with just over half expecting that rate hike to take place at the Fed’s March meeting; an 8 percent chance the next move will be a rate cut, and a 17 percent chance of no change in rate in 2016.

Ray Dalio, founder of hedge fund Bridgewater Associates, in a new letter to investors says history is in the making, as central banks have backed themselves into a corner with monetary policies that are about to run out of steam. Dalio expects central banks to keep trying new ideas to stimulate economies, including negative interest rates and more money printing. Dalio says investors should expect to experience lower than normal returns with greater than normal risk.

The Organization for Economic Growth and Development say governments in the US, Europe and elsewhere should take “urgent” and “collective” steps to raise their investment spending and deliver a fresh boost to flagging economic growth. In its most forceful call to action since the financial crisis, the OECD said the global economy is suffering from a weakness of demand that can’t be remedied through stimulus from central banks alone.

The OECD cut its global growth forecasts, saying global gross domestic product will expand 3.0 percent in 2016, the same pace as in 2015 and 0.3 percentage point less than predicted in November. The OECD urged governments that can borrow at very low interest rates to boost their spending on infrastructure. The OECD said that if governments work together, fresh borrowing could have such a positive impact on growth that it would reduce rather than increase their debts relative to economic output.

The number of Americans filing for unemployment benefits unexpectedly declined last week to a three-month low. Initial jobless claims dropped by 7,000 to 262,000 in the week ended Feb. 13. Last week coincided with the period that the government surveys businesses and households to calculate payrolls and the jobless rate for February.

High stake talks to keep Britain in the European Union will take place over the next 36 hours, as Prime Minister David Cameron heads to Brussels to hammer out a deal he can sell to British voters. He has called for reform in four areas: measures to curb migration, safeguards to protect London’s financial district, Britain to be excluded from an “ever closer union” and for greater competition in the bloc. Most officials expect a referendum to be held in late June.

The US government’s Energy Information Administration said crude stockpiles rose 2.1 million barrels last week, to a peak of 504.1 million barrels in the third week of hitting record highs in past month. The EIA also cited record high gasoline inventories.

Standard & Poor’s has downgraded the credit ratings of several Middle East nations, in its second mass cut of large oil producers in almost exactly a year. Citing pressures from the drop in crude prices, the ratings agency lowered Saudi Arabia by two notches to A- stable, and stripped Bahrain of its investment grade status. S&P also cut the ratings of Bahrain and Oman to reflect lower oil price assumptions.

Anglo American’s credit rating was cut to junk by Standard & Poor’s, following similar downgrades by Moody’s Investors Service and Fitch Ratings this week. Anglo became the first major London-based miner to be rated junk. They are trying to sell off coal and iron ore assets to pay down debt.

Bloomberg is reporting Citigroup plans to exit retail banking in Argentina and Brazil, where the company has maintained operations for more than 100 years.  Citi announced plans in October 2014 to drop consumer banking in 11 markets, including Peru, Costa Rica and four others in Central and South America.

Marriott and Starwood have scheduled separate shareholder meetings to consider Marriott’s $12.2 billion buyout bid that will create the world’s largest hotel business. If approved, the transaction could close in mid-2016. After the bell yesterday, Marriott posted earnings; revenue fell short of estimates.

Chinese conglomerate Tianjin Tianhai is acquiring electronics distributor Ingram Micro for $6 billion, or $38.90/share in cash (representing a 31% premium to Ingram Micro’s close on Wednesday). Ingram Micro will maintain its headquarters in California, but they will suspend their dividend and buyback programs.

IBM has agreed to purchase Truven Health Analytics for $2.6 billion, its fourth health data-related acquisition in less than a year. Closely held Truven provides cloud-based data management and analytics to more than 8,500 health-care clients, including hospitals, insurers and government agencies

Boeing engineers and technical workers approved a six-year contract extension that brings better salary, plus vacation, layoff and retirement benefits. Boeing reaffirmed its outlook for strong growth and cash flow over the next five years, and defended accounting practices for the 787 Dreamliner.

This morning Walmart reported fourth quarter profit topped projections, and revenue fell as sales growth slowed at its US stores during the holiday quarter. The 0.6 percent increase in sales at U.S. stores open more than a year marks the chain’s sixth straight three-month period of growth after a long run of decreases.

Walmart lowered its annual sales forecast, saying it now expects to see flat sales instead of 3 to 4 percent growth. The chain said the change in expectations is because of the continued strength of the U.S. dollar and the impact of the decision it announced it January to close 269 of its stores across the globe.

Walmart has been ramping up its efforts in the last year to become a more serious rival in e-commerce to Amazon.com. And yet, some of the numbers in today’s earnings report only serve to showcase how much Amazon is still pummeling Walmart in the category. Walmart said its online sales growth for the full year was 12 percent, with a total e-commerce sales haul of $13.7 billion.

That may sound like a healthy increase, until you consider that Amazon’s total e-commerce sales during the same period were north of $83 billion. Walmart reported $130 billion in revenue in the quarter, a 1.4 percent decrease from the same quarter last year. Profit dipped 8 percent to $4.5 billion. Earnings per share were $1.49, slightly better than the $1.46 that analysts had expected.

Also before the opening bell, MGM Resorts reported a $1.4 billion loss for the fourth-quarter; that compares to a loss of $287 million in the year-earlier period.

In other earnings news: Barrick Gold shares dropped despite a smaller quarterly loss. Newmont Mining posted weaker than expected earnings. CF Industries reported fertilizer prices weakened. GoDaddy said a strong dollar weighed on results. Noble Energy posted an unexpected profit. Nvidia reported higher chip demand, and offered strong guidance. Priceline said hotel bookings increased.

And T-Mobile tripled profits. Virgin America reported a higher fourth-quarter profit that met analysts’ estimates amid lower fuel costs, and said it expects passenger unit revenue to continue to decline in the first quarter. Nestle missed forecasts with a 4.2 percent rise in annual underlying sales and predicted only a similar outcome this year, saying it was getting harder to raise prices in a tough economic environment. DISH Network reported lower net income in 2015 from a year earlier, as pay-tv subscriptions dropped. Dish shares down more than 4 percent.

The FCC has just voted to break the chains that bind you to your cable TV set top box. The FCC vote allows third-party manufacturers to make set-top boxes that deliver cable television. The proposal also requires cable and satellite companies to make their content available for these alternative boxes. According to a July Senate study, more than 99 percent of cable customers in the United States currently rent a box from their cable company for $231 per year on average.

The idea of the FCC proposal is that third-party devices like Nexus Players or Apple TVs could eventually provide cable alongside other streaming apps and Internet services. You can see why the cable industry isn’t keen on this change. Opening the market could drive down cable box prices and push cable companies to spend money improving their set-top tech. Don’t return your cable box just yet though. The rule will now go into the comment period—in which businesses and customers can now weigh in—before the final vote.

Financial Review

A Perfect Gift

Sinclair Noe — June 3, 2015

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

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DOW + 64 = 18,076
SPX + 4 = 2114
NAS + 22 = 5099
10 YR YLD + .10 = 2.37%
OIL – 1.68 = 59.58
GOLD – 7.70 = 1186.00
SILV – .27 = 16.58

The U.S. trade deficit narrowed in April on a drop in imports. The Commerce Department said the trade gap narrowed to $40 billion from March’s revised deficit of $50 billion. The 26 percent drop in the April trade deficit was the largest decrease since early 2009 and reflects a surge in imports in March following the end of a West Coast ports labor dispute.

Service industries expanded in May at the slowest pace in 13 months. The Institute for Supply Management’s non-manufacturing index, which includes an array of industries from real estate to dining, declined to 55.7 from April’s 57.8. Readings above 50 signal expansion. Limited growth in orders reflects an American consumer who has been saving the extra cash from low gasoline prices and rising employment rather than spending it. Arts and entertainment, real-estate firms and rental companies led the list of the 15 non-manufacturing industries that reported growth in May. Mining, which includes oil extraction, contracted. An index of employment in service industries dropped to 55.3 in May from 56.7.

Payrolls processor ADP reports private employers added 201,000 jobs in May, the most since January. The ADP data came ahead of the U.S. Labor Department’s more comprehensive non-farm payrolls report on Friday, which includes both public and private-sector employment. It is estimated that the Friday Jobs Report will show 225,000 new jobs in May and the unemployment rate steady at 5.4%.

Meanwhile, the Labor Department has released details on the April jobs report. Payrolls grew in 50 U.S. metro areas with a population of 1 million or more in April compared with a year earlier. The biggest increase occurred in Silicon Valley’s San Jose metro area, where payrolls grew 6%. That was followed by the areas surrounding Orlando, Fla., where payrolls grew 4.3%, and Riverside, Calif., which saw 4.1% payroll growth. Employment in New Orleans was the only metro area without an increase; holding steady in April from a year ago. Austin, Texas had the lowest unemployment rate in April, at 3%, followed by Salt Lake City, Utah, at 3.1%. The Las Vegas area had the highest jobless rate at 7.1%. Metro Phoenix came in at 4.9%.

Two weeks before a FOMC policy meeting, the Fed publishes the Beige Book, an anecdotal assessment of the economy, named for its unassuming beige binding and page turning eloquence. Reports from the Federal Reserve’s 12 major regional district banks show a “generally optimistic” outlook for U.S. economic growth, which is “expected to continue at a modest to moderate pace in several districts.”

“Modest growth” was seen since the April 15 Beige Book publication in four Fed districts, while “moderate growth” was seen in three others. Dallas was the only district to report that its economic pace “slowed slightly.” Richmond and New York were the only districts in which consumer spending hadn’t picked up since April 15. And auto sales picked up everywhere except in New York and Cleveland. The Fed highlighted the effect of low gas prices in some of its districts, saying they had provided “a tailwind for consumer spending”; however that assessment has not yet been backed up by hard data. Employment levels were up slightly, with some districts reporting labor shortages.

The European Central Bank left interest rates unchanged at record lows. ECB president Mario Draghi said monetary policy stimulus is filtering through to the economy as planned, and he insisted the European Central Bank needs to see its bond buying through to the finish. Since the ECB started its $1.2 trillion quantitative easing program three months ago, inflation in the 19-nation euro area may have bottomed out. The inflation rate in the Eurozone was positive for the first time in six months in May, rising to 0.3 percent from zero. Draghi said:  “The recovery is on track exactly according to our projections.”

The fly in the European soup bowl could be Greece. The Greeks presented their proposal for a bailout; creditors presented a take-it-or-leave-it ultimatum in reponse; Greece threatened to miss a loan repayment to the IMF due on Friday if they can’t get a proposal they can live with. German Chancellor Angela Merkel stepped in to unblock the stalemate. Greek Prime Minister Alexis Tsipras is meeting today with European Commission President Jean-Claude Juncker.

OPEC is set to carry on pumping oil nearly flat-out for at least the next several months. OPEC is scheduled to meet Friday to determine production quotas and with oil prices having stabilized at around $65 a barrel there’s little appetite within OPEC to modify production limits or address Iran’s request to give it more room in the market as sanctions ease. OPEC officials will be meeting with executives from several major oil companies. Today, BP CEO Bob Dudley said he believes global oil supplies will continue to grow, putting downward pressure on prices.

And in an interesting twist, the leaders of six of Europe’s largest oil producers are calling for a plan to price greenhouse gas emissions, citing climate change as “a critical challenge for our world.” In a letter to the executive secretary of the United Nations Framework Convention on Climate Change and the president of the upcoming 2015 Paris Climate Conference, the CEOs of BP, Royal Dutch Shell, Statoil, Total, Eni, and BG Group focus on creating a framework for carbon pricing in countries that currently lack one, and then connecting that framework internationally.

The OECD, which has a history of cutting its growth outlooks, has done it again, reducing its global forecast due to lagging investment and risks, including a possible Greek default. Chief Economist Catherine Mann said that despite “monetary accommodation, less fiscal drag and a reduction in oil prices,” we’re not getting growth that is “matching the average of the past two decades.”  The OECD now expects the world economy to expand 3.1% in 2015, down from 3.7% predicted in October. Last year, the world economy grew 3.3%.

Several of FIFA’s big corporate sponsors including Coca-Cola, Visa, and Adidas said they welcomed the resignation of the soccer governing body’s president, Sepp Blatter, amid a wide-ranging corruption scandal, and urged the organization to enact swift reforms to restore its credibility. Of all the individuals and firms tied up in the scandal over bribery and corruption at FIFA, so far scrutiny has largely escaped KPMG. KPMG was the auditor for FIFA for the entire time under investigation, and it served as advisor for the Russia and Qatar official organizing committees when they prepared the winning bids that are now the target of corruption investigations in the U.S. and Switzerland.

Looking to expand its user base and rev up its revenue engine, Pinterest is planning to launch “buyable pins,” enabling users to buy items they see directly via Pinterest. Although Pinterest won’t take a cut of each transaction, merchants will have the option to pay for “promoted pins” – giving the company an important revenue source following its $11 billion valuation. Instagram has also announced a similar feature, permitting advertisers to add a button to encourage viewers to click through to their website.

The internet is the future of course, but online advertising has always been a fraction of the huge budgets spent on TV ads. That’s expected to change by 2019. PriceWaterhouseCoopers estimates that online advertising, which in 2014 brought in $49.45 billion in revenue in the US, will climb to $83.89 billion by 2019. That year will prove to be a major tipping point in advertising, with online ads overtaking television for the first time. Over this same period, TV advertising in the US will grow from $69.2 billion to $81.05 billion.

Wendy’s unveiled a new $1.4 billion share buyback, announced the closing of the sale of its bakery operations, reiterated guidance for 2015 and provided a longer-term outlook.

Avian flu has been the bane of American poultry farmers for months. Three deadly strains have forced them to kill off entire flocks of chickens, turkeys, and other birds to stop infection spreading, and to shut down facilities for costly disinfection procedures. Now consumers are going to start feeling the effects too. The price of wholesale consumer-grade eggs in the US reached an all-time high of $2.62 per dozen yesterday.

The nation’s population of egg-laying hens has been decimated. More than 30 million hens have been killed in Iowa alone, and it will be more than a year before egg production returns to normal across the country. On June 1, the fast-food chain Whataburger announced it will be limiting the hours that customers can order breakfast at its 800 restaurants in 14 states. Instead of serving breakfast taquitos and biscuit sandwiches with scrambled eggs 12 hours a day, Whataburger will offer them for four hours on weekday mornings and six hours on weekend mornings.

Takata will “rapidly” reduce its use of ammonium nitrate as an air bag propellant after it appeared “to be one of the factors” contributing to inflator ruptures; that was part of the testimony of Takata executive Kevin Kennedy before  a congressional subcommittee yesterday. However, Representative Michael Burgess, the Texas Republican who chaired the hearing, said he “couldn’t believe” what he was being told. “They are still making an air bag with ammonium nitrate as a propellant without a desiccant and they’re putting that in replacement and new vehicles.” Burgess said, “It almost seems like there should be a warning label stamped on the car.”

Hedge-fund manager John Paulson is donating $400 million to Harvard University, the biggest gift in the school’s history. Harvard’s School of Financial Engineering and Applied Sciences will be renamed after Paulson. Paulson rose to fame and fortune in 2007 by using credit default swaps to bet against the subprime mortgage lending market, essentially a bet that mortgages would fail. That gamble paid off big. And while $400 million sounds like a large amount; it won’t make a big difference, not like donating the money where there is actual need. Harvard already has a $36.4 billion endowment, so really it was a perfect choice… for someone like Paulson.

FINANCIAL REVIEW

Before the Flood

Sinclair Noe — December 11, 2014

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

DOW + 63 = 17,596
SPX + 9 = 2035
NAS + 24 = 4708
10 YR YLD + .01 = 2.18%
OIL – 1.22 = 59.72
GOLD + 1.30 = 1228.40
SILV + .04 = 17.20

We have a lot to cover. Let’s start with the economic news. The government reported early this morning that retail sales in November expanded at the fastest pace in eight months, rising 0.7%. A wide variety of retailers reported healthy sales last month. Retail sales growth hit 1.7% for autos, the most since August; and 1.2% for clothing, the most since April. Sales at building material and garden equipment stores jumped 1.4%, the most since April; while online or non-store retailers saw a 1% sales gain.

The Commerce Department reports business inventories rose 0.2% in October, as building material and clothing stores both built stocks heading into the holiday season. That represents a 4.8% gain from October 2013.

The number of people who applied for unemployment benefits hit the lowest level in three weeks, as employers continued to lay off very few workers. Initial claims for regular state unemployment-insurance benefits inched down by 3,000 to 294,000 in the week that ended Dec. 6.

The prices paid for imported goods fell 1.5% in November, the largest drop since June 2012, dragged down by lower fuel prices. Excluding fuel, import prices declined by 0.2% last month. The price of US-made goods exported to other nations, meanwhile, fell by 1% in November, the biggest decline since April.

Household wealth in the US dropped $140 billion from July through September, or 0.2% from the previous quarter to $81.3 trillion. The Federal Reserve used to call this report the flow of funds survey. Survey says the net worth of households dropped because of stock market weakness over the summer; the value of financial assets, including stocks and pension fund holdings, held by American households decreased by $315 billion in the third quarter. So the drop may be temporary, as stocks have rebounded in the fourth quarter. Household real-estate assets climbed by $214 billion.

The OECD, the Organization for Economic Cooperation and Development has ranked 43 nations on various economic measures. The typical American is even poorer than his or her equivalent in Greece. The median Australian is four times wealthier. The Canadians are twice as wealthy. The US continues to lead the world in billionaires (571 in 2014, with China a distant second at 190). But Americans rank 26th in median wealth (defined as assets owned, minus debts owed for the person on the middle rung of the wealth ladder).

Oil prices continued to crumble. I thought $60 would be an important level of support, but the price cut through that level like a hot knife through butter, to settle at 59.72, the lowest closing price since July 2009. Oil prices are now down 39% year to date. There are several reasons for the drop in oil prices. First, the US has been producing more oil, including shale oil, and yesterday the US Energy Information Administration reported that supplies had increased 1.5 million barrels for the week ended December 5th. Meanwhile, OPEC has not cut production as they try to maintain market share against the shale producers. Also, there is some geopolitical positioning as Saudi Arabia plays hardball with Russia and Iran over Syria. This makes any rapid recovery of oil prices unlikely, especially as additional supply looks set to reach the market from northern Iraq and Libya. Next, the Chinese economy is slowing slightly and the Eurozone is stagnant. The International Energy Agency estimates global oil demand for 2014 will now average 92.4 million barrels per day, reflecting the weakest growth in 5 years. OPEC predicts that demand for its oil will drop by about 500,000 a day in 2015. Also consider that oil is purchased in dollars and the dollar is strong; as the dollar increases in value relative to other currencies, it means you can buy more oil with each dollar. Oil’s price plunge started not long after the dollar rally began to accelerate; if the dollar rally falters, look for oil to find support, but it hasn’t happened yet.

As oil prices have dropped, the yield on junk bonds has been climbing because there are a bunch of junk bonds financing oil development projects; prices on high-yield bonds have declined 2.4% this month and 5.7% since the end of August, even as US equities have climbed to new highs. The divergence may signal junk-bond traders are picking up on a fundamental problem of overvalued energy companies in frothy markets. The energy sector accounts for 22% of US high-yield issuance and 16% of loan issuance through December. Some analysts are predicting a wave of defaults in the next couple of years. New York-traded oil futures around $60 a barrel would push energy companies with a riskier credit profiles to a level that would imply a 30% default rate.

Treasury Secretary Jacob Lew said today it was “premature” to talk about risks of contagion in US financial markets from the drop in oil prices. Asked for his reaction to the fact that many leveraged loans are tied to the energy sector, Lew said in general there will be winners and losers from the drop in energy prices. Overall, he said the drop in oil prices was like “a tax cut for the economy.” It may be premature to talk about contagion but don’t expect Secretary Lew to ring a bell when contagion is no longer premature.

In Washington, the politicians are wrangling over a spending bill to fund the government. A vote was supposed to take place today, but so far no vote. Then the vote was pushed back to 8PM Eastern, but that may or may not happen. The reason is that they aren’t sure they can muster enough votes for passage. Both Republicans and Democrats are opposed to the funding bill for different reasons that are not directly related to funding the government. Some Republicans are upset that the spending bill would delay any action to confront Obama over immigration. Some Democrats are upset about provisions that would scrap parts of the Dodd-Frank Financial Reform Law regarding federal insurance of some banks’ derivatives trades, plus a provision that would loosen campaign finance restrictions. The omnibus appropriations bill also combines a continuing resolution, and the whole thing is reportedly 2871 pages. I haven’t read it. The politicians that may or may not vote on it, have not read it. This is no way to run a government, which may shut down at midnight.

Can you name the worst performing global stock market in 2014? If you answered Russia’s RTX Index, you are correct; it is down 43% year to date. The Russian central bank raised interest rates again today, the fifth rate increase this year; rates now stand at 10.5%. It didn’t work. The Russian ruble fell 1.6% today.

Can you name the second worst performing stock market this year? The answer is the ASE Index, or the Athens Stock Exchange in Greece, which has been dropping like a rock this week, down 7.9% today, and down 29% year to date. The ASE had rallied to an almost three-year high in March. Greece’s government said this week it would start the process of electing a new president early, like next week early, even though they haven’t even figured out who the candidates will be.

A US appeals court has overturned the convictions of 2 former hedge fund managers for making illegal insider trades. The court held that defendants can only be convicted of insider trading if the person trading on confidential information knew the original tipper disclosed it in exchange for a personal benefit. So, if you were wondering how to get away with insider trading, the courts have now laid out the secrets. You cannot ask for a specific insider tip, pay for that insider information, and then trade and profit from that information. You can ask for specific insider tips but you must not pay for it directly; you can provide indirect compensation such as meals, travel, hookers, cocaine, box seats to a basketball game or even future compensation at some unspecified future moment in time; then you can trade on that information and profit from that information. So, apparently the courts have ruled that insider trading is acceptable as long as the trader is not blatant about directly paying for the insider information.

Insider trading is still cheating, of course. And it hurts the honest traders on Wall Street; and it hurts regular everyday investors; and it erodes the integrity of Wall Street, which I must admit is an oxymoron; and it further diminishes the integrity of the legal system, which is currently pretty low.

If you’re planning on traveling to California, think again. The Golden State is getting pounded by the Pineapple Express, a massive Pacific storm that is causing flooding and high winds and power outages. The storm is still centered out at sea but it is expected to bring up to 6 inches of rain to some areas near San Francisco and 4 feet of snow to the Sierra Nevada Mountains. We’ll get some remnants of the storm in Arizona over the next few days. The term Pineapple Express refers to a warm, moist air mass that brings rain to the Pacific. It’s called a Pineapple Express because the moisture stream comes from near Hawaii where pineapples are grown. Another way to think of the Pineapple Express is a river of water in the sky. In 1862, a Pineapple Express hit California and reportedly dumped up to 8 feet of rain on some places, leading to the worst flooding in recorded history of California, Oregon, and Nevada. Known as the Great Flood of 1862, both the Sacramento and San Joaquin valleys flooded, and there was extensive flooding and mudslides throughout the region. Nowadays, the extensive waterways and earthen dams from San Francisco to Sacramento would be demolished by that kind of flooding.

There is another round of storms expected to hit the coast next week, but it is nothing like the great storm of 1862, and it is not enough to end the drought in California, which some scientists say has been the worst drought in California in more than 1,000 years. Meteorologists say we would need to see 5 more storms like this before they would consider the drought to be ended. Meanwhile, much of the rain from this storm will wash away, leaving some landslides in its wake.

FINANCIAL REVIEW

Faster and Faster but No Liftoff

Sinclair Noe — November 25, 2014

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

DOW – 2 = 17,814
SPX – 2 = 2067
NAS+ 3 = 4758
10 YR YLD – .05 = 2.26%
OIL – 1.95 = 74.22
GOLD + 2.90 = 1202.20
SILV + .20 = 16.77

The major stock indices couldn’t close at records, but Apple reached a milestone today. Apple’s market capitalization hit a record $700 billion; that’s double from 3 years ago when Tim Cook became CEO. Apple is the first S&P 500 company to ever reach a $700 billion market cap. Yet, on an inflation-adjusted basis, it still has way to go to be the most valuable company of all time. Microsoft’s market cap peak of $613 billion in 1999 translates to nearly $874 billion in 2014 dollars. When Microsoft was at the top, it was trading at 72 times earnings. Apple’s price-to-earnings ratio is currently 18, in line with the overall S&P. It’s a little tough to imagine what Apple will do in the future to match the growth they’ve experienced in the past.

The economy is better than you thought. The Commerce Department revised its estimate of third quarter gross domestic product from 3.5% up to 3.9%. There will be another revision before settling on a final number. Second quarter GDP came in at a 4.6% growth rate; combined second and third quarter GDP was the strongest back to back growth since 2003. Let’s break down the data.

A couple of key factors behind the increase include more consumer spending along with a little more business investment. Falling gas prices meant that people could go to the gas station and still have cash for other purchases. A separate report from the New York Fed show household debt balances also increased $78 billion in the third quarter at $11.7 trillion. Overall household debt still remains 7.6% below the 2008 peak of $12.7 trillion, but the increase was enough for the NY Fed to conclude that household deleveraging is over. Not so fast. The Conference Board reported that consumer confidence declined in November. The Consumer Confidence Index dropped to 88.7 from 94.1 in October. Consumers lowered their opinions on business conditions and the labor market. Maybe consumers are finished with deleveraging, or maybe they took on debt because wages haven’t kept pace with a growing economy.

Growth in domestic demand was revised up to a 3.2% pace in the third quarter instead of the previously reported 2.7% pace. Consumer spending grew at a 2.2% pace instead of the previously reported 1.8% rate.

Business investment was also up. Nonresidential investments grew by 7.1%, revised up from 5.5%, while investment in equipment reached 10.7%, with a stronger pace of spending on equipment than previously thought accounting for the bulk of the revision. Corporate, after tax profits grew at a 3.2% rate in the third quarter; that was down from a very strong 8.6% increase in corporate profits in the second quarter; still, after 6 months of extremely strong profit growth, companies were well positioned to spend a little on equipment. The strength in business investment spending would point to more hiring as well. In a separate report, the Federal Reserve Bank of Atlanta says the quality of new jobs is improving; 95% of the new jobs in October were full-time, which is a move in the right direction.

Export growth was lowered to a 4.9% rate from the previously reported 7.8% rate, while imports were revised up. That left a trade deficit that contributed 0.78 percentage point to GDP growth instead of the previously reported 1.32 percentage points. Government spending, which grew 4.2%, turned out to be a little lower than the Commerce Department initially estimated.

The Department of Agriculture reports net farm income in the US is forecast to be $97 billion, down 21% from a year ago and the lowest since 2010. Farmers are selling livestock for more, but that’s because many farmers culled their herds during the droughts of the past couple years; crop receipts are down, along with prices for many commodities, while expenses have increased.

Also today, the S&P/Case-Shiller home price index increased 4.8% for the 12 months ended in September, down from 5.1% reported for the 12 months ended in August. So home prices are going up, but at a slower pace; and that has been the trend; home price gains have now slowed for 9 straight months. In Phoenix, home prices dropped 0.1% from August to September, and for the past 12 months, prices increased a modest 3%.

A couple of extra bits on the housing market; Corelogic reports that distressed sales, both REO and short sales, accounted for 11.8% of total home sales nationally in September; that’s down from 15.2% distressed sales from September of 2013, but it is still a pretty high number. And another consideration is that back in the mid-2000s we saw a surge in mortgage debt fueled by an increase in home equity lines of credit, or HELOC, loans; it was a way for homeowners to tap into equity. The majority of HELOCs were originated at the peak of the home equity boom between 2004 and 2006, so there is concern of an oncoming wave of defaults when the estimated $190 billion in HELOC loans reset between Q4 2014 and 2017. The fear is that payment shock will not only cause a wave of defaults, but that it also may impact bank balance sheets and the mortgage markets where HELOCs are concentrated. Unlike the first-lien market when banks sold off most of the credit risk, more than 85% or $580 billion worth of HELOC loans are on bank balance sheets.

So, when you combine the stronger GDP numbers with the weaker consumer confidence index and a lackluster housing market, what you get is more of the same; an economy that looks like it should fly but can’t quite achieve escape velocity. Even when you add in corporate capital expenditures improving, that is just a step in the right direction without creating a discernible trend. Part of the problem is that the rest of the global economies are stuck in quicksand.

The Organization for Economic Co-operation and Development says the global economy will slowly improve over the next 2 years but Japan will grow less than previously expected while the euro zone struggles with stagnation and an increased deflation risk. The OECD calculates that a gradual 10% depreciation of the euro and the yen against the dollar over the next two years could potentially raise growth in the euro area and Japan by around 0.2 percentage point next year and twice as much the following year. Overall, the global economy is set to grow by 3.3% this year, 3.7% in 2015 and 3.9% in 2016. In the United States growth is projected to gain more momentum and remain above trend, reaching 3.1% next year.

Oil prices have plunged more than 30% since midyear on growing global supplies of oil and weak demand growth. OPEC is meeting Thursday in Vienna to discuss oil prices, but before the official meeting an official from Venezuela says that informal talks before the meeting point toward no output cuts. That’s bad news for Venezuela, and even worse news for Russia, which is watching its oil-dominated economy stumble under lower prices. Crude futures extended losses on that news. Rumors on production cuts were flying today. The low prices for oil may be considered another indicator of global economic growth. As oil producers such as Venezuela and Russia fret about the drop in oil prices, more affordable energy would benefit the worldwide economy. Many people feel the global recession was really triggered by the rise in oil prices from 2000 through 2008 and some of the slow growth or stagnant growth in the global economy is because prices stayed so high for so long.

Jeff Gundlach, the CEO of Doubleline Capital, says oil markets are in their “second part of the cycle” wherein prices will drop because producers are getting squeezed after oil settled below $80. Production will see an increase “maybe on the sly” by countries that depend on oil revenue, creating a “vicious cycle” for the commodity’s price. He predicted that $70 is the “line in the sand” for West Texas Intermediate: Any drop below that level will lead to a significant fall in price. He also said an oil price around $75 (which is where we are today) would suggest that the consumer price index should probably be near zero, meaning that there is no inflation in the economy.

And just to keep things interesting, much of the oil boom in the US was done with financial engineering. There is an astonishing amount of debt that continues to build up on the smaller exploration and production companies’ balance sheets. Even before the oil price plunge, aggregate debt-to-equity ratios in the smaller publicly traded energy companies are now at 93%, up from around 70% in 2012 and 2013, and around 50% between 2005 and 2011. This in a highly cyclical industry that used to go through periodic banker-driven shakeouts and even bankruptcies.

And it is not just OPEC countries holding on for dear life waiting for production cuts. Particularly in the gas and natural gas liquids drilling directed sector, every operator (and their financier) is waiting for every other operator to stop or slow their drilling programs, so there can be some recovery in the supply-demand balance. And at some point, you have to wonder if the banks will put an end to the boom.

Friday, June 06, 2014 - Jobs Report Friday

Financial Review with Sinclair Noe

DOW + 88 = 16,924
SPX + 8 = 1949
NAS + 25 = 4321
10 YR YLD + .01 = 2.59%
OIL + .31 = 102.79
GOLD - .90 = 1253.30
SILV - .02 = 19.11

Another record high close for the Dow Industrial Average and the S&P 500.

It’s said that it takes a war to end a war; 70 years ago, 150,000 soldiers invaded Normandy, and it’s estimated that about 4,400 lost their lives in the biggest military assault in history, D-Day. There were ceremonies on the beach today, as well as locations around the world, to honor the soldiers lost and the veterans still with us; their numbers are dwindling with the passage of time, but about 3,000 made the pilgrimage to Normandy today.  For the rest of us, it’s hard to imagine what happened 70 years ago, but whatever difficulties we may face in our day to day lives seem small compared with what those men faced. This is a special day, one that should never be forgotten.

Each month we analyze the jobs report. The jobs number came in about as expected. Non-farm payrolls added 217,000 jobs in May. The unemployment rate, which is drawn from a different survey of households, remained unchanged at 6.3%.

April’s employment numbers were revised down to 282,000 jobs added from 288,000. March payroll figures were not revised, remaining at 203,000 jobs added. This is the fourth consecutive month that non-farm payrolls increased more than 200,000. That is the first time that we have seen four consecutive months of 200,000 or more since October of 1999.

The labor force participation rate also remained unchanged from the 62.8% rate reported for April. The participation rate has shown no clear trend since this past October but is down by 0.6% over the year. At 62.8%, the labor participation rate remains at lows not seen since the late 1970s, a sign that many Americans have given up the search for work entirely and remain wary about their prospects of getting a job, not even bothering to look for one. There are 3.37 million workers who have been unemployed for more than 26 weeks and still want a job; this is down from 3.45 million in April. Long-term unemployment is trending down; now at the lowest level since March 2009, but still high.

There are many reasons why the participation rate is low, and one key factor that we’ve heard repeated is that it is simply a case of demographics, or older workers who are near retirement age. However, according to data from the OECD, the employment to population ratio for workers between ages of 25-54 is down by 3.5 percentage points from its pre-recession level; and for workers between the ages of 55-64 it is only down by 0.9 percentage points.

With today’s jobs report, the US economy is now back to pre-recession peak levels of employment; we have recovered the number of jobs that were lost, and employment is now at an all-time high. This is the longest post-World War II recovery the US has experienced. The US lost 8.7 million jobs in the recession. Through the first five months of 2014, the economy has added 1,068,000 payroll jobs - slightly better than during the same period in 2013 even with the severe weather early this year. From the period between World War II and the 1980s there was a fairly predictable pace for recoveries. It took roughly six months for US employment levels to recover after each post-war recession through the 1980s. Then, things changed. It took 15 months after the 1990–91 recession for employment to reach its pre-crisis levels, and 39 months after the 2001 recession.

While the addition of nearly nine million jobs since hiring bottomed out in February 2010 is certainly good news, the number is still far from what is necessary to accommodate new graduates and millions of others who have entered the work force since payrolls last peaked in January 2008 at 138,365,000 jobs. We now have about the same number of jobs as we did then, but millions more who might wish to hold them. So, we’re back to where we were but not where we should be.

Here's one way of looking at that. There were 7.6 million unemployed people in the US in January 2008, and the unemployment rate was 4.9%. Today, there are 9.8 million unemployed Americans, well over 2 million more than before the recession, and the unemployment rate is much higher.

Another important milestone as today’s report marks the 51^st consecutive month of private sector job gains, which matches the longest previous string of consecutive employment gains. Our current streak matches the one that ran from February 1996 to April 2000. These two milestones give us an indication of how deep the losses were, but also how much further we need to go to get back to a solid economy.

The number of persons working part time for economic reasons declined in May to 7.26 million from 7.46 million in April.  These workers are included in the alternate measure of labor underutilization, known as U-6, which decreased to 12.2% in May from 12.3% in April. This is the lowest level for U-6 since October 2008, and down from the peak of 17.2%, but still high by historical standards.

Within various job segments, the business and professional services segment added 55,000 jobs, the same as its average monthly job gain over the prior 12 months. The healthcare industry added 34,000 jobs for the month, twice its average monthly gain for the prior twelve months. Retailers added 12,500 jobs and the transportation and warehousing sector added 16,400. The manufacturing sector added 10,000 jobs, and the length of the typical workweek for manufacturing workers increased slightly to just over 41 hours, a sign factory managers would rather add overtime instead of hiring additional workers. By contrast, the workweek for all employees in the private sector, including white-collar workers, was unchanged at 34.5 hours.

In May, average hourly earnings rose 5 cents to $24.38; over the past twelve months, average hourly earnings have risen 2.1%. We frequently hear that employers would hire more workers but the workers lack the skill set for the jobs. If employers were actually having difficulty finding workers with the necessary skills we should expect to see occupations or industries in which wages are rising rapidly. That is how employers attract workers for positions they have trouble filling. We are not seeing any major sectors of the economy with significant increases in wages, so that tends to invalidate the issue of a skills mismatch.

Even as private employers have gradually increased hiring in the recovery, the work force at government agencies and the Postal Service has shrunk dramatically. Total government employment is still down by more than one million from where it was four years ago. State and local governments added 6,000 jobs.  State and local government employment is now up 107,000 from the bottom, but still 637,000 below the peak. It appears state and local employment is now increasing.  Federal government layoffs are ongoing, with another 5,000 jobs lost in May.

Unlike previous reports, the gains have been broad based—there were new jobs created in many sectors, including higher paying and important ones like manufacturing and construction. But 50% of all the jobs being created in this country are still in the low-wage category: retail clerk positions, home heath aids, waitresses and the like. And more importantly, pay isn’t going up much. While it is certainly better to have a job compared to no job, better still to have a job that pays decent wages, and that is still missing.