Financial Review

Knock On

Sinclair Noe — November 16, 2015

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DOW + 237 = 17,483
SPX + 30 = 2053
NAS + 56 = 4984
10 YR YLD – .01 = 2.27%
OIL + 1.32 = 42.06
GOLD – 1.80 = 1083.10
SILV – .03 = 14.35

World leaders wrapped up G-20 meetings in Turkey with a vow to boost intelligence-sharing, cut off terrorist funding and strengthen border security in Europe, as they sought to show resolve and unity following the deadly terror attacks in Paris. This year’s G-20 agenda also included efforts to hasten global economic growth, with a particular focus on addressing the effects of China’s economic slowdown. French warplanes launched an assault on ISIS targets in Raqqa, Syria. Meanwhile, the authorities in France announced that they had conducted sweeping police raids around the country overnight, detaining two dozen people.

ISIS released a video today saying they will strike Washington. The Department of Homeland Safety said it had no “specific credible information of an attack on the U.S. homeland.” CIA Director John Brennan said he would be surprised if the group doesn’t have additional attacks in preparation.

Markets across the globe are still processing the weekend’s coordinated terrorist attacks in Paris. Asian exchanges traded lower overnight. European shares reversed early losses and closed in positive territory. The euro dropped, as investors scrambled for safe-havens like the U.S. dollar.

French President Hollande declared that France is at war. Hollande urged lawmakers to approve a three-month extension of the nation’s state of emergency, new laws that would allow authorities to strip the citizenship from French-born terrorists, and provisions making it easier to deport suspected terrorists.

The attacks are also likely to hit France’s economy, which has the largest number of tourists in the world. The sector accounts for almost 7.5% of the country’s GDP. The specific wording by President Hollande is of note, because of course it opens up a can of worms about NATO, the EU, and various agreements for open borders in the EU. This means likely restrictions on import-export activity.

It is nearly impossible to calculate the side effects of the Paris attacks. A couple of quick thoughts include an increase in surveillance. UK Prime Minister David Cameron has already announced the Brits will hire 1,900 new spies to deal with ISIS. The CIA is surely going to place a few ads as well. This will drive the tech heads in San Jose even crazier.

Next, think about the role of Russia in Syria and then expand it out to the role of Russian oil and Saudi Arabian oil vying for global market share. The oil market has been bound up with geopolitics and the threat of conflict for a century, and today’s trading in the oil patch is far from the final word on the direction of those markets.

White House officials confirmed Putin and Obama met privately at the G-20 in Turkey and agreed to “a Syrian-led and Syrian-owned political transition.” These are delicate positions in the dangerous dance between Sunni and Shia playing out in the deserts of Syria and Iraq.

The major stock indices in the US started in negative territory, but then rallied. There were some interesting theories bandied about for the recovery. One story talked about the increase in oil stocks as investors looked for safe havens; although the story didn’t go so far as to suggest that increased military action in the Middle East threatens oil supply routes or even that cutting off ISIS black market oil trading removes a small chunk of supply.

Another story mentioned the travel and tourism industry had a bad day, but then explained that previous terror attacks have taught investors that it doesn’t make financial sense to panic. And then the idea that citizens steadfastly refuse to allow terrorists to dictate how we will live our lives because terrorism won’t succeed in the long run.

I missed a good discussion on whether traders felt the terror attacks might push the Fed to pass on a rate hike in December. Nor was there much discussion about the probability of the stock markets’ bullish affection to war. I don’t know why the markets moved higher. Maybe after a lousy week last week, the shorts closed out positions because it was just time for an up day.

The response in the US has been to fly French flags at football games. The NYSE and Nasdaq observed a minute of silence at 9:25 AM Eastern, before the opening bell. And already, nine states (at last count) have said they would shut their doors to Syrian refugees, in direct violation of the Pottery Barn Rule. The governors of Florida, Alabama, North Carolina, Texas, Arkansas, Louisiana, Indiana, Illinois, and Massachusetts all said they would not accept refugees fleeing the Syrian conflict; go ahead and connect the dots.

There has yet to be a single Syrian refugee resettled in Alabama to date, even though there is  a US State Department-approved refugee processing center in Mobile. And it is uncertain whether any governor would have the power to ban refugees from a given country, as resettlement is handled at the federal level. The State Department said this morning that the US still plans to try to admit 10,000 Syrian refugees into the country in the coming year; final destination to be determined.

Marriott International said that it had agreed to buy Starwood Hotels and Resorts Worldwide for $12.2 billion in cash and stock, creating the world’s largest hotel company. The timing of this acquisition was just exquisite. Under the terms of the deal, Marriott will pay $72.08 a share in cash and stock for Starwood, whose brands include Westin, the W, Sheraton and St. Regis. Starwood shareholders would own 37 percent of the combined company. Combined, the companies operate more than 5,500 hotels with 1.1 million rooms worldwide in 30 countries, with 300,000 employees.

For the first time in at least a decade, imports fell in both September and October at the three busiest seaports in the US. The three – Los Angeles, Long Beach, and New York harbor – handle more than half of the goods coming into the country, and saw imports fall just over 10% between August and October; typically known as peak shipping season. The slowdown in imports is likely an adjustment from a sizable inventory build-up earlier this year.

S&P 500 earnings are on track to close their first season of negative growth since 2009, with more than 90% of components having already reported results, S&P 500 earnings are down 0.9 percent in the third quarter. Estimates call for sub-zero growth in the current quarter as well setting up for a bona fide ‘earnings recession’ (two consecutive periods of declines). According to FactSet, this already occurred in the second and third quarters. All this comes as the Fed prepares to hike rates for the first time in almost a decade – a move that could weaken corporate earnings even further.

Japan has unofficially entered recession. Japan just booked two consecutive quarters of negative gross domestic product. GDP contracted at an annualized pace of 0.8% in the third after a 0.7% pace of contraction in second quarter. The Nikkei 225-share index dropped 1 percent.

The average price of crude sold by OPEC fell below $40 a barrel for the first time 2009. The daily OPEC Basket Price fell to $39.21 a barrel on Nov. 13. The basket, an average of export grades from each of the group’s 12 members, typically trades below international oil futures as some OPEC nations pump denser or higher-sulfur crude that’s less profitable to refine. OPEC’s annual revenues may be curbed to $550 billion at current prices from an average of more than $1 trillion in the last five years.

 The number of oil wells in North Dakota that have been drilled but not fracked has topped 1,000 for the first time in September, as producers wait for prices to recover before turning them on. As a result, more than 8% of oil wells in North Dakota are now sitting idle, harming the industry’s ability to grow production; daily output in the state fell 2% in September to about 1.16 million barrels a day.

The nation’s second largest for-profit college, Education Management Corporation, will forgive nearly $103 million worth of student loan debt to settle claims that it violated consumer protection laws; specifically, misleading students about the benefits of a degree from its schools, and misrepresenting job placement numbers.

In a separate action, the company agreed to pay an additional $95 million to settle four whistleblower lawsuits that claimed it misled the government about its recruiting strategy. EDMC operates a network of 110 under the names: Art Institute, Argosy University, Brown Mackie College, and South University. EDMC did not admit to any wrongdoing.

Constellation Brands, the maker of Robert Mondavi wines and Svedka vodka, agreed to acquire Ballast Point Brewing & Spirits for $1 billion to add to its beer portfolio. The deal is expected to be completed this year and will be financed with cash and debt.

Ericsson said it has not engaged in any merger talks with Cisco Systems, despite rumors Cisco was actively pursuing the Swedish maker of networking equipment.

Blackstone  has reportedly agreed to sell its facility management group GCA Services unit for about $1 billion to Goldman Sachs  and Thomas H. Lee Partners.

Canadian Pacific CEO Hunter Harrison met with Norfolk Southern CEO James Squires, proposing a possible merger, which was coolly received by the Norfolk boss.

The Supreme Court refused to be drawn into the debate over Planned Parenthood, rejecting an appeal by abortion opponents who said they had a right to see some of the group’s internal documents, including its medical-standards manual. The appeal by New Hampshire Right to Life sought the disclosure of information related to a 2011 federal grant made to the Planned Parenthood chapter in northern New England.

Surveillance Will Continue Until the Paranoia Stops

Financial Review with Sinclair Noe

DOW – 75 = 16,368
SPX – 10 = 1909
NAS – 20 = 4334
10 YR YLD - .05 = 2.42%
OIL + .71 = 97.63
GOLD + 7.10 = 1314.00
SILV - .06 = 20.05

Normally, at least for the past 5 years, any dip has been seen as a buying opportunity. Lately, investors see a dip as reason to sell and ask questions later.

The Bank of England holds UK interest rates at a record low of 0.5% for another month. And the European Central Bank holds interest rates at 0.15% and announced they would keep rates low for an extended period of time. ECB President Mario Draghi warned there would be a "continued moderate and uneven recovery" in the eurozone. The annual inflation rate in the 18 countries of the eurozone was 0.4 percent in July, down from 0.5 percent in June; not quite deflation, but not headed in the right direction. Italy just announced its second consecutive quarter of negative GDP; which is the basic definition of a recession. Meanwhile, the website of the ECB has been hacked, and the hacker reportedly contacted the ECB and demanded a ransom for the stolen data.

The New York Times reported yesterday that a Russian crime ring had hacked more than a billion internet passwords, maybe more than 4 billion. It’s being called the biggest hack in history; which may or may not be accurate. Russian hackers are just a small part of the hacking world, about 2%. The major global hackers are Indonesia, China, the US, Taiwan, Turkey, and India. And while Russia may not constitute the same volume as other hackers, they make up for it in audacity; for example, the breach of the Target retail stores. And the recent tensions and sanctions between Russia and the US probably mean there will be no coordinated effort to crack down on international hacking. Of course, it might be argued that for true audacity, nobody can touch the NSA.

How dangerous is this hack? Hard to say. We still don’t know which websites were breached. We still don’t know how the hacked data will be misused. And we are being advised that the best thing to do is to change your password on various sites you use; which isn’t that difficult. There are, of course, companies that you can pay to provide cyber protection; coincidentally, these same companies are the ones that alert us to cyber problems; and I have a nagging suspicion some of them might actually create the problems in the first place. What this really does is to raise awareness that data hackers can collect almost anything, and digital security has been a weak spot in technological progress.

Perhaps braced by Moore’s Law, technology marches on; the journal Science reports that IBM researchers have developed a new computer chip they call TrueNorth.  The new chip was “designed to approximate the structure and function of the brain in silicon”, plus it is power efficient. The chip contains 5.4 billion transistors, yet draws just 70 milliwatts of power. By contrast, modern Intel processors in today’s personal computers and data centers may have 1.4 billion transistors and consume far more power, about 35 to 140 watts. The new chip weaves together all those transistors into an on-chip network of 4,096 neurosynaptic cores, producing the equivalent of 256 synapses. IBM has also tethered 16 of  these chips together in four four-by-four arrays, which collectively offer the equivalent of 16 million neurons and 4 billion synapses, showing that the design can be easily scaled up for larger implementations.

Think of the synapses as memory, and the neurons are the processor; working together they provide fairly complex pattern recognition, and what might be described as sensing capabilities. Right now, the chip is not real fast, but it can be strung together, and on a per watt basis, it really starts to fly. The low power consumption opens up a world of possible uses. This might be the chip that powers the internet of things, embedded in all sorts of devices and possibly revolutionizing mobile devices.

The big question is whether the chips can learn? Not yet, however IBM has already tested the chip’s ability to drive common artificial intelligence tasks, including recognizing images; TrueNorth was able to recognize things like people, cyclists, cars, buses, and trucks with about 80% accuracy. Keep in mind that this is a new chip, still in its early stages of development.  IBM is still investigating how to commercialize this processor and has made no commitments to either manufacture the chip itself or license the design out to others.

The problem with the idea of having even more devices than your smartphone and tablet gathering information for your convenience, of course, is the many ways all that data can be used against you. Traditionally, we think of the government as the invader of privacy, but as capabilities change, we see private corporations getting into the act. Last year the Wall Street Journal reported on new facial recognition technology; police could use an iPhone to take a photo, and then cross check the face in a criminal database; sounds good in the battle against terrorism, but the company that makes the technology wasn’t just considering sales to law enforcement, but also to the health care and financial industries. Yea, I don’t know exactly what those applications might be but I don’t think I like it.

Are health care companies going to start sensing every drop of sweat, every minute we work out, every time we puff a cigarette or sip a cocktail? Maybe we won’t even have to bother going to the doctor anymore. And what about the health insurance companies? Financial engineers believe they can pretty much put a price on anything. So what is your freedom worth? You need air, water, food, and relationships to survive. You want to go shopping, to the movies, to see friends. You have kids, romantic attachments, familial obligations. You like being able to travel, to explore, to watch TV. You need medical care. What are each of these worth? It’s a question that analysts are thinking about.

Or how about the school districts in Houston that require students to wear electronic tagging badges to improve security and increase attendance rates; the same electronic tagging badges formerly used to keep track of cattle.

The “Internet of Things” is probably the next Big Thing. How big? ABI Research estimates that over 30 billion devices will be connected to the Internet of Things by 2020; Gartner puts the number at 26 billion – not including 7.3 billion PCs, tablets, and smartphones. That’s a lot of internet-connected things, considering that there are “only” a little over 7 billion people on this planet, and many of those people are not connected to the internet, much less to electricity. And as technology increases and prices drop, in accordance with Moore’s Law, it opens up the possibility of connecting almost everything from the simple to the complex, and not only connecting, but sensing, monitoring, and controlling almost every facet of your work, home, and private life.

And then that brings us back to the hackers. How secure would all those embedded devices be in a world full of such things. You don’t need to break a code, it would be easier than ever to hack into everything you do, or think about doing. Don’t worry, I’m sure it will all work out fine, but the surveillance will continue until you stop being paranoid.

Some things never change. Bank of America is the latest big bank to work a deal with the Department of Justice. We’re still waiting for an official announcement but it looks like BofA has agreed to a $16 billion settlement for its role in the sale of toxic mortgage securities. The deal is reportedly for about $9 billion in cash and more than $7 billion in soft-dollar relief to consumers; things like loan mods or refi’s which they are supposed to be doing anyway; and this could still be a sticking point in the deal. The two sides continue to hammer out details and are still negotiating a statement of facts. For example, will BofA be forced to admit wrongdoing, and if so, will they actually describe what they did and who did it when they broke the law. Will they be able to deduct the fine from their taxes, thus sloughing off the burden onto taxpayers?

If or when the record deal goes through, Bank of America will have paid more than $50 billion in penalties and consumer relief in deals with government agencies, not including private investors, after acquiring subprime giant Countrywide and investment firm Merrill Lynch at the height of the crisis. And that raises the biggest question of all: how is it possible to cheat so many people out of so many billions without anybody actually breaking a law?

There is an interesting side case that is important to understand the BofA settlement. The bank had been low-balling the DOJ, offering to settle for maybe $3 billion, until last week, when Judge Jed Rakoff a federal judge in Manhattan ordered the bank to pay nearly $1.3 billion for selling 17,600 loans, many of which were defective. Bank of America had previously lost that case, which involved its Countrywide Financial unit, at a jury trial. Turns out, that going to trial was a very, very bad idea for BofA, and when Rakoff issued his ruling, the bank had no negotiating leverage in this case. The Department of Justice started preparing a suit to take to trial, and Bank of America returned to the negotiating table. The case before Judge Rakoff dealt with a Countrywide loan program known as the Hustle, which represented only a small fraction of the firm’s mortgage portfolio, meaning that penalties in cases dealing with larger programs could skyrocket.