Financial Review

No F8 but What You Make

Sinclair Noe — April 12, 2016

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DOW + 149 = 17,705
SPX + 19 = 2061
NAS + 38 = 4872
10 Y + .04 = 1.78%
OIL + 1.28 = 41.64
GOLD – 2.40 = 1256.70

Earnings season is underway. Later this week big US banks will start releasing results, including JPMorgan Chase, Citigroup and Wells Fargo; the big banks are looking like one of the weakest sectors this earnings season. Expectations for earnings are low this quarter. Analysts surveyed by FactSet expect corporate profits to be down 9.1 percent from a year ago, hurt primarily by the steep drop in oil prices and other commodities. The entire energy sector is expected to report a loss this quarter.

This Sunday, oil producers meet in Doha, Qatar to consider some sort of production cuts. Iran has repeatedly showed zero interest in a production freeze at the current level, saying it would keep pumping until production reaches the pre-sanction level of around 4 million barrels a day. Today, Russia and Saudi Arabia announced a production freeze regardless of whether Iran participates in the plan to tackle a supply glut.

It may be the world’s biggest traffic jam. As seaports struggle to cope with a global oil glut, huge queues of supertankers have formed in some of the world’s busiest sea lanes, where some 200 million barrels of crude lies waiting to be loaded or delivered. The vessels, filled with oil worth around $7.5 billion at current market prices, would stretch for almost 25 miles if formed up in one straight line. Meanwhile, the latest American Petroleum Institute (API) inventory data recorded a build of 6.2 million barrels for the latest weekly data, compared with an expected build of around 1 million.

Wells Fargo chose the wrong time to expand its oil-lending. The bank targeted some of the least creditworthy borrowers in the shale industry, demanding oil and gas reserves as collateral, a type of financing thought to be low risk. With oil now hovering close to $40 a barrel, the value of those reserves held as collateral has plummeted.

This pressure was clearly illustrated yesterday when Chesapeake Energy pledged almost all of its oil and gas reserves, real estate and derivatives contracts to keep its $4 billion credit line. U.S. shale production, meanwhile, is seen reaching a two-year low.

Standard & Poor’s reported that it downgraded 44 US junk-rated companies in March, while upgrading just 15. This comes on top of the 82 issuers it downgraded in February. In the first quarter, about 45% of S&P’s downgrades hit oil & gas companies. Not a surprise, given the state the industry is in; the bigger surprise is that 55% of the downgrades hit companies outside oil & gas.

The International Monetary Fund lowered its estimate for global growth, citing volatility in financial markets, slowing momentum in developed economies and continued difficulty for emerging-market nations, as it also highlighted a growing backlash against trade and global ties. The IMF cut its estimate for global growth to 3.2% this year and 3.5% next year. That represents a downgrade of 0.2% for 2016 and another tenth for 2017 from what it forecast in January. The IMF’s estimate for the U.S. was cut to 2.4% in 2016, a downgrade of 0.2%, and to 2.5% in 2017, representing another tenth of point off its January forecast.

Several Fed policymakers are speaking today. Philly Fed President Patrick Harker, who has urged his colleagues to “get on with” raising rates again, said this morning that he wants to hold off on a second rate hike until inflation picks up. Harker said that given the behavior of oil prices, inflation is likely to be “quite low…. probably even negative” in the first quarter.

Dallas Federal Reserve President Rob Kaplan said he’s not too concerned about the slowing economic growth in the first quarter, and the US economy is likely to grow at just under 2 percent for the year. Kaplan says “we still believe the underpinnings for solid growth are there…We still think the consumer is going to remain strong this year. The job market is strong.” Kaplan sees an interest rate hike in the not-too-distant future, provided gross domestic product numbers recover as he believes they will. “I think people should expect it’s going to be a slow, patient, gradual normalization.”

Also today, San Francisco Fed President John Williams will discuss U.S. monetary policy and the global economic outlook, while the Richmond Fed’s Jeffrey Lacker speaks on “Economic Leadership in an Uncertain World”.

The National Federation of Independent Business (NFIB) said its small business optimism index dipped 0.3 point to a reading of 92.6 last month, the lowest since February 2014. It has declined from a reading of 100 in December 2014 and has pushed further off its 42-year average of 98. The soft reading fits in with recent economic data on consumer and business spending as well as wholesale inventory investment that have suggested economic growth slowed sharply from the fourth quarter’s 1.4 percent annualized rate.

The US government posted a $108 billion budget deficit in March, more than double the amount from the same period last year. The government had a deficit of $53 billion in March of 2015. The current fiscal year-to-date deficit was $461 billion, up 5 percent from a $439 billion deficit this time last year. Receipts last month totaled $228 billion, while outlays stood at $336 billion.

U.S. import prices rose in March for the first time in nine months as the cost of petroleum products increased, but the lingering effects of a strong dollar suggested inflation will continue to increase gradually. The Labor Department said import prices gained 0.2 percent last month after a downwardly revised 0.4 percent drop in February. It was the first time since June that import prices rose and the largest increase since May. Prices of imported products were down 6.2 percent in the 12 months through March. Weak import prices have contributed to holding inflation below the Federal Reserve’s 2 percent target.

A committee in Brazil’s lower house of Congress has voted to recommend President Rousseff’s impeachment for allegedly manipulating public finances, a step that increases the chances of her removal from office. A vote in the full lower house is expected to take place on Sunday. If the proceedings continue to Brazil’s Senate, the chamber could decide by a simple majority to put Rousseff on trial, suspending her position for up to six months, and VP Michel Temer would become acting president.

Alibaba is making its biggest overseas bet yet. The Chinese online retailer announced it was buying a controlling stake in the Singapore-based Lazada Group for about $1 billion. The acquisition will allow Alibaba to take advantage of growth opportunities in Southeast Asia.

About 40,000 Verizon workers say they’ll go on strike tomorrow unless the company negotiates a new contract with the Communications Workers of America and the International Brotherhood of Electrical Workers. At issue are pension benefits, outsourcing, and health care costs.

No. 3 U.S. railroad CSX Corp reported a lower quarterly net profit, in line with analysts’ expectations, citing declines in most freight segments, especially coal. First-quarter net income came in at $356 million, or 37 cents per share, down more than 19 percent from $442 million, or 45 cents per share, a year earlier.

Facebook Messenger wants you to chat with businesses and get updates from them, too. That’s the future Facebook pitched at F8, its annual conference for software developers in San Francisco. Facebook handed the more than 50 million businesses on Messenger the tools needed to build interactive experiences, or “chat bots,” that reach the 900 million people who use the messaging app each month.

Chat bots are chat robots, interactive software powered by artificial intelligence often with an assist from humans, which are designed to simulate human conversation. They are popping up on messaging services where you can use them to perform simple tasks. Chat bots are already popular in Asia, where messaging services such as WeChat help users schedule doctor’s appointments, shop for the latest styles, play games or the lottery and send money to friends.

One example of how business is using chat bots already – KLM Airlines recently began allowing passengers to check in, get flight updates, make travel changes and talk to customer service reps in its Messenger app. For some reason I’m just guessing that might not be as good as talking to an actual person, at least not yet.

Among other F8 stuff, Facebook is launching live video streaming working across all devices and services. Mark Zuckerberg gave a demonstration by streaming video from a drone flying in the conference hall. A more compelling use might be high quality live broadcasts – think TV, news, sports, and such. Or you could just start your own TV show. Already some TV stars are getting bigger audiences on the Live Platform than they’re getting on their TV shows.

Facebook also revealed a 360-degree video camera and software system today at its F8 developer conference, which is the kind of video you want for 3D or virtual reality. The camera, which will cost at least $25,000 to build, includes 17 different capture devices that are synchronized, and can record two hours of 360-degree video at up to 60 frames per second. Facebook is also releasing software that stitches the footage together seamlessly. But Facebook doesn’t really want to get into the camera business, so both the hardware and software, as well as the stitching code, are open source projects.

According to research firm Gartner, global shipments of personal computers fell 9.6% to 64.8 million units during the first quarter, marking the first time since 2007 that shipments dropped below 65 million units (IDC reported similar results worldwide). In the U.S., PC shipments totaled 13 million devices, representing a 6.6% decline from a year earlier and the lowest volume in three years. The sector has faced headwinds in recent quarters which include an economic slowdown in China, the strong U.S. dollar and the growing popularity of smartphones.

Financial Review

Defeat Devices

Sinclair Noe — September 29, 2015

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

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DOW + 47 = 16,049
SPX + 2 = 1884
NAS – 26 = 4517
10 YR YLD – .04 = 2.09%
OIL + .80 = 45.23
GOLD – 4.40 = 1128.70
SILV + .04 = 14.74

Single-family home prices rose in July, matching the pace of price gains in June but falling just short of expectations. The S&P/Case Shiller composite index of 20 metropolitan areas in July gained 5 percent year over year. San Francisco, Denver and Dallas experienced the highest year-over-year home appreciation among the 20 cities with price increases of 10.4 percent, 10.3 percent and 8.7 percent, respectively.

The worst performing cities on the list include Detroit, and the only surprise is that Chicago was even worse than Detroit. The Sunbelt cities – Miami, Tampa, Phoenix and Las Vegas – which were the poster children of the housing boom have yet to make new all-time highs. Phoenix home prices were up 0.7% in July, and up 4.6% year over year.

The Conference Board said its index of consumer attitudes rose to 103.0, the highest since January, from a downwardly revised 101.3 the month before. The present situation index, a measure of current conditions, also climbed to an eight-year high of 121.1 from 115.8. Yet the expectations index declined to 91.0 from 91.6, suggesting Americans are a bit more cautious about the next six months.

After 2 weeks of solid drawdowns, API reports a huge 4.6 million barrel crude oil inventory build last week – the 2nd biggest weekly build in over 5 months.

The Senate yesterday passed a procedural vote to extend federal agency funding levels until December 11 as Congress moved to avoid a government shutdown on Thursday, when the new fiscal year starts. The Senate overwhelmingly advanced the government funding bill; it still has to go to the House for a vote.

The International Monetary Fund is warning of large positions that mutual funds in the United States have built in high-yielding bonds issued by risky companies here and in emerging markets around the world. The warning comes at a time of increased nervousness about China and other emerging markets like Brazil. And it highlights a growing concern on the part of regulators and economists that mutual funds, in their hunger to load up on high-risk, high-yield securities in a low interest rate environment, will be hard pressed to sell them during a market reversal.

Carl Icahn says the Fed is blowing it. Activist investor Carl Icahn released a new video titled “Danger Ahead,” which warns that trouble is coming to the financial markets. Icahn believes the Fed got the US economy into this mess and that its zero-interest-rate policy has created an “earnings mirage.” In the film, Icahn criticized both political parties for not reaching a tax compromise that would encourage American widget makers to bring more than $2 trillion in foreign profits back to the U.S. He criticized Wall Street sales folk for having a code of ethics he jokingly characterized as less virtuous than the mafia.

He criticized earnings reports wholesale as “suspect” due to financial engineering via share buybacks and M&A. Icahn says companies are simply buying other companies to create the perception of growing earnings and that a lot of companies are buying back stock that shouldn’t be. Icahn says: “A buyback is a short-term fix, but it weakens the balance sheet.” So, activist investor Carl Icahn is now opposed to financial engineering? The only surprise here is that…, actually there is no surprise.

Goldman Sachs lowered its S&P target. Goldman Sachs US equity strategist David Kostin lowered his S&P 500 price target to 2,000, down from his previous target of 2,100. Kostin wrote, “The impetus for these reductions is that our models now incorporate a slower pace of economic activity in the US and China and a lower oil price than we had been previously assuming.” For 2016, Kostin sees S&P 500 earnings per share of $120 and a year-end target of 2,100. At best they are late to the analysis, at worst it’s a contrarian indicator.

The new iPhones had a strong debut, with estimates that Apple sold a record 13 million over the weekend. Apple charges $749 for an iPhone 6S with 64GB of storage. But how much does it actually cost Apple to build the phone? Teardown.com ripped apart a new iPhone to figure out exactly what’s inside, and found that the total cost of components is $245. The most expensive bits are the processors, followed by the touch screen. This does not mean Apple is making $499 in profit on each phone, though, as it doesn’t include costs like manufacturing and shipping.

Yahoo’s board has authorized the company’s plan to spin off of its 384 million-share stake in Alibaba even though the IRS has declined to rule on whether the move will be tax free. Yahoo cautioned that the spinoff is still “subject to certain other conditions, including final approval by Yahoo’s Board of Directors (and) receipt of a legal opinion with respect to the tax-free treatment of the transaction.” The stake is worth $22.75 billion.

Sprint has confirmed  that it won’t take part in the FCC’s broadcast incentive auction for wireless spectrum next March. The auction, for prized low-band airwaves that will help with indoor penetration and in rural areas, won’t be cheap, so skipping it should make a major difference to cash burn, a vital issue for Sprint.

Reynolds American has agreed to sell the international rights to its Natural American Spirit division to Japan Tobacco for about $5 billion. The deal doesn’t include the brand’s U.S. operations, Winston-Salem.

After nearly two years’ worth of delays, Tesla kicks off Model X deliveries today. Prices top out at $132,000. Initial demand looks strong. Tesla has booked roughly 30,000 reservations for the vehicle. The launch isn’t the only big project for Tesla, which aims to open a $5 billion battery factory in Nevada next year.

By now, you’ve heard about the Volkswagen diesel scandal. The company installed software that would cheat emissions tests, and then when the cars went back out on the road, in regular driving situations, the cars would emit 40 times the legal limit for nitrogen oxide, or NOx. The CEO of Volkswagen, Martin Winterkorn was fired. To make matters worse, it appears that Volkswagen was warned about the illegality of the software as far back as 2007 by Robert Bosch. Bosch is the engineering and electronics firm which supplied VW with certain components that are at the center of the scandal, but it did so for testing purposes only.

According to Automotive News Bosch told VW that using the technology in a production vehicle was unlawful. VW’s supervisory board, said the board had received an internal report at its meeting on Friday showing VW technicians had warned about illegal emissions practices in 2011. No explanation was given as to why the matter was not addressed then.

Now, you may wonder how serious this whole mess really is; sure it’s a hit to VW’s reputation; there will likely be recalls of millions of cars; there will be class action lawsuits, and more. But then you recall General Motors had a problem with faulty ignition switches that resulted in 124 deaths and even more injuries. GM was charged criminally with hiding the defect from regulators and in the process defrauding consumers, but the case was put on hold as part of a deal where GM pays a $900 million fine and signed a deferred prosecution agreement – basically saying they won’t do it again.

Volkswagen pollution is harder to link to individual deaths, but it is still a deadly bit of deception. The New York Times reports that the chemicals that spewed illegally from the Volkswagen diesel cars — known as nitrogen oxides or NOx — have been linked to a host of respiratory and cardiovascular illnesses, as well as premature deaths.

Of course all that death an illness can’t be linked back to VW directly, but scientists now calculate that the excess pollution from VW, about 46,000 tons since late 2008, likely resulted in 106 deaths, plus an as-yet uncalculated number of illnesses. Of course, that’s just for the illegal emissions. Most of the air pollution from cars is perfectly legal.

In fact, the average gap between real-world emissions and official test results has been growing. A new report by the International Council on Clean Transportation, the research group that first flagged suspicious emissions patterns at Volkswagen, found that under normal conditions the average carbon-dioxide emissions for passenger cars are some 40% higher than the official amounts certified by European lab tests.

In 2001, the gap was less than 10%. Daimler showed a gap of nearly 50% between what researchers measured on the road and what technicians recorded in official lab tests. The artificial, and predictable, conditions under which cars are tested makes it easy for carmakers to engineer favorable emissions-test results without breaking any rules. Tuning engines to perform most efficiently at the power and load levels commonly used in tests is one way to do it.

And it’s not that VW was the only car company trying to skirt emissions standards. For years, emissions from cars built by almost every major manufacturer have been higher out on the road than when tested in labs. Over the years, several major auto manufacturers — including GM, Ford, Honda and, yes, Volkswagen — have been forced to pay hefty fines and recall vehicles after getting caught using defeat devices. In what was then the largest environmental enforcement case in U.S. history, companies including industry leaders Caterpillar, Cummins Engine, Mack Trucks and Volvo Truck agreed to pay $83 million in fines and reprogram the computers.

Financial Review

Shoddy Excuse for a Market

Sinclair Noe — August 25, 2015

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

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DOW – 204 = 15,666
SPX – 25 = 1867
NAS – 19 = 4506
10 YR YLD + .14 = 2.13%
OIL + 1.07 = 39.31
GOLD – 14.50 = 1141.40
SILV .10 = 14.80

Leading Asian markets fell again with the Shanghai Composite Index closing with a 7.6% loss and the Nikkei down 4.0%, while other key Asian markets closed with milder losses and Hong Kong ended up in positive territory. European markets were broadly higher, led by the first rise in the FTSE 100 in 11 sessions; the FTSE closed up over 3%; the Euro Stoxx 50 closed up 4.7 percent.

China’s stock market has dropped 22% in the past 4 sessions. Today, their central bank responded by cutting interest rates for one-year lending by 25 basis points to 4.6%, while the one-year deposit rate will fall a quarter of a percentage point to 1.75 percent. The required reserve ratio will be lowered by 50 basis points for all banks to cover funding gaps. China’s surprise yuan devaluation on Aug. 11 led to a tightening in liquidity as the PBOC subsequently bought its currency to stabilize the exchange rate and curb capital outflows.

Roughly $4.5 trillion has evaporated from the Chinese markets since the middle of June – real, tangible wealth that no longer exists. Equities on mainland Chinese exchanges still trade at a median reported earnings multiple of 60+ times. The yuan may face more downside pressure as a result of the latest monetary easing, making it harder to keep depreciation in check. The US dollar rallied for the first time in 5 days.

Against that backdrop this morning, stocks on Wall Street rallied. The Dow Industrial Average gained over 441 points this morning; and for a fleeting moment it looked like the carnage of the past week was but a blip on the screen. It turned out to be a classic dead cat bounce. The Dow lost 646 points from the intraday high to the close; the biggest reversal to the downside since October 29, 2008.

The Standard & Poor’s 500-stock index closed down 1.4 percent, to 1,867, after earlier rising almost 3 percent from Monday’s close. The S&P 500 closed down 12.5 percent from its May high; the Dow ended down 14.6 percent from its May high. Not as bad as yesterday, but still plenty ugly. And the final hour of trading was just nasty, panicky stuff, about a 500 point loss on the Dow in one hour.

So it begs the question: what spooked the markets in the final hour? There are many catalysts in play in the market’s turn, from fears about China to corporate earnings and commodity prices, toss in concerns about emerging market credit. But at the core, much of this plunge is about a loss of faith in cheap money stimulus. In China, the concern is that the people’s Bank of China isn’t responding with enough force, or that they have responded with too much force and it is backfiring; take your pick.

In the US, the concern is that the recovery should be stronger by now, and there is the threat of the Fed hiking interest rates at the mid-September FOMC meeting. It all highlights just how addicted the markets are to cheap money stimulus from central banks, and how that addiction has distorted valuations.

So, for the moment we don’t know what spooked the markets in the final hour of trade. Maybe it was just an algorithm that triggered. Maybe we put too much faith in a shoddy Chinese market that wasn’t built to last and now looks like nothing more than a shiny knock-off of western markets. Maybe too many people grew weary of the pep talks from financial advisers repeating the mantra, don’t worry, you’re in it for the long haul; it just dredges up old ghosts.

If the Financial Crisis of 2008-2009 taught us anything, it was a lesson in the fragility of the financial and capital markets and the stages of denial as market developments unfold. And just because stocks drop in price it doesn’t mean they are cheap or on sale or great values. Maybe there were some big hedge funds that started forced liquidations when things turned south. Maybe traders remembered that the Fed could still hike rates next month, even in the maw of a market correction. I’m still not sure why the Fed seems inclined to a rate hike but they seem to like the idea.

The economic news was decent enough: New U.S. single-family home sales rose a bit less than expected in July. Sales increased 5.4 percent to a seasonally adjusted annual rate of 507,000 units. The stock of new houses for sale increased 1.9 percent to 218,000 last month, the highest level since March 2010. Still, supply remains less than half of what it was at the height of the housing boom. The median price of a new home rose 2 percent from a year ago to $285,900.

Home prices continued to rise in June. The S&P Case-Shiller 20-city composite index rose 5 percent year-over-year in June. Home prices in Phoenix posted a 4.1% gain year-over-year.

Consumer confidence rebounded in August. The Conference Board said its index of consumer attitudes jumped to 101.5, up from a reading of 91.0 in July. In the report, Lynn Franco at the Conference Board said, “Consumers’ assessment of current conditions was considerably more upbeat, primarily due to a more favorable appraisal of the labor market … The uncertainty expressed last month about the short-term outlook has dissipated and consumers are once again feeling optimistic about the near future. Income expectations, however, were little improved.”

Financial firm Markit said its preliminary or “flash” reading of its Purchasing Managers Index for the services sector slipped to 55.2 in August from the final 55.7 reading in July. The U.S. services sector expanded at a slower pace in August than July as new business growth softened.

The Congressional Budget Office says the US budget deficit is likely to fall by $60 billion in 2015 due to strong revenue gains. The CBO said it now estimates a $426 billion deficit for fiscal year 2015, down from its $486 billion forecast made in March. It also forecast a fiscal 2016 deficit of $414 billion, a reduction of $41 billion. The CBO says the government may be able to pay its bills without a debt limit hike through early December.

Oil prices managed a mild rally but couldn’t close above $40 a barrel.  API reported a huge 7.3 million barrel drawdown in oil inventories this week (against expectations of a build) and sparked a headline-driven jerk higher in crude prices.

Oil prices dropping below $40 dollar-a-barrel sounds like a beautiful thing. It means cheap gas for your SUV and lower energy bills. At $2.60 a gallon, gas is now about a dollar below where it was last year at this time. And it could continue to fall. Eleven states now have gas prices under $2. When President Obama predicted in his State of the Union Address in January that “the typical family this year should save $750 at the pump,” he was probably right. Multiply that by the nation’s 115 million households and you get a total savings of over $86 billion. That’s huge.

Lower gas prices help poor people in particular; households with incomes of less than $50,000 spent 21% of their income on energy in 2012, while households earning more than $50,000 spent 9%. Additionally, Americans who live in chillier regions like New England and the Midwest could save another $750 or so on energy bills. The bad news is largely restricted to the Dakotas, Texas, Oklahoma, and Alaska. And when oil prices are low, we tend to use more gas; we loosen up on conservation, demand increases and that, of course, leads to higher prices; not all at once, but slowly, over time.

Boeing expects to cut several hundred jobs in its satellite unit through the end of this year. The company said some of those people could find work in other parts of Boeing. The cuts come as commercial orders have been delayed due to lack of funding following the closure of the Export-Import Bank. Boeing also raised its outlook for aircraft demand in China despite the recent turmoil in the nation. Boeing sees China buying 6,330 aircraft in the next 20 years, a 5% jump from last year’s forecast.

Hacked companies, get ready — a federal court just made it easier for the government to sue you. “Monday’s decision from the Third Circuit Court of Appeals clarifies the Federal Trade Commission’s powers, giving it more ammunition against businesses that fail to invest in their own security.” The court’s decision finds that the FTC acted appropriately when it sued Wyndham Worldwide Corporation, a massive international hotel chain and hospitality conglomerate, after Wyndham was hacked three times in two years, exposing the credit card data of more than 600,000 customers.”

Infidelity website Ashley Madison and its parent company, Avid Life Media, have been sued in federal court in California by a man who claims that the companies failed to adequately protect clients’ personal and financial information from theft, saying he suffered emotional distress. The lawsuit seeks class-action status.

Financial Review

Generally Quite High

Sinclair Noe — May 6, 2015

 

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

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DOW – 86 = 17,841
SPX – 9 = 2080
NAS – 19 = 4919
10 YR YLD + .07 = 2.24%
OIL + .30 = 60.70
GOLD – 1.80 = 1192.20
SILV – .02 = 16.59

A worldwide sell-off in government bonds deepened today. Benchmark 10-year Bunds now trade at 0.53%, having hit a record low of 0.05% last month, when many expected them to turn negative. For German bund investors that represents a 12% loss over the past 2 weeks, or roughly 25 years of yield just went down the drain. In the past month, the yield on French 10 year debt is up 42 basis points, on 10-year Italian bonds the yield is up 62 basis points, Australia up 62 basis points, Hong Kong up 29 basis points. And here in the US, the 10 year Treasury yield has jumped from 1.9% a month ago, to 2.24% today. Around the world yields have been rising and bond prices have been falling.

Meanwhile, oil prices have been rising. Crude prices hit fresh 2015 highs; earlier in the session prices topped $62 a barrel before sliding back. This follow a 22% gain in April. A couple of reports show oil supplies dropping for the first time this year. U.S. oil inventories fell 3.9 million barrels last week, the first weekly decline since Dec. 26, according to data provided by the U.S. Department of Energy. Late yesterday, the American Petroleum Institute reported stockpiles fell by 1.5 million barrels. The data showed a sharp drop in imports for the week, likely just a blip in the reporting. Meanwhile, domestic oil production remains strong at more than 9.3 million barrels a day, declining by just 4,000 in the weekly data, and crude inventories remain near record highs, at 487 million barrels. So, the price of oil rallied well before any recovery in supply-demand balances.

Still, the price of oil is what it is, and compared to 2 months ago, it has now recovered enough to provide inflationary pressure. Fuel prices are a key ingredient to a basket of goods that are measured to determine inflation. And the price of oil affects much more than just the price at the pump; it affects manufactured goods or anything that requires energy or transportation. We don’t know if the recovery in oil prices will continue or not, but the recovery has been strong enough to have an inflationary impact. When oil prices rise because of increased demand that indicates the economy is strong and we need more oil to transport all the products being made and services being sold; however, when oil prices rise due to a reduction in supply that indicates the economy is shrinking not growing; when we have a recovery in inflation without a recovery in growth, the result is stagflation, which is still a form of inflation, even if it turns out to be temporary.

And the bond market hates inflation because it erodes the real, inflation adjusted return on bonds. An uptick in inflation could also give the Fed leeway to raise short-term interest rates in order to reduce the demand for credit and help prevent the economy from overheating. So this might go a long way to explaining the meltdown in bonds in the past few weeks.

There are other explanations to consider as well. The increase in oil prices might be due, in large part to speculative traders, first betting on lower oil prices, and as prices moved a little higher, they were caught in a short squeeze. Tens of millions of barrels are struggling to find buyers in Europe with traders of West African and North Sea crude blaming poor demand. The deep disconnect between the oil futures and physical markets looks similar to the events of June 2014 when the physical market weakness became a precursor for a futures price crash. Traders said around 80 million barrels of Nigerian and Angolan crude oil are on the market with at least a dozen May-loading cargoes still available. Futures prices do not match the physical market.

Still, higher oil prices have an inflationary impact that is being felt in the bond market, kind of, sort of. The bond market is not oblivious to higher oil prices, but there might be another reason for falling bond prices. Maybe central banks have decided to ease up on bond purchases. The Federal Reserve stopped large scale asset purchases a few months ago, but the European Central Bank stepped in with their own quantitative easing program, buying about $66 billion worth of bonds a month, which would push bond prices higher, unless there was a pause in their purchase plan. Maybe that has something to do with the bond meltdown, maybe not. These are complex markets, and they can be moved for any number of reasons, but we do know that whatever is happening is reflected in price, and the price has been moving lower. And as bond prices move lower, stock prices have also been moving lower.

This morning, Federal Reserve Chairwoman Janet Yellen warned of the risks in the stock and bond markets in the environment of low interest rates. Yellen said that equity market valuations are “generally quite high” and “there are potential dangers there.” Yellen was speaking at a forum on finance in Washington, and she added: “Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

Using a valuation technique sometimes referred to as the Fed model, U.S. equities remain cheap compared with government bonds. The S&P 500’s earnings yield, or profit as a percentage of price, stands at about 5.5 percent, more than twice the 2.2 percent rate on 10-year Treasuries. Still, Yellen said the Fed is aware of the possibility that there could be a sharp jump in long-term rates when the Fed raises interest rates. The announcement from Yellen sounded like so much jawboning; the Fed may have some concerns about inflation but right now the economy is not showing signs of strength, not enough to warrant a rate hike.

Productivity in the U.S. fell in the first quarter; the largest back-to-back decline in more than two decades. The measure of employee output per hour decreased at a 1.9% annualized rate, following a 2.1% drop in the fourth quarter. Part of the blame may be attributed to the harsh weather, port-related delays, the stronger dollar and a drop in oil costs that brought the economy to a near-halt in the first quarter and hurt efficiency and profits. The lack of business investment in new technology may also mean productivity will continue to stall. As worker costs are pushed up, it also means corporate profits will be challenged.

ADP, the payroll processing firm, reports the economy added just 169,000 private sector jobs last month; the first time in two years that new jobs created has dipped below 200,000 for two months straight. ADP says job creation has slowed for five months in a row. Mark Zandi, chief economist of Moody’s Analytics issued a report saying: “Fallout from the collapse of oil prices and the surging value of the dollar are weighing on job creation. However, this should prove temporary and job growth will reaccelerate this summer.” The ADP report is sometimes considered an indicator, or maybe an omen, of the Labor Department’s monthly jobs report, which will be reported Friday.

Greece has made a €200 million-euro interest payment to the IMF, although concerns over its future continued to rattle European markets. Athens faces another €750 million-euro debt repayment due on May 12 and it isn’t clear where the money is going to come from. The cash-strapped country still remains in a deadlock with creditors over its next tranche of bailout funding. Meanwhile, the possibility of a Greek default is another factor weighing heavily on the European bond market. It is estimated that past week’s losses on German bonds erased $410 billion in valuation – more than enough to pay for the Greek debt. I’m just saying.

The 2010 “flash crash” that sent the Dow plunging almost 1,000 points was five years ago today. But since then, there have been changes made in the hope of reducing the chances that it could happen again. The British trader fighting extradition to the U.S. on charges of having contributed to the 2010 “flash crash” told a London court today that he’d done nothing wrong.

In today’s edition of “Banks Behaving Badly”: According to its latest quarterly filing, JPMorgan is in “advanced stages” of settlement talks with the DOJ and Federal Reserve over previously disclosed foreign exchange investigations. The bank said the amount it may need to pay – in excess of legal reserves – could be as much as $5.5 billion. Meanwhile, JPMorgan has been placed under formal investigation in France as part of a probe into alleged tax evasion by senior managers at investment firm Wendel, part of a wider investigation in which as many as 14 Wendel executives face charges including tax evasion and insider trading over transactions conducted in 2004-2007. The bank is suspected of acting as an accessory to tax evasion.

The City of Los Angeles has filed a civil lawsuit against Wells Fargo alleging the bank has been looking the other way as its sales people opened up accounts and issued credit cards to customers without their knowledge or permission. Wells Fargo has pushed to get every customer to carry at least 8 different Wells Fargo accounts. Wells Fargo employees said that the company had a systematic, high-pressure quota system for employees that ultimately left them with the choice of engaging in fraud, or being disciplined or fired. Employees were expected to constantly get customers to open new accounts and purchase new banking products, or else. To reach the quota, sales people just started inventing accounts. Some employees went so far as to raid client accounts for money to open additional accounts.

In addition to charging fees on unwanted accounts, San Francisco-based Wells Fargo harmed customers by placing them into collections based on unauthorized withdrawals and reported damaging information on their credit reports when unwarranted fees went unpaid. The lawsuit seeks a court order shutting down the alleged wrongdoing, along with penalties of up to $2,500 for every violation and restitution for customers who were harmed. Wells Fargo denies the allegations.

Financial Review

Blue Light Special

Sinclair Noe — February 19, 2015

 

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DOW – 44 = 17,985
SPX – 2 = 2097
NAS + 18 = 4924
10 YR YLD + .04 = 2.11%
OIL – .77 = 51.37
GOLD – 6.10 = 1208.20
SILV – .12 = 16.48

The S&P 500 is up 5.2 percent in February, rebounding from a January slump. If the index holds those gains it will be the best monthly performance since October 2011.

Crude-oil futures fell to the lowest level in a week, after data showed inventories have built up much faster than expected. According to a report from the American Petroleum Institute late yesterday, US crude stocks rose by 14.3 million barrels last week vs. expectations of a 3.2 million. The today the US Energy Information Administration released a report showing crude inventories rose 7.7 million barrels for the week ended Feb. 13; that was about double expectations, but far less than the API report. And prices bounced back.

The latest EIA data peg total commercial crude inventories at 425 million barrels, with the government referring to the total as “the highest level for this time of year in at least the last 80 years.” One possible reason for the rising inventories is that there has been a United Steelworkers strike at 11 refineries that account for 13% of US output capacity.  A slowdown in refining would lessen the demand for crude oil. Another possible reason why inventories continue to rise is that most domestic oil drillers have taken on debt, and they have to keep pumping oil to service that debt, at least for now.

The number of Americans filing new claims for unemployment benefits fell more than expected last week, offering fresh evidence that the labor market was gathering steam. Initial claims for state unemployment benefits dropped 21,000 to a seasonally adjusted 283,000 for the week ended Feb. 14.

Leading U.S. economic indicators edged up 0.2% in January, and the December index was revised lower to 0.4%. The Conference Board said the lack of strong momentum in residential construction, along with a weak outlook for new orders in manufacturing, poses a downside risk for the US economy.

The Arizona Regional Multiple Listing Service (ARMLS) reports that for the second consecutive month, inventory in the Phoenix residential real estate market was down year-over-year. Active inventory is now down 4.9% year-over-year. Housing prices bottomed in Phoenix is 2011 at about the current level of inventory. Overall sales in January were down 0.3% year-over-year. And cash sales were down 12% to 32% of total sales. Now, with tighter inventory, we might see a little more price appreciation in 2015.

Greece has submitted a formal request for a six-month loan extension, and it looks like the new Greek government blinked; they pledged to abide by all its previous commitments and recognize the bailout as legally binding. However, the wording of its first point implied that Greece wants to haggle over implementing reforms demanded by the original bailout agreement. Even so, the request is still a major climbdown for the new government, led by Tsipras’ radical left-wing Syriza party, which swept to power on a pledge to overthrow the bailout agreement in January and subsequently declared it “dead”. It pledges to honor all of Greece’s debts and, just as importantly, to continue accepting monitoring visits from the three institutions that have overseen Athens’ implementation of the bailout to date, the hated “troika” of European Central Bank, the International Monetary Fund and the European Commission.

And this morning, Germany rejected the request for bridge financing. The Germans called the proposal a Trojan Horse, that looks to end the current bailout program and acquire bridge financing. Greece’s current €240 billion ($273 billion) financing arrangement expires as the end of this month. After that, the country would find itself cut off from European and International Monetary Fund loans that have kept it afloat for five years. A Greek government spokesman insisted that the eurogroup had only two options: either to accept or reject the Greek request. “It will then be clear who wants to find a solution and who doesn’t.”

Euro-region finance ministers will make a “detailed assessment” of the request and formulate a response later today.

Japanese exports surged in January, providing more evidence that the world’s third largest economy is slowly climbing out of recession. Exports rose by 17% on year last month, their biggest jump since late 2013, while imports in January contracted 9% Y/Y. Helped by gains in financial and shipping companies, Tokyo’s Nikkei touched its highest level since May 2000, that’s a 15 year high. The GDP numbers out yesterday showed the world’s third-largest economy emerging from a brief recession—if you use the conventional definition of two straight quarters of contracting GDP.

True, that was about half the 3.7% analysts had forecasted. But it’s a welcome development, especially given that export growth was a key driver of the quarter. The weak yen engineered by the Bank of Japan seems to be giving a spark to Japan’s important exporting sector.

The key question for the future of Japanese growth is how consumer demand responds. For the moment, Japanese consumers, like consumers worldwide, are getting a real wage raise thanks to declining energy prices. But to create sustainable consumer growth, corporations have to be convinced to give workers a larger cut of profits. It just might be possible. The largest employer in the US, Wal-Mart, signaled today that it was going to begin raising wages for its workforce, in a nod to both rising political pressure and tightening labor markets. Similar dynamics are in place in Japan.

Wal-Mart reported fourth-quarter profit rose to $4.97 billion, or $1.53 a share, from $4.43 billion, or $1.36 a share, a year ago.  Sales rose to $131.6 billion from $129.7 billion. Wal-Mart missed on both the top and bottom line. But the big news from Wal-mart is that the company said it will give raises to about 500,000 full-time and part time employees and ensure hourly employees earn at least $9 an hour, $1.75 above federal minimum wage. By Feb. 1, 2016, current employees will earn at least $10 an hour.

The company also said it would strengthen a “department manager” role, giving it a minimum wage of $13 per hour this year and $15 next, thus offering low-wage hourly workers a clearer path to advancement. Including similar bumps at Walmart-owned Sam’s Clubs, the company expects 500,000 workers to receive a raise at a cost of $1 billion a year.

That all sounds good and magnanimous, but Wal-Mart was more or less dragged, kicking and screaming to this moment. Over the past three years, Wal-Mart has faced a wave of union-backed attacks: legal, political, media, and consumer pressure, anchored by the first coordinated store walkouts in the company’s history.

Back in its 2007 fiscal year, before the recession, Walmart reported $183,500 in revenue per employee and $5,938 in profit. Not bad, but by 2014 those numbers had risen 18 percent and 22 percent. The company’s sales and profits rose nicely in that time while the company kept a lid on its payroll. Gains went to Walmart shareholders, not Walmart workers. Of course, it takes a lot of people to run a Wal-Mart store, and the unemployment rate has dropped down to 5.7%, meaning Wal-Mart now faces competition for workers.

The decision is likely to ripple across the economy and will undoubtedly lead to similar moves by other companies. Indeed, Wal-Mart is not the first to raise wages, just the biggest; and as the biggest, it sets a standard for the entire retail industry. Walmart CEO Doug McMillon told analysts higher wages lead to a better experience for workers and customers, “which can drive higher sales and returns for our shareholders.” In Walmart’s case, many of the 1.3 million US workers are also customers that can spend their extra dollars at Wal-Mart. And most Wal-Mart workers will spend their paychecks as soon as they are cashed. It still is just about $1 billion in wage increases, and so don’t look for a big change in economic numbers on a nationwide level. All things equal, that amounts to a gain of 0.097% in average hourly earnings for retail workers. For all workers, that translates into a rise of 0.01% — basically, nothing. But it is a step in the right direction.

We’ve all heard the stories of cybersecurity breaches and hack attacks. Maybe you wonder how hackers manage to hack what should be secure computers. Well, in the case of Lenovo, the world’s largest PC maker, they pre-installed a virus-like software on laptops that makes the devices more vulnerable to hacking. Users reported as early as last June that a program called Superfish pre-installed by Lenovo on consumer laptops was ‘adware’, or software that automatically displays adverts. Superfish was malicious software that hijacks and throws open encrypted connections, paving the way for hackers to also commandeer these connections and eavesdrop, in what is known as a man-in-the-middle attack.

The Los Angeles Times reports that two medical scopes used at UCLA’s Ronald Reagan Medical Center may have been contaminated with the potentially deadly, antibiotic-resistant bacteria known as CRE. Two patients have died from complications that may be connected to the bacteria, and authorities believe that 179 more patients have been exposed. The really scary part of this is that infections occurred even though the instruments had been cleaned according to the manufacturer’s instructions.

Most healthy people aren’t at risk of catching a CRE infection, but in hospitals this bacteria can be quite dangerous: CRE kills as many as half of all people in whom the infection has spread to the bloodstream. The Centers for Disease Control and Prevention (CDC) are working with the California Department of Public Health to investigate the situation, which is expected to result in more infections.

The problem isn’t just in Los Angeles, though. Last month, USA Today reported that hospitals around the country struggle with transmissions of bacteria on these scopes—medical devices commonly used to treat digestive-system problems—and there have been several other under-the-radar outbreaks of CRE.

Samsung Electronics has acquired mobile wallet startup LoopPay, indicating its intention to launch a smartphone payments service to compete with Apple Pay and others. Despite strong backing, mobile payments have been slow to catch on, as many retailers have been reluctant to adopt the infrastructure required for the mobile payment options to work. LoopPay, however, works off existing magnetic-stripe card readers by transmitting a magnetic signal similar to that of a swiped card, putting Samsung at an advantage.