Financial Review

That’s Her Story

Sinclair Noe — February 10, 2016

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

Subscribe: iTunes | Android | RSS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

Financial Review

Burn the Doors

Sinclair Noe — July 13, 2015

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

Subscribe: iTunes | Android | RSS

DOW + 217 = 17,977
SPX + 22 = 2099
NAS + 73 = 5071
10 YR YLD + .01 = 2.43%
OIL – .35 = 51.85
GOLD – 5.30 = 1158.50
SILV – .12 = 15.60

Greece and Eurozone creditors reached a tentative agreement that might unlock about $95 billion in new aid to Greece in exchange for new tough concessions by the Athens government, which included reforms to the pension system, higher taxes, and privatization. However, the €85 billion-euro deal is not official until the Greek parliament on Wednesday passes the deal; and that might be a tough ask given the “no” vote in the recent referendum. Before we get to a Wednesday vote in Athens, there are several Eurozone finance ministers that will have to approve a €12 billion-euro package of short-term bridge financing, to allow the Greek banks to reopen. If the new deal is approved, the bank “holiday” could be lifted as soon as Thursday. And then after that, the Euro Union countries would have to sign off on a deal, unanimously. So, it’s a very complicated deal with considerable risk. Wall Street has never been good at reading the fine print, and stocks moved higher today on the idea that the never-ending negotiations over Greek debt might finally be ending, when in fact, they are just kicking into another gear.

And then even if the all these different governments approve an actual deal, well governments change, and the next government in Athens might not want to be stuck with the deals made by this government. But even if you get past that stumbling block, the deal being offered is even more onerous than the one that was offered 3 weeks ago, which it was widely determined, was unsustainable. In other words, nobody has yet addressed the important concept of how Greece can grow its economy to actually pay back the bailouts. The simple answer is they won’t. In a handful of months, fears over the sustainability of Greek debts will once again grow.

And the idea that privatization will raise the funds is laughable. This is like the story of the man in a mountain cabin, with the winter storm blowing ice and snow outside. He burns through all his firewood, and then he burns the chairs, and then he burns the cabinets, and finally he burns the doors to the cabin.

A couple of months ago, I thought a deal with Greece was inevitable because the cost of failure was too high. In the past month I thought the Troika would try to punish Greece, no matter the cost. Somehow they have crafted a deal that inflicts punishment and persuaded Tsipras to agree to the pain. The quasi-deal agreed to overnight represents the overthrow of the democratically elected government of Greece. Tsipras has surrendered. Greece is no longer a sovereign state. Brussels and Berlin have seized control. Greece needs a modern day equivalent to the Marshall Plan, not more austerity. And the worst damage may be to the Euro Union. If you think this is over, think again.

Meanwhile, we have  story to tell of a debt riddled economy, struggling under failed austerity schemes, unable to pay its debt, sending bond prices tumbling and stocks wobbling, And the creditors smell blood as they circle for the kill. There is no credible plan. No, we’re not talking about Greece anymore; this is Puerto Rico.

Puerto Rican officials are meeting with creditors for the first time since Governor Alejandro Garcia Padilla last month said the commonwealth can’t afford to pay its debts. The IMF has prepared a report suggesting Puerto Rico should try to persuade creditors to exchange old bonds for new bonds with longer maturities and lower debt payments.

Meanwhile, never-ending negotiations seem to be dragging on and on. No, we’re not talking about Greece or Puerto Rico, this time it is Iran. Talks between Iran and six major powers pushed into their 17th day with top Iranian officials saying the talks could go on for days. European officials suggested over the weekend that today was a make-or-break day for the nuclear talks, as both sides said only a final few issues remained to be resolved; so far today, no deal has been made but the talks have not broken down. US diplomats said they wouldn’t be pressured to walk away from talks as long as progress was being made. Who knows? At this point just wait for something conclusive. If the deal is made, we will know because the price of oil will take a big hit.

OPEC lowered its projection for 2015 global oil demand by about 100,000 barrels a day, to 29.2 million a day. That’s more than 2 million a day less than the group’s 12 members pumped last month. Saudi Arabia told OPEC it raised oil production to a record 10.5 million barrels a day in June, exceeding a previous record set in 1980.

U.S. power stations generated 31% of electricity from natural gas in April compared with 30% from coal, research firm SNL Energy estimates, the first time that gas has overtaken coal. In 2010, coal accounted for 45% of power. The milestone has been a long time in coming, with the shale boom causing gas prices to plummet and increasing regulation leading to higher expenses for coal.

In US markets, attention shifted (squirrel) from international headlines to worries about interest rates and also earnings reporting season. Last week Federal Reserve Chair Janet Yellen said she still expected to raise US interest rates this year. Fed funds futures show a 37 percent chance the central bank will increase its benchmark rate in September, up from 33 percent on July 10, and a 69 percent chance by December. The difference between two- and 10-year yields, known as the yield curve, widened to the steepest since November.

Janet Yellen heads across town on Wednesday to testify before the House Financial Services Committee. On Thursday, she will repeat the performance before the Senate Banking Committee. The biannual appearances are billed as reports to Congress on monetary policy, but the questions tend to range widely.

The Treasury reports that the federal government ran a budget surplus of $52 billion in June. That is $19 billion lower than the surplus seen in the same month a year ago. For the fiscal year to date, the government’s budget deficit is $313 billion. That is $52 billion smaller than the year-ago period. The government’s budget year runs from October through September.

According to Deloitte’s second-quarter CFO survey, finance chiefs from large North American companies are concerned about the economy, and have less confidence in the prospects for their own companies. The survey, which measures the views of more than 100 CFOs, found net optimism at its lowest level in two years, down to 18.8% vs. 34.4% last quarter. The number of CFOs that reported rising optimism about their own company fell sharply to 38% from 48% last quarter. A full 65% of those surveyed believe U.S. stock markets are overvalued, up from just 46% last quarter.

MPLX LP has agreed to buy MarkWest Energy Partners LP for about $15.8 billion, creating a master-limited partnership giant with natural gas and crude oil presences. The companies said the combination would create the fourth-largest master-limited partnership with a $21 billion market capitalization. MPLX was created by Marathon Petroleum  in 2012 to own and operate pipelines and other midstream assets. MarkWest Energy Partners processes natural gas in plays including the Marcellus and Utica shales.

Diversified energy firm Black Hills has agreed to acquire natural-gas utility SourceGas Holdings for $1.9 billion from investment funds managed by General Electric and Alinda Capital Partners. The deal allows the South Dakota-based Black Hills to expand in Colorado, Nebraska, Wyoming and Arkansas.

BP may have to pay out over $2 billion more than the $10.3 billion it has set aside to compensate businesses over the 2010 oil spill in the Gulf of Mexico. The money for the firms is in addition to the $18 billion settlement that BP agreed to last week, which resolved all actions against the company from federal, state and local governments.

Mexico’s new oil regime will undergo a major test on Wednesday when the government holds the first auction for private oil companies of 169 oil blocks that are both onshore and offshore. At least 17 companies are expected to participate, though the auction comes as oil prices are low. Pemex, the old national oil company, has decided not to participate. The Mexican Congress passed legislation last year to end Pemex’s monopoly and open the country’s oil patch to international competition.

Detroit’s “Big Three” carmakers are scheduled to start talks with the United Auto Workers (UAW) over a new contract for employees, and a two-tier wage system is likely to be a main topic of discussion. Ford, General Motors and Fiat Chrysler, along with the UAW, have until September 14, when the current contract expires, to reach an agreement.

Apple grabbed 92% of the operating profit of the world’s top eight smartphone companies in first quarter, up from 65% a year earlier. Samsung took 15% in this year’s period. The reason why Apple and Samsung earned over 100% combined is because some rivals only broke even or lost money.

On the earnings front: eBay reports tomorrow, Intel will deliver results on Wednesday, Netflix reports after the close on Wednesday (Netflix shares have nearly doubled in the year-to-date), Google reports on Thursday (expect questions about Google’s $65 billion cash pile and how they might spend it).

The nation’s largest banks will post second-quarter earnings this week, starting with JPMorgan Chase and Wells Fargo on Tuesday; Bank of America on Wednesday, and Goldman Sachs and Citigroup on Thursday. And the expectation is for continued pain due to sagging net interest margins, or the spread between what a bank pays to borrow money and what it can charge on loans. The wild card for banks could be results from their bond, currencies and commodities trading operations. Trading revenue tends to swing wildly each quarter.

Financial Review

Magnitude of Falsity is Enormous

Sinclair Noe — May 12, 2015

 

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

Subscribe: iTunes | RSS

DOW – 36 = 18,068
SPX – 6 = 2099
NAS – 17 = 4976
10 YR YLD – .03 = 2.25%
OIL + 1.50 = 60.75
GOLD + 9.50 = 1194.00
SILV + .21 = 16.58

The Treasury market continued to sell-off this  morning, pushing the yield on the benchmark 10-year Treasury up to 2.35% intraday, the highest point since Nov. 21. The selling eased by the afternoon, sending the yield down to 2.25 percent. The intense selling in the Treasury market was fueled by a similar meltdown in the Eurozone’s government bond market which has been going on for more than two weeks. Germany’s 10-year bund yield is 14 times higher than a month ago.  The yield on the 10-year benchmark German bond known as the bund increased 12 basis points to 0.71% intraday and European peripherals, such as Spain, Italy and Portugal, also saw their yields jump between 10 and 13 basis points.

At a panel discussion in Zurich this morning, NY Fed President William Dudley outlined that he does not know when interest rates will rise but repeated recent comments that the policy tightening will depend on the US economy. In other words, the Fed won’t send out engraved invitations and you will need to stay alert but the markets shouldn’t be surprised when the Fed raises rates. Dudley said the conditions that will determine the timing of the Fed raising rates from their current near-zero levels are “well specified” and “market participants should be able to think right along with policymakers, adjusting their views about the prospects for normalization in response to the incoming data.” Dudley went on to say that when the Fed raises rates it “will have implications for global capital flows, foreign exchange valuation and financial asset prices even if it is mostly anticipated when it occurs.”

The National Federation of Independent Business said its small-business optimism index rose 1.7 points to 96.9. It’s the second-worst reading since October. Overall business investment has sagged, with energy companies slashing capital expenditure budgets and laying off thousands of workers as lower energy prices undermine exploration and drilling activity. Nine of the NFIB index’s 10 components rose last month, with the exception of sales. The NFIB said despite the turmoil in the energy sector, “the shale states exhibited stronger capital spending and hiring than the rest.”

Oil production from seven major U.S. shale plays is expected to fall by 86,000 barrels per day in June. According to the latest report from the Energy Information Administration Oil output at the Eagle Ford shale play in South Texas is forecast to see the biggest decline, down 47,000 barrels per day, while production at the Bakken shale play, centered in North Dakota, is expected to drop by 31,000 barrels per day.

Job openings at US workplaces declined to 4.9 million in March from 5.1 million in February. The Labor Department’s JOLT survey measures the number of job openings in the economy, a measure of how aggressively employers are looking to hire, and more job openings indicates a labor market turning in favor of employees over employers. The number of hires in March, however, rose to 5.07 million from 5.01 million in February, while total separations also rose to 4.98 million from 4.79 million in February. The numbers of people quitting their job ticked up slightly in March, to 2.78 million from 2.72 million in February. Quits are seen as a sign of strength in the labor market, as workers wouldn’t be quitting their jobs unless they were reasonably confident they could find another one. It might also signal the possibility of higher wages in the not so distant future.

The US budget surplus in April rose to the highest level since 2008 on record revenue as hiring improved during a month when Americans file tax returns. The Treasury Department reports revenue exceeded spending by $156 billion last month, compared with a $106 billion surplus a year earlier. The April surplus was the fifth-highest on record for any month. So far this fiscal year, which began Oct. 1, the deficit declined to $282 billion compared with $306 billion in the same seven-month period a year earlier. Even though spending increased 6%, more people had jobs (the unemployment rate dropped to 5.4% in April) and that added to the Treasury’s coffers. So, it looks like one of the best ways to cut the deficit is to grow the economy. Who knew?

The Trans-Pacific Partnership faced its first test with a critical vote in the U.S. Senate today. Senate Democrats staged a last-minute rebellion against one of President Barack Obama’s top legislative priorities by blocking a test vote on a trade measure that didn’t include companion measures they sought. The vote, 52-45, effectively delays fast-track legislation Obama wants to expedite approval of trade accords. Supporters needed 60 votes to advance the bill to a final vote. Senate Majority Leader Mitch McConnell said the Democrats’ opposition was “pretty shocking” and vowed to keep working to reach an agreement he could bring back for a vote later. TPP would create a free trade zone covering 40% of the world economy – making it the biggest trade deal since NAFTA.

Verizon is buying AOL for $4.4 billion. The biggest U.S. wireless carrier will gain access to AOL’s mobile video platform and content. AOL bought Time Warner for more than $160 billion in 2000 in what turned out to be one of the most disastrous corporate mergers in history. AOL was spun off from Time Warner in 2009 at a value of about $3.4 billion. It’s easy to think of AOL in terms of an epic acquisition failure, or for the catch phrase “you’ve got mail”, or not at all. Actually, AOL has built up a decent infrastructure for the online ad marketplace, particularly for video and mobile platforms. And they have been making money; and they are growing; revenue is up 39% in the past year; profit is up 19%. It even brought in $600 million in revenue last year from 2 million customers dialing in for internet access.

In a separate matter, Sprint and Verizon will pay a total of $158 million to resolve nationwide allegations that they engaged in mobile cramming, a practice in which cell phone providers place unauthorized third-party charges on customers’ bills. Sprint will pay $68 million and Verizon will pay $90 million. Of those amounts, $50 million will be refunded to Sprint customers and $70 million will be refunded to Verizon customers. The rest will go to the 50 states that brought suit against the mobile phone carriers. The carriers also agreed to take steps to ensure that they only bill customers for third-party charges that have been authorized by the customers. The carriers have set up phone lines for customer questions about refunds.

Many on Wall Street have long argued that the banks did not generally break the law when they packaged shoddy mortgages and sold them to investors in the lead-up to the financial crisis of 2008. But yesterday a federal judge dealt a strong blow to that version of history. She ruled that two banks misled Fannie Mae and Freddie Mac in selling them mortgage bonds that contained numerous errors and misrepresentations. “The magnitude of falsity…is enormous,” declared U.S. Judge Denise Cote, adding, “The origination and securitization of these defective loans not only contributed to the collapse of the housing market, the very macroeconomic factor that defendants say caused the losses, but once that collapse started, improperly underwritten loans were hit hardest and drove the collapse even further.”

The two banks, Nomura and RBS, have been the only ones out of 18 financial firms that took their case to trial, arguing that it was the housing crash, and not deceptive loan documents, that caused the bonds to collapse. The other firms – including Goldman Sachs and Bank of America – settled, together paying nearly $18 billion in penalties.

More than seven years after the financial crisis, Congress is still fretting that some megabanks might be “too big to fail.” Yesterday, the House Financial Services Committee subpoenaed three federal agencies (the Department of Justice, the NY Fed, and the Treasury) citing “extraordinary stonewalling” from the agencies and lingering questions as to whether regulators went easy on banks deemed to be too large to prosecute. One case in particular got the attention of lawmakers; when the DOJ settled with HSBC despite overwhelming evidence the bank laundered money for terrorists and Mexican drug cartels.

Another for-profit college is in trouble. ITT Educational Services was charged with fraud today. The Securities & Exchange Commission said the company’s chief executive and chief financial officer misled investors and auditors with “outright misstatements” and “half-truths” about its student loan program. ITT Educational Services allegedly created a fraudulent scheme to show that it was doing better financially than it really was. Students had been defaulting on their loans in droves, but the SEC claims that CEO Kevin Modany and CFO Daniel Fitzpatrick hid the real cost from investors. More than 51,000 students take online courses or attend the 135 ITT Technical Institute campuses located in 39 states. ITT also runs the Daniel Webster College in New Hampshire.

After the financial crisis, student loans started to dry up.To entice lenders, ITT offered to back the loans if student loan defaults rose over a certain threshold. When defaults started rising in 2012, the company had to pay third party lenders to make good on its guarantees. ITT also started making student loan payments on its own to mask the default rate. Shareholders were kept in the dark about all these payments. The company is also being sued by the Consumer Financial Protection Bureau over alleged predatory student lending. The CFPB has also taken Corinthian College to court for the same issue. Corinthian filed for bankruptcy last week and abruptly closed all of its remaining campuses.

FINANCIAL REVIEW

One Thing Is One Thing

Sinclair Noe — January 13, 2015

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Financial Review with Sinclair Noe

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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