Financial Review

Road Trip

Sinclair Noe — July 1, 2016

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DOW + 19 = 17,949
SPX + 4 = 2102
NAS + 19 = 4862
10 Y – .03 = 1.46%
OIL + .88 = 49.21
GOLD + 19.60 = 1342.30
SILV + .98 = 19.78

Puerto Rico defaulted Friday on debt that is supposed to be guaranteed by the Puerto Rican constitution. In other words, Puerto Rico was supposed to pay creditors who hold general obligation bonds before paying anyone else, even police. But Governor Alejandro García Padilla said: No.

He argued that paying teachers, emergency personnel and other critical needs must come first. Puerto Rico did not make the $800 million payment to its bondholders due on July 1. Puerto Rico’s government says it is in a “dire” financial position with only about $350 million in cash on hand right now.

Puerto Rico’s default marks the first time that a state or U.S. territory has failed to pay general obligation bonds since the Great Depression. The default was expected, and thus isn’t causing much havoc in the wider bond market. The island is over $70 billion in debt. Congress passed a bill this week preventing lawsuits on the default and imposing strict financial oversight.

A default would force the three major insurers backing Puerto Rico’s debt to pay out as much as hundreds of millions of dollars to bondholders. Ambac Financial Group backs $122 million in Puerto Rico debt due Friday, company disclosures show. National Public Finance Guarantee backs $173 million in general obligation debt coming due Friday, records show. Assured Guaranty backs $428 million coming due in the third quarter, most of it also due Friday.

Bond yields are making record lows. Heavy overnight buying pushed longer-dated US yields down to record lows. The 10-year yield touched 1.37% and the 30-year yield hit 2.20% as money rushed into government debt amid further speculation of more easing by the world’s biggest central banks. Additionally, Japan’s 10-year yield sank to a record low of -28 basis points and the UK’s 10-year yield fell to its own all-time low of 78.1 basis points.

Now, before all that money moves into the safe haven of US Treasuries, it must be converted into dollars. Immediately following last week’s Brexit vote, the dollar index spiked up about 3%, up 2.5% against the euro, and up 12% against the pound. That might not sound like much but in the currency exchange markets, those are really big moves. But since that initial response, the currency markets have started to consolidate.

The simple truth is that there are very few immediate consequences of Brexit; it will take time for this story to play out. It’s reasonable to expect the dollar to continue to attract safe haven moves; not because the US economy is particularly strong but because it will likely be stronger than the UK or Eurozone.

While we can fret about a possible breakup of the Euro Union or even the UK – which may or may not happen – reduced trade in the UK will probably reduce productivity and cut economic growth by maybe 2 or 3%. Even though the UK is the seventh largest trading partner of the US, that is not enough to substantially torpedo US economic growth. It doesn’t help us but it is not a lethal blow.

Spending on construction dropped 0.8% in May, with weakness mostly concentrated in the public sector. A 1.8% monthly decrease in April was marked down to a 2.0% decline. Still, total spending during the first five months of the year was 8.2% higher than in the same period a year ago. Private outlays were 0.3% lower than April, while public spending was 2.3% lower. Residential spending was 5.3% higher.

The Institute for Supply Management (ISM) said its index of national factory activity rose to 53.2 from 51.3 the month before. A reading above 50 indicates expansion in the manufacturing sector and a reading below 50 indicates contraction. The employment index rose to 50.4 from 49.2 a month earlier. New orders climbed to 57.0 from 55.7. The prices paid index fell to 60.5 from 63.5.

U.S. safety officials have opened a preliminary investigation into 25,000 Model S cars after Tesla’s Autopilot recorded its first fatality. The incident, in which a man driving a Tesla Model S was killed in a collision with a truck in Florida, has prompted an investigation by federal highway safety regulators. Tesla said in a blog post that the crash was the first in the more than 130 million miles that the semi-autonomous driving system has been used. That compares with a fatality every 94 million miles for all vehicles in the United States.

The company also said that customers were required to give “explicit acknowledgement” that they realize Autopilot is new technology still under development, otherwise the system will remain off. Drivers are also told that they are required to keep their hands on the wheel at all times.

The National Highway Transportation Safety Administration is also advising owners of 313,000 recalled Honda and Acura vehicles (from 2001-2003) to replace their Takata-made air bags immediately after testing showed there’s as high as a 50% chance of them rupturing in a crash. According to the regulator, eight of the 10 U.S. deaths caused by Takata air bags occurred in these models.

America’s Interstate Highway System is 60 years old this week. Back in 1919, Dwight Eisenhower struck out on a road trip across the country. His military convoy, the first to cross the US by car, was an effort to gather info on the state of American roads at the time. It averaged 52 miles per day. This road trip and a view of the German autobahns would plant the seeds of the future US Interstate Highway System.

The Federal Highway Act of 1956 created the interstate highways and gave the United States incredible gains in mobility of personal travel and cargo shipments as new segments opened in state after state. It was a remarkable achievement that helped make the U.S. economy the world’s leader. And since President Eisenhower floated the idea, the highway system has grown to 47,856 miles of roads, bridges, ramps, and curves, the meshwork that defined American post-war expansion and exceptionalism. And this weekend those highways will be packed.

This July 4 weekend is expected to see the highest volume of travelers on record for the holiday, according to a report by AAA. Nearly 43 million people will be traveling between June 30 and July 4. The majority of travel will be done by car — 84% of travelers will take to the road as gas prices are expected to be the lowest since 2005 at an average of $2.32 a gallon. Thus far in 2016, American drivers have saved $20 billion in gasoline spending compared with last year, according to AAA. More than 3 million Americans are expected to fly and 3.3 million will take a bus, cruise, train or other mode of transportation.

Now, if you do travel on the highways this weekend, or any time, you are bound to notice that they are showing their age. In recent years the federal government has fallen behind on its maintenance budget by almost a third (spending $20 billion a year of a needed $33 billion). Congestion is on the rise and roads and bridges are often in disrepair. The Department of Transportation estimates that by 2030, we might have an annual $86 billion funding gap—and that’s just to keep those old highways and bridges functioning. Actually improving the infrastructure and making it really functional and productive could cost up $150 billion per year.

We know it is a good investment. For every dollar in gas tax revenue spent on highway maintenance, the government would save between $4 and $10 on future repairs.  The infrastructure gap is a check on growth and a pernicious hidden cost of doing business. We consistently under-estimate the benefits of good roads and bridges – not to mention rail, canals, schools, and parks – and we over-emphasize the hassles and the costs. We are falling behind globally as a result.

One area that would seem to be prime for an upgrade is the construction industry itself. When it comes to big public infrastructure building and maintenance we seem to get stuck with projects that are over budget and late. A new report just released identified five trends disrupting the construction industry: higher-definition surveying and geo-location, next generation 5-D building information management software (including integration of augmented reality devices), digital collaboration and mobility, the Internet of Things and advanced analytics, and “future proof design and construction,” which spans from new building materials, such as self-healing concrete, aerogels, and nanomaterials, to innovative construction approaches, such as 3-D printing and preassembled modules.

The McKinsey Global Institute estimates that the world will need to spend $57 trillion on infrastructure by 2030 to keep up with global GDP growth. That should serve as some incentive for disrupting the construction industry. Yes, it will cost money to maintain the infrastructure we have, and it will cost even more to upgrade and grow, but 60 years of the US Highway System have proven that this is an investment that pays much more than it costs. Conservative estimates claim that every $1 spent to build the Interstate has returned an estimated $6 of economic growth. That’s a rough guess; it’s almost impossible to measure the full impact.

Think about your own commute. Wouldn’t it be great if there were no more potholes, if every fifth bridge you crossed was not functionally obsolete, if the traffic lights were truly synchronized to keep you rolling along without interruption, and if you never got trapped in congestion again? Now multiply that by 200 million other drivers. Now consider that every year, $13.9 trillion in goods are shipped from sites in the US. The business of America is conducted on our roads; this is the lifeblood of the economy.

So, anyway, something to think about if you are heading out on a road trip this weekend. Have a happy holiday and a safe trip.

Friday, June 27, 2014 - Biscuits on the Table

Financial Review with Sinclair Noe

DOW + 5 = 16,851
SPX + 3 = 1960
NAS + 18 = 4397
10 YR YLD  + .01 = 2.53%
OIL - .10 = 105.74
GOLD – 1.80 = 1316.10
SILV - .25 = 20.97

The major stock indices traded lower for most of the day, and only in the final minutes turned to positive territory. For the week, the Dow slipped 0.6 percent and the S&P 500 declined 0.1 percent, while the Nasdaq gained 0.7 percent. Volume spike today as the Russell Indices were reconstituted.

The Russell Indices are compiled by Russell Investments. The Russell 3000 is an index of the 3000 largest stocks in the US. The Russell 2000 is the 2000 smallest stocks in the Russell 3000. Once a year, the Russell indices are reconstituted, to reflect changes such as acquisitions, bankruptcies, or just changes in the size of the companies listed in the index. The reconstitution probably explains the increase in volume and the last minute increase in prices today.

Some things we need to know heading into the weekend; including Ukraine, Iraq, and Argentina. We’ll start with the situation in Ukraine. The European Union signed a free-trade pact with Ukraine today and warned it could impose more sanctions on Moscow unless pro-Russian rebels act to wind down the crisis in the east of the country by Monday. Georgia and Moldova signed similar deals, holding out the prospect of deep economic integration and unfettered access to the EU's 500 million citizens, but alarming Moscow which is concerned about losing influence over former Soviet republics.

EU leaders meeting in Brussels demanded that, by Monday, Ukrainian rebels agree to ceasefire verification arrangements, return border checkpoints to Kiev authorities, free hostages and launch serious talks on implementing Ukrainian president Poroshenko's peace plan.

EU leaders said they were ready to meet again at any time to adopt significant sanctions on Russia. Diplomats said they could target new people and companies with asset freezes as early as next week. More than 60 names are already on the list. Although it has drawn up a list of hard-hitting economic sanctions against Russia, the EU is still hesitating over deploying them because of fears among some member states of antagonizing their major energy supplier.

Meanwhile, leaders of the European Union's 28 member states voted on the next president of the European Commission, which serves as the EU's executive branch. The president sets the policy agenda, enforces rules and represents Europe abroad. They elected Jean Claude Junker on a 26-2 vote. The losing votes belonged to the United Kingdom and Hungary, and they really have a strong dislike for Junker; so much so that they may try to exit the EU. That probably won’t happen, but there is talk of an “in or out” referendum for the Brits.

A funny thing is happening in Iraq. The US is lining up support for Iraq from Iran and Syria. And the bombing has apparently started, but we’re still trying to figure out who is throwing the bombs. The first aerial bombing took place Monday or Tuesday, apparently carried out by the Syrian Air Force, acting at the behest of the Iranian government in support of the Iraqi government, which the US government supports, but only if the Iraqi’s purge the government of all the goofs who messed up over the past 10 years or so.

Which is to say, the war in Iraq is escalating. Already, the war involves Iraq, Syria, Iran, Turkey, Saudi Arabia, Qatar, ISIS or ISIL if you prefer, Israel, Lebanon, and of course the US. The Pentagon denied reports of US drone strikes along the Iraq-Syria border after reports by BBC of drone bombings. The Murdoch Street Journal reports Syrian airstrikes. Unidentified bombers have reportedly launched an air strike on ISIS positions in northern Iraq. Iraqi television has claimed they are US planes, but the Pentagon has denied responsibility.

US planes were identified by Iraqi television, but the Saudi Al-Arabiya network claims that the raid was carried out by Syria. Meanwhile, Iranian Special Forces sent in to help protect Baghdad and a few select holy sites, along with surveillance drones. And Israel has bombed Syria in retaliation for an attack from Syria that killed Israeli civilians in the Golan Heights.

And so with all this going on, the Pentagon admitted yesterday that armed US drones are now flying over Iraq, equipped with Hellfire missiles, deployed from a base in Kuwait, in addition to unarmed surveillance flights by drones and manned aircraft, and supplemented by US military advisers on the ground.

Meanwhile, the Pentagon says the United States has opened a "joint operations center" in Baghdad, boosting the total number of US service members to 500. And the New York Times reports that Iraqi government officials are saying that the US is planning to send more than 1,000 private security guards to Iraq to protect US troops, which amounts to far more than the US government has previous acknowledged.

For years Iraq has been a major oil producer; it kept Saddam in business all those years; back then Iraq produced about 2.5 million barrels a day; recently output has increased to more than 3 million barrels, and it’s estimated that production could easily top 6 million barrels. In a country of about 30 million, there should be enough natural resources for profound prosperity, but that is not the case. In recent years, none of this oil wealth trickled down to the grassroots, especially in Sunni areas of the country where signs of reconstruction, economic development, restored services, or jobs were hard to find. Instead, the vast new revenues disappeared into the recesses of a corrupt government, and from there – who knows?

So here’s where Iraqi oil, or the lack of its revenues at least, comes into play. Communities across Iraq, especially in embittered Sunni areas, began demanding funding for reconstruction, often backed by local and provincial governments. In response, the Maliki government relentlessly refused to allocate any oil revenues for such projects, choosing instead to denounce such demands as efforts to divert funds from more urgent budgetary imperatives. That included tens of billions of dollars needed to purchase military supplies including, in 2011, 18 F-16 jets from the United States for $4 billion. In a rare moment of ironic insight, Time magazine concluded its coverage of the F-16 purchase with this comment: “The good news is the deal will likely keep Lockheed’s F-16 plant in Fort Worth running perhaps a year longer. The bad news is that only 70% of Iraqis have access to clean water, and only 25% have clean sanitation.”

My grandmother used say, as long as we’ve got biscuits on the table, nobody should go hungry. I guess they never heard that saying in Iraq.

Nothing in today's complex world has a single cause, but you have to think that a major reason for all this is the oil.

Argentina is in trouble. They have until Monday to pay a group of hedge fund managers over $1.3 billion on defaulted bonds. If they don’t pay, they risk default. If it goes into default, investors lose faith in Argentina’s capacity to pay, interest rates on its bonds surge, and the country is forced to print money to pay creditors, the economy could collapse.

Then again, if Argentina does pay this group of hedge fund managers over $1.3 billion worth of bonds by July 30, it opens itself up to lawsuits from other investors who also own those bonds, lawsuits that could cost the country up to $15 billion. That's over half the money it has in its central bank.

The story goes back to 2001, when Argentina was going through a financial crisis. Argentina issued bonds, and they defaulted on those bonds. After the default, hedge fund manager Paul Singer and some other hedge funds swooped in to buy the defaulted bonds for pennies on the peso. They knew they were buying defaulted bonds, but the idea was that things might improve or there might be a deal negotiated; that’s what usually happens, debt issuers restructure debt, and negotiate with creditors to pay less. Creditors usually take the deal because it is better to get something rather than nothing. Most of Argentina’s creditors have decided to accept 70 cents on the dollar.

But Paul Singer is demanding 100% face value of the bonds. And if he is not paid, there is a clause that says no other creditors can be paid. And if Argentina pays the full amount to Singer, the other creditors will likely not be satisfied with a 70% haircut. And the reason Argentina is in this jam is because Singer sued, and it went all the way to the US Supreme Court, and the Supremes sided with the hedge funds, and let stand a district court ruling.

The Supreme Court has been busy handing down decisions this week; and we will likely get a couple more decisions on Monday; I guess they don’t hand down decisions on Friday, and opt instead for an early happy hour. Anyway, the decisions of the past week were downright strange for one reason; several were unanimous. Wednesday, the court decided Riley v. California, which unanimously held that police cannot search the cellphones of people they arrest without a warrant. On Thursday, the court handed down two of its major opinions of this year: National Labor Relations Board v. Noel Canning, about the president's recess appointment power and McCullen v. Coakley, about abortion clinic buffer zones.

You will recall that the court is split ideologically, with 5 justices leaning right and 4 justices leaning left, so it’s a little surprising to see the twain meet. Unanimity is rare; a fractured court is the norm, and yet, we had three unanimous decisions among people who are inclined to disagree; and at a time when the House of Representatives is suing the president and people from one side can’t have a civil conversation with someone from the other side. Maybe this is an example of the rule of law being more important than politics. Before we declare a victory for compromise, maybe there’s a little more to how the court arrived at unanimity.

Even when the court agrees on a ruling, it can divide over the reasoning and even how the rule should be applied. In other words they take very different paths to arrive at the same place. It is possible that a 5-4 decision is not an indication of a polarized court. You have to read the decisions behind the vote. And conversely, a unanimous decision can mask deep divisions that appear down the road.