Financial Review

Unsavory Business Model

Sinclair Noe — May 11, 2016

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DOW – 217 = 17,711
SPX- 19 = 2064
NAS – 49 = 4760
10 Y – .02 = 1.74%
OIL + 1.57 = 46.23
GOLD + 11.40 = 1277.70

The Dow Jones industrial average had its worst day since Feb. 11. The S&P 500 closed 0.96 percent lower for its worst day since April 7. Consumer discretionary led nine sectors lower. Oil turned higher and extended gains to close at a high for the year after the EIA’s weekly inventory report showed a decline of 3.4 million barrels, versus expectations of a slight build. Yesterday, the American Petroleum Institute reported a 3.4 million-barrel increase in crude inventories for the week; so, really, take your pick.

A federal judge has blocked Staples acquisition of Office Depot after a judge agreed to the Federal Trade Commission’s request for a preliminary injunction on antitrust grounds. The FTC said the proposed merger would likely eliminate competition. The same result occurred when Office Depot and Staples sought to combine in 1997. Staples will now pay a $250 million break-up fee to its smaller rival for terminating the transaction.

The U.S. government posted a $106 billion budget surplus in April, down 32 percent from the same period last year.

The International Monetary Fund has published a new research paper that says public sector corruption siphons $1.5 trillion to $2 trillion annually from the global economy in bribes and costs far more in stunted economic growth, lost tax revenues and sustained poverty. Extrapolating from 2005 World Bank research, the paper estimated that around 2 percent of global gross domestic product is now paid in bribes annually. But it said corruption’s indirect costs are substantially higher, reducing government revenues by encouraging tax evasion and reducing incentives to pay taxes, leaving less money available for public investments in infrastructure, health care and education.

On Monday, the International Consortium of Investigative Journalists posted online its database of documents related to more than 200,000 offshore accounts created through Panamanian law firm Mossack Fonseca. You can read and search through the database at your leisure at offshoreleaks.icij.org. On Monday, 300 economists signed a letter urging world leaders to end tax havens, saying they only benefited rich individuals and multinational corporations, while boosting inequality. Which is probably true, yet not quite complete. What we are also learning from the Panama Papers is that offshore accounts are a business model for the financial system. It is a core business for global financial institutions.

Tax evasion by wealthy individuals is only a small part of the story. Legal tax avoidance is almost certainly more important. Most of that involves companies; some companies designed to hide the activities of individuals or families, and also large global corporations.

And while it might be impossible at this time to measure the exact amount of evasion and avoidance, we could look at the gross global output and then the amount the financial sector claims in profits, and then try to extrapolate how much of that comes from  tax evasion and avoidance schemes; and don’t forget the manipulation of currency exchanges, and interest rate exchanges, and bond markets and equity markets and commodity markets and derivatives markets, and well… all the other markets that banks have admitted to rigging.

Add it all up and it might total hundreds of billions a year; if we add in the bribery and corruption the IMF calculates (and that should be added in because that money ends up in banks), then we are looking at trillions of dollars a year.

There has been an explosion in financial sector activity and profits in the past 40 years or so, and the bankers claim that it is: “driven by the benefits of a more efficient allocation of capital by rational markets” but a more realistic interpretation is that growth has been driven by an unsavory system that turns a blind eye to a socially counter-productive business model.

As the Puerto Rican debt crisis continues to unfold, mutual fund managers have been busy trimming their holdings to reduce exposure to the commonwealth’s crisis. Over the past year, the number of funds with exposure to the island has been pared to 29 – out of a pool of 562 municipal bond funds – from as many as 48 in June 2015, according to data from Morningstar. Total dollar exposure has been cut as well, from about $9.9 billion last summer to $6.3 billion now.

Pacific Investment Management Co.’s Total Return Fund cut its holdings of emerging-market debt to the lowest level in almost two years in April. Emerging bonds fell to 9.4 percent of assets, the smallest proportion since August 2014, and down from as much as 29 percent in August 2015.

An impeachment vote on Dilma Rousseff. After months of wrangling, the Brazilian senate will vote on whether or not to impeach the country’s embattled president. National media polls show she’s likely to lose and face trial on charges she broke national budget laws. Today could effectively be her last on the job. The Brazilian newspaper O Estado de S.Paulo says President Dilma Rousseff has packed up all her personal belongings at her office and had them sent to the official presidential residence. Brazil’s highest court says it has rejected an appeal to halt the impeachment process in the Senate. An impeachment vote is expected any time now, like in the next few minutes.

Canadian oil sands companies near Fort McMurray are beginning to restart their operations, as the out-of-control wildfire continues to rage but has now moved far enough away from the oil sands’ sites to allow them to return. Royal Dutch Shell is the first firm to turn on its operations, resuming production at its Albian mine. Before Shell’s restart, the total decline to output in the area reportedly reached at least 839,000-barrels per day, or close to one-third of Canada’s overall daily production.

Department store operator Macy’s reported a 7.4 percent fall in first-quarter sales, the fifth straight quarter of decline, as customers cut back on buying apparel.

 Hershey, the chocolate candy maker, reported a drop in net sales for the third quarter in a row, hurt by weak demand in North America, the chocolate maker’s biggest market.

DuPont’s first-quarter results beat Wall Street estimates and the chemicals and seed producer raised its full-year guidance as it sees lower currency impact than expected. DuPont and Dow Chemical agreed in December last year to a $130 billion all-stock merger, in a first step towards breaking up into three separate businesses; that deal faces intense regulatory scrutiny.

Hit by a sharp appreciation in the yen, Toyota is predicting net income to drop 35% to $13billion for the fiscal year ending in March, snapping three straight years of record profit. Toyota also stated it would repurchase as much as $4.6 billion, or about 3.2%, of its stock.

Chipotle Mexican Grill has spent more than $1 billion on share buybacks in the past year, part of efforts to cope with a food-safety crisis and a flagging stock price. But the move has raised questions about whether the money would be better spent elsewhere. The cost of the repurchases is roughly twice the cash Chipotle’s restaurants generated in the same period. Meanwhile, Chipotle has retained two leading food safety experts – including a critic of the burrito chain’s early response to disease outbreaks last year – as it redoubles its efforts to guard against health scares.

Walmart has filed a lawsuit against Visa for allowing customers to verify chip-enabled debit card transactions with a signature instead of a PIN. The lawsuit says that Visa requires Walmart to accept signature-based transactions for chip debit cards, which Walmart says are a less secure method of payment than PIN-based payments. The dispute is really about money: Wal-Mart pays Visa about five cents more per signature transaction than it does for those that use a PIN. The two have tangled frequently in different lawsuits over the last several years.

Mitsubishi Motors now says that cheating on gas mileage ratings on its cars extends to nine models sold in Japan and others that are no longer sold, vastly increasing the scope of the scandal. That encompasses virtually all the models it sold in its home country. They insist that the scandal does not involve cars sold in the US. Mitsubishi has not disclosed a plan yet to compensate customers. Mitsubishi is only the latest automaker to become enmeshed in controversy over its gas-mileage ratings. In the US, Hyundai, Kia and Ford had to revise gas mileage figures on some models in recent years after their rating methods were called into question.

Google will no longer accept ads for payday loans. Google defines payday loans as loans due within 60 days of being issued and in the U.S. loans with an annual interest rate of 36% or higher. Payday lenders will no longer be able to purchase ads that appear above search results for key terms under Google’s AdWords program. But they will still appear in search results.

The change does not rein in companies marketing loans for mortgage, student, car and commercial loans as well as credit card offers. The ban, which takes effect on July 13, comes ahead of stricter regulations from the Consumer Financial Protection Bureau. Facebook officially banned payday loans last August. Payday lenders and their lobbyists complain the move is discriminatory, but we know that there is a special place in hell for usurers.

Financial Review

Before the Deluge

Sinclair Noe — October 1, 2015

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

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DOW – 12 = 16,272
SPX + 3 = 1923
NAS + 6 = 4627
10 YR YLD – .02 = 2.04%
OIL – .11 = 44.98
GOLD – 1.80 = 1114.50
SILV un = 14.63

Manufacturing grew in September at the slowest pace in more than two years. The Institute for Supply Management said its manufacturing index dropped to 50.2% last month from 51.1% in August, reflecting a stronger dollar and weaker global economy that is hurting U.S. exports of many major American-made goods. That’s the weakest reading since May 2013, although any reading above 50 indicates growth.

The number of people who applied for unemployment benefits rose by 10,000 to 277,000 in the week ended Sept. 26, but initial claims remain extremely low in a sign of steady improvement of the labor market. The average of new claims over the past month, meanwhile, fell by 1,000 to seasonally adjusted 270,500. The level of new claims sank below 300,000 in early March and has remained there for 30 straight weeks, a feat last accomplished in 1973, when the nation’s working population was 40% smaller. Tomorrow morning is the monthly jobs report from the Labor Department.

Construction spending increased 0.7% in August, and gained 13.7% over 12 months. Residential construction rose 1.3%, while nonresidential construction grew 0.3%. Construction of lodging climbed 2.8% and has climbed 41.4% over 12 months.

Not all American homes are rising in value and not all markets are experiencing the recovery evenly. According to a report from Zillow, almost 30% of all homes lost value in August from a year earlier; that’s down from a high of 65% in 2009, although a normal housing market would be closer to 20%. Overall, the median value of homes rose 3.3% year-over-year to $180,800, but appreciated at half the pace of August 2014.

President Obama has signed into law a bill that extends federal funding until December 11 after the Senate and the House yesterday passed the proposal, as expected. Had Congress not approved the measures, the government would have shut down today, the first day of the new fiscal year. Republicans and Democrats now have around ten weeks to formulate a long-term budget, with the parties looking to strike a two-year deal.

Hurricane Joaquin is headed for the East coast, maybe. Where it lands is still uncertain. Joaquin is a Category 3 hurricane with winds of 125 miles per hour and gusts to 155 miles per hour; an increase of the sustained winds to 130 mph would make it a Category 4 storm. Right now it is hitting the Bahamas and within the next 24 hours, it is expected to head north, possibly hitting the Carolinas, or Virginia, or even making land near New England.

The best guesstimates have it headed for New York City. If the hurricane heads for the coast, it will lose some of its punch and slow down to a Category 1 or possibly a tropical depression before landfall. Even if it veers to the northeast and heads out into open waters, it is expected to produce serious flooding. Beyond the wind and the rains, there is a strong possibility of waves approaching 30 feet and storm surge of 8 feet.

Even as the track of the storm is uncertain, the governors of Virginia and New Jersey have already declared a state of emergency.  We all remember Hurricane Sandy but if current projections hold, Joaquin won’t be another Sandy, but nature is unpredictable. Parts of the eastern U.S. from Florida to New Jersey are under flood watches and warnings today, with more than 10 inches of rain already having fallen in some areas this week.

The weather is a staple for the commodity markets. The rain and flooding is expected to be a big problem for cotton farmers in Georgia and the Carolinas. Atlantic hurricanes can be mildly bullish for energy markets as oil and gas platforms could be shut down as a precaution. They could also damage infrastructure, such as refineries and transportation. Traders now expect minimal disruptions to energy markets.

The big three U.S. automakers – GM, Ford, and Fiat Chrysler – reported a jump in September sales as cheap gasoline and ultra-low interest rates drove demand for sport utility vehicles and pickup trucks. Total U.S. auto sales, an early glimpse of consumer spending each month, are expected to have risen about 14% last month.

According to auto industry consultancy Edmunds.com sales got a boost from the calendar, with the entire Labor Day weekend falling in September for the first time since 2012. GM said its total sales in September rose 12%; Ford posted sales gains of 23%; and Fiat Chrysler says September sales were up 14%.

Deere and the United Auto Workers union have reached a tentative agreement to replace the six-year master labor contract that ended at midnight last night. The deal is for another six years and will now go to a vote of the 10,000 Deere manufacturing staff that the UAW represents.

Ratification of a contract between the UAW and Fiat Chrysler appears to be impossible after workers at assembly plants in Ohio and Michigan on Tuesday overwhelming voted against a proposed four-year deal.

Samsung is now accused of Volkswagening its TVs. Yep, that’s the new word for cheating on environmental tests. Independent lab tests show Samsung televisions use less power when they are tested for energy efficiency ratings than during real world use. Sweden’s government has also been looking into TVs from unspecified manufacturers that “clearly recognize” the video used in testing, and which “immediately lower their energy use by adjusting the brightness of the display” in response.

Google and Microsoft have ended a long-running patent spat involving about 20 suits in the U.S. and Germany. Microsoft had alleged that Google’s former Motorola Mobility unit infringed its IP. Google, which held onto most of Motorola’s patents following its sale to Lenovo, alleged that Xbox consoles infringed its patents. Now they’ve made nice with each other, Google and Microsoft plan to cooperate on various patent issues.

The Centre for Economic Policy Research says the Eurozone recession is over. Like the National Bureau of Economic Research in the U.S., the CEPR labels recessions based on a variety of economic indicators and not the informal definition of two consecutive quarters of negative GDP growth. The CEPR said the period from the third quarter of 2011 to the first quarter of 2013 represented the second post-financial crisis recession in the Eurozone. The reason the CEPR feels confident in saying the Eurozone is out of the recession is that the duration of the recovery has made up for its slow speed. However, the Eurozone recovery has been “unusually lackluster” by historical standards.

The third quarter was ugly for stocks, but there were a few winners. More than 3 dozen companies in the S&P 500 posted double digit gains for the quarter. Chipotle, Amazon, and Google posted 20% gains for the quarter. Merger news also pushed some stocks higher, such as Teco, AGL Resource, Cablevision, Chubb, and Molson Coors. Also making the list: Activision Blizzard, Nike, Under Armor, Best Buy, Royal Caribbean, Southwest Airlines, Reynolds American, and Altria.

Merger activity has been strong in 2015. According to data from Thomson Reuters, $3.19 trillion in deals were announced year-to-date, just 2% below 2007 levels. Many of the transactions were worth more than $10 billion, making up 36.5% of the total. In the third quarter there were fewer deals than in any other three-month period this year, yet the dollar volume surpassed $1 trillion. Energy has been the top industry by value, as companies sought strength in consolidation as the price of commodities plummeted. There was also a slew of health care transactions, especially in insurance and pharmaceuticals. Goldman Sachs and Morgan Stanley were the top-ranked financial advisers on these deals.

Bankers like to make big dollar deals; they don’t like to get their hands dirty with smaller loans, but that doesn’t mean they won’t take a cut. For many years the big banks have bankrolled smaller consumer lenders, also known as payday lenders. In the past they were known as loan sharks, and even as the names changed, the terms didn’t; these lenders are still charging outrageous rates, sometimes more than 200%.

But now the Consumer Financial Protection Bureau (CFPB) is starting to tighten regulations on the consumer lenders. The lenders have come under scrutiny for a range of practices that can lead borrowers to believe they are paying far less in interest and fees than they actually are. Now that regulation is getting tighter, the big banks are trying to protect their loans to the subprime lenders; the big change is an amendment that says that if one of the loan sharking companies faces regulatory action that has a material impact on its business, it would constitute a default. And a default would give the big banks the right to seize the lender’s assets, at least in theory; or a pound of flesh if it suits them.

JPMorgan Chase shareholders have won court permission to pursue their securities fraud lawsuit as class action against the bank over the “London Whale” trading scandal, which caused a $6.2 billion loss. Shareholders led by pension funds in Arkansas, Ohio and Oregon alleged that JPMorgan, CEO Jamie Dimon and CFO Douglas Braunstein knowingly hid increased risks at the Chief Investment Office operating in London, including on an April 13, 2012 conference call when Dimon called reports about the synthetic portfolio a “tempest in a teapot.”

It turned out to be a $6.2 billion loss by the London Whale and fallout contributed to even bigger losses for shareholders as market capitalization dropped by $40 billion from April 13 to May 21, 2012. And don’t forget the $1 billion in fines reached in a settlement with regulators that included a rare admission of wrongdoing.

Financial Review

While the Sun Shines

Sinclair Noe — March 26, 2015

 

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

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DOW – 40 = 17,678
SPX – 4 = 2056
NAS – 13 = 4863
10 YR YLD + .09 = 2.01%
OIL + 2.22 = 51.43
GOLD + 9.00 = 1205.10
SILV = .15 = 17.20

Saudi Arabia and its Gulf allies started bombing targets in Yemen as the country slides closer toward civil war. A Saudi military spokesman said there were no immediate plans to launch ground operations in Yemen. Importers say the Saudi attack is not expected to disrupt oil supplies, but the threat of spreading war in the region could likely impact oil flows. Yemeni President Hadi reportedly fled the country yesterday. The White House says the US will provide “logistical and intelligence support.”

Yemen is a fairly small oil producer, but still the news helped push oil prices up almost 5% today, and there are several reasons. First, if things go wrong, this could turn into a proxy war between Shiite Iran, which is backing the rebels, and Saudi Arabia and other Sunni monarchies that supported the Yemeni regime.  The Saudi action could exacerbate tensions in Libya, Syria and Iraq; in other words, this could be part of a trend in the region.

Yemen is also geographically strategic, at the chokepoint of the Red Sea; so there might be the possibility the rebels could disrupt oil tanker traffic; 3.8 million barrels a day are transported through a 25 mile wide stretch of water between Yemen and Djibouti. Foreign ships have been warned not to get to close to Yemen ports.

The flip side of the bullish case for oil is that the Saudis will now need to pay for their military actions, and that means they can’t afford to cut back oil production.

Another consideration is the strong US dollar, which would only get stronger if the Fed hikes rates. This has been a light week for economic data which means it has been a good week for Federal Reserve policymakers to make a case for hiking interest rates. St. Louis Fed President James Bullard says now may be a good time to start normalizing US monetary policy, “so that it is set appropriately for an improving economy over the next two years.” Bullard says there is a concern that prolonged low interest rates could feed into asset price bubbles over the next few years. Atlanta Fed President Dennis Lockhart was interviewed on CNBC today; he says the strong dollar is something that he has upgraded in terms of importance, and that it could have “some dampening effect,” still Lockhart see a rate hike coming “mid-year or a little bit later.” Fed Chairwoman Janet Yellen wraps up the week with a speech tomorrow, just in case the Fed heads haven’t hammered home their point.

When the Fed talks, people listen, and then economists write papers. Laurence Ball economics professor and monetary policy expert at Johns Hopkins University, in a paper to be published next week by the Center for Budget and Policy Priorities says the Fed could create more jobs by letting the unemployment rate fall lower. It should seek to push the rate “well below 5%, at least temporarily,” he writes. That could help bring some discouraged workers to reenter the labor market, as well as help the long-term unemployed find work and involuntary part-time workers find full-time jobs. Mr. Ball allows that a low unemployment rate might result in a temporary jump in inflation above Fed targets but he considers that an acceptable side effect. In other words, it would be easier to fight inflation down the road with rate hikes than it would battling persistently low inflation or deflation with rates already close to zero.

The number of people who filed new applications for benefits at their state unemployment offices, known as initial claims, fell by 9,000 to a seasonally adjusted 282,000 in the period stretching from March 15 to March 21. New claims have tracked below 300,000 for three straight weeks after a weather-induced spike in February that pushed them to the highest level since last spring. And they are running about 9% lower now compared to one year ago.  Layoffs remain near a 15-year low.

A rebound in home prices is good news in the wake of the housing crash — but there can be too much of a good thing. Home prices are rising 13 times faster than wage growth nationwide, according to a report from RealtyTrac. From 2012-2014, median home prices climbed 17% while median wages rose 1.3%.

The House of Representatives today passed a bill to revamp Medicare’s payment formula for doctors. The bill would end the temporary patches known as the “doc fix” that lawmakers approve to prevent payment cuts to doctors. Part of the $214 billion measure is paid for by raising Medicare premiums on wealthy seniors. Passed on a vote of 392 to 37, the bill now goes to the Senate.

The Consumer Financial Protection Bureau has released a plan to rein in payday lenders. The CFPB proposal would require lenders either to ensure borrowers are able to pay back loans or to provide affordable repayment options or other protections such as capping the number of times borrowers can roll over debt. Four out of five payday loans are rolled over or renewed within two weeks. The CFPB’s proposals under consideration also would restrict payday lenders from some questionable practices by preventing repeated and unexpected withdrawals from consumers’ bank accounts. Most payday lenders can access borrowers’ checking accounts and withdraw the funds they are owed, often resulting in high fees when the withdrawal exceeds the checking account balance. In most cases, regulation for payday lenders largely falls to the states, which determine such factors as the maximum interest rates lenders can charge. Annual percentage rates on payday loans, which are offered in 36 states, are typically just shy of 600% in Idaho, Nevada, Texas and Utah, according to a report by the Pew Charitable Trusts. The CFPB proposals will now be opened for feedback from payday lenders and other before putting forward a plan.

Labor Secretary Tom Perez announced plans to travel to Seattle to sit down with workers and employers to discuss “how flexible workplace policies can help support families and businesses.” Perez said only 12% of private sector workers have access to paid sick days. It’s a big problem for low-wage workers. Two thirds of workers at the bottom 25% of the pay scale, the country’s lowest earners, do not receive paid time off for illness, according to the Labor Department. Three quarters of part time employees are not paid when they miss work due to illness. In some cases, they lose their jobs. In a video statement, Perez said: “We are way behind the rest of the world on this. You shouldn’t have to choose between the family you love and the job that you need.”

Of course, Seattle is the headquarters of Microsoft, and today Microsoft announced a new policy requiring suppliers with at least 50 employees to offer workers either 15 days of unrestricted paid time off, or 10 paid sick days and 5 paid vacation days. Microsoft works with a variety of businesses that supply goods and services, ranging from building maintenance and food service to management consulting and “software localization.” The new requirement will apply only to workers at suppliers who do “substantial work” for Microsoft and who have been with the supplier for at least nine months. Microsoft concluded that mandating paid time off for suppliers would ultimately benefit the company and employees by contributing to a “happier and more productive workforce.”

The Commerce Department reports that corporate spending on research and development rose 6.7 percent in 2014, almost twice the previous year’s gain and the biggest advance since 1996. The pickup was capped by a 14 percent fourth-quarter surge that signals additional increases are on the way. More research may help rekindle business investment in equipment that has been bogged down since late last year. Orders for non-military capital goods excluding aircraft, a proxy for future spending on new gear, slumped 1.4 percent in February. It marked the sixth straight decrease, the longest stretch since mid-2012. Investors are now rewarding companies looking to the future rather than those using their horde of cash to buy back shares. Shares of the 190 companies in the S&P 500 that disclosed R&D spending in 2014 outperformed the overall index by 6.1 percentage points. One of the benefits of increased spending on R&D is an increase in productivity, although productivity gains lag R&D spending, sometimes by several years.

The U.S. Energy Information Administration has just released data showing that in just one year, California has increased solar power from 1.9 percent to 5 percent of the state’s total power generation. California isn’t just producing the most utility-scale solar electricity of any state; it’s producing more than all the other states combined. And that’s only what the major electricity producers are generating; it doesn’t include rooftop solar, in which California is also leading the nation. In small-scale solar, capacity for another 2.3 gigawatts has been installed, according to the California Public Utilities Commission. California now accounts for about half of the country’s solar power capacity.

The surge in California’s solar output was driven by a handful of massive new plants, including the Topaz Solar Farm in San Luis Obispo County and Desert Sunlight Solar Farm in the Mojave Desert. Each has a capacity of 550 megawatts, making them among the largest solar plants of their kind in the world. With those plants and others, California added nearly 1,900 megawatts of new utility-scale solar capacity in 2014, raising the state’s overall solar sector to nearly 10,000 megawatts — or enough to power some 2.4 million homes.

Renewable energy, including hydro power and rooftop solar, now constitutes about a third of California’s electricity. And remember that California is going through one of the worst droughts in its history, which has resulted in hydroelectric power being cut in half. The annual increase in California’s solar generation in 2014 offset 83 percent of the decrease in hydroelectric generation. When you don’t have rain, you have to harvest sunshine.

FINANCIAL REVIEW

Bring Your Umbrellas

Sinclair Noe — September 29, 2014

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Financial Review

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

DOW – 41 = 17,071
SPX – 5 = 1977
NAS – 6 = 4505
10 YR YLD – .04 = 2.49%
OIL + .59 = 92.61
GOLD – 4.40 = 1216.00
SILV – .20 = 17.56

Starting with economic data:
Consumer spending accelerated in August. Consumer spending rose 0.5% last month after being unchanged in July. Growth in personal income ticked up 0.3%, in line with forecasts. Some of the strength in spending came from a decrease in the saving rate, which eased back from a 1-1/2-year high in July.

One area where spending dipped – housing. The National Association of Realtors issued its index of pending home sales for August. Pending sales dropped 1% from an 11 month high in July. Signaling that upcoming closings of existing homes are likely to slow down, the index of pending home sales hit a seasonally adjusted 104.7 in August, compared with 105.8 in July.

The Fed’s preferred gauge of inflation was up 1.5% in August from a year earlier, down slightly from the reading in July. Excluding volatile food and energy prices, so-called core prices also advanced 1.5% year over year. Price increases measured by the PCE index slowed to a 1% annual pace late last year before accelerating during the spring and then plateauing this summer. A separate measure also shows inflation is largely in check. The Labor Department’s consumer-price index rose 1.7% in August from a year earlier. That was a marked slowdown from the better-than-2% pace recorded the previous four months.

Weak inflation gives the Fed leeway to maintain its low-interest rate policy without causing the economy to overheat. The Fed aims to set monetary policy so that prices will increase 2% a year. Now, the next logical question might be: why does the Fed target 2% inflation? And the official answer is that the Fed thinks 2% is consistent with its mandate of price stability and maximum employment. Of course, you could make the argument that 4% inflation could be just as stable as 2%, as long as everyone came to expect 4%, and there were no curve balls, we could have price stability at 4% just as easily as 2%. And the notion that the Fed might raise rates if inflation does hit 2%, well that doesn’t seem to be a good idea when it comes to maximum employment; just because inflation hits 2%, that seems a weak reason to tighten credit and slam the brakes on recovery.

So, back to the question: why 2%? Apparently they haven’t figured out a better way to turn the money spigot on and off; perhaps a combination of population growth and productivity growth; expanding the money supply to match the growth of people and things. Instead, they picked a number out of thin air, which is also how they create more money.

Each year Forbes comes out with its list of the 400 wealthiest Americans. It takes just over $1.5 billion to make the list, and it’s just Americans. Bill Gates is the richest American for the 21st year in a row, with a net worth of $81 billion. He’s the world’s second richest person, behind Mexico’s Carlos Slim. The second richest American is Warren Buffet at $67 billion; Larry Ellison is number 3 at $50 billion. All together the 400 wealthiest Americans are worth a staggering $2.29 trillion, up $270 billion from a year ago. That’s about the same as the gross domestic product of Brazil, a country of 200 million people.

Today’s geopolitical hotspot is not in Iraq, or Syria, or Israel, or Ukraine, or even Scotland; it’s Hong Kong. No we did not see this one coming. Tens of thousands of pro-democracy protesters blocked Hong Kong streets today, carrying umbrellas and chanting slogans and singing songs. Riot police had largely withdrawn and there were none of the clashes, tear gas and baton charges that had erupted over the weekend. As tensions eased, some exhausted demonstrators slept on roadsides while others sang songs or chanted slogans. The protesters are demanding full democracy and have called on the city’s leader Leung Chun-ying to step down after Beijing last month announced a plan to limit 2017 elections for Hong Kong’s leader, known as the Chief Executive, to a handful of candidates loyal to Beijing.

China rules Hong Kong under a “one country, two systems” formula that accords the former British colony a degree of autonomy and freedoms not enjoyed in mainland China, with universal suffrage set as an eventual goal. This protest could go a couple of ways: first, mainland China could send in the tanks, but they seem to be veering away from this idea, and instead, just letting the whole thing stew in its own juice, allow the dysfunction to burgeon until a local backlash is triggered or, failing that, at least stew until the local worthies have had enough and publicly petition Beijing to help them out of the mess. It’s a tightrope act. The problem is that news might get through to the mainland, and they might demand universal suffrage. Even worse, Americans might hear about it and might actually demand the right to vote.

Ohio established its early voting period in 2005, following a 2004 general election in which some voters in urban areas were forced to wait up to 12 hours to cast a ballot. Today, the US Supreme Court ruled against in-person early voting in Ohio. The first week of early voting, which the legislature cut, overlapped with voting registration and allowed residents to register and cast a ballot on the same day. The Supremes think that is a bad idea. If voters do get stuck in long lines again, maybe they can take an umbrella.

In today’s edition of “Banks Behaving Badly”, we start with the case of Commerzbank. In 2012, the Federal Reserve Bank of New York entered into an agreement with Commerzbank that required its New York branch to improve compliance with anti-money laundering laws and regulations. After finding the branch still failed to maintain adequate controls, the Fed issued a cease and desist order last year. Now, the US Attorney for Manhattan is investigating Commerzbank AG for alleged violations of money-laundering laws, potentially throwing a wrench in efforts by Germany’s second-largest bank to settle separate allegations that it violated sanctions by doing business with Iran and Sudan.

Meanwhile, the New York Department of Financial Services directed the bank to take steps to terminate a handful of employees who engaged in misconduct; that, as part of a $650 million settlement over the sanctions related violations. So, you have the US attorney going after Commerzbank; you have the state regulator going after Commerzbank, and all this after the NY Federal Reserve Bank of New York signed an agreement with Commerzbank that they must clean up their act, and when they didn’t they issued a cease and desist. I guess they just can’t help it.

Next on the docket is a familiar visitor, Bank of America. The SEC said Bank of America overstated its regulatory capital by greater and greater amounts in its regulatory filings, eventually reaching billions of dollars. The bank reported the overstatement in April and has been working with regulators to resolve the matter. The SEC has fined BofA $7.6 million. I’m sure that will be a huge deterrent.

Back in July, Lloyd’s Banking Group agreed to pay more than $380 million to British and United States authorities to resolve investigations into the manipulation of rates, including one used to determine fees paid by Lloyds related the bailout Lloyd’s received during the financial crisis. Lloyd’s admitted to criminal wrongdoing by some of its employees who manipulated the Libor, or London interbank offered rate, which is the global benchmark for interest rates on pretty much everything from mortgages to derivatives to the rate on a taxpayer bailout of a bank, apparently. Now, Lloyd’s says it has fired 8 employees and clawed back about $4.9 million in bonuses.

This is wrong on so many levels: first, the employees have continued to work for the bank; next, none of them are going to jail for admitted criminal wrongdoing; and third, the claw back comes from bonuses, which means that someone in the bank, who determines bonuses, thought that these rate rigging employees were doing such a fine job, that they deserved six figure bonuses.

Two former Wells Fargo employees have been charged by the SEC with insider trading. An analyst at the bank would tip off a trader in advance about market moving upgrades or downgrades. Nice.

Back in 2006, Congress approved the Military Lending Act on concerns that payday lenders, which offer double-digit interest loans tied to a borrower’s next paycheck, were preying on soldiers and their families, by hitting them with triple digit interest rates on short-term loans and subprime double digit rates on mortgages. It just didn’t seem right that people who were putting their life on the line for their country, should have to pay a pound of flesh to the shylocks of the world. The law set a 36% interest rate cap on a range of high-cost loan products; which still works out to about a half pound of flesh. And then, to really show how much Congress supports our troops, they left a whole bunch of loopholes in the Military Lending Act, because many payday lenders are also big campaign contributors. And so payday lenders just made minor changes to their payday loans, and kept charging rates that would make Tony Soprano blush.

The ultimate price of those loans for military members turned out to be particularly steep, costing them their homes, their cars, and, in some cases, their jobs. The military considers personal indebtedness to be a threat to national security, so high levels of debt can imperil service members’ security clearances.

Now Congress could have made some different choices; they could have decided to pay our troops a living wage; they could have set up a Military Bank to offer soldiers the same low rates they offer the bankers – essentially zero percent interest; and they could have closed the loopholes for the payday lenders. And now 7 years after the fact, that’s what they are debating – closing the loopholes. Last year, the Senate Commerce Committee convened a hearing on abusive practices aimed at military members. And the Defense Department started to solicit input about whether the protections, as they currently stood, needed to be updated. And maybe, when Congress gets back from their 2 month vacation, they will actually consider maybe doing something.

Tuesday, August 12, 2014 - Hype is Hurting

Financial Review with Sinclair Noe

DOW – 9 = 16,560
SPX – 3 = 1933
NAS – 12 = 4389
10 YR YLD + .02 = 2.44%
OIL - .15 = 97.22
GOLD + .60 = 1309.50
SILV - .10 = 20.02

The Dow Industrial Average has now gone negative year-to-date. Seven of the 10 main groups in the S&P 500 declined, with energy companies dropping 0.7 percent to lead the slide as Brent crude settled at the lowest level since July 2013. The International Energy Agency said a supply glut was shielding the market against threats in the Middle East.

As we wrap up earnings season, 73% of companies have beaten earnings estimates, slightly above the 1-year average of 72%, but “beating estimates” this time doesn’t mean what it did in recent quarters. For the past few years, analysts have ratcheted down their estimates in the run-up to earnings season, setting the bar lower and lower—and setting up an easy beat. Companies are beating by an average of 4.2%, above the 1-year average of 3.2%. Q2 earnings growth is 8.4%, up from an expected 4.9% on June 30. This is the second-highest earnings growth rate since Q4 2011. Revenues are now up for 5 consecutive quarters and at all-time highs, and it now looks like revenues might be driving earnings. The strongest sectors for upside earnings surprises have been telecom services, health care (especially biotech), and information technology; while consumer staples is the weakest. US banks and thrifts had their second best quarter in 2 decades, with more than $40 billion in net income.

Profit margins have soared. Net profit margins more than doubled from 4.6% in March 2009 to 9.8% at the end of the first quarter. Margins could come in just shy of 10% when all the second-quarter results are in. The problem is that high margins tend to mark a peak rather than a normal level of profitability. In other words, it’s tough to keep the margins high, and there are several reasons: most of the fat has been cut and it is difficult to further improve labor efficiencies and that’s confirmed by last week’s productivity report showing that the real output of nonfarm business has been hovering around 3% year to year since Q2-2010, consistently higher than real GDP growth; capital spending has been low, but is likely to rebound; and with interest rates near all-time lows, companies will find it difficult to find better financing to boost margins. As margins stagnate or slip, the best defense is to look for companies that are growing revenues.

Actually, the best defense might be to discount analysts’ expectations; something that Wall Street is doing with greater frequency. The problem is that analysts issue glowing earnings growth expectations for the next few quarters, based on pro forma estimates, minus the bad stuff, and heavily adjusted; which in turn drives up share prices. Traders buy in. As the distant quarters get closer and closer, the analysts ratchet down expectations, making for a bar that is easy to hurdle, and again the traders buy in.

In its latest report on earnings expectations and reported earnings, FactSet found a startling change in how the market reacts to these fabricated earnings beats. Over the past five years, companies with upside earnings surprises saw their stock prices rise on average 1% from two days before the announcement to two days afterwards; and downside earnings surprises were punished with a 2.3% decline in stock price over the four-day window. So far in the second quarter earnings season, companies have been crushing earnings, and the market is languishing. FactSet found that this time around the market didn’t reward these juicy earnings surprises at all. Stocks of these companies actually dropped 0.1% over the four-day window. And downside earnings surprises got hit with a 3% decline. The hype is hurting.

The share of unemployed Americans competing for each open job hit a six-year low in June. The Labor Department's monthly Job Openings and Labor Turnover Survey, or JOLTS report, showed the number of unemployed job seekers per open job fell to 2.02 in June, the lowest level since April 2008. Job openings, a measure of labor demand, increased to a seasonally adjusted 4.67 million in June, the highest level since February 2001. At the same time, hiring reached its highest point since February 2008. Much of the increase in employment growth since the 2007-2009 recession ended had been driven by a sharp decline in the pace of layoffs, as opposed to a higher rate of hiring.

Job growth has topped 200,000 in each of the past six months, a stretch last seen in 1997. The unemployment rate has declined to 6.2 percent from 6.7 percent at the end of 2013. The JOLTS report shows some of the slack is coming out of the labor market, and the next sign of a tightening labor market is if we start to see wage growth. Meanwhile, a gauge of small businesses’ intentions to hire has also surged to a fresh post-crisis high, with 13% of respondents to a survey by the National Federation of Independent Business indicating their intentions to hire. That’s the largest percentage since September 2007. The problem is they aren’t actually hiring. The JOLTs hiring rate is nowhere near as buoyant as the job opening rates. The US hiring rate, hires as a share of total employment, hit 3.5% in June. You might expect businesses to intend to hire before they actually hire, but there is also a disconnect; and it might be in a skills mismatch or it might be in a wages mismatch.

During the Great Recession and its aftermath, the federal government acted to help victims of the severe downturn by funding programs that extended unemployment benefits—to up to 99 weeks in some cases, up from the standard 26 weeks. As the economic recovery continued, weak as it was for many in the working class, many lawmakers on the right began to believe that these extended benefits were a drag on employment—the theory being that government checks reduced the incentive for recipients to find a job, and that cutting off this lifeline would compel unemployed workers to look harder for work and perhaps take jobs they may not have accepted if the benefits had continued. Relying on this premise, Congress allowed the federally-funded Emergency Unemployment Compensation program to lapse last December.

Now, more than seven months later, data are available to test this idea. Coming from perspectives that diverge greatly along the ideological spectrum, scholars at both AEI and EPI, the Economic Policy Institute and the American Enterprise Institute, a couple of think tanks at opposite ends of the spectrum, have come to the conclusion that this “bootstraps” theory is incorrect—curtailing jobless benefits did not boost employment. Because unemployment benefits are contingent upon the people who receive them proving that they are looking for a job, receiving jobless benefits appears to make recipients at least just as likely, and certainly not less likely, to rejoin the ranks of the employed.

The US budget deficit was $95 billion at the end of July, down 3 percent from the same period last year. The fiscal year-to-date deficit at the end of July was $460 billion, the lowest level since the same period in fiscal year 2008, compared with a deficit of $607 billion for the same period in fiscal year 2013.

The National Association of Realtors released metro area home-price data for the second quarter, and it looks like growth in home prices is slowing, especially in the East. Nationwide, the median existing single-family home price in the second quarter was $212,400, up 4.4% from the second quarter of 2013. The median existing home price for the Phoenix area is $198,600, up 8.6% from one year ago.

The inventory of all existing homes for sale rose 6.5 percent in June from a year earlier to 2.3 million, an increase from a 13-year low of 1.8 million in January 2013. That’s a 5.5-month supply at the current sales pace, less than the six months that is considered equilibrium between buyers and sellers. Breaking it down further, inventory tightened at the market’s low end and grew at the top. The number of U.S. homes for sale in the bottom third of the market -- below $198,000 -- fell 17 percent in June compared with a year earlier, according to a Redfin analysis of 31 large U.S. metropolitan areas. The supply was up 3 percent in the middle market and jumped 15 percent at the top. The rising inventory of more expensive properties is giving a boost to sales. At the bottom of the market, first-time buyers, even those with the credit, savings and income to overcome tougher underwriting requirements, must face off against other bidders. First-time purchasers accounted for 28 percent of all sales of previously owned homes in June, down from about 40 percent historically.

A funny thing happened in New York yesterday; Manhattan prosecutors filed criminal charges against a dozen payday lending companies and their owner, accusing them of making payday loans that defied New York's limits on interest rates, or usury laws. The defendants in the case tried to cover their tracks with a maze of offshore corporations, to make it look like they weren’t doing business in New York. Under New York state law, the maximum interest rate that can be charged is 9 percent annually and the general usury limit is 16%, with a bunch of exemptions. The defendants in this case are accused of charging between 300% and 700% interest. Remarkably, most states still have usury laws on their books, but not all. In Arizona the legal rate of interest is 10%.

You may very well have a credit card that charges more than 10%, and the reason that is not considered usury is federal court decisions and statutes have virtually exempted credit card companies by allowing them to charge customers, regardless of their state of residence, the interest rates allowed by the state in which they are incorporated. This means that there are no limits on credit card interest rates in practice, even if certain limits remain on the books, the only exception being the 18 percent interest limit for federally chartered credit unions. And so it is a very rare event when anyone faces a criminal charge of usury.