Financial Review

Bon Appetit

Sinclair Noe — January 6, 2016

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DOW – 252 = 16,906
SPX – 26 = 1990
NAS – 55 = 4835
10 Y – .07 =  2.18%
OIL – 1.98 = 33.99
GOLD + 16.30 = 1094.80

Sometimes the world can be a messy place. Global markets get discombobulated. That has been the case in the first few trading days of the year. Saudi Arabia and Iran are about as friendly as cats and dogs, China’s economic growth is grinding slower, and then, in left field, North Korea drops a bomb, or at least tests a bomb, maybe.

North Korea announced that scientists had successfully detonated a hydrogen bomb. The U.S. Geological Survey reported that a magnitude 5.1 earthquake was triggered near North Korea’s nuclear test site in the northeast of the country, but could not confirm that it was related to an H-bomb test.

China’s central bank set the yuan’s reference rate at an unexpectedly weak level, a reminder of the shock depreciation in August that sparked a wave of financial-market turmoil. Chinese media said that last summer’s selling ban on major shareholders would remain in place until the government publishes new rules on such sales.  The Shanghai Composite Index jumped 2.3 percent. Emerging-market stocks dropped to a six-year low and developing-nation currencies declined versus the dollar, while shares in Europe resumed losses after closing higher on Tuesday. Investors are continuing to replace risky assets with safe havens such as Japanese yen, U.S. Treasuries, German Bunds and gold.

Surely this was not what the Federal Reserve was expecting in December when they raised interest rates above zero for the first time in nearly a decade. Today, we found out more about what the Fed was thinking with the publication of the FOMC meeting minutes. The official account emphasized the expectation of Fed officials that “economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate” over the next year. And that is the plan if everything goes well. The minutes indicate that some officials are worried the Fed is once again overestimating the health of the economy.

And even though the vote to hike rates was unanimous, there were some nervous and reticent voters. The Fed is expected to raise interest rates by about one percentage point over the next year, an expectation based on the predictions of Fed officials in their December economic forecasts, and confirmed today by Federal Reserve Vice Chairman Stanley Fischer. In an interview on CNBC, Fischer said that four rate hikes by the U.S. central bank this year is close to his expectations, but added that global uncertainty could still veer this path off course.

Fed officials generally expect the strength of the domestic economy, propelled by increased consumer spending, to outweigh the weakness of the global economy. We had confirmation of this line of reasoning today in the ISM non-manufacturing survey. The Institute for Supply Management’s non-manufacturing index, which covers almost 90 percent of the economy, came in at 55.3 last month. While the level is down from November’s 55.9 and the weakest since April 2014, readings greater than 50 signal growth. In other words, the domestic economy is still chugging along, but the rest of the world is weighing on things.

And the Fed minutes included economic forecasts that sound good. The medium-term projection for real GDP growth was revised up slightly, on balance, from the previous forecast, primarily because of the recently passed Bipartisan Budget. The forecast for inflation was revised down slightly in the near term in response to recent data for consumer prices and the further decline in the price of crude oil but they feel confident they will hit their 2% inflation target by next year.

Even after stripping out volatile food and energy components, prices rose just 1.3 percent in the 12 months through November, according to the Fed’s preferred measure for core inflation. The thinking is that oil prices will start to move higher later this year. Also, the longstanding pattern is that inflation rises as unemployment declines.

Most of the news on the labor market has been good. Private-sector employment gains ramped up last month. ADP reports employers added 257,000 jobs in December. This is the strongest gain since December 2014. The ADP report is used as an early indicator of the Labor Department’s employment report, which will be released Friday and covers government jobs in addition to those in the private sector. The past two years have shown some of the best job growth since the 1990s.

The good news on employment has not translated into higher wages and that means there has been no inflationary pressures from all the job gains. Under normal circumstances, the Fed’s forecast of higher inflation might pan out, but the global economy is weak and that is having a deflationary impact.

In a separate report today, the nation’s trade deficit dropped 5% in November to the smallest amount in a year, but not because the economy is much improved: U.S. exports fell slightly, hitting the lowest level since the start of 2012, and imports dropped even faster. The trade gap declined to a seasonally adjusted $42.4 billion from $44.6 billion in October. U.S. exports slipped 0.9% to $182 billion in November. Imports fell a sharper 1.7% to $224 billion. The lower deficit in November was largely the result of falling imports of electronic goods as well as lower prices for crude oil and other commodities.

Still, the Fed was willing to hike rates despite tangible evidence. The question is how long they will continue to raise rates absent some signs of inflation. Financial markets expect only two quarter-point increases this year, according to pricing in federal funds futures. Fed vice chair Stanley Fischer said today, “We make our own analysis and our analysis says that the market is under-estimating where we’re going to be.” Maybe. Or perhaps the Fed is over-estimating where the economy is going to be.

Brent crude slipped to a fresh 11-year low overnight, while WTI dropped below $34 per barrel. Oil prices came under pressure as the World Bank predicted China’s troubles will spill over to emerging markets, which will face the decline in commodity prices. In addition to the economic concerns and geopolitical issues, the market remains overwhelmed with a global glut of oil. Saudi Arabia, the largest producer in OPEC, has refused to cut production. And many US producers have kept oil wells flowing despite the crushing financial blow of low prices.

Taken together, it’s a formula for a prolonged period of low prices.  Today, the Energy Information Agency reported gasoline inventories last week surged the most since 1993. Gasoline stocks rose 10.6 million barrels in the week ending Jan. 1 compared with expectations for a 2.3 million-barrel gain. That sent futures to the lowest since 2009.

As fuel prices fall, three of the largest U.S. airlines said they will charge customers more. Delta Air Lines increased prices on flights by up to $4 one-way and Southwest Airlines followed suit. American Airlines also raised domestic fares to match its rivals. While U.S. airlines regularly adjust their fares, hiking prices for nearly all domestic flights is less common and an industry-wide match even less so, and then to do a rate hike with fuel prices dropping – well, thank you, thank you very  much.

U.S. regulators have grown so concerned that traders are using high-speed computers to manipulate markets that they’re planning a new tactic to clamp down on the practice. The Financial Industry Regulatory Authority said it plans to issue report cards this year that will grade firms on how much spoofing flows through their order books, and expects brokers to use the assessments to root out misconduct.

Shares of Apple slid 2.5% on Tuesday following a report that suggested the tech giant may significantly slash its iPhone 6S and 6S Plus output. Japanese news outlet Nikkei reported Apple is expected to reduce production on its flagship device by about 30% between January and March. Apple suppliers Cirrus Logic, Skyworks, Qorvo, Avago, and InvenSense also tumbled on the news.

Puerto Rico’s latest default means a $10.3 million hit for Ambac Financial, which insures some of the debt the island’s infrastructure authority PRIFA failed to disburse on Monday. The payment on its own is small for Ambac, but with more than $2 billion total par exposure to Puerto Rican debt, the company could be in trouble if defaults continue.

Chipotle Mexican Grill has been served with a grand jury subpoena as part of a criminal investigation related to a norovirus outbreak at a California restaurant. The disclosure came as the chain projected a double-digit decline in sales after several outbreaks linked to food-borne illnesses. The company will formally report its financial results on Feb. 2, but today Chipotle warned investors that it expected a drop of 14.6 percent in same-store sales for its fourth quarter. For the full month of December, same-store restaurant sales were down 30 percent.

The norovirus outbreak happened in Simi Valley, California in August followed by another outbreak near Boston College in December, and that is in addition to E. Coli outbreaks in several states. All told, more than 500 people were sickened after eating in a Chipotle restaurant in the last half of 2015. Bon appetit.

Twitter is building a feature that will allow for posts much longer than its standard 140 characters, and is currently considering a 10,000-character limit. An end-of-first quarter launch is targeted. Apparently the idea that brevity would engender a respect for eloquence just hasn’t panned out.

Turkey Shoots

Sinclair Noe — November 24, 2015

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DOW + 19 = 17,812
SPX + 2 = 2089
NAS + 0.33 = 5102
10 YR YLD – .01 = 2.24%
OIL + .89 = 42.64
GOLD + 6.70 = 1076.40
SILV + .05 = 14.30

The US economy expanded at a faster pace in the third quarter than previously reported. Gross domestic product rose at a 2.1% annualized rate, up from an initial estimate of 1.5%. Nearly all of the improvement was because of revised data on inventories, which showed businesses restocking shelves at a faster pace than the government first estimated.

Still, company stockpiles remained elevated compared with sales, indicating that new orders and production will cool further to clear shelves and warehouses heading into 2016. Inventories grew at a $90 billion annualized rate from July through September, almost twice as much as previously estimated, but down from the second quarter.

The improvement in inventory levels was offset by a slight downward revision in consumer spending last quarter. Cheap gasoline is giving households a little extra money, and consumers are spending, just not quite as fast; consumer spending was revised down to 3% from 3.2% in the initial estimate for the third quarter. Consumption during the current fourth quarter, including the holiday shopping season, is expected to increase at an annualized rate of about 3%.

For all of 2015, the rate of economic growth is expected to be about 2.5%, not much different from the 2.4% rate in 2014. Not great but good enough. The GDP report was the one of the last big economic reports before the Fed FOMC meeting December 16^th; the other big report will be the November jobs report, which will be published on Friday, December 4^th. In reality, not much has changed since June or even October, when the Fed did not raise rates.

Corporate profits after tax, without inventory valuation and capital consumption adjustments, fell at a 3.2% pace from the second quarter, the biggest drop since the fourth quarter of 2014. On a year-over-year basis, corporate profit growth was 1.4%, compared with 8.5% year over year growth in the second quarter. That measure of corporate profits tracks most closely with what companies report in earnings statements. Profit data aren’t inflation adjusted.

The Conference Board reports that its index for consumer confidence fell to 90.4 from 99.1 in October. Despite a strong advance in hiring last month, consumers expressed more caution about the job market and future economic conditions in the most recent survey. The fall is in the expectations, not the current conditions, component. The decline in job expectations is dramatic and raises the question whether global effects, which have been negative for the US, are beginning to weigh on the American consumer, which would not be a positive for the holiday spending outlook.

Existing home prices rose in September. The S&P/Case-Shiller 20-city composite index gained 0.2%. Prices rose 5.5% for the year, up from a 5.1% yearly gain in August. The index is still about 12% lower than its 2006 peak. Phoenix home prices were up 0.2% in September, and up 5.3% over the past 12 months.

At the peak, prices in Phoenix were 127% above the January 2000 level. Then prices in Phoenix fell slightly below the January 2000 level, and are now up 54% above January 2000 (54% nominal gain in almost 16 years).

These are nominal prices, and real prices (adjusted for inflation) are up about 40% since January 2000 – so the increase in Phoenix from January 2000 until now is about 14% above the change in overall prices due to inflation.

Turkey has shot down a Russian military jet near the Syrian border. Turkish officials said the jet was downed after it knowingly violated Turkish airspace. The two Russian pilots ejected before the plane crashed but they were shot in their parachutes as they floated to earth. And then Turkish tribesmen reportedly destroyed a Russian helicopter with a TOW antitank missile as it tried to rescue the airmen. The Russian Ministry of Defense confirmed that one fighter pilot had been killed by ground fire and that a marine deployed on the search-and-rescue helicopter died but that the rest of the crew had managed to escape.

Russia’s retaliation so far has been largely symbolic. Russia’s foreign minister canceled a Wednesday visit to Turkey, and a large Russian tour operator announced it was suspending sales to Turkey. The two countries are also significant trade partners, or at least they were. A reminder that Turkey is a member of NATO. Today, French president Francois Hollande was in Washington and conducted a joint press conference with President Obama. They vowed to intensify their nations’ military attacks on ISIS in Syria and Iraq. They also announced that next week’s climate change summit in Paris would be a “powerful rebuke” to terrorists.

In the immediate aftermath markets reacted nervously, with the lira selling off, Russian stocks sliding and global government bonds climbing as investors move to safe havens. Meanwhile, a car bomb exploded outside a hotel housing judges supervising parliamentary elections in Egypt’s North Sinai, killing at least three people and injuring 14. The region is the main area of operations for the Egyptian affiliate of ISIS.

Citing “increased terrorist threats” from militant groups in various regions of the world, the US State Department has issued a global travel alert ahead of a busy Thanksgiving week. The department did not advise people against travel but said US citizens should be vigilant, especially in crowded places. The announcement comes as Brussels remains on lockdown and follows the discovery of an explosive belt near Paris and the mobile phone of a fugitive believed to have taken part in the November 13 attacks.

Ford is the latest automaker to say it will not equip future cars with Takata air bag inflators that use ammonium nitrate, the chemical propellant that has been linked to eight deaths and more than 100 injuries worldwide. Ford’s auto recalls with Takata airbags have so far affected about 1.5 million vehicles, including certain older model-year Ford Mustangs, Ford GTs and North American-built Ford Rangers.

Costco has an E. Coli problem. Nineteen people have been infected with E. coli in California, Colorado, Missouri, Montana, Utah, Virginia, and Washington. They have tracked the source to Costco’s rotisserie chicken salad. You might want to stick with turkey for the next few days.

Skyworks Solutions has withdrawn its agreed takeover bid for PMC-Sierra after an increased offer of $2.3 billion from Microsemi gained the backing of the target’s board. Skyworks said it won’t modify its bid and that the company is entitled to an $88 million termination fee from PMC. Semiconductor makers have pursued mergers at a record pace this year.

China’s securities regulator has canceled a requirement that brokerages must hold a net positive purchase position on daily proprietary trading as the nation’s stock market stabilizes following a summer slump. With the Shanghai Composite now having gained more than 20% from its August low, regulators are withdrawing from a government campaign to prop up shares.

New York Attorney General Eric Schneiderman is clamping down on “spoofing,” issuing subpoenas to interdealer brokers BGC Partners, TFS-ICAP, GFI Group, and Tullett Prebon Financial Services. The investigation is focused on placing offers with the intent to cancel them before they trade in order to trick other investors by creating the illusion of demand. Earlier this month, high-frequency trader Michael Coscia became the first person to be found guilty of spoofing in a criminal case.

National Football League player Dwight Freeney can proceed with his lawsuit alleging that Bank of America was complicit in a fraud scheme that caused him to lose more than $20 million and forced his Rolling Stone restaurant to close. The Arizona Cardinals linebacker last Thursday defeated a bid by the parent company and its Merrill Lynch unit to dismiss, among others, fraud and negligent misrepresentation claims stemming from the bank’s recruitment of him in 2010 to manage his assets. US District Judge Margaret Morrow in Los Angeles didn’t rule on the merits of Mr. Freeney’s claims but agreed that he alleged enough facts to move forward with the case.

Just in time for the busiest shopping week of the year – iSight Partners, a privately held cyber intelligence firm is warning retailers about what they call “the most sophisticated point-of-sale malware seen to date.” The firm had shared information about the malware, dubbed ModPOS, with clients in October, and briefed dozens of companies about its dangers. Some retailers have found digital evidence that linked threat indicators they had previously seen to ModPOS, though that does not necessarily mean they were victims of breaches. Just a reminder that if you are concerned about cyber security while holiday shopping, cash still works.

CalPERS, the California Public Employees’ Retirement System said it paid $3.4 billion in performance fees to its private equity managers since 1990 while the controversial sector generated $24.2 billion in profits for retirees. CalPERS has been hard-pressed to keep up with looming obligations to its 1.7 million current and future retirees.

The CalPERS fund, the largest pension fund in the country now at about $295 billion, is considered about 74% funded, down from 77% as of June 30, 2014, mostly because of weak performance from its global stock portfolio. The global stock portfolio posted returns of 1% for the last fiscal year, ended June 30. Private equity, by contrast, returned 8.9% for the year but not without risk and hefty fees.

Jeff Bezos’s space exploration company Blue Origin achieved a key milestone: sending a rocket into space and then landing it safely back on Earth. Making reusable rockets is a central goal for a generation of companies that are trying to cut the cost of space travel and exploration. A Blue Origin vehicle called New Shepard flew to space on Monday, reaching an altitude of 100 kilometers, and then landed back at its launch site.