Financial Review

Pick a Lane

Sinclair Noe — November 17, 2015

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DOW + 6 = 17,489
SPX – 2 = 2050
NAS + 1 = 4986
10 YR YLD – .01 = 2.26%
OIL – .95 = 40.79
GOLD – 12.30 = 1070.80
SILV – .06 = 14.29

Global equity markets moved higher today, following the rally yesterday on Wall Street and brushed off concerns related to Friday’s terror attacks in Paris. In their final communique from a summit in Turkey, the leaders of the world’s largest economies stuck to a goal of lifting their collective output by an extra 2% by 2018, even though growth remains uneven and weaker than expected globally. G20 leaders also endorsed plans to address Syria’s refugee crisis, taxation, climate change, cyber security and inequality.

France launched another set of airstrikes on the ISIS stronghold of Raqqa in Syria early Tuesday as the country steps up its response to last week’s deadly attacks. The bombings follow a second night of home searches in France and Belgium to catch those responsible and linked to the killings. President Francois Hollande is now looking to expand his powers under France’s state-of-emergency statute and has called on the U.S. and Russia to form a “big unified coalition” to destroy ISIS.

Meanwhile, Russian officials said they had found evidence that the passenger jet that crashed in Egypt last month was downed by a bomb, the first time those investigating the crash have cited proof of a terrorist attack. Russia’s military doubled its attacks in Syria on Tuesday. President Putin ordered Russian naval forces in the Mediterranean to work as allies with French warships in attacking ISIS targets in Syria; not necessarily a France-Russia alliance, but certainly greater military coordination.

The consumer price index increased by a seasonally adjusted 0.2% in October. The CPI measures prices at the retail level and is used to determine cost of living adjustments. The cost of housing and medical care, two of the biggest expenses for most families, climbed again and are running above a 3% annual rate. Rents rose 0.3% in October and medical care jumped 0.7%, the biggest increase in five months. Food prices, meanwhile, rose just 0.1%, marking the smallest gain in five months. Energy prices advanced 0.3%, even though the price of gasoline was down last month. The discrepancy comes from seasonal adjustments. Overall inflation is up 0.2% in the past year. Core prices, excluding food and energy, are up 1.9% in the past 12 months.

Separately, a new report from Aon Hewitt shows health insurance costs for employees of midsize and large companies averaged $4,700 in 2015; that’s up 130% from $2,001 in 2005. The report shows 38% of employers have increased their participants’ deductibles and/or copays in the last year, and another 46% may do so in the future. Employers are making cutbacks in health coverage in other ways, too. Some 18% of companies are reducing subsidies for covered dependents, and 17% are adding a surcharge for adult dependents who have access to other health coverage. Plus, 43% of companies are considering using unitized pricing, in which employees pay per person instead of individual versus family.

So there are some signs of inflation in some areas but no indication that inflation is overheating, at least according to the headline inflation numbers. Still, for most of us, it seems like there is inflation; housing and rents have increased, health care, education, and food prices seem to be on the rise. Even wages are starting to show gains. The economy has added jobs at a rapid pace over the past few years, putting some upward pressure on wages and reducing the unemployment rate to 5%. The government said real, or inflation-adjusted, hourly wages advanced 0.2% in October. Real wages have climbed 2.4% in the past 12 months.

You’re not just imagining it. Prices are going up, except for commodities. And the price of energy has an oversized influence on the annual inflation rate. The Federal Reserve’s preferred measure of inflation is the Personal Consumption Expenditures index, or PCE, which is running at a 1.3% annualized pace; still below the Fed’s target of 2% inflation but likely to rise quickly with expected increases to health care premiums over the next few months.

Now add fiscal policy to the mix. After years of gridlock the government has finally approved a 2 year budget, and it actually includes some spending; it will likely add 0.3% to gross domestic product, rather than subtracting 2% from growth; it might even result in a few government jobs, rather than cutting government jobs. And those government workers will go out and spend their paychecks on Main Street, adding to demand and circulating money through the economy. Next year will be the first since 2010 that fiscal policy adds to growth. For years, Fed Chair Bernanke (and more recently Chair Yellen) complained about headwinds from fiscal policy, or the lack thereof. Now we are about to see a shift from monetary policy alone to fiscal policy – a passing of the baton, which is always the most perilous part of a relay; too early or too late, and the race comes to a grinding halt.

The next concern is whether fiscal policy is capable of running with the baton (to extend the analogy), and staying in the correct lane. If government spending goes to projects that improve productivity – things like infrastructure and education – then it will likely improve growth. French President Francois Hollande said he will step up spending on security in the wake of the terrorist attacks in Paris, but this type of spending is not likely to result in economic growth. So, it’s not just a matter of changing from monetary policy to fiscal policy, it is important that something is actually accomplished with the stimulus. This has been the big drawback of monetary policy; the Fed dropped money on Wall Street but it never made it to Main Street.

A new Reuters analysis shows that corporate spending on buybacks and dividends has surged relative to investment in long-term growth through R&D and other forms of capital spending, in a troubling sign that corporate America may be undermining itself. Almost 60% of the 3,297 publicly traded non-financial U.S. companies examined bought back their shares since 2010. In fiscal 2014 alone, the total amount returned to shareholders (including share repurchases and dividends) reached $885 billion, way more than the companies’ combined net income of $847 billion. And the spending on buybacks, or financial engineering squeezes out investments in R&D, which has dropped.

Industrial production fell 0.2% in October but manufacturing output advanced 0.4% in October. Overall production was held down by a drop in mining and utility output. In addition, the Fed revised August production higher to a 0.1% gain from previous estimate of a 0.1% drop. As a result, industrial production was up at a 2.6% annual rate in the third quarter.

The National Association of Home Builders/Wells Fargo housing market index pulled back 3 points to 62, slightly below expectations but up from 58 a year ago. A reading over 50 signals improvement. Builders have reported strong results in the most recent earnings season. D.R. Horton, the largest US homebuilder, reported a 44% jump in profit in the most recent quarter, with orders up 19%. Lennar, the number-two builder by volume, also reported profit and revenue that were better than expected. Orders rose more than 10%.

Greece has reached a preliminary deal with its international lenders on home foreclosures reform, removing a major obstacle holding up fresh bailout loans for the debt-laden country. The changes will see Athens qualify for a €2-billion-euro sub-tranche of new financial aid to pay off state arrears and €10-billion-euro in funds to help recapitalize the country’s four main banks.

Walmart beats. Walmart earned $1.03 per share from continuing operations in the third quarter, but $0.99 excluding adjustments to its leases. Still, that was marginally higher than the $0.98 expected by analysts. Comparable-store sales, or sales at stores open at least a year, at Walmart’s US stores were up 1.5%. E-commerce sales were up by 10%.

Home Depot beats. The do-it-yourself home-improvement chain earned $1.36 per share in third quarter, beating expectations for $1.32. This was driven by a healthy 5.1% gain in comparable-store sales, which was better than the 4.6% expected by analysts.

Urban Outfitters missed. Urban Outfitters reported record third quarter sales that missed estimates, and earnings per share matched estimates, but comparable-store sales climbed by just 1% during the period, missing expectations for 3.4% growth. The news came after shares dropped 7.4% following the company’s announcement that it acquired a group of restaurants including the fast-casual chain Pizzeria Vetri. Apparently I’m not the only one who fails to see the synergy between retail clothing and pizza.

Shares of Dick’s Sporting Goods are getting clobbered. Dick’s reported third quarter adjusted earnings of $0.45 per share, missing expectations by a penny. Same-store sales, or sales at stores open at least a year, were up 0.4% in the quarter across the company, less than the 1.9% increase that was expected. And then the salt on the wound: the company lowered fourth quarter guidance.

A New York state judge denied a temporary restraining order sought by daily fantasy sports companies DraftKings and FanDuel in an effort to keep operating in the state after NY Attorney General Eric Schneiderman deemed the games to be illegal gambling. The government will now move for an injunction against the companies which will be heard in court on Nov. 25. DraftKings continues to operate as usual in New York despite the pressure from Schneiderman’s office, but FanDuel stopped taking new deposits from state players on Friday.

A US House of Representatives investigative panel plans to hold a 2016 hearing on skyrocketing drug costs. Earlier this month, the U.S. Senate Special Committee on Aging launched a probe into drug pricing at Valeant and Turing, signaling growing bipartisan agreement over the need to review prescription medicine costs across the nation.

Financial Review

The End of Summer

Sinclair Noe — September 21, 2015

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DOW + 125 = 16,510
SPX + 8 = 1966
NAS + 1 = 4828
10 YR YLD + .08 = 2.21%
OIL – .26 = 46.42
GOLD – 6.50 = 1134.40
SILV + .03 = 15.31

The National Association of Realtors says sales of previously owned homes fell 4.8% in August to an annual pace of 5.31 million, marking the first decline in four months. The sales rate in July was revised down slightly to a seasonally adjusted 5.58 million, but that was still the highest level in eight years. The median price of homes sold was up 4.7% to $228,700 from 12 months ago. Inventories of existing homes on the market rose 1.3% to 2.29 million, representing 5.2 months’ supply at current sales trends. Sales fell in all major regions except the Northeast, where they were unchanged.

The Federal Reserve reports businesses racked up new debt at an annual rate of 8.3% in the second quarter. That was the fastest growth since the first quarter of 2008 and was driven mostly by corporate bond issuance. While issuing debt, the corporate stockpile of cash rose to $2.06 trillion from $1.99 trillion. The Fed report also shows that households and nonprofits saw their net worth increase by $695 billion in the second quarter, mostly due to the rise in home values but also due to the stock market. Household credit grew 3.9% in the second quarter, mostly due to student and auto loans. The total debt outside the financial sector – of households, businesses and all forms of government – rose to $43.98 trillion from $43.51 trillion.

Investors will be looking for hints on when the Fed may finally raise rates when a number of central bank officials including Chair Janet Yellen, appear in public this week. Over the weekend, St. Louis Fed President James Bullard said there is a powerful case to be made for a rate hike, which he said could come in October.  Richmond Fed President Jeffrey Lacker explained why he dissented in favor of higher interest rates. San Francisco Fed President John Williams said “most likely” the right time to start lifting interest rates will arrive this year. Bullard is a non-voting member of the Fed. Federal Reserve Bank of Atlanta President Dennis Lockhart, a voting member of the FOMC spoke today, saying he is in favor of a rate hike before the end of the year, even though he voted against a hike at last week’s meeting.

Pope Francis went to east Cuba today to celebrate the second Mass on Cuban soil. In his first two days in Havana, the pope met Cuba’s Fidel and Raul Castro. But there was no encounter for dissidents. Three were hauled away from Revolution Square on Sunday before the pope celebrated Mass for tens of thousands. Pope Francis will fly from Cuba to the United States tomorrow.

Greek voters have given the left-wing Syriza party the second chance it was asking for, following another high-stakes election that marks the next phase of the country’s debt crisis. Syriza leader and former Prime Minister Alexis Tsipras had enraged many Greeks by breaking an election pledge and ignoring the outcome of a referendum, but that did not stop citizens from putting him back in power. Results: Tsipras gathered around 35% of the vote.

The election is over, the economic problems are not. The financial markets are no longer concerned that Syriza will be the template for a political backlash against budget cuts or that it could start the breakup of monetary union by leaving the single currency. There is no reason for the markets to worry about Greece, at least for now. The Greek economy has contracted by 29% in the past 6 years. Greece can’t pay its debts. Tsipras will step up the pressure for debt relief now that he has his new mandate. He will be turned down. Greece will likely default at some point.

The U.S. and China are negotiating what could become the world’s first arms control agreement for cyberspace, with each country committing not to be the first to use the weapons to cripple the other’s critical infrastructure during peacetime. The proposed accord would address attacks on power stations, banking systems, cellphone networks and hospitals, but would not protect against most of the cybercrimes China has been accused of conducting, including the widespread poaching of intellectual property and the theft of millions of U.S. government employees’ personal data.

Some of the most popular Chinese names in Apple App Store were found to be infected with malicious software in what is being described as a first-of-its-kind security breach. The applications were infected after software developers were lured into using an unauthorized and compromised version of Apple’s developer tool kit. Meanwhile, Apple says that last week’s rollout of iOS 9 marked the “fastest iOS adoption ever,” with more than 50% of existing devices upgrading to the new mobile operating system just five days into its launch.  The company began taking preorders for its newest smartphones, the iPhone 6s and iPhone 6s Plus, on September 12. It will begin selling the new hardware in retail stores this Friday.

Apple aims to release its first car in 2019. Although many reports have suggested that Apple is working on a self-driving car, the company’s first vehicle likely won’t be fully autonomous, according to a report in the Murdoch Street Journal. It will be electric. Apple has already been aggressively hiring for its car project, poaching employees from companies like Ford, General Motors, Tesla, Volkswagen, and more.

Many of its recent hires have expertise in connected and autonomous vehicle systems. It remains unclear if Apple will develop its “Apple Car” from the ground up or if it will team up with an existing auto manufacturer. Rumors have suggested Apple has held discussions with BMW over a potential partnership that would see the BMW i3 used as the basis for the Apple Car.

The Environmental Protection Agency (EPA) says Volkswagen used software for diesel VW and Audi branded cars that deceived regulators measuring toxic emissions and could face penalties of up to $18 billion. Volkswagen has for years promoted its TDI turbodiesels as a clean and efficient alternative to hybrids, but now it appears the cars were clean only when hooked up to emissions testing devices and dirty the rest of the time, spewing out about 40 times the allowed levels of pollution.

The EPA and California regulators began asking questions in May 2014 after West Virginia University researchers published a study that found lab results did not match up with road tests. The software was designed to detect when auto emissions were being hooked up to the cars; and only then the car’s emissions-control machinery would kick in. Once the test was over, the software noticed that, too, and returned to its illegally and dangerously dirty operations.

Think about that for a moment. Code had to be written for the express intent of cheating on auto emissions tests. People in the manufacturing process had to know it was happening. It took substantial testing to make it work. It happened across different models and brands. It lasted for 6 years, until it was discovered by an outside source.

It’s estimated that about 482,000 of the cars were manufactured and sold from 2009 through 2015, and are still on the road. It is a near certainty that VW will recall the cars to remove the allegedly illegal software that deceives emission inspection stations; it is less certain what VW will do to bring the cars into compliance with clean-air regulations without hampering their performance and gas-mileage.

At least one class-action lawsuit has already been filed on behalf of Volkswagen and Audi owners. It claims fraud and breach of contract, citing the “diminished value” of the nearly 500,000 recalled diesel vehicles, which usually sell for a premium price over their gasoline counterparts. Specifically, after recalled Volkswagen diesels are fixed, the cars might have degraded horsepower and fuel efficiency. Volkswagen could be criminally prosecuted. And there is evidence that the excessive pollution spewed out by VWs is deadly. VW shares down about 17%, and the company lost nearly $17 billion in market capitalization.

Remember Standard Chartered, the British bank accused of violating sanctions against Iran back in 2006? The investigation into those violations produced one of the most memorable quotes from a bankster, as one senior exec with Standard Chartered purportedly said: “You (blanking) Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians?”

In 2007, StanChart committed to stop dealing with Iranians; then in 2012 they were fined $1 billion for sanctions breaches and compliance failures. Well, a new Financial Times report reveals that even after the 2012 fines, StanChart still had some compliance issues, and they could not say with certainty whether they were still dealing with Iranian customers; and US regulators are now investigating further sanctions breaches.

If the bank is found to have breached sanctions again, it could incur further fines or lose its vital dollar clearing license. And of course, according to the recent Yates Memo from the DOJ, they might seek criminal charges for repeat offenders; requiring the bank to turn over criminally culpable individuals as part of any settlement. This should be an interesting test of the Yates Memo.

You have probably never heard of Daraprim, it is a drug which has been on the market for 62 years, it is the standard of care for a food-borne illness called called toxoplasmosis caused by a parasite that can severely affect those with compromised immune systems, and it is used by HIV/AIDS patients. The pill sells for $13.50, or it used to, until about a week ago, when the price shot up to $750 a pill.

A spokesman for Turing said the company will use the money from the sales to further research treatments for toxoplasmosis, which he said has long been neglected. He also said the firm had plans to invest in marketing and education tools to raise awareness of the disease; a reasonable and reasoned answer, but one that has been unsatisfactory for many, especially in light of the corporate history. It turns out that Turing was a hedge fund that bought the marketing rights to Daraprim in August, and basically decided to jack up the price.