Wednesday, June 25, 2014 - Use Your Library Card at a Copy Shop for a Horseback Ride to the Moon

Financial Review with Sinclair Noe

DOW + 49 = 16,867
SPX + 9 = 1959
NAS + 29 = 4379
10 YR YLD - .02 = 2.56%
OIL + .74 = 106.77
GOLD - .60 = 1319.40
SILV + .09 = 21.12

One of the jobs of the Commerce Department is to calculate the gross domestic product of the country; clearly it is a difficult task to figure out the value of all the goods and services produced, and so they tend to revise the numbers as they gather information. In April the Commerce Department figured the economy grew, just barely, 0.1% in the first quarter; last month they revised their GDP numbers to negative1.0%; today they revised GDP even lower. The economy shrank by 2.9%.

To understand the big move, you first have to realize that the GDP number is supposed to measure everything; construction and demolition, marriages and divorces, broccoli sales and cigarette sales, yoga classes and cancer treatments. One of the big reasons for the negative number is that the cost of healthcare dropped significantly.

The US spent $6.4 billion less on health care in the first quarter than in the last quarter of 2013. Government statisticians initially forecast a 9.9% increase in health-care spending, and what we got was a 1.4% decline. Considering all the millions of previously uninsured people who are gaining access to health insurance under the Affordable Care Act, how can they be shrinking so dramatically?

Health-care costs overall have been increasing more slowly in recent years compared with the pace before the 2007-09 recession. Slow growth in the price of health-care services combined with a decline in the amount of health care people consumed in the first quarter. Still, health-care spending is expected to accelerate again in coming quarters as the millions of people who gained health insurance coverage during the Affordable Care Act’s first open enrollment period begin to use their new coverage. Most people who got coverage at the start of the year, are just now figuring out how to use the coverage. So, the idea that people are spending less on health care may hurt the GDP number but that doesn’t mean it’s a bad thing. This also means that the economists don’t really understand how Obamacare is affecting the economic data; and that means they don’t really know how long it will distort data. This is new territory.  

A couple of other areas were also involved in shrinking the economy. Companies continue to hoard cash and shun investing in new equipment or new employees; and that will continue until demand picks up; we’ve been told demand will pick up, any day now…, it’ll pick up…., that’s what we’ve heard for a few years.

Another rough spot for GDP was in trade. The trade deficit widened in the first quarter, which would typically indicate growth, but in the first quarter both imports and exports dragged down growth. And then trade was disrupted by the weather, the excuse that keeps giving and giving.  And now that the winter has turned to spring and spring to summer, the economy will bounce back like a kangaroo on a trampoline. Maybe. Consider that when the economy shrank in the first quarter of 2009, the country lost 2.3 million jobs and the markets were in a free fall. Fast forward to first quarter 2014 and the markets are around record highs while the country added about 600,000 new jobs; hardly the stuff of gloom and doom.

Today’s GDP revision might give the Federal Reserve cause for pause, or more likely it will reinforce their dovish inclinations for monetary policy. On the fiscal side, if policymakers in Washington are concerned enough to give the economy a boost, they can consider straightforward measures that would promote growth and create jobs: invest in infrastructure, restore extended unemployment benefits, hire public-sector workers like teachers and first responders, and basically abandon austerity measures in general.

You may remember the gloom and doom days of 1973, when OPEC imposed an oil embargo; prices jumped, lines formed at gas stations to buy rationed gas. Lawmakers responded by limiting the export of oil from the US; we could still export gasoline and diesel but not oil. It didn’t make much common sense but that was the response to the embargo. Things have changed.

Now, oil drillers are tapping shale formations and so much oil is flooding out of the ground that prices for ultralight oil have dropped as much as $10 below the price of traditional crude oil. Which sounds good if you are a consumer, because you might think it would result in lower prices at the pump. But as you know, the price at the pump has been going up because of the crazies in Iraq, and Libya, and Ukraine. Rather than let the oil build up and let prices drop, the plan is to export that oil under a process known as a private ruling which would relax the export restrictions.

The private rulings by the Commerce Department define some ultralight oil as fuel after it has been minimally processed, making the oil eligible for sale outside the US. Export could start in August, and could increase to more than 700,000 barrels a day by next year. The Commerce Department has given permission to two companies to ship ultralight oil: Pioneer Natural Resources and Enterprise Products Partners.

So if you were hoping that all that domestic oil drilling would lead to lower prices for America, yea, that’s not going to happen.

Have you ever been on the floor of one of the commodity exchanges, or maybe seen pictures of the commodities traders? Thirty years ago, the scene was a violent confrontation of traders battling it out in the pits. Nowadays, the trading is much more subdued. Traders walk around with a portable computer that calculates the price in real time. That formula that is on every commodity trader’s computer is a continuous time option pricing model known as the Black-Scholes-Merton formula. Robert Merton and Myron Scholes won the 1997 Nobel Prize in Economics for their formula; Fisher Black passed away in 1995.

Robert Merton went on to create computerized arbitrage trading formulas and he advised hedge funds for a while, including the Arbitrage Management Company and Long Term Capital Management. He then settled down to work as a professor at MIT, where his current academic include financial innovation, controlling macro financial risk, and managing sovereign risk.

Bob Merton says your 401K is dangerous. In an article published in the Harvard Business Review, Merton writes: "The only way to avoid a catastrophe is for plan participants, professionals, and regulators to shift the mind-set and metrics from asset value to income."

Instead of telling you how much you’ve accumulated in your 401K, the plan administrators should be telling you the amount of sustainable income an employee can expect to receive in retirement. The “risk is retirement income uncertainty, not portfolio value.” That's not to say that 401k money shouldn't be invested in stocks. In fact, Merton says, 401k investment managers should invest participants' savings in a mixture of "risky assets," including equities, and "risk-free assets," such as long-term US Treasurys and deferred annuities. Merton says the solution  for employees who want to lock in retirement income, “the obvious decision is to buy the annuity.”

By disclosing annual income, Merton says, employers would help employees quickly and easily calculate how much of their annual salary they can expect to replace in retirement, together with Social Security. As a result, employees would be better able to take action to ensure they are on track to retire as planned.

The Supremes are in session and handing down decisions on a daily basis. Let’s start with American Broadcasting Company v Aereo; the Supremes delivered a major victory to the nation’s television networks, ruling that an upstart Internet company was violating copyright laws by transmitting their programs without paying for them. It was a 6-3 vote; in the majority, Justice Breyer said Aereo’s use of modern technology to stream broadcast television was not much different than cable systems that must pay the networks for its content. Meanwhile, in the minority, Justice Scalia said that Aereo is a copy shop that gives its customers a library card. I’m not sure how you might use a library card at a copy shop, but anyway, Kinko’s is out of business and so is Aero.

Today the Supremes also ruled on a couple of fourth amendment cases. The Fourth reads, in part: “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause…” and apparently your smartphone falls under the category of “papers and effects”.

 Riley v. California and United States v. Wurie featured similar facts. Defendants were detained validly, one for driving with expired tags and the other for a hand-to-hand drug sale. Police searched them, as they had every right to do, and seized their phones. Without getting a warrant, they looked at the contents of each phone and found evidence that led, eventually, to much more serious charges: gang-related attempted murder in the first case and drug distribution and weapons violations in the other.

California state courts refused to overturn Riley’s conviction when he appealed the attempted murder charge, but the 1st Circuit Court of Appeals reversed Wurie’s conviction and ordered a new trial on the grounds that the warrantless search violated the Fourth Amendment’s prohibition against “unreasonable searches and seizures.”

Police can search a suspect’s pockets, or briefcase, or car when making a valid arrest because there may be weapons nearby or evidence of crime that could be lost. In addition, officers can search when there are “exigent circumstances,” meaning when there is no time to lose, in order, say, to stop a crime in progress, prevent suspects from destroying evidence, or rescue a kidnap victim. Prosecutors in both cases argued that searching a cell phone is really just the same thing as the valid search of personal items. Chief Justice Roberts didn’t buy it, replying, “That is like saying a ride on horseback is materially indistinguishable from a flight to the moon.”

Roberts wrote the opinion for the unanimous decision and concluded: “We cannot deny that our decision today will have an impact on the ability of law enforcement to combat crime… Privacy comes at a cost.”

Monday, June 16, 2014 - Manic Monday

Financial Review with Sinclair Noe

DOW + 5 = 16,781
SPX + 1 = 1937
NAS + 10 = 4321
10 YR YLD - .01 = 2.59%
OIL - .12 = 106.79
GOLD – 4.20 = 1272.70
SILV un = 19.77

It’s Monday, and that means mergers. Today’s acquisition news comes from Medtronics, the medical device maker, announcing it will acquire Covidien for nearly $43 billion. Medtronics was founded in a garage in Minneapolis in 1949, but they will change their headquarters to Ireland, which is where Covidien has been headquartered since 2009. Covidien is actually a Massachusetts company, and they operate out of Massachusetts. Medtronics will continue to operate out of Minneapolis; the whole deal is about a lower tax rate, and for Medtronics, the ability to repatriate $20 billion in offshore profits, without paying tax.

Meanwhile, the IPO market remains white hot, and 14 companies will come to market this week. So far this year 124 companies have priced in the US, up 57% from a year ago. Total proceeds raised come to $25.8 billion, up almost 41% from 2013.

Data today showed industrial production climbed more than forecast in May. Output at factories, mines and utilities rose 0.6% after a revised 0.3% drop in April that was smaller than previously estimated. In a separate report, the New York Fed’s Empire manufacturing report rose to 19.28, better than expectations.

The Fed FOMC meets later this week to determine monetary policy. After their meeting concludes Wednesday, Fed officials will release their updated projections for interest rates, growth, inflation and unemployment, and also are likely to trim their bond-buying program by an additional $10 billion a month.

The latest report from the International Monetary Fund, the IMF, might suggest the Fed doesn’t need to be in a hurry to exit a Zero Interest Rate Policy. Of course, the IMF doesn’t set Fed policy, but the latest IMF forecast for the US economy cuts the outlook for growth to 2% from the 2.8% predicted back in April; the lower forecast is mainly a result of the weakness in the first quarter. The IMF kept if 2015 forecast unchanged at 3%. The forecast says the economy is starting to rebound but will remain below historical averages as the population ages and productivity growth slows. Their forecasts show we won’t return to full employment until the end of 2017, with inflation remaining low.

The IMF suggests the US raise the minimum wage as one way to boost the economy; other suggestions include more spending on infrastructure and education, plus changing parts of its tax system, including boosting the federal gasoline tax and reinstating the tax credit for research and development, to help spur growth. In the future, policymakers should also reform corporate taxes, introduce a carbon tax and move toward a federal value-added tax.

IMF Director Christine Lagarde says the oil shock that could result from the current tension in Iraq might affect the economy but for that to happen, the shock would have to be rather deep and rather long-lasting. You’ll probably start seeing the price increase at the pump, as prices hover just below $107 a barrel. And oil prices are being whipsawed by the headlines; if we see fighting in Baghdad, we could easily see prices pop up to $120 a barrel.

Iraq, excluding the Kurdish region, holds 150 billion barrels in proven crude reserves, the world’s fifth-biggest deposits. A pipeline from the Kirkuk region to Turkey has been shut down since March, and now Kurdish troops are defending the Kirkuk oilfields from ISIL rebels. Even if the rebels are turned back, the Iraqi government in Baghdad may have a hard time displacing Kurdish troops in the future.

Meanwhile, Ukraine said Russia cut natural gas supplies after demanding fuel payments be made in advance, the first time shipments have been affected in this year’s crisis in relations between the two countries. Tensions escalated over the weekend with 49 servicemen killed when pro-Russia fighters shot down an aircraft.

British climate change economist Lord Nicholas Stern says our current models “grossly underestimate” the economic damage that will be wrought by climate change. In 2006 Stern wrote a scientific paper that estimated the externalized costs of burning fossil fuels will impact the world economy by five per cent to 20 per cent of global GDP, which would work out to between $2.3 trillion and $9.1 trillion each year. Now, Stern says he “got it wrong on climate change; it’s far, far worse.”  So, Stern and a colleague, Simon Dietz just published a new preliminary paper that makes a few key updates, and now Stern believes that “climate change is the greatest markets failure the world has ever seen.”

The old model looks at any point in time, measures the economy’s productive capacity, and then gauges how much climate change will dampen that productivity in that moment. But climate change can also reduce that productive capacity itself. Stronger storms can damage infrastructure; sea level rise can force people to abandon homes, businesses or equipment; and climate damage can channel more investment into repairs and away from creating new capital. Stern and Dietz account for that, and the result is a double hit: at any given moment, the effects of climate change are reducing the economy’s ability to produce wealth, but they’re also reducing the economy’s overall capacity to produce wealth at future moments.

Other factors in modeling climate change’s economic effects are what scientists call “tipping points”; moments when global warming kicks off feedback loops in the planetary ecology that cause the effects to speed up. Examples of tipping points include the polar ice melting in a way that results in sudden huge collapses rather than gradual melting; or melting permafrost in the northern hemisphere releasing underground methane that in turn speeds up global warming even more. They can also include second-order social effects that damage economies: drought and food scarcity kicking off wars or mass refugee movements, for instance.

June is a big month for the Supreme Court and several major rulings are expected in the next few weeks, and some cases have already been decided.

Last Thursday, the Supremes announced opinions on only two of the 22 cases it has in front of it: POM Wonderful v. Coca-Cola which deals with whether a company can sue another one for unfair competition based on false or misleading product descriptions; and Clark v. Rameker, which weighs whether individual retirement account (IRA) inheritance can be exempted from Chapter 7 bankruptcy under the “retirement funds” exemption.

In the POM case, the court ruled that POM, a company that makes pomegranate juices, had the right to sue Coca-Cola for falsely advertising one of its juices as being made mostly of pomegranate and blueberry juice when it was actually made of apple and grape juices. POM, which makes a special pomegranate-blueberry juice blend, claimed it lost sales as a result of Cola-Cola’s false labeling. The ruling reversed a decision from the Ninth Circuit Court of Appeals, which essentially said POM lacked the legal standing to sue because of a conflict with state and federal law.

In Clark v. Rameker, the court ruled that IRA inheritance funds do not meet the “retirement funds” exemption and must be included as part of the estate in the bankruptcy process. Because an IRA is intended for the retirement of the person who originally put the funds into the account, and an inherited IRA functions essentially as a fund that can be used at any time and not just for retirement, the exemption does not apply.

Today, the Supreme Court handed Argentina two major defeats in cases brought by bondholders who refused to accept reduced payments after the country’s 2001 default. The Supremes decided against hearing Argentina’s appeal of an order requiring it to pay holders of defaulted notes from 2001 when making payments on its restructured debt. The next payment on those bonds comes due June 30. Shortly after the first decision, the Supremes handed down another ruling allowing the bondholders to issue subpoenas to banks in an effort to trace Argentina’s assets abroad.

The inaction by the Supreme Court is a victory for the minority of investors, led by a hedge fund controlled by billionaire Paul Singer, who have refused to exchange their defaulted bonds for about 30 cents on the dollar. Argentina calls those investors “vultures” because they bought many of the bonds post-default at a discount, angling to eventually collect a windfall; in other words, they bought the bonds for pennies on the dollar, refused to accept 30 cents on the dollar, and the Supremes say they now must be paid the full face amount of the bonds.

In response to today’s decisions, lawyers for Argentina wrote: “Since Argentina lacks the financial resources to pay the holdouts in full (what would amount to $15 billion) while also servicing its restructured debt to 92 percent of bondholders, Argentina will have to face, objectively, a serious and imminent risk of default.”

Argentina claimed that lower-court rulings misread Argentina’s bond agreements and violated its immunity as a sovereign nation. In court filings, the Argentine government has said it would comply with lower-court rulings. But in public pronouncements, Argentine President Cristina Fernández de Kirchner has vowed not to pay a group of creditors she has referred to as “predators.”

Also today, the Supremes dealt a rare blow to the gun lobby Monday by ruling that purchasers must report when they are buying firearms for other people.

Other rulings expected this week might include Sebelius v. Hobby Lobby, which deals with whether a for-profit company has to provide contraceptive care for its employees if the owner has a religious objection, even though the employees are entitled to it through the Affordable Care Act (ACA), also known as Obamacare.

Also, American Broadcasting Company v. Aereo, which should be of interest if you watch TV over the internet. Aereo is a Web startup company that allows consumers to pay an $8 or $12 subscription fee to watch their local TV networks live on any Internet-connected device. The major broadcasters say this amounts to theft of their product.

And a couple of cases that deal with the Fourth Amendment: Riley v. California, and United States v. Wurie; both cases are about whether the police have to obtain a warrant to search an individual's cellphone when an arrest is made.

Monday, April 21, 2014 - Why Stocks Continue Going Higher

Financial Review with Sinclair Noe

DOW + 40 = 16,449
SPX + 7 = 1871
NAS + 26 = 4121
10 YR YLD un 2.72%
OIL - .01 = 103.64
GOLD – 4.30 = 1291.30
SILV - .21 = 19.54

The S&P 500 has gained for five straight sessions, marking the longest winning streak since October. This has not been a pretty rally. Volume was light today; that has been part of the trend; light volume on up days and heavy volume on down days.

We are smack dab in earnings reporting season, and 87 companies have posted results through this morning with 62% beating earnings expectations; that’s down from 66% beating earnings over the past 4 quarters, and those earnings expectations have been ratcheted lower and lower, so it should be an easy bar to cross. And still the markets have been moving higher.

Dozens of S&P 500 components will report earnings this week, including Apple, Biogen, Facebook, McDonald’s, AT&T and Caterpillar. More than 30 companies in the Nasdaq 100 (NDX) are slated to report earnings. After the close of trade Netflix posted a first-quarter profit of $53 million, or 86 cents a share, up from $3 million, or five cents a share, a year ago. The company in January had projected a profit of 78 cents a share. The stock shot up about 7% to $372 in extended-hours trading. After a jump of 300% in 2013, Netflix had slumped recently.

As part of the earnings announcement, Netflix announced a price hike, but it will only be for new customers, and the hike won’t happen for about 2 or 3 months, and existing customers will be grandfathered in with a non-specific grace period.

Also, Netflix sent a letter to shareholders in opposition to the proposed Comcast-Time Warner Cable merger. The letter says that if the merger is approved, “the combined company’s footprint will pass over 60 percent of U.S. broadband households...with most of those homes having Comcast as the only option for truly high-speed broadband. The combined company would possess even more anti-competitive leverage to charge arbitrary interconnection tolls for access to their customers. For this reason, Netflix opposes this merger."

Two months ago, Netflix agreed to pay Comcast for access to its high-speed network to improve the video quality and loading speed for Netflix streaming customers.

On a related note, major television broadcasters and Aereo will argue before the US Supreme Court tomorrow in a case that is about much more than the future of a controversial startup. The outcome could have far-reaching effects on the future of television and cloud computing, the quality of wireless service, and entrepreneurs trying to create the next big thing in technology.

You’ve never heard of Aereo? Don’t feel bad, I’m not even sure I’m pronouncing it correctly. It is a 2 year old startup that captures broadcast airwaves and then streams those signals to users, for about $8 a month. The broadcast channels such as NBC, CBS, ABC, and Fox are transmitted free of charge to anyone who has a television and an antenna. But cable companies like Comcast and Time Warner pay the broadcasters billions of dollars in fees for the right to re-broadcast the network TV channels as part of paid cable packages. Aereo argues it doesn't need to pay those fees because the broadcast signals which it's capturing and then retransmitting to its subscribers over the Internet, are free.

Broadcasters sued, claiming Aereo is violating copyright law by retransmitting the shows and threatening their industry's business model. If Aereo is legal, they fear there’s nothing stopping cable companies from copying Aereo to avoid paying the broadcasters billions of dollars in fees. If Aereo wins, broadcasters have threatened to yank their broadcast signals off the free airwaves and instead offer them only to paid subscribers.

Aereo streams network TV to subscribers via servers in “the cloud.” A Supreme Court decision against Aereo threatens to outlaw the entire cloud-computing industry. If Aereo is violating copyright law, that means other cloud providers could also be held responsible for helping users access illegal content. For example, Google or Dropbox could be responsible for policing the content stored in a Google Drive or Dropbox account to avoid copyright violations.

If Aereo wins and broadcasters follow through on their threat to stop beaming over-the-air programming, it could have an unintended benefit for smartphone users. As people consume more data on their mobile devices, it has created a shortage of wireless spectrum that could lead to dropped calls and slower wireless speeds if more airwaves aren't freed up.

The government is preparing to auction off some of those unused broadcast airwaves to wireless companies so they can improve service and avoid network congestion. An Aereo victory could prompt broadcasters to sell more of those airwaves to wireless companies, which could ultimately lead to improved smartphone service.

Now, think back a few years, no a few more years, maybe you are old enough to remember when the entertainment industry sued Sony, claiming that allowing customers to use its Betamax VCRs to record TV programming for later viewing amounted to copyright theft. The Supreme Court dismissed their arguments.

Sometimes it is difficult to make sense of the cyber world. For example, do you like Cheerios? The little circular breakfast cereal? Well, if you like Cheerios on Facebook, General Mills thinks that is reason enough to prevent you from suing them, or at least that’s what they thought. Last week, General Mills revealed a new rule to prevent people from joining class action lawsuits if they had joined the General Mills online communities, or entered a contest, or subscribed to newsletters or liked Cheerios on Facebook.

Under the new terms, those who violated the rule would be limited to arbitration or informal negotiations as a means of conflict resolution. And when you think about it for a moment it seems a bit heavy handed that a cereal company could take away your right to sue, even if you found a rat in your Progresso soup, or something yucky in your Yoplait, or actual leprechaun parts in your Lucky Charms. General Mills has now reversed the policy, and they even claim there was no policy in the first place, it was just a misunderstanding of how far they could throw around their corporate weight.

Financial markets have been fairly calm lately — no big banking crises, no imminent threats of euro breakup. But it would be wrong and dangerous to assume that recovery is assured; our still-sluggish economic progress could still be undermined by bad policies, or the argument of the past few months is that the economy could be derailed by inclement weather.

The Conference Board’s leading index is designed to forecast economic activity, not the weather. So, the split between the leading and coincident indexes so far this year offers further evidence of how the weather slowed growth in the first quarter. It also supports expectations that economic activity is picking up this quarter.

The board compiles 10 forward-looking data series, including jobless claims and new orders, to calculate its leading index, and the coincident index contains four series, including nonfarm payrolls and business sales. While growth in the coincident index usually follows the rate of the leading index with a lag, the gap between the two has widened in recent months.

Today, the board said its leading index increased a larger-than-expected 0.8% in March, and the coincident index increased 0.2%. In the past four months, which included the harsh winter period, the leading index has increased 1.5% while the coincident is up just 0.4%. The gains in the leading index mean economic fundamentals should allow the recovery to pick up steam in coming months. If so, the coincident index should post better gains. Today’s Leading Economic Index says, “The economy is rebounding from widespread inclement weather and the strengthening in the labor market is beginning to have a positive impact on growth.”

The Fed is trying to exit QE, but it won’t be easy, and they say one of the determinants is the employment picture and inflationary pressures. A new research paper by Fed economists says those two categories should not be considered separately.

Fed Chairwoman Janet Yellen has argued that a significant portion of the long-term unemployment problem is due to a depressed economy rather than structural issues such as aging or the gap between workers’ skills and employers’ needs. According to her line of thinking, Fed policies could help spur hiring by boosting demand. If the problem is primarily structural, as some other economists have argued, Fed policies are less likely to make any difference in employment. In a speech earlier this month, Yellen said, “I believe that long-term unemployment might fall appreciably if economic conditions were stronger.”

The new research paper corroborates Yellen’s findings. The new research says that by using regional data sets rather than simply national figures, and economists were able to “discriminate the independent influences of short- and long-term unemployment” on inflation.

“The results suggest that long-term unemployment has exerted similar downward pressure on inflation to that exerted by short-term unemployment in recent decades.”

Or economic recovery could be undermined by green men.

For the past two weeks, pro-Russian gunmen in green uniforms with no insignias, have been taking over government buildings in eastern Ukraine. Russia did not claim them; they were unidentified “green men”. To no one’s surprise, US intelligence is now saying the “green men” are indeed Russian military, and this is a pretty clear breach of the non-escalation agreement reached last week in Geneva. So, now the US State Department is saying that Russia and their “green men” need to vacate occupied buildings and checkpoints, accept an amnesty and address their grievances politically, or the financial sanctions against Russia will be escalated.