Oil Rally Helps Fuel Equity Gains

Charles Schwab: On the Market

Posted: 9/28/2016 4:15 PM ET

Oil Rally Helps Fuel Equity Gains

U.S. stocks finished with solid gains powered by the energy sector as crude oil prices rallied on the heels of a Reuters report that OPEC has reached a production cut deal, though a finalized plan may not come until November. Treasuries and gold ticked lower, while the U.S. dollar was nearly unchanged. Meanwhile, some rate hike uncertainty may have been revived as a plethora of Fed officials either have or will deliver remarks today, including Chairwoman Janet Yellen who gave financial regulation testimony to a House panel. In other developments, Dow member Nike offered a mixed earnings report and a preliminary read for durable goods orders in August was relatively upbeat.

The Dow Jones Industrial Average (DJIA) rose 111 points (0.6%) to 18,339, the S&P 500 Index gained 11 points (0.5%) to 2,171, and the Nasdaq Composite added 13 points (0.2%) to 5,319. In moderate volume, 910 million shares were traded on the NYSE and 1.8 billion shares changed hands on the Nasdaq. WTI crude oil surged $2.38 to $47.05 per barrel, wholesale gasoline was $0.08 higher at $1.44 per gallon and the Bloomberg gold spot price declined $4.50 to $1,322.82 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was nearly unchanged at 95.47.

Dow member Nike Inc. (NKE $53) reported fiscal 1Q earnings-per-share (EPS) of $0.73, above the $0.56 FactSet estimate, as revenues increased 8.0% year-over-year (y/y) to $9.1 billion, north of the projected $8.9 billion. The company said its global futures orders of athletic footwear and apparel were up 7.0% y/y, below the expected 8.3% increase as North American and Greater China orders were below forecasts, while Western European demand was slightly ahead of estimates. Shares traded lower. 

BlackBerry Ltd. (BBRY $8) posted flat 2Q EPS, compared to the $0.05 per share loss that was anticipated, as revenues declined 28.2% y/y to $352 million, below the projected $392 million. The company raised its full-year earnings outlook, reflecting improving margins and reduced interest expense, as well as planned investments in growth areas. BBRY also said it is focusing on software development, including security and applications, and plans to end all internal hardware development by outsourcing that function to partners. Shares finished nicely higher.

Durable goods orders relatively upbeat, mortgage applications dip

August preliminary durable goods orders (chart) came in flat month-over-month (m/m), compared to Bloomberg's estimate of a 1.5% decline and July's negatively revised 3.6% gain. Ex-transportation, orders declined 0.4% m/m, versus the 0.5% forecasted decrease, and July's downwardly revised 1.1% rise. Orders for non-defense capital goods excluding aircraft, considered a proxy for business spending, rose 0.6%, above projections of a 0.1% dip, and following the unfavorably revised 0.8% rise in the month prior.

Schwab's Chief Investment Strategist, Liz Ann Sonders notes in her article, Every Picture Tells a Story: Recession Risk Up, but Not High, that leading indicators weakened in August, but are not yet flashing a recession warning. Recession models show rising, but still low risk of a coming contraction in economic activity. Economic recoveries don’t tend to die of old age; they die of excess…of which there's little in this recovery. Read more at www.schwab.com/marketinsight and follow Liz Ann on Twitter: @lizannsonders.

The MBA Mortgage Application Index dipped 0.7% last week, after falling 7.3% in the previous week. The decrease came as a 1.6% drop for the Refinance Index more than offset a 0.8% increase for the Purchase Index. The average 30-year mortgage rate fell 4 basis points (bps) to 3.66%.

Treasuries ticked lower, with the yields on the 2-year and 10-year notes, as well as the 30-year bond all gaining 1 basis point to 0.75%, 1.57% and 2.29%, respectively. Schwab's Chief Fixed Income Strategist, Kathy Jones points out in her article, With a Whimper Instead of a Bang: Is the Great Bond Bull Market Over?, the end of the bull market doesn't mean a bear market is starting, as slow global growth, deflationary pressures abroad, a firm dollar and demographic trends are likely to keep yields low. Investors should focus less on short-term changes in the market and more on structuring a fixed income portfolio that can work for them over the long run. Read the whole article and other timely bond market commentary at www.schwab.com/onbonds. Follow Kathy on Twitter: @kathyjones.

Tomorrow, the U.S. economic calendar will yield the final look (of three) of 2Q GDP, projected to be adjusted slightly higher to a 1.3% quarter-over-quarter annualized rate of growth, after 1Q's 0.8% expansion. Additionally, we will receive weekly initial jobless claims, forecasted to increase by 8,000 to a level of 260,000, which will be followed by pending home sales, expected to come in flat m/m for August after increasing 1.3% in July.

Europe moves higher, Asia mixed 

European equities traded higher, with financials rebounding amid a recovery in shares of Deutsche Bank AG (DB $12). DB received a boost from the announcement that it agreed to sell its U.K. insurance business and its CEO eased concerns that the company will need to raise capital. Also, the German government denied a media report that it was preparing a contingency plan if the bank faces a capital shortfall. DB has sold off sharply as of late as capital concerns have ramped up, with the U.S. Department of Justice seeking a record $14.0 billion fine in relation to its alleged practices leading up to the 2008 mortgage crisis. Oil & gas and basic materials issues also gained ground to aid the markets, with crude oil prices rebounding in continued choppy action as headlines are sparking speculation regarding what this week's informal OPEC meeting may bring in terms of a production agreement. The euro and the British pound dipped versus the U.S. dollar, while bond yields in the region finished mostly lower.

With the volatility likely to remain as global market uncertainty heightens, Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, reminds investors, Three Reasons Why Now is Not the Time to Retreat from Global Diversification and why Your portfolio may be less diversified than you think. Read these articles, as well as Jeff's World Tour: An Around The World Look At the Economic Landscape, at www.schwab.com/oninternational. Follow Jeff on Twitter: @jeffreykleintop.

Stocks in Asia finished mixed on the heels of the advance in the U.S. yesterday on some upbeat consumer confidence and services sector data, while monetary policy uncertainty in Japan festered. Japanese equities fell as the yen pared yesterday's advance, while a large portion of stocks were adjusted lower to account for their dividend payments, per Bloomberg. Also, uncertainty surrounding the Bank of Japan's (BoJ) recently announced new monetary policy direction likely hamstrung equities with comments earlier in the week from BoJ Governor Kuroda that suggested a move further into negative interest rate territory weighed on the banking sector. For more on this topic, Schwab's Kathy Jones offers her article, Negative Interest Rate Policy: What Is It and Could It Happen Here at www.schwab.com/onbonds. Mainland Chinese stocks declined and Hong Kong shares rose in light volume posturing ahead of next week's golden week holiday break. Australian securities ticked higher, with strength in technology issues being met with weakness in oil & gas and basic materials stocks. Indian stocks advanced, while South Korean equities declined.

The international economic docket for tomorrow will include retail sales from Japan, CPI from Germany, business climate data from the Eurozone and consumer credit from the U.K.

Financial Review

What Are the Odds?

Sinclair Noe — June 14, 2016

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DOW – 57 = 17,674
SPX – 3 = 2075
NAS – 4 = 4843
10 Y – .01 = 1.61%
OIL – .39 = 48.49
GOLD + 1.70 = 1286.50

The rally for sovereign debt has passed an important milestone, with the yield on Germany’s benchmark 10-year bonds hitting zero for the first time and closed slightly negative, -0.01%. And as German bond yields slide into negative territory, the European Central Bank is running out of German debt to buy for its asset-purchase program. The central bank may have to consider scrapping the minimum yield limit or dropping a rule that prevents it from holding more than a third of any bond issue.

The strong demand is standing out in cautious trade ahead of a series of policy meetings at major central banks and rising uncertainty over whether the UK will stay in the EU. Four polls put the “Leave” campaign ahead of “Remain”. The latest polls show as much as a 7-point lead for the exit camp. The polls might be wrong; they were wrong about the vote for Scottish independence.

While a significant numbers of voters say they want to leave the EU, when it comes time to actually cast their vote, fear over the potential political and economic impact might steer them to take the safer course. British betting parlors still have odds of a Brexit at just 40%.

One month ago, the odds makers were placing a 20% chance on the possibility of the UK leaving the EU. Betting doesn’t tell what the future will be, it tells us what the probable future will be. The bookies are usually right.

Reuters is reporting the ECB would publicly pledge to backstop financial markets in tandem with the Bank of England should Britain vote to leave the European Union. The preparations illustrate the heightened state of alert ahead of the June 23 referendum. An official announcement from the ECB would come on June 24 if an early-morning result showed that British voters had chosen to leave the EU.

The aim is to underpin investor confidence across Europe and contain further market jitters. Providing extra funds to banks after a Brexit vote would ease pressure on them and reduce the potential for panic as financial markets digest the result on Friday, June 24, shortly before closing for the weekend. The Bank of England has already sought to avert any liquidity squeeze by providing injections of cheap funding for banks ahead of the vote.

Investors have amassed their largest cash pile since 2001 and cut equity holdings to a four-year low. Even though world bond yields have never been lower and many bank deposit rates around the world are now negative, investors are willing to hold more cash in their portfolios than at any time since November 2001.

According to a Bank of America Merrill Lynch report, risk appetite fell to its lowest level in four years, consistent with recession, although growth and profit expectations hit a six-month high and inflation expectations a one-year high. Fund managers held an average 5.7 percent of their portfolio in cash, up from 5.5 percent in May. If you are looking for the pony, consider that there is a lot of cash that can come off the sidelines fast.

The cost of imported goods rose 1.4% in May, the biggest increase in four years, largely because of a rebound in oil prices, which jumped 17.4%. Although import prices are still 5% lower compared to a year ago, they are no longer falling. Excluding fuel, import prices rose a much smaller 0.3% in May. That was still the largest gain since March 2014. The price of goods exported by the US to other nations, meanwhile, climbed 1.1% in May.

Shoppers increased their spending in May. The Commerce Department reports retail sales rose a seasonally adjusted 0.5 percent last month, the second straight increase after a 1.3 percent gain in April. Online and non-store purchases climbed 1.3 percent in May. Sporting goods stores, restaurants, clothiers and auto dealers also enjoyed higher sales.

Rising gasoline costs fueled a 2.1 percent jump in spending at gas stations; we didn’t buy more gas, we just paid more. Sales declines hit building material stores, furnishers and department stores last month. Total retail sales have risen 2.5 percent from a year ago.

The Federal Open Market Committee meeting for June kicked off today, with the interest rate decision and press conference due tomorrow. Market implied odds of a rate hike at this meeting have dropped to zero in the aftermath of the latest jobs report. They were higher than 30 percent as recently as May 26. Of course, the FOMC could hike rates or take other action; not likely but not totally impossible. The more probable move is that the Fed continues jawboning.

Today’s retail sales report would probably be enough to justify a rate hike, were it not for the May jobs report, which came in at a very weak 38,000 jobs. Federal Reserve Chair Janet Yellen said in a June 6 speech in Philadelphia, “We are now close to eliminating the slack that has weighed on the labor market since the recession.”

And the unemployment rate now stands at 4.7%; if you think back 7 years ago, or even 2 years back, you would think that 4.7% unemployment would indicate full employment, but it doesn’t.

Payrolls have increased by an average of 116,000 per month over the past 3 months; well below last year’s 229,000 per month pace of job growth. The Labor Department reported on June 8 that job openings rose to 5.8 million in April from 5.7 million in March. Hires, meanwhile, fell to 5.1 million, from 5.3 million.

Businesses complain that there is a shortfall of qualified workers. Usually this might indicate that we are near an inflection point in the labor market. Business needs workers, even if that means paying up and even training candidates for the position; the scales might be tipping from employers to employees, but the transition is slow.

The National Federation of Independent Business’s optimism index rose 0.2 point to 93.8. Most of the index’s sub-gauges rose or stayed neutral. Fewer owners expect to invest in capital expenditures, and the number of job openings and earnings trends both declined.

Oil prices are down this morning, pushed lower for the fourth consecutive day, despite a bullish report from the International Energy Agency. The IEA revised its demand forecast upward for this year by 100,000 barrels a day, to 1.3 million barrels a day from 1.2 million barrels a day.

The possibility of a Brexit is also weighing on oil; if the UK leaves the EU, the British pound will likely take a hit and the greenback will appreciate. As oil trading is conducted in dollars, a stronger dollar would push down oil prices in the US.

Moody’s has placed Microsoft’s ‘AAA’ credit rating under review for downgrade following the software giant’s deal to buy LinkedIn for $26 billion, citing concerns that it would be funded through new debt. Why is Microsoft taking out such a big loan if it has enough cash to buy LinkedIn 4x over? Taxes. Microsoft can avoid paying a 35% tax rate to repatriate cash from overseas and could also deduct interest payments.

Marriott International is on track to win unconditional EU antitrust approval for its cash and share purchase of Starwood Hotels and Resorts Worldwide. The deal $12.5 billion deal will combine Marriott’s Ritz-Carlton and Starwood’s Sheraton and Westin chains together to create the world’s largest hotel company.

Zenefits announced another layoff today. It’s cutting about another 106 people, about 9% of its salesforce, and it is shutting down its Arizona sales office, though it is not pulling out of Arizona altogether.

Iran is preparing to unveil an agreement for Boeing jetliners within days that could be valued at about $25 billion. The transaction would be the first struck by the plane maker since sanctions were lifted in January and would require US government approval. An order listed at $27 billion announced by Europe’s Airbus Group SE also needs a US Treasury Department license before it can be finalized.

Boeing is poised to land a comparable deal if they can get the appropriate government permissions. Iranian officials say the country needs to invest about $50 billion to bolster its fleet with 400 mid- and long-range jetliners and 100 short-haul planes.

High-speed internet service can be defined as a utility, a federal court has ruled in a sweeping decision clearing the way for more rigorous policing of broadband providers and greater protections for web users. The decision affirmed the government’s view that broadband is as essential as the phone and power and should be available to all Americans, rather than a luxury that does not need close government supervision.

Today’s 2-to-1 decision from a three-judge panel at the United States Court of Appeals for the District of Columbia Circuit came in a case about rules applying to a doctrine known as net neutrality, which prohibit broadband companies from blocking or slowing the delivery of internet content to consumers.

The court’s decision upheld the FCC on the declaration of broadband as a utility, which was the most significant aspect of the rules. For now, the decision limits the ability of broadband providers like Comcast and Verizon to shape the experience of internet users. Without net neutrality rules, the broadband providers could be inclined to deliver certain content on the web at slower speeds, for example, making the streams on Netflix or YouTube buffer or shut down.

Such business decisions by broadband providers would have created fast and slow lanes on the internet, subjecting businesses and consumers to extra charges and limited access to content online. Cable and telecom companies say they will continue to fight the rule, and the next step would be to take the case to the Supreme Court; which you will recall is short one justice.

Financial Review

154 More Days

Sinclair Noe — June 8, 2016

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DOW + 66 = 18,005
SPX + 6 = 2119
NAS + 12 = 4974
10 Y – .01 = 1.70%
OIL + 1.01 = 51.37
GOLD + 18.90 = 1263.10

The Dow closed above 18,000 for the first time since April.

The European Central Bank’s corporate-bond buying program kicked off this morning with the bank buying debt issued by companies including Anheuser-Busch InBev, Telefonica, Siemens, and Renault. Borrowing costs in Europe had already fallen to unprecedented levels with the average yield on investment-grade company notes in euros dropping to 1 percent this week.

In the sovereign debt space, where the ECB also continues to be a buyer, the yield on Germany’s 10-year bund is within a hair of turning negative, falling to (yet another) record low of 0.033 percent this morning.

Commerzbank, one of Germany’s biggest lenders, is examining the possibility of hoarding billions of euros in vaults rather than paying a penalty charge for parking it with the European Central Bank. Such a move by a bank part-owned by the German government would represent one of the most substantial protests yet against the ECB’s ultra-low rates. Although no decision has yet been taken, the lender has held discussions on the matter with German authorities.

The bulk of negative-yielding debt is concentrated in Japan and Europe. Globally, the total is now $10.4 trillion, according to Fitch Ratings. Individual European countries that do not use the euro are largely trying to weaken their respective currencies, as investors flock to safety.

The European Central Bank, which oversees the euro, introduced negative rates to stimulate growth in the Eurozone. The Bank of Japan also wants to stimulate growth, as well as weaken the yen. The goal is the same: Flood the financial sector with money, hoping that it chases yield into riskier investments.

But if the goal were to coax money into riskier assets, such as stocks, the plan has been a failure so far. European stocks were down 30% at one point after the introduction of negative rates. In Japan, stocks are up only slightly since the beginning of the BOJ’s experiment in January of this year.

Job openings hit 5.8 million at the end of April, up slightly from 5.76 million openings in March, according to the Job Openings and Labor Turnover Summary (JOLTS) report. The report beat analyst consensus estimates of 5.7 million job openings for the month. The job openings rate was 3.9 percent in April, with the biggest increase in wholesale trade, transportation, warehousing, and utilities at 65,000 openings.

Professional and business services saw the biggest decrease, down 274,000 openings. April hires fell to 5.1 million, slightly lower than the previous month’s 5.3 million. The hiring rate was 3.5 percent, little changed in the private sector and down 31,000 for government hires, according to the report. There were 5 million separations, which includes quits, layoffs and discharges.

Last week’s anemic jobs report for May pushed interest rates lower, but the desire for mortgages was already on the rise. Mortgage application volume jumped 9.3 percent last week from the previous week, according to the Mortgage Bankers Association. The volume may have been making up for a big drop two weeks ago, or reacting to a slight drop in interest rates.

The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,000 or less) decreased to 3.83 percent from 3.85 percent, with points decreasing to 0.33 from 0.36 (including the origination fee) for 80 percent loan-to-value ratio loans.

The World Bank slashed its global growth forecast. The World Bank cut its global growth forecast for 2016 to 2.4% from 2.9% as a result of “sluggish growth in advanced economies, stubbornly low commodity prices, weak global trade, and diminishing capital flows.” The bank sees “mounting risks” and expects a “further slowdown in major emerging markets.” Specifically, China’s growth is forecast to slow to 6.7% from 6.9% and both Russia and Brazil are expected to see “deeper recessions” than initially forecast. India’s growth is expected to hold at 7.6%.

While oil markets will start rebalancing after a slump next year, an oversupply in natural gas won’t disappear until the end of the decade, the IEA warned, slashing its gas demand outlook for a fourth straight year. “Slower generation growth, rock-bottom coal prices and robust deployment of renewables constrain gas’s ability to grow faster in today’s low-price environment.” Global consumption will expand by 1.5% annually until 2021, down from last year’s forecast of 2% growth through 2020.

Meanwhile, both Brent and WTI are holding strong above $51 per barrel, helped by industry data showing a larger-than-expected draw-down in U.S. crude inventories, worries about attacks on the Nigerian oil industry and strong Chinese demand. According to data from the API on Tuesday, oil stockpiles fell by 3.6 million barrels last week. Energy Information Administration figures released today show a 3.2-million-barrel drop in inventories.

The dollar declined against the yen. The euro edged up. The dollar index was down again today. The dollar has lost some of its strength after Friday’s disappointing jobs report. That has helped energy companies, as well as mining companies and chemicals and machinery makers and commodities in general; a weaker dollar makes American goods more affordable in other countries.

If the Fed were to raise rates or even suggest that the recent jobs number was just a transitory anomaly, then the lack of strong fundamental support could produce a rather pronounced correction to the down side. Consider that oil traded today at nearly a 100% increase off of the lows that were created just this February; that kind of price movement is not just a simple supply-demand story.

The International Energy Agency reports that 1.26 million electric cars, both battery and plug-in hybrid, were sold worldwide in 2015. Is that a lot? It depends on how you look at the numbers and who is asking the questions. The trend is certainly up. Keep in mind that there were only a few hundred electric cars on the road in 2008 and the current number is a lot higher than anyone would have expected back then. The number has tripled just since 2013.

The United States now has 400,000 electric vehicles on the road, a massive increase since 2010. But there is still a long road ahead, and that road is full of cars with gas engines. There are 1 billion vehicles on the road worldwide at present and that number is expected to increase dramatically in the next 20 years as demand in countries like India and China continues to soar.  For now, lower gasoline prices are an obstacle for more electric vehicle sales.

According to Fortune’s annual ranking of companies by revenue, Walmart is still the 800-pound gorilla. With $482 billion in revenue, it sells more than Apple, Amazon and Microsoft put together. It’s bigger than the No. 2 company, Exxon Mobil, and No. 3, Apple, combined. Its sales are greater than the GDP of Poland. That’s based on revenue. Forbes puts together a list of the 2000 biggest companies around the globe, and revenue is just one metric they use. According to Forbes, the top 3 spots on their list are held by Chinese banks.

Today’s top gainer was a micro-cap stock called Gevo, up 102%. On Tuesday, Alaska Air Group flew two flights using the company’s renewable alcohol to jet fuel. The flights departed using a mixture of traditional jet fuel and a 20% bio-fuel blend made from fermented corn. They flew from Seattle to San Francisco and then on to Washington DC. The airline estimates that the 20% bio-fuel blend will reduce greenhouse gas emissions by 50%.

Keurig Green Mountain is pulling the plug on Kold, its counter-top soda machine. Many consumers balked at the price of the device, which initially cost $369, and its pods, which had cost $1.25 to make an 8-ounce drink. The move comes 10 months after Keurig rolled out Kold and three months after JAB Holding, a major global coffee player, took the company private for about $14 billion.

When Aubrey McClendon drove his Chevy Tahoe into a bridge the day after he was indicted for allegedly rigging the price of oil and gas leases, suspicions arose that he had killed himself. But a two-month probe by Oklahoma Police has found nothing to suggest the Chesapeake Energy founder committed suicide.  Investigators found no information that this was anything other than a car accident, but also admitted: “we may never know 100% what happened.”

Reports of Roger Goodell’s death have been greatly exaggerated; actually his passing was an outright lie – the result of a computer hack. The National Football League became the latest high-profile victim of hackers as the league’s official Twitter account was intercepted and wrongly announced the passing of NFL Commissioner Roger Goodell. The tweet has been deleted. Goodell is alive and well.

The primary season effectively wrapped up last night. Both the Republicans and Democrats have a presumptive nominee. And what the primary season has taught us is that most states don’t know how to hold an election.

Whether it was a lack of polling places in Arizona, or voters scrubbed from voter rolls in New York, or far too many provisional ballots that will likely never be counted in Texas, or broken machines and polling sites that opened late in California, or a judge’s ruling today in Ohio striking down provisions of the state’s recently enacted voting laws; it all points to confusion and the potential for big problems. By the way, we have 154 days until the Election Day. Good luck.

Financial Review

Breaking Up Is Hard To Do

Sinclair Noe — February 16, 2016

Podcast: Play in new window | Download (Duration: 20:26 — 9.4MB)

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DOW + 222 = 16,196
SPX + 30 = 1895
NAS + 98 = 4435
10 Y + .03 = 1.78%
OIL – .36 = 29.08
GOLD – 8.50 = 1201.30

Top oil officials from Russia, Saudi Arabia, Qatar, and Venezuela met in Doha and have agreed to freeze crude output at January levels, targeting a supply glut that’s sent prices to 13-year-lows. According to the International Energy Agency, Saudi Arabia produced 10.2 million barrels per day last month, below its most recent peak of 10.5 million barrels per day set in June 2015. Russia produced nearly 10.9 million barrels per day in January, a post-Soviet record.

To be clear, the idea is to freeze production at those levels, not cut production. January levels of oil output would most likely keep global supplies running faster than demand for months to come, if not longer. There really wasn’t much incremental production expected from Russia, Qatar and Venezuela for the rest of this year, given these countries are already stretching their production limits.

Iran was absent from the Doha meeting, and no surprise why: The Islamic Republic is planning to ramp up shipments as it looks to regain market share lost after years of international sanctions. Over the weekend, Tehran sent its first cargo of oil to Europe since the end of sanctions last month, and announced plans to boost production and exports by 1 million barrels per day in 2016.

Oil prices jumped up at news of the meeting, which was seen as an effort to stem the oversupply that has been driving down crude oil prices and shaking world commodity and stock markets. But those gains were largely erased later after word that the four nations had agreed only to freeze output rather than cut it.

While the U.S. was on holiday yesterday stock markets across the globe rallied, with Japan’s Topix index soaring 8 percent and shares in Europe capping their biggest two-day gain in more than four years.

The Bank of Japan’s negative interest rates take effect today. The Bank of Japan, which announced the decision on Jan. 29, will now charge lenders 0.1% to park additional reserves, prompting banks to lend and businesses to spend and invest.

Bad loans at Chinese banks are at their highest level in nearly a decade. Nonperforming loans at Chinese banks surged 51% year-over-year to $1.2 trillion, hitting their highest level since June 2006. McKinsey Global Institute reports half of all loans are linked, directly or indirectly, to China’s overheated real-estate market; unregulated shadow banking accounts for nearly half of new lending; and the debt of many local governments is probably unsustainable.

The Bank of Korea kept policy on hold. South Korea’s central bank held its key interest rate at 1.50%, as expected. The Bank of Korea said the economies of both the US and the Eurozone appeared to have “weakened somewhat” and the Chinese economy continued to slow.

This was one of those days when bad news was good news. The thinking goes as follows. If the Japanese economy shrank by 0.4% in the final three months of 2015 and Chinese exports fell by more than 11%, policymakers will sit up and take notice. Central banks will stimulate activity by cutting interest rates, even when they are already negative, and by expanding their quantitative easing (QE) programs.

Right on cue, Mario Draghi popped up before the European parliament to administer a bit of his own soothing balm. ECB President Mario Draghi says the European Central Bank “will not hesitate to act” to boost its stimulus in March if it believes recent financial-market turmoil or lower oil prices could weigh further on consumer prices.

Most analysts now expect the ECB to cut its already-negative deposit rate — charged to banks for storing funds at the central bank — by at least another 0.1 percentage points in March, to minus 0.4%, and to accelerate its bond-purchase program, which is currently running at €60 billion a month.

The National Association of Home Builders reports homebuilder sentiment fell in February; the index was down 3 points to 58, from an upwardly-revised 61 in January. The sub-gauge that tracks current sales conditions also dropped three points, settling at 65 in February.

Royal Dutch Shell has surpassed Chevron as the world’s second-largest non-state oil company after completing its acquisition of the BG Group. Exxon Mobil remains the globe’s most valuable oil company with a market value of $337B, almost twice as big as Shell.

Moody’s Investors Service says Deutsche Bank will be able to make interest payments on its riskiest debt this year and in 2017, stating that the bank can make payments due in April and only “a major, unforeseen event” would prevent those due a year later.

How much did VW managers know about the company’s emissions scandal and when did they know it? Reuters reports that a high-ranking employee warned senior Volkswagen managers in May 2014 that U.S. regulators might examine car engine software as part of an investigation into pollution levels. The notice came in the form of a letter, which was sent more than a year before the German automaker’s public admission that its cars had been equipped with software to manipulate emission test results.

Freeport-McMoRan has agreed to sell an additional 13% stake in its Morenci mine to Sumitomo Metal Mining, Japan’s second-biggest copper producer, for $1 billion in cash. The deal will take Sumitomo’s share in the Arizona based open-pit copper mining complex to 28% from 15%.

Freeport expects to record a gain of about $550 million on the transaction and expects it to close in mid-2016. Morenci is Freeport’s biggest mine by production and the largest copper mine in North America. In short, Morenci is Freeport’s crown jewel asset with the biggest copper reserves and the longest mine life.

Mining companies have had a hard time lately, and copper prices have taken a big hit, but if you are trying to figure out what went wrong at Freeport McMoRan, look no further than the oil market. It wasn’t too long ago that Freeport was a miner. But in 2013, when oil prices were high, it bought McMoRan Exploration Co. and Plains Exploration for roughly $9 billion. In the end, the deal led to an explosion in Freeport’s debt, which stood at nearly $20 billion at the end of 2015.

Before the big oil deal, debt was only about $3.5 billion. Putting some perspective on those two numbers, debt as a percentage of the capital structure was 15% before the acquisitions and over 60% at the end last year.  The stock is down over 80% since the start of 2013. Rounding, to keep the math easy, Freeport went from a $40 billion-market-cap company to around a $7 billion cap. That’s more than $30 billion lost.

In the press release, Freeport-McMoRan stated: “This transaction represents an important initial step toward our objective to accelerate debt reduction and restore our balance sheet”. So, while most investors were thinking about whether Freeport-McMoRan will be able to sell its oil and gas assets, the company came up with a deal to sell a part of its key copper asset.

Freeport-McMoRan itself stated multiple times that good copper assets are very hard to find, but now the company is selling its copper assets to get rid of the debt created by the oil asset purchase. And what happens to Freeport McMoran if oil prices stay low for longer than expected? Will they end up selling off all of their valuable copper assets to pay for their bets on oil?

A slowdown in the Chinese economy has hit the mining industry hard. On Monday, ratings agency Moody’s cut Anglo American’s debt rating to junk, citing a deterioration in commodities market conditions; that follows a fourth quarter earnings report that showed a loss of $5.6 billion. Anglo outlined plans in December last year to restructure its portfolio to between 20 and 25 assets, down from 55 and cutting its workforce to about 50,000 people, an 85,000 reduction. Anglo American will streamline its asset portfolio to De Beers, platinum and copper, holding just 16 assets down from 55

Home security services company ADT Corp. has agreed to be purchased by affiliates of Apollo Global Management for about $6.9 billion. ADT shareholders are to receive $42 a share. That’s a 56% increase from Friday’s closing price of $26.87. The companies said ADT would be merged with Protection 1, which is also owned by Apollo, to create a business with nearly a third of North America’s electronic security products market. Apollo Global Management, which agreed last week to buy Apollo Education Group with other investors, acquired Protection 1 last year.

Apollo Global Management is part of a consortium of private equity investors who have bid on Apollo Education Group, the parent company of University of Phoenix, but it might not be a done deal. Schroders Plc, Apollo Education Group’s largest shareholder, plans to vote against a $1.1 billion takeover.

The U.K. firm, which spoke to Apollo Education’s management last week, said that based on the limited information it has access to, a price tag of $9.50 per share “significantly undervalued” the company’s assets. First Pacific Advisors LLC, the second-biggest investor in Apollo Education, with a holding of about 7 percent, told its clients that a deal valued at $1 billion “would be unquestionably rejected” by the firm.

According to a new 13F filing, Alibaba owned 33 million shares of Groupon at the end of the fourth quarter, a stake valued at $95 million. While the disclosure fuels speculation that Alibaba could try to acquire Groupon, it should be noted the company has taken stakes in many American firms without fully acquiring them.

HSBC has decided to keep its headquarters in Britain, rejecting the option of moving back to its main profit-generating hub in Hong Kong following a 10-month review. The unanimous decision by the bank’s board gives a boost to London’s status as a global financial center, which has faced challenges from tougher regulation since the financial crisis. Analysts had estimated the cost of moving out of London at up to $2.5 billion.

Stock repurchase plans have exploded over the last few years, thanks to cheap money following the Fed’s zero interest rate policy of the last few years. According to data from FactSet, over the 12-month period ending last September, $566 billion was spent on share repurchases, nearly 65% of net income.

In the trailing 12 months ending in the third quarter of 2015, 130 companies had a buyback to net income ratio that exceeded 100%. And that begs the question of how those companies are investing for future growth. It also begs the question of how individual investors can value earnings per share growth.

Buybacks can paint a deceptive picture of corporate growth because it shrinks share count and makes earnings per share look stronger than they really are. For example, if a company’s net income is $10 million and shrinks its outstanding shares by 5 percent to 19 million from 20 million shares, its reported EPS jumps to $0.53 from what would have been $0.50, yielding EPS that is 6 percent higher even though net income hasn’t changed at all.

Narayana Kocherlakota has resigned as President of the Minneapolis Federal Reserve Bank, and his successor is Neel Kashkari. Kashkari joined the Minneapolis Fed in January. Prior to joining the central bank, he was an executive at bond giant PIMCO and then lost a bid to become the governor of California. Kashkari worked at the Treasury Department under Henry Paulson before and during the financial crisis. Kashkari oversaw the Treasury’s Troubled Asset Relief Program; and before that he worked for Goldman Sachs.

Today, Kashkari made his debut speech as Minneapolis Fed President and he said: “While significant progress has been made to strengthen our financial system, I believe the [Dodd-Frank] Act did not go far enough,” adding that the nation’s biggest banks remain too big to fail and pose significant risk to the economy. Kashkari said that policymakers must give serious consideration to breaking up banks. Another idea is to turn large banks into public utilities “by forcing them to hold so much capital that they virtually can’t fail.”

Another idea is to tax leverage throughout the financial system “to reduce systemic risks wherever they lie,” he said. “Large banks must…be able to make mistakes —even very big mistakes— without requiring taxpayer bailouts and without triggering widespread economic damage.” Kashkari says the Minneapolis Fed will develop a plan to end too-big-to-fail banks and make it public by the end of the year.

Goldman Sachs Asset Management says the worst of the credit-market selloff is probably over and it’s now waiting for a sign that the situation has stabilized so it can plow cash back into U.S. junk bonds and other corporate debt. Credit went into meltdown this year as questions mounted around the efficacy of central bank policies and the ability of China’s government to stem capital outflows while maintaining economic growth.

The selloff pushed spreads on high-grade and junk-rated company bonds in the U.S. to levels unseen in at least 3 1/2 years. Goldman’s research suggests that once sentiment becomes less negative, the “magnetism” of the yields on offer will draw investors back. We’ve been through the worst of the adjustment and you should start looking for things to buy.

They’re not quite sure when you should start buying, maybe a month, maybe a little longer. Given that they’ve gotten 5 of their 6 beginning of year calls wrong so far, Goldman‘s credibility isn’t great. But in 2007, there was a bounce in subprime from March to May, and in 2008, the self-congratulatory “Mission Accomplished” post-Bear phase, which lasted till about July. So near-term moves are anyone’s guess. What we do know is that Goldman is happy to sell, so their message is buy.

The fourth-quarter earnings reporting season is winding down and it is shaping up as the worst quarter for earnings growth since the financial crisis. With 87% of companies in the S&P 500 having reported results for the last three months of 2015, overall earnings per share are slated to show a drop of 4% from a year earlier, making it the worst quarter for growth since the third quarter of 2009.

Per-share earnings have now fallen for three straight quarters; and even though estimates had been ratcheted lower, total per-share earnings beat expectations by the smallest amount since the second quarter of 2011.

Financial Review

Risk Off

Sinclair Noe — February 11, 2016

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

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DOW – 254 = 15,660
SPX – 22 = 1829
NAS – 16 = 4266
10 Y – .06 = 1.64%
OIL – .17 = 27.28
GOLD + = 50.10

It’s a bad day for global stock markets.  Markets in Hong Kong opened for the first time this week and had their worst start to a lunar new year since 1994, falling 3.9 percent, adding to a 12% plunge since the beginning of the year. The MSCI Asia Pacific excluding Japan Index lost 2.2 percent. The Europe Stoxx 600 dropped 3.6%.

In her testimony to Congress yesterday, Federal Reserve Chair Janet Yellen was not certain whether she had the legal authority to cut rates into negative territory. Yellen on Wednesday said the crucial question confronting the Fed was whether the domestic economy is strong enough to keep growing modestly even as the global economy struggles. This is the question.

Today, Yellen headed over to the Senate Finance Committee and repeated her testimony from yesterday before opening it up for questions. Yellen said the cause of the market selloff is “not mainly our policy,” noting that the market was tranquil in the immediate aftermath of the increase in interest rates in mid-December. She doesn’t think the Fed will cut rates anytime soon. The key for the central bank is whether the negative shocks hitting the economy persist, Yellen said. The central bank will know more in a few weeks.

Bond investors are making it clear that they do not expect further rate hikes from the Fed, and the bet seems to be that the rest of the world will drag down the US, rather than the US economy serving as an economic engine for the rest of the world.

Futures traders are betting that the Federal Reserve will refrain from raising interest rates for at least two years as stocks and other risky assets plummet. The yield on the 10-year Treasury note dropped as low as 1.53%, the lowest level since August 2012, and close to the record low of 1.39%. The probability for one rate hike by December has dropped to about 10%, from 94% less than two months ago.

In Sweden, the Riksbank surprised analysts by cutting its main repo rate to minus 0.5 percent, from minus 0.35 percent this morning. Negative rates are breaking out all over the world. Yields on German government bonds that mature over the next seven years are negative. Swiss 10-year bonds offer negative yields and today the Swiss National Bank did not rule out even deeper cuts. And after the Bank of Japan moved to negative short-term yields earlier this year, the yield on the Japanese 10-year note fell into negative territory Tuesday.

And while paying a government to park your cash may sound like an automatic losing proposition, here’s something that might surprise you: buying an index of Japanese government bonds or Swiss government bonds has returned more than 6% so far in 2016. Remember, as rates go down, price goes up.

The idea behind negative rates is that it will force the banks to put money into circulation; they will lend money rather than pay to park money; the money will start to circulate through the economy, stimulating business and commerce. When interest rates turn negative, Europeans turn to cash.

The amount of cash across the euro zone rose to more than 1 trillion euros last year, with almost 30 percent of it hoarded in 500 euro notes. Cash in circulation is almost double the amount of 10 years earlier and has risen steadily throughout the debt crisis, a trend that reflects fears about the euro zone and its banks as well as exasperation with low returns on savings.

Even though there is more cash in circulation, it doesn’t mean it is actually circulating. The reality is that in a deflationary environment, people hold onto money because whatever you might buy today will be cheaper tomorrow. ECB data has shown that nervous individuals keep more of their money at home or in a vault.

CoCo bonds are getting hit hard, again. A lot of the recent worries with European banks have been centered on CoCo bonds, or contingent convertible bonds. These bonds automatically convert debt to equity when a bank’s cash reserves fall below a certain level.

So, in the event of a default, the holders of CoCo bonds no longer have a bond that pays interest, they now own stock in the bank that can’t pay interest on its debts. It is, essentially a bail-in. Today’s selling has run the yields on Deutsche Bank’s and Santander’s CoCo bonds to fresh highs (yields rise when prices fall), causing more concerns about Europe’s banks.

Deutsche Bank expects to write down the value of its Postbank by about a third, ahead of a planned sale of the retail unit as part of a strategic overhaul. The institution’s book value will be cut to $3.1 billion. Deutsche Bank shares are down around 35% since the start of the year.

Bank stocks across Europe are down, with the Bloomberg Europe Banks Index dropping 5.6%. Credit Suisse Group slid to a 27-year low as the bank grapples with a restructuring plan. Societe Generale missed fourth-quarter profit estimates, with earnings declining 35 percent at its investment bank.

Morgan Stanley will pay $3.2 billion to settle federal and state charges that it misled investors in residential mortgage-backed securities that later soured during the financial crisis. The case against the bank alleges that Morgan Stanley painted a rosy picture to investors about the quality of the residential mortgages it had securitized, even though the loans had material defects.

Puerto Rico’s Senate has cleared legislation that would enable the island’s main electricity provider to restructure almost $9B of debt. The bill now moves to Puerto Rico’s House of Representatives, which would need to approve it before Feb. 16, when the restructuring agreement between creditors and the electric utility, PREPA expires. A previous deal fell apart in January after the territory’s legislature had failed to pass the act by a previously agreed date.

Oil prices hit a 12-year low. West Texas Intermediate futures dropped to $26.13 a barrel, breaking below the $26.19 low from January to reach the lowest since May 2003. Supplies at Cushing, Oklahoma, the biggest US oil-storage hub, rose by 523,000 barrels to 64.7 million last week, according to government data.

The site is considered full at 73 million barrels. And at some point you have to wonder what happens when all the storage tanks are full. Shortly after hitting a low for the day, OPEC sent out a tweet from the United Arab Emirates Energy Minister saying: “OPEC is ready to cooperate on a cut, but current prices are already forcing non-opec producers to at least cap output”.

Well, that was good enough to push oil prices a little higher, and that in turn helped lift stocks, but not before the S&P 500 index hit an intra-day low of 1810 – taking out the intra-day low of Jan. 20 at 1812. We told you in January that after the S&P dropped below 1860 there really wasn’t any meaningful support for a while. Nine days ago I repeated that a drop below 1860 and it was Katy bar the door, or short the Spiders. Well today, we dropped through minor support at 1812 and broke it.

Next we look for confirmation. The next levels of minor support are a couple of hundred points lower around 1560, and we don’t have major support…, well we don’t want to talk about it right now. In other words, we could be looking at a very, very big drop if 1810 does not hold. Look for some support at 1810 along with some support for oil prices at $26. We might see a bounce, but if these levels don’t hold, it gets really dangerous.

Now, is OPEC serious about production cuts? No. And here’s why. Saudi Arabia just announced it will send ground troops to Saudi Arabia, supposedly to fight ISIS, but more to support Sunni rebels which are currently being pounded by Russia and Assad. The exact role of the Saudis in Syria has not been determined, and it might not pan out. Still, increased involvement would be in addition to the Saudi’s engagement in Yemen and Bahrain.

Now normally, military action in the Middle East would result in a fear premium for oil, but these are not normal times. No fear premium now, although it could come later if we see escalation that draws the Iranians into conflict. For now, it means the Saudi’s will have to pump oil at 100% to pay for their military excursions.

Jobless claims dropped by 16,000 to 269,000 in the week ended Feb. 6; that’s a 7-week low. The number of people continuing to receive jobless benefits dropped by 21,000 to 2.24 million. With staffing additions probably slowing this year as the labor market makes it tougher to attract skilled workers, employers are showing little appetite to reduce headcounts.

Boeing plans to cut jobs in its commercial airplane division (the company’s largest business), as part of cost reductions in the wake of market share losses to Airbus. But wait, there’s more…, The US Securities and Exchange Commission is reportedly investigating Boeing Commercial Airplanes’ accounting practices with respect to the company’s 787 Dreamliner and 747 jumbo jet programs.

Nearly one in five vehicles on U.S. roads is in need of repair of a safety issue serious enough to be involved in a federal government recall, according to Carfax. That means there are more than 47 million cars nationwide with open recalls, up 27% from a year ago. NHTSA data shows that in 2015 there were close to 900 recalls affecting a record 51 million vehicles.

PepsiCo reported better-than-expected quarterly net revenue as higher sales of snacks and non-fizzy beverages such as Gatorade in North America helped reduce the impact of a strong dollar. PepsiCo increased its annual dividend and increased its stock buyback program. However, the company forecast 2016 adjusted earnings below many analyst estimates, citing a strong dollar.

Rio Tinto, the world’s second-largest mining company, reported that in 2015 it earned half of what it earned in 2014, and changed its dividend policy so that they won’t increase automatically. The commodities that Rio Tinto produces have been getting crushed for about a year now; and it’s not just iron ore and copper. Rio Tinto owns the largest diamond mine and diamond production increased 25%, even as fewer people bought diamonds. So the good news is that diamond prices are down, just in time for Valentine’s Day.

Financial Review

Sub Zero

Sinclair Noe — January 29, 2016

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

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DOW + 396 = 16,466
SPX + 46 = 1940
NAS + 107 = 4613
10 Y – .05 = 1.93%
OIL + .46 = 33.68
GOLD + 2.80 = 1118.80
SILV + .02 = 14.34

It’s Friday and also the last trading day of the month.

For the week, the Dow gained 2.3%, the S&P added 1.7% and the Nasdaq increased 0.5%.
That left the Dow down 5.5% for the month, or a loss of 959 points. The Nasdaq lost 7.9%, or 394 points in January, its largest monthly loss since May 2010.

The S&P was down 103 points, or 5%, although at one point last week the S&P was down 11% since the start of the year.

An index of US Treasury bonds returned 1.8% for January, which has been the best month of the year for bonds, at least over the past few years. The yield on the 10-year note dropped 24 basis points for the month.

Gold and silver shared the safe haven spotlight with Treasuries. Gold gain $58.60, or 6% for the month. Silver added 53-cents or 3.8%, year-to-date.

The dollar has gained just over 1% year-to-date, but is still below November highs.
Even with today’s gain, oil closed out the month of January with a loss of $3.37 or 9%.

The U.S. economy expanded at a slower pace in the fourth quarter. Gross domestic product rose at a 0.7% annualized rate in the three months ended in December after a 2% gain in the third quarter. GDP expanded 2.4% for a second straight year, led by the biggest gain in consumer spending in a decade.

Household purchases rose at a 2.2% annualized pace in the fourth quarter, down from 3% in the third quarter; so consumer spending slowed in the quarter, but businesses saw big cuts in spending.

Business investment decreased at a 1.8% annualized rate, the first drop since the third quarter of 2012 and compared with a 2.6% pace in the third quarter. Businesses cut spending on stockpiles to try to pare unwanted inventories. That effort trimmed growth by 0.5 percentage point in the fourth quarter. Home construction grew at a solid 8.1% annual rate.

Separately, the Labor Department reports wages and salaries rose 0.6% in the fourth quarter – the same pace as in the previous three months, indicating gradual tightening in the labor market has yet to put pressure on employers to boost pay. Wages of all employees, including government workers, advanced 2.1% from the same period in 2014.

The Bank of Japan said that it would adopt a negative interest rate policy for the first time, in an attempt to kick start the world’s number three economy. The central bank said it cut the deposit rate it pays on cash parked at the BOJ by commercial banks in excess of legally required reserves, to minus 0.1% from the previous plus 0.1%. The goal was to push down borrowing costs across a broad time spectrum to stimulate inflation.

Just one week ago, Bank of Japan Governor Haruhiko Kuroda said he was not thinking of adopting a negative interest rate policy now, signaling that any further monetary easing will likely take the form of an expansion of its current massive asset-buying program. So, this really was shocking news for global markets.

The yen tumbled after the announcement. The benchmark Topix index closed 2.9% higher. Money is pouring into bonds all over the world, pushing yields lower. Germany’s 10-year yield is off 6 bps at 0.33%, making for the lowest reading in nine months, and yielding about the same as a US 3-month note.

Now, these negative rates in Japan are not being applied at the retail level; this is directed at the banks, and the reserves held by banks with the central bank. But if the negative rates last long enough, it could work to the consumer level. For now, the idea is to nudge banks to make loans and circulate money through the economy, with a little punishment for banks that hoard the cash.

In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good. If banks make more customers pay to hold their money, cash may go under the mattress instead. We have seen negative rates over the past year or so in the Eurozone, and Sweden, Denmark and Switzerland.

We don’t really know yet how it will play out, and we don’t have historic data to guide us. This time it really is different. We’ve heard that before, but it is true this time. For the Eurozone and now for Japan, rates are at the lowest levels in at least 500 years – and, yes, Deutsche Bank did look that far back in sovereign debt records.

So what do negative interest rates tell us about the global economy? We appear to be in a long-term low growth and low inflation environment. Perhaps the central bankers, including the Fed, need to re-think their ideas about acceptable levels of inflation; perhaps a 2% rate of inflation is too low. Today’s action by the Bank of Japan will almost certainly influence the Fed’s thinking on future interest rate hikes.  At the very least it should lead to discussion of how monetary and fiscal policy is conducted and coordinated on a global scale.

And for investors, we need to consider whether the US economy really is so much stronger than our global business partners; and we should also consider the spread between global and international rates and the spread between US long-term and short-term Treasuries (it is flattening, and you know that’s not good); also the impact of negative interest rates on a variety of asset classes, including equities, currencies, and commodities.

Oil prices started the session with big gains but pared losses throughout the day as the dollar index gained more than 1%.  It proved near impossible to prop up oil on the notion of a Russia-OPEC deal to cut production. The Wall Street Journal reported that an Iranian oil official said the country would not join an immediate OPEC production cut. The paper said Iran wants to boost crude exports by 1.5 million barrels a day. Baker Hughes reports energy firms in the US cut oil rigs for the sixth straight week and were expected to shed more.

Puerto Rico plans to propose a debt exchange to investors, offering to swap existing bonds for two new types of securities to help the U.S. commonwealth alleviate its debt burden. Both classes of debt would delay payments, giving the island time to make fiscal adjustments and spur economic growth. One would eventually pay interest at 5%, while the other would carry a value determined by Puerto Rico’s fiscal health.

The World Health Organization is warning that the Zika virus is “spreading explosively” in the Americas, and will convene a special meeting on Monday about whether to declare a public health emergency. While there is no approved vaccine, U.S. health officials and drug makers could start working on an experimental one soon. Both GlaxoSmithKline and Sanofi are considering developing a treatment.

Xerox said it would split into two companies, one holding its legacy hardware operations and the other its business process outsourcing unit, in which activist investor Carl Icahn will get three board seats. The company, whose shares had fallen more than 30% in the past 12 months, has been trying to turn itself around by focusing on software and services as businesses cut costs and a switch to mobile devices hits demand for printers.

Fourth-quarter earnings reporting season is well under way, with S&P 500 companies on average expected to post a 4.1% drop in earnings, according to Thomson Reuters. Excluding energy companies, earnings are seen rising 2.1%.

Chevron reported its first quarterly loss in more than 13 years on Friday as the oil producer struggled to cope with plunging crude prices that are eroding profitability across all its divisions. The company posted a fourth-quarter net loss of $588 million, or 31 cents per share, compared with a net profit of $3.47 billion, or $1.85 per share, in the year-ago period. The last time Chevron posted a quarterly loss was the third quarter of 2002. Chevron last month announced it would cut its 2016 budget by 24% to $26 billion.

It’s time now for another edition of Banks Behaving Badly: In today’s edition we take you back to last summer, when we told you tens of thousands of Malaysians gathered in Kuala Lumpur and demanded to know how almost $700 million linked to the debt-laden government investment fund 1Malaysia Development Berhad (1MDB) ended up in prime minister Najib Razak’s personal bank accounts. 1MDB was set up by Najib six years ago and has been the subject of intense scrutiny for borrowing $11 billion to fund questionable acquisitions. $6.5 billion of that debt came from three bond deals underwritten by Goldman Sachs, which charged nearly $600 million in fees, and resulted in little or no development in Malaysia.

We now have an answer from the attorney general appointed by Najib to investigate Najib. The AG says the $700 million that just appeared in the Prime Minister’s personal bank account was a personal gift from the royal family of Saudi Arabia, and there was no bribery or corruption. So, the Prime Minister has been cleared of all wrongdoing because hey, sometimes wealthy Saudis just hand out really lavish gifts. Meanwhile, Tim Leissner, chairman of the Goldman Sach’s Southeast Asia ops, is taking leave of absence from Goldman and moving from Singapore to LA.  And that’s the way they do it.

Thursday, June 05, 2014 - The European Central Bank Has Done Something

Financial Review with Sinclair Noe

DOW + 98 = 16,836
SPX + 12 = 1940
NAS + 44 = 4296
10 YR YLD - .02 = 2.58%
OIL - .18 = 102.46
GOLD + 9.60 = 1254.20
SILV + .24 = 19.04

The Dow and the S&P finished with record high closes.

We start in Europe. The European Central Bank has done something. No, I’m serious, they did something; not just talked about doing “whatever it takes”, they actually took some action; nothing terribly bold; probably not enough, but something. Specifically, the ECB cut its benchmark interest rate to 0.15% from 0.25%, and the deposit rate to minus 0.10% from zero. The rate cuts will take effect next week, on June 11. They are trying the  negative interest rate, which has never been tried on a large scale, in a bid to push down the value of the euro and encourage banks to invest excess cash rather than hoard it in central bank vaults.

The ECB will also begin offering four-year loans to banks at the benchmark interest rates, under conditions meant to ensure that lenders use the money to issue loans to businesses. The loans are designed so that they can’t just borrow the money from the ECB at 0.15% and toss it into government bonds.

Also, the ECB will start buying packages of loans, or asset-backed securities; another measure designed to push lending to small businesses; right now there aren’t enough loans in the private sector to make this a big deal; but the idea is that the banks can get cheap money, lend it out, and then sell off the loans to the ECB. It’s called the targeted longer-term refinancing operations, or T.L.T.R.O., as if the world needs another financial acronym. Also, the ECB will no longer offset the impact of its holdings of bonds bought to combat the euro zone crisis in 2010 and 2011 by simultaneously withdrawing comparable amounts of money from the financial system.

This is a scaled down version of Quantitative Easing, and a very scaled down version of Abenomics. So Draghi and the ECB stopped short of using the metaphorical bazooka of full scale QE large scale asset purchases of sovereign bonds, probably because they would have a tough time working out which country’s bonds to buy; instead the ECB will purchase private sector asset-backed securities.

The idea of negative interest rates has been tried before, but not on a continental scale; still the negative part, is just a minus 0.10%, so it probably won’t be a huge game changer. If it isn’t sinking in just yet, here’s the simplified concept. Normally, if you put $100 on deposit with the bank they might pay you a small interest rate, say 1% a year. At the end of one year, you would have $101. Negative interest rates are just the opposite; if you put $100 on deposit with the bank, you would have to pay them, and so at the end of the year, you would have $99.

The theory is that when it becomes more costly for European banks to keep money in the ECB, they will have incentive to do something else with it; lend it out to consumers or businesses, for example. Or if negative rates make it less attractive for global investors to park money in Europe, it could cause the euro to fall on currency markets, helping reverse a rise in its value that has made European exporters less competitive.

Will negative interest rates work? Not necessarily. If the banks don’t start lending, they will have to start paying the negative interest rate, and then they will likely pass the cost on to the customer. They might not call it a negative interest rate, but banks are notorious for charging fees to their clients. If, or when the banks start charging fees for deposits, or however they pass along the costs, people might start pulling their money out of the banks. People might buy something when they take their money out of the bank, or they might just put it under their mattress at home.

On a smaller scale, Denmark tried negative interest rates a couple of years ago, and nothing really changed one way or the other; the Danish krona depreciated a little but it did not lead to a noticeable increase in real interest rates or an increase in bank lending.

Still, the ECB had to try something. ECB President Mario Draghi has been talking for 2 years about doing something. Now the question is whether it will work. The Eurozone faces low inflation and even deflation in certain countries. Deflation is a much bigger problem than inflation, and much less responsive to most monetary policy. Japan has been trying to escape the effects of deflation for the better part of two decades. Central banks can pump liquidity into the markets but they have a harder time creating demand in an economy.

One of the bank’s aims is to weaken the euro, which allows exporters in the euro zone to sell their products more cheaply abroad. A weaker euro also tends to push up inflation by raising the prices of fuel and other imported goods. Markets got the message. The euro fell 0.37 percent against the dollar, to $1.355, its lowest level in four months. Of course, if the Euro currency depreciates significantly, you have to wonder if Europe’s major trading partners would just sit back and fail to respond.

Will it work? I’m guessing it won’t. “Are we finished?” Mr. Draghi asked rhetorically at one point in his news conference. “The answer is no. If need be, we aren’t finished here.” Earlier, Draghi said, “If required, we will act swiftly with further monetary policy easing.” Which sounds a lot like what he said 2 years ago: “whatever it takes.”

If it sounds like the ECB’s moves are fraught with uncertainty, you are correct. This whole monetary system, whether in Europe or Japan or China or the US, is just a big experiment.

Today, Securities and Exchange Commission Chair Mary Jo White gave a speech on the stock markets and High frequency trading and dark pools. Depending on perspective it was either a major crackdown or same old same old. Mainly she said the SEC will start the process of looking into these things, which is disappointing because the SEC is supposed to be the regulator of these things. Instead we find out the SEC is looking into developing rules targeting high-speed traders, less transparent trading venues and order-routing practices, a move designed to promote fairness for investors, shine more light on the markets and bolster stability. I knew the SEC was behind the curve on these issues, but this is just sad.

Still, I guess it’s important because it does mark the first time Chairwoman White has articulated her plan for revamping equity market structure rules since she took over at the SEC in the spring of 2013. White said she has numerous regulatory proposals in the works, including an "anti-disruptive trading" rule to rein in aggressive short-term trading by high-frequency traders during vulnerable market conditions, and a plan to force more proprietary trading shops to register with regulators and open their books for inspection.

Dark pools allow investors to execute trades anonymously and do not make trading data available until after the trade is complete, if at all. White says she wants more transparency for the dark pools, and the SEC is seriously thinking about finding out who and where these dark pools are and maybe asking them to disclose more to the public and to regulators about how they operate. Any regulations that are ultimately proposed will have to be vetted through a public comment process and approved by a majority of the SEC's five commissioners. But ultimately, Chairwoman Mary Jo White wants the SEC to actually understand how the stock markets work. And to this end the SEC seems to be all in favor of disclosure. To be fair, disclosure is the SEC's answer to most questions, but it's especially the answer to questions that the SEC doesn't especially want to talk about.