Financial Review

Dominoes on Edge

Sinclair Noe — December 6, 2016

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

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DOW + 35 = 19,251
SPX + 7 = 2212
NAS + 24 = 5333
RUT + 14 = 1352
10 Y + .01 = 2.40%
OIL – .95 = 51.88
GOLD – .80 = 1170.20

Another record high for the Dow industrial average. This is starting to be old hat. Also, a record high for the Russell 2000 –  close but no cigar for the S&P. Still, it looks like the stock market, at least the US stock market loves the idea of Trumponomics, at least for now.

The rest of the financial world – not so much.

The bond market certainly has not been happy. Government bond prices have unraveled. The yield on the benchmark 10-year Treasury note for example, surged from 1.6% at the end of September to 2.40% today. And there is the inverse relationship to price and yield; as yield moves higher prices moves lower, or in this case prices have cratered.

So, is the stock market or the bond market smarter when it comes to predicting what’s next for broader financial markets and the economy? Will inflation sour the growth outlook, and which market will reflect that sooner? Perhaps the biggest threat to financial markets right now is a sense of complacency.

The U.S. trade deficit jumped almost 18% in October as imports rose to the highest level in 14 months. The nation’s trade gap climbed to a four-month high of $42.6 billion. October imports increased 1.3% to $229 billion, marking the highest level since August 2015. The U.S. imported more drugs, computer accessories, cell phones and other consumer goods.

Exports, meanwhile, slipped 1.8% to $186.4 billion in October. That’s the smallest amount in three months. The decline in exports was largely related to fewer shipments of farm products such as soybeans and corn as well as petroleum and other industrial supplies.

Bankers are running out of private sector solutions for Banca Monte dei Paschi and have told the Italian lender to prepare for a state bailout this weekend after Matteo Renzi suffered a referendum defeat. Renzi will remain in his job as Prime Minister for at least a week; snap elections have not yet been called.

While financial markets responded relatively calmly, sources told the Financial Times that the political upheaval made it “more difficult” to secure a €1-billion-euro investment from Qatar on which Monte de Paschi’s €5-billion-euro capital-raising plan hinges. Shares in the bank have lost more than 85% in value this year. Plans by leading Italian banks to raise billions of euros from investors to boost their financial strength have been damaged by the outcome of Sunday’s referendum, a leading ratings agency said on Tuesday as it downgraded its outlook for the sector.

Fitch – which said it had a negative outlook on the Italian banking industry for 2017 – said profitability in the sector was already frail before the referendum. So, why no bank run in Rome? Well, Eurozone rules come into effect: first the shareholders lose, then bondholders get bailed in and their bonds are exchanged for stock, and then depositors above the deposit insurance level of €100,000 are forcibly converted to equity. Only then can the government step in with bailouts.

No idea who would buy all the newly converted stock, and without buyers, you have a bank run of sorts. And if you have a bank run of sorts in Italy, the German banks (specifically Deutsche Bank) start looking very, very dangerous. So, the idea that Italian banks are having a hard time finding private recapitalization brings up visions of dominoes on edge.

Despite approving a set of “short-term” debt relief measures, talks between Eurozone ministers and the IMF broke down on Monday with little headway having been made in resolving splits over Greece’s €86-billion-euro bailout. And it looks like the International Monetary Fund has abandoned the bailout program, at least until the Eurozone gives Athens more debt relief or Greece legislates more spending cuts.  The Greek government, facing a population worn down by years of austerity, has warned creditors not to push it too far.

Reaching a deal to cut production is one thing; getting an actual reduction in global output is another. Crude production from OPEC members is likely to have risen to a record 34.16 million barrels a day in November, with African members leading the gains.

Federal and Los Angeles officials said they had been alerted by authorities in another country to a “specific” threat against the city’s Red Line commuter rail system, prompting them to beef up security and alert the public. Los Angeles Police Chief Charlie Beck told a news conference, “This threat is imminent, … it is very specific, but the credibility still needs to be vetted.”

Amazon wants to automate grocery shopping. Amazon is testing a grocery store in downtown Seattle that lets customers walk in, grab food from the shelves and walk out again, without ever having to stand in a checkout line. Customers tap their cellphones on a turnstile as they walk into the store, which logs them into the store’s network and connects to their Amazon account through an app.

The service is called Amazon Go. It uses machine learning, sensors and artificial intelligence to track items customers pick up. These are then added to the virtual cart on their app. If they pick up an item they later decide they don’t want, putting it back on the shelf removes it from their cart. Amazon envisions opening more than 2,000 brick-and-mortar grocery stores under its name, depending on the success of the new test locations. Target and Walmart plan to expand a service that lets shoppers order online and pickup curbside to 1,000 stores by the end of next year.

The Supreme Court ruled that Samsung’s violation of Apple’s smartphone design patents may involve only a component, rather than the entire product – a decision that means Samsung might not have to pay penalties reaching into the hundreds of millions of dollars. The justices reasoned that the patent infringement could affect just a component of the phones, such as their appearance, rather than all their capabilities.

The legal battle between the two tech giants represented the first design patent case to reach the high court in more than a century. A jury in 2012 had ruled that because Samsung infringed on three of Apple’s iPhone design patents, it must fork over the entire profits from the phones in question. Now the case will return to the U.S. Court of Appeals for the Federal Circuit to determine what portion of its profits Samsung must pay – a process several justices predicted will be difficult.

In a separate case, the Supreme Court sought to crack down on insider trading, ruling unanimously that tips passed between relatives and friends are illegal even if the corporate insider receives no financial benefit.

The decision marked the first time the high court had clarified what constitutes insider trading in nearly two decades, and it upended a legal standard set by a New York-based federal appeals court in 2014 that had made prosecutions more difficult. The decision was written by Justice Samuel Alito, saying: “Giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.”

Wall Street has been watching the case carefully for a sign of where the justices stand on the issue. The earlier case, which the high court refused to hear, made it almost impossible to obtain convictions unless prosecutors presented evidence showing the tipster received a direct benefit. The high court called that decision “inconsistent” with its precedents.

Requiring that insiders get rewarded didn’t sit well with most of the justices during oral argument in October. In some instances, Justice Stephen Breyer said, “to help a close family member is like helping yourself.” Federal prosecutors have used a 1983 rule, like the one agreed upon by the justices, to convict both corporate insiders and the people they tip off. Maintaining such a rule, Justice Elena Kagan said last month, was important to maintain “the integrity of the markets.”

A group effort? YouTube, Facebook, Twitter and Microsoft are stepping up efforts to remove extremist content from their websites by creating a common database that will be up and running in early 2017. The web giants will share “hashes” – unique digital fingerprints they automatically assign to videos or photos – of terrorist material to enable their peers to identify the same content on their platforms.

5G and its multi-gigabit cellular speeds probably won’t hit the market until 2020, but AT&T has started testing the technology inside of one of Intel’s offices in Austin, TX. The company is particularly interested in how the new network will stand up to streaming 4K video, but will also test a wide variety of uses, including VPN, VoIP, “unified communications applications” and good old internet access.

Financial Review

Veterans Day 2015

Sinclair Noe — November 11, 2015

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW – 55 = 17,702
SPX – 6 = 2075
NAS – 16 = 5067
10 YR YLD closed 2.34%
OIL – 1.14 = 43.07
GOLD – 3.00 = 1087.20
SILV – .09 = 14.45

“To us in America, the reflections of Armistice Day will be filled with solemn pride in the heroism of those who died in the country’s service and with gratitude for the victory, both because of the thing from which it has freed us and because of the opportunity it has given America to show her sympathy with peace and justice in the councils of the nations…” Those were the words of President Wilson in 1919, one year after hostilities ended in World War I on this date in 1918, in the 11^th hour, of the 11^th day, of the 11^th month. Back then it was called Armistice Day. Today we call it Veterans Day. And for all the veterans – Thank you.

The 11^th day of November is celebrated in China as Singles Day, symbolized by the four lonely 1s of 11/11. Apparently, this is kind of the anti-Valentine’s Day. Alibaba broke its own record for sales on China’s Singles Day, the world’s largest Internet shopping event, generating more than $9.3 billion in gross merchandise volume by midday Wednesday. Sales now look on track to hit $13 billion. More records: In the first eight minutes of this year’s sale, the company posted more than $1 billion in sales, topping last year’s 17 minutes to hit the billion-dollar mark.

AB InBev has completed an agreement to buy SABMiller for $105 billion, one of the largest mergers in corporate history. Under terms of the deal, SABMiller will sell a 58% stake in its MillerCoors joint venture to partner Molson Coors for $12 billion. A combined AB Inbev-SABMiller would have controlled close to 70% of the U.S. beer market, so the sale of the U.S. division was seen as a concession to competition authorities. In other brewing news, shares in Carlsberg A/S rose as much as 8.7 percent after the beer-maker announced a cost-cutting plan which will see it shed about 2,000 employees.

Iraqi oil puts pressure on shale; 19 million barrels of oil are due to arrive by ship from Iraq in American ports this month, the biggest influx from that country since June 2012, as OPEC members continue to defend market share in the face of low oil prices. The tactic seems to be working as yesterday the Energy Information Administration cut its U.S. crude oil production forecast for 2016 by 1 percent to 8.77 million barrels a day. The American Petroleum Institute said Tuesday that inventories rose by 6.3 million barrels last week. This all adds to concerns about oversupply. Crude oil fell to the lowest level in nearly three months.

Britain’s relationship with the EU is working but the Bank of England Governor Mark Carney says they will do whatever is needed to adapt should Britons vote to leave the bloc in a referendum. Britain is due to vote to stay in the EU before the end of 2017. The announcement came as U.K. unemployment fell to the lowest level in more than seven years, dropping to 5.3% in the third quarter. Also on tap: ECB chief Mario Draghi will deliver a speech today at the Bank of England’s Open Forum.

Online orders for Apple’s iPad Pro started today. The 12.9 inch-screen tablet, aimed in large part at business users and creative pros, will start at $799 but costs more than $1,000 if buyers want a keyboard and stylus included. Yesterday, Apple shares fell 3.1% after a Credit Suisse report said Apple had cut its orders for iPhone 6 components by as much as 10%.

Meanwhile, Apple is in talks with banks in the US about creating its own mobile-to-mobile payments service that sounds a lot like PayPal’s Venmo app. The app would reportedly let people send payments to each other directly from their phones, and automatically take it out of their checking accounts on the back end. While Apple already has its own payments system thanks to Apple Pay, the service so far has been mobile-to-merchant, and the mobile-to-mobile space has largely been dominated by PayPal’s Venmo app, but there is competition from Facebook’s Messenger app, Snapchat, and Square.

Macy’s shares plunged by as much as 14% after the department-store chain said its sales growth was weak because of muted consumer demand. Macy’s also lowered its guidance for 2015 earnings per share. Sales fell 5% to $5.87 billion, below the expectation for $6.1 billion. Bad news for Macy’s could be great news for customers, the company’s revenues have plunged, which means year-end sales are likely to be fantastic.

The New York state attorney general has ordered the fantasy sports sites DraftKings and FanDuel to stop accepting bets in New York, saying that the operations were essentially illegal gambling. The AG said the fantasy sites were considered gambling because customers “are clearly placing bets on events outside of their control or influence, specifically on the real-game performance of professional athletes.” The state of Nevada took a similar action in mid-October, with the Nevada Gaming Control Board saying the companies had to cease operations in the state.

DraftKings and FanDuel have indicated they would continue to let customers play while they contest the order in New York. Four smaller daily fantasy sports sites: DailyMVP, DraftDay, DraftOps, and MondoGoal Trading say they will stop letting users from New York enter their paid contests.

Nomura lowered its price target on Valeant Pharmaceuticals to $175 from $220. Nomura had been one of the most bullish on the company. The analyst for Nomura wrote: “Valeant’s business update call did not address all our outstanding questions; however, management’s willingness to be as open as possible in its responses was a positive first step towards rebuilding credibility with investors.” Here’s the big problem though, share price has dropped from $263 to $78.90. Every now and then it is a good idea for Wall Street analysts to open their eyes before issuing a forecast.

Valeant’s biggest investor is Bill Ackman of Pershing Square; he doubled down when the bad news on Valeant first hit; after Citron Research, a short-selling firm led by Andrew Left, issued a report two weeks ago asking if the company was running an Enron-like fraud. The stock had already been under pressure after the company was scrutinized for raising the prices for two acquired drugs. The Citron report, though, focused on Valeant’s relationship with Philidor, a specialty pharmacy. Citron has accused Valeant of using Philidor to book “phantom sales.” Valeant is the largest holding in Pershing Sqaure, and that hedge fund is now down about 19% for the year.

And the hits keep coming. A U.S. judge said Valeant Pharmaceuticals and hedge fund manager William Ackman must face a lawsuit accusing them of insider trading in Allergan before making an unsuccessful takeover bid for the maker of Botox. The lawsuit was filed on behalf of investors who sold Allergan shares in the two months before the defendants on April 22, 2014 announced an unsolicited $51 billion bid for Allergan. Pershing had by then quietly amassed a 9.7 percent stake in Allergan, which soared in value after the bid was announced. Investors said Pershing bought those shares knowing that Valeant was preparing a bid that could, and later did, become hostile.

Who knows? Maybe Valeant is an extraordinary bargain at current prices, but I’m guessing it will take years therapy before anybody is able to laugh at this.

The U.S. Department of Transportation has denied an appeal by railroads challenging new “crude-by-rail” regulations on trains hauling hazardous flammable materials. The rules issued in May include the phasing in of tougher tank car standards over several years and require new expensive braking systems on trains hauling more than 70 cars of crude oil by 2021.

General Electric’s stock did something yesterday that it hasn’t done in seven years: it closed above $30/share. In the years since June 10, 2008, GE’s stock has struggled despite CEO Jeff Immelt’s efforts to reassure investors that the company was changing. The mood seems to have shifted over the past year as the company offloaded its finance business and completed its biggest acquisition of all-time with the purchase of Alstom’s energy assets.

On Nov. 11, 1915, exactly three years before the end of World War I, IBM listed for the first time on the New York Stock Exchange — its name then Computing-Tabulating-Recording Co. IBM isn’t making a big deal of Wednesday’s 100th anniversary, which comes at an inauspicious time. Its stock has been the second biggest drag on the Dow Jones Industrial Average this year. For really, really long-term investors, consider this: If you had bought one share of IBM when it first listed on the NYSE at $47, you would now own 11,879 shares with a value of $1.6 million, according to the company. That’s a 3.4 million percent return.

Ups And Downs In US Stock Market

Financial Review

Strange Days

Sinclair Noe — August 12, 2015

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW – 0.33 = 17,402
SPX + 1 = 2086
NAS + 7 = 5044
10 YR YLD – .01 = 2.13%
OIL + .23 = 43.31
GOLD + 16.80 = 1126.80
SILV + .18 = 15.64

Strange days indeed. While the closing numbers paint a picture of a calm day on Wall Street, it was anything but. The Dow Industrial Average started the session deep in the red; with a session low of a 277 point loss. And then it started clawing higher, briefly going positive for the day. US stocks gapped lower on the open following the lead of global stocks, Asian currencies, commodities and government bond yields were all heading south after China allowed the yuan to fall sharply for a second day, triggering concerns over the country’s economic health. The currency is down 4% over the last two days.

The IMF has offered a cautious endorsement of the new pricing regime – which lets the market play a greater role in setting the value of the currency – in a step that may help Beijing win reserve currency status later this year. Late in the day, the Chinese government reportedly stepped in to prop up the yuan. And once again the shorts were shredded.

The number of available jobs fell in June, even as companies hired more. The latest Job Openings and Labor Turnover Survey, or JOLTS, shows there were 5.25 million job openings, down from 5.36 million in May, while the number of hired rose to 5.18 million from 5.06 million. The quits rate — a measure of worker willingness to leave to search or go to a new job — stayed at 1.9% in June. There were 1.6 unemployed in June for every job opening.

The United States posted a budget deficit of $149 billion in July, up 58 percent from the same period last year. The government had a deficit of $94 billion in July of 2014. The July deficit was larger because of $42 billion in payments that were shifted into that month from August. About $4 billion in extra revenue was also included in July for the same reason. Accounting for those items, the July deficit would have been $111 billion.

Grain commodity futures collapsed after the US Department of Agriculture raised its projections for output. In a report, the USDA said it now expects corn production to total 13.7 billion bushels this year from about 81 million acres of land, up from the forecast of 13.53 billion a month ago. Soybean output is expected at 3.916 billion bushels, up from 3.885 estimated last month. Corn and soybeans futures fell about 6%. Persistent rains in the Midwest early in the growing season led many to believe the crops would be light. A period of heavy rainfall, while concerning at the time, can often be recovered from prior to harvest, and the weather has been good for the past month or so. “Rain makes grain” is an old farmer axiom for good reason.

The global oil glut will last through next year and oil prices will be lower for longer. That’s the conclusion of the International Energy Agency in its widely followed monthly report. Stockpiles won’t be reduced until the fourth quarter of 2016, or after, if sanctions on Iranian crude are lifted. The production surplus was 3 million barrels a day in the second quarter of 2015, the highest in 17 years.

Just eight days after it defaulted on bond payments for the first time, Puerto Rico said it planned to issue $750 million more in bonds for several construction and maintenance projects. Issuing new debt while planning to restructure pre-existing debt, and even letting certain bonds default, “reflects the individual financial circumstances of the various issuers across the commonwealth,” announced GDB President Melba Acosta. So far, little is known about the island’s debt restructuring proposal; details will be made public at the end of this month.

McDonald’s plans to close  59 net U.S. locations this year, attempting to reverse its worst sales slump in more than decade. According to a franchise operations document, the chain is closing 184 restaurants and opening 125 new ones in 2015. The move follows seven straight quarters of slumping sales across the nation, and marks the first time in 45 years McDonald’s has closed more U.S. locations than it has opened.

Kraft Heinz said it will eliminate 2,500 jobs in the United States and Canada, including about 700 at its headquarters in Northfield, Illinois. Kraft Heinz currently has about 46,000 employees; the company expects to save about $1.5 billion in annual costs by the end of 2017.

Capital One is buying GE’s health care lending unit  for approximately $9 billion. The sale means GE has shed $78 billion in assets this year, bringing it closer to its year-end goal of $100 billion. . The deal is expected to close in the fourth quarter. The size of GE’s finance arm, GE Capital, and the potential risk stemming from its lending portfolio has made it subject to government oversight. GE plans to apply next year to escape its designation as a systemically important financial institution following the sale of finance assets. For Capital One, the deal will bolster its healthcare lending operations.

Financial industry software maker Fidelity National Information Services said it would buy SunGard Data Systems for $9.1 billion including debt, scooping up one of the longest-held investments in private-equity history.

Wells Fargo may divest its crop insurance business, one of the biggest in the U.S., as regulatory restrictions on banks force some to reconsider underwriting insurance policies. Wells Fargo expects a price tag of about $1 billion for the unit, and has launched an auction for the business.

More Legionnaire’s disease concerns are surfacing after GlaxoSmithKline shut down a North Carolina plant upon discovering the bacteria in a self-standing cooling tower. The closure is not expected to disrupt supplies of medicines made at the factory, which ironically include Glaxo’s $7 billion-a-year inhaled respiratory drug Advair. About 400 of the 850 employees who work at the plant were told to stay away until the towers are cleaned.

Dark pools are getting darker. Credit Suisse and Barclays have entered settlement negotiations with the SEC and NY attorney general over facilitating unfair advantages, incorrect stock pricing and other wrongdoing in their dark pools. Credit Suisse is in talks to pay a fine in the high tens of millions, which would be the largest fine ever levied against a private trading venue operator, while Barclays’ discussions also suggest a large fine.

U.S. prosecutors have separately announced charges against an insider-trading ring consisting of 32 traders and hackers, marking the first time criminal allegations have been brought for a securities fraud scheme involving hacked inside information. Stolen press releases gave the rogue traders $100 million in illegal proceeds by allowing them to trade on news before it hit the wires. Hackers were then paid a flat fee or a percentage of the profits gained from the trading.

Discount Tire is recalling nearly 80,000 light truck and SUV tires because the tread could separate. Discount Tire says there are no reports of deaths or injuries due to the defect. Stores will notify owners and will either replace the tires for free or offer refunds.

Angry Orchard Cider Company is recalling select cases of Crisp Apple Hard Cider over concerns that the bottles may explode. The actual cider poses no health risk.

The breakfast cereal Wheaties has partnered with a craft brewery in Minneapolis, to create a limited-edition Hefeweizen beer named HefeWheaties. Beer, the breakfast of champions.

More than 35,000 combat veterans have had their health care delayed by a Department of Veterans Affairs computer program that automatically put them in limbo, many for years. Yet the VA says it lacks the authority to override the system. The veterans, most of whom served in Iraq and Afghanistan, were erroneously put onto a “pending” list for failing to fill out a means test. But combat veterans are not required to fill out means tests to receive health care. About 16,000 of the cases have been pending for more than five years. Under VA rules, combat veterans are eligible for five years of free health care after discharge, but the period begins the day of discharge.

Yesterday we told you about Google’s plan to form a new holding company called Alphabet. Just one problem. Google/Alphabet decided on this name for its new holding company even though it couldn’t secure the most obvious domain name (or social media accounts, for that matter). Alphabet.com belongs to the fleet management company owned by BMW, and they aren’t giving up the domain. So Google/Alphabet is using abc.xyz. Yea, not so good.

A meteor shower that could feature as many as 100 shooting stars an hour will peak tonight. The Perseid meteor shower should be particularly brilliant this year because the sky will be dark and the view won’t be obstructed by moon light, as a new moon rises Friday. The meteor shower continues for a couple of days but tonight is the best night. To watch, you do not need a telescope; in fact a telescope or binoculars will hurt your viewing because the meteors move fast. For best viewing get away from city lights or any lights, lean back and look up toward the constellations Cassiopeia and Perseus in the Northeast part of the sky.

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.

Tuesday, June 17, 2014 - What Could Go Wrong?

Financial Review with Sinclair Noe

DOW + 27 = 16,808
SPX + 4 = 1941
NAS + 16 = 4337
10 YR YLD + .06 = 2.65%
OIL - .30 = 106.60
GOLD un = 1272.70
SILV + .09 = 19.86

The FOMC, the Federal Open Market Committee started two days of meetings today; tomorrow they are expected to announce more of the same. The FOMC is largely expected to taper its asset purchase program by $10 billion to $35 billion. Effective July 1, the Fed is expected to lower its asset purchases to $15 billion in agency mortgage backed securities (MBS) and $20 billion in Treasuries. The Fed is also expected to maintain its current forward guidance language on federal funds rate support; in other words, they will keep telling us that rates might increase sometime next year.

The committee is likely to make some upgrades to its description of the economic outlook in its economic projections. The committee will probably need to reduce its 2014 real GDP growth forecast to take into account the Q1 disappointment, and we can probably expect the committee to reduce its unemployment rate forecast and lift its inflation forecast slightly.

The consumer-price index climbed a seasonally adjusted 0.4% in May from a month earlier. It marked the fastest increase since February 2013 and doubled the pace of economists' forecasts. Excluding food and energy components, so-called core prices increased 0.3%, the fastest pace since August 2011. From a year earlier, core prices were up 2%, the most since February 2013, and now match the Fed's target.

Another inflation measure closely watched by the Fed, the core personal-consumption expenditure, has stayed far below 2%. Inflation at wholesale level unexpectedly dropped by 0.1% in May, but remember the PPI rose 0.6% in April, so this is just a leveling out process. Wage pressure remains stubbornly low and consequently, the pace of the economic growth remains uneven. In May, the real average hourly wage fell 0.2%. Real wages have fallen three straight months even as inflation has picked up slightly.

The average hourly wage for a typical American worker registered just $10.28 in May, adjusted for inflation and measured in constant dollars. The real hourly wage totaled $10.31 in June 2009, the last month of the 2007-2009 recession. This is part of a trend that stretches back about 30 years.

Still, with core prices up 2% on an annual basis, the Fed will need to address the topic of inflation tomorrow. Let’s hope they also mention the lack of wage gains.

Another report today shows housing starts posted a bigger-than-forecast 6.5% decline. Housing starts declined to an annual rate of 1 million units last month from 1.07 million in April. What’s more, permits for new construction fell by 6.4% in May to a 991,000 annual pace, the slowest in fourth months.

The situation in Iraq is still bad. The ISIS rebels are about 40 miles north of Baghdad and seem intent on the idea of attacking the capitol city. Or they might attack the major source of revenue for the ruling government, and that means oil. One of three major oil refineries has now fallen under control of ISIS; the other two are in Baghdad and the south and not considered to be threatened at this time. About 2.5 million barrels of oil a day are exported from Basra, Iraq’s main port, located in the south.

The world consumes about 92 million barrels a day, so that would be a major disruption, and it would not be surprising to see prices jump; with price levels increasing along with the severity of the given scenario, running anywhere from a few dollars per barrel to a worst case of $200 a barrel.

Not too long ago, Iraq was claiming that it would be producing 12 million barrels a day by 2017. That now seems a little too optimistic.  At best, the ISIS rebellion guarantees that any potential additional Iraqi oil output gains are not going to materialize in the near future. No oil companies are going to invest in Iraq until and unless the situation stabilizes.

Although the consequences for Iraqi oil production of what has happened so far appear to be minimal, all this comes at a time when the earlier and still ongoing conflicts in Libya and Syria have already disrupted nearly 2 million barrels a day in world oil production. If Iraq’s recent 3 million barrels a day was also taken out, we would be talking about a significant disruption in world oil supplies, and likely an oil price in excess of $150 a barrel.

The worst case scenario sees a regional conflict break out that pits the Middle East’s Shiites (Iran) against the Sunnis (Saudi Arabia), leading to a compromise of the Strait of Hormuz. Forty percent of the world’s exported oil is transported through this waterway.

And if that isn’t enough, focus you attention on Ukraine. Yesterday, Russia announced it was cutting off natural gas shipments to Ukraine; today an explosion destroyed one of Ukraine’s main pipelines for gas headed to Western Europe.

EU-brokered talks failed to reach a compromise between the countries, which remain far apart on a “fair” price for gas. Ukraine’s state-run gas operator filed a suit in an international arbitration court, claiming $6 billion in overpayment for gas since 2010. Its Russian counterpart filed a suit of its own, alleging unpaid debts worth $4.5 billion on gas delivered since 2009. Until these cases are resolved, Ukraine will receive only gas it pays for upfront, and must not impede the flow of gas destined for the EU, which gets around 15% of its gas via pipelines that pass through Ukraine. There is another pipeline running from Russia directly to Germany, but still, the global energy picture looks less and less stable.

On Friday we reported that Tesla, the electric car company started by Elon Musk, was freeing up its patents, making its technology available to competitors. Now Nissan and BMW are considering negotiations for cooperation on charging networks; basically using and enlarging Tesla’s existing network of 97 charging stations in the US. Nissan already produces the electric Leaf and BMW last week unveiled the electric i8 in Germany.

So, why design new chargers and invest in building a whole new infrastructure for BMW and Nissan drivers? The Tesla network already stretches from coast to coast and is expected to expand rapidly over the next year. And Tesla leads in battery technology, with a gigafactory planned to start production in 5 years, which will be the biggest battery making facility in the world, producing 500,000 lithium-ion battery packs per year; more than enough for Tesla and its competition.

SolarCity, the largest US installer of residential solar panels whose largest shareholder is entrepreneur Elon Musk, announced that it plans to acquire solar panel maker Silevo and expand into manufacturing with new panel factories, likely including the world’s largest high efficiency solar panel plants in New York. At a conference call announcing the move, Musk said: "We expect to have to install 10 gigawatts [of high-efficiency panels] a year. If you look at the current capacity in the world, we're not able to do that right now."

It's not just a supply question. Solar panel prices have been falling in recent years thanks to a production boom in China; and the panels getting produced, though cheap, aren't terribly efficient and prices have begun bottoming out anyway. Prices might start climbing soon. Government subsidies for renewables start getting phased out in 2016, and the political environment for rebooting subsidies remains unstable at best. Plus, recent moves by the US to slap tariffs on Chinese panels likely served as a catalyst for looking into building the Silevo plant.

According to a study by two professors at the Stern School of Business at New York University and one professor from McGill University, a quarter of all public company deals may involve some kind of insider trading. The professors examined stock option movements, when an investor buys an option to acquire a stock in the future at a set price, as a way of determining whether unusual activity took place in the 30 days before a deal’s announcement. They determined statistically that the odds of the trading “arising out of chance” were “about three in a trillion.” [...] But, the professors conclude, the Securities and Exchange Commission litigated only “about 4.7 percent of the 1,859 M&A deals included in the sample.”

The study also says: “While the SEC has taken action in several cases where the evidence was overwhelming, one can assume that there are many more cases that go undetected, or where the evidence is not as clear-cut, in a legal/regulatory sense.” Plus another finding from the abstract: “Historically, the SEC has been more likely to investigate cases where the acquirer is headquartered outside the US.”

A new survey by Greenberg Quinlan Rosner, on behalf of Better Markets, finds voters regard Wall Street and big banks as “bad actors. A 64% majority believes the “stock market is rigged for insiders and people who know how to manipulate the system. Another 55% believes “Wall Street and big banks hurt everyday Americans by pouring money into ’get rich quick schemes’ rather than real businesses and investments. A 60% majority favors “stricter regulation on the way banks and other financial institutions conduct their business” and just 28% oppose. Support for stricter regulations inspires bipartisan support; most notably voters who own stocks are more likely to support stricter regulation than voters overall. And there is urgency in the issue because 83% of voters believe another crash is likely in the next 10 years.

Thursday, April 10, 2014 - Mr. Toad’s Wild Ride

Financial Review with Sinclair Noe

DOW – 266 = 16,170
SPX – 39 = 1833 (-2.1%)
NAS – 129 = 4054 (- 3.1%)
10 YR YLD - .06 = 2.62%
OIL - .20 = 103.40
GOLD + 5.80 = 1319.10
SILV + .19 = 20.13

If you want to know why the stock market is up one day and down the next, and not just little moves but triple digit swings – I don’t know. If anybody says they know, they probably don’t. Maybe it’s the Fed, maybe it is earnings reporting season, maybe it’s a strong economy or a weak economy, or maybe the markets are just trying to imitate Mr. Toad’s Wild Ride. The one thing we know is that stock prices fluctuate, and over time a pattern or trend develops; right now things are wobbly.

In economic news, the Labor Department said that the number of people applying for unemployment benefits dropped to 300,000, the lowest level in nearly seven years.

The Treasury Department says the federal budget deficit for the first half of the 2014 fiscal year totaled $413 billion, down $187 billion from where it stood at this point last year, as tax revenue surged and spending sank.  In March, the Treasury collected $216 billion in taxes, up 16% from a year ago, helping reduce the deficit for March to $37 billion from $107 billion last year. 

Meanwhile, spending sank by 14%, or $40 billion; military spending has been cut, federal government jobs have been cut, and Fannie Mae and Freddie Mac are no longer a drain but rather a contributor to the Federal coffers. Tax receipts have been increasing as the stock market improved (not necessarily today but remember last year was strong). Also, the economy has been better, not great but better. 

The budget gap last month was the smallest deficit recorded for the month of March since 2000. Over all, the deficit is expected to equal 4.1% of gross domestic product in 2014, down from nearly 10% in 2009, during the depths of the recession. It is the fastest four-year reduction in deficits since the demobilization after World War II.

California is sinking. Scientists estimate that the Central Valley accounts for about 20% of the groundwater that is pumped in the nation. It's the lifeblood of the flourishing agriculture industry, producing crops from almonds to plums, nectarines and cotton. And the water to irrigate is pumped from aquifers that are not being replenished by rainfall.

The US Geological Survey published a study that found that 1,200 square miles of the Central Valley were sinking half-an-inch per year, but the rate is not consistent everywhere. The town of El Nido, just south of Merced sank almost a foot a year between 2008 and 2010. A foot a year is not sustainable. You can’t really mitigate against a foot a year.

Farmers are digging deeper wells, and as the water is pumped out of clay aquifers, the earth above falls to fill the void, and the clay compresses. It’s called subsidence. The land sinks and the compressed clay cannot hold as much water as it once did. Once subsidence happens there is no way to undo it.

About 30% of California’s water supply comes from underground supplies, more during droughts, and about 80% of state residents rely to some degree on groundwater. Some towns, cities and farming operations depend entirely on it. And it has been a problem for a long time. Three generations ago, so much groundwater was pumped from aquifers that half the valley sank like a giant pie crust, sagging 28 feet near Mendota and inflicting damage to irrigation canals, pipelines, bridges, roads and other infrastructure.

The sinking only stopped because of 2 massive government funded irrigation projects, the federal Central Valley project and the California State Water project, which flooded the region with water from distant mountains and relieved pressure on the natural underground water supply. Now, the drought and climate change have opened up a new era of groundwater pumping. The result is the ground is sinking and the land subsidence is perhaps the worst ever seen in California.

This causes multiple problems for infrastructure. Dams and irrigation canals rely on gravity to move water, but when the ground sinks, the water doesn’t always flow as expected.  Flood safety is another concern; flood control channels might not perform as expected as levees sink. Bridges sag; well casings fail; and then there is the issue of the state’s multi-billion dollar high-speed rail line plotted to run through an area that is sinking by about a foot a year.

While the San Joaquin Valley faces the worst problems of land subsidence, other regions of California are dealing with similar problems on a smaller scale. The USGS has been studying sinking ground in the Coachella Valley for years in conjunction with the local water district. In a 2007 USGS study, researchers determined that the ground had subsided up to 4 inches in parts of La Quinta, with smaller effects in parts of Palm Desert and Indian Wells, during a year-and-a-half period from 2003 to 2005.In the Coachella Valley, the ground has sunk in some places where groundwater levels have fallen. Uneven settling has cracked the foundations of houses and fractured walls, swimming pools and roads.

After years of drought, water tables are dropping fast. Well-drilling costs are soaring. The biggest problem is the gradual, irreversible compaction of the earth that occurs when aquifers are pumped to historic lows. It doesn’t make the aquifer unusable. It just reduces the amount of water that can be stored in it, now and in the future.

The Basel Committee on Banking Supervision released its final ruling on just how much derivatives traders have to hold in reserve to pay off on defaults. International regulators are trying to safeguard trades and bring more openness to a $700 trillion market, known for its secrecy.

Swaps are what investors use to help guard against risk (at least theoretically). They’re bought by pension plans and retirement funds to protect against fluctuations in interest rates, meaning they affect most people who own annuities. They’re used by the US government to limit exposure in the mortgage market and cut home-loan costs. Investors can also hedge an investment in a company by buying a swap that will pay them if a borrower stops paying its debts. They’re called swaps because investors and banks exchange, or swap, payments over time based on how interest rates move or how the creditworthiness of companies changes.

Think of it as a form of insurance, with a few major exceptions; swaps do not require an insurable interest. For example, you can buy life insurance for your spouse and your spouse can buy life insurance on you because you have an insurable interest in each other. Your doctor can’t buy a life insurance policy on your life because your doctor does not have an insurable interest. And when you think about it that is a good way to approach insurance. Otherwise, your doctor might buy an insurance policy on your life and then bet against you; which is essentially what many people did with swaps in the financial crisis; they bought insurance on mortgage debts betting mortgages would default.

More frequently, swaps dealers sold swaps to people or entities who didn’t need the swaps or didn’t understand the swaps; for example the city of Detroit or the nation of Greece; they bet interest rates would go one way, and then they took on more debt than was prudent and when rates turned, they lost everything. Swaps made bankers billions of dollars before helping to blow up the global economy in 2008.

The other significant difference between swaps and insurance is that insurance companies must have reserves to pay claims. Swaps dealers, not so much; and so when defaults happen, the swaps contracts have a nasty history of not covering the risks they are supposed to cover. In other words, they never paid their claims.

After the crash, regulators set to work to make them less dangerous, through changes that in the process would make them less profitable. Where swaps had been one-on-one deals before, now they would be backstopped by third parties in clearinghouses that ensure everyone can pay, with the aim of avoiding emergency bailouts and panic. And the new Basel Rules now applies a minimum 20% risk weighting to money deposited at clearinghouses, which are third parties that guarantee the transactions. Note that is not a 20% in actual reserves, just a 20% risk weighting on money deposited at clearinghouses; big difference.

Today’s edition of “Banks Behaving Badly” features a hedge fund, SAC Capital Advisors, run by Steven A. Cohen. A judge has accepted a guilty plea from the hedge fund firm as part of a $1.2 billion criminal settlement for insider trading. In total, SAC Capital has agreed to pay $1.8 billion to resolve criminal and civil probes into insider trading. The Department of Justice said that payout is the largest insider trading settlement in history. The judge said: "These crimes clearly were motivated by greed, and these breaches of the public trust require serious penalties."

Now here is the peculiar part; if these breaches of the public trust require serious penalties why would they not include prison time? The answer is that you can avoid prison if you can pay enough money. SAC Capital has lots of money. Manhattan U.S. Attorney Preet Bharara said: "Today marks the day of reckoning for a fund that was riddled with criminal conduct." Not exactly. Today marks the day SAC Capital writes a check and continues on; that does not constitute a day of reckoning.