Financial Review

No Fear

Sinclair Noe — October 31, 2016

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

Subscribe: iTunes | Android | RSS

DOW – 18 = 18,142
SPX – 0.26 = 2126
NAS – 0.97 = 5189
10 Y – .01 = 1.83%
OIL – 1.94 = 46.76
GOLD + 2.30 = 1278.00

Another Merger Monday. For the second consecutive week, we have a batch of big mergers announced. US mergers and acquisitions activity in October was already at a record high before these deals were announced, led by AT&T’s giant deal for Time Warner.

GE is merging its oil and gas business with Baker Hughes. GE will own 62.5% of the new publicly traded company, which will have combined revenue of $32 billion, while Baker Hughes shareholders will own 37.5% and will receive a one-time special dividend of $17.50 a share when the deal closes. The combination of GE Oil & Gas and Baker Hughes will create the second-largest player in the oil-field services industry in terms of revenue after Schlumberger.

Telecommunications company CenturyLink said it would buy Level 3 Communications in a cash-and-stock deal with an equity value of about $24 billion, or about $34 billion, including debt. The deal implies a purchase price of $66.50 per share – a premium of approximately 42% above where Level 3 shares were trading last week, before reports surfaced of a potential acquisition. The combination will increase CenturyLink’s fiber network in the US to 450,000 miles from about 250,000.

Blackstone Group will buy TeamHealth Holdings in a deal valued at about $6.1 billion. TeamHealth is a hospital staffing provider. Blackstone will pay TeamHealth shareholders $43.50 per share held, a premium of about 18 percent to the stock’s Friday close.

 Multiple sources say a long-rumored merger between DraftKings and FanDuel is imminent; the pair’s recent settlement with NY Attorney General Eric Schneiderman cleared a key obstacle to the pair-up. Some of the major details discussed last week included executive leadership, the name of the company, whether one site or two will be used, and where the company headquarters will be located. Combined, the two firms cover 90-95% of the daily fantasy market.

Brocade Communications spiked as much as 24% today after a report that the company is finalizing talks to sell itself. Bloomberg reported that a sale of the data-storage and networking provider could be announced as soon as this week, and Broadcom is one of the interested potential buyers. Broadcom makes semiconductors, part of the components that go into Brocade’s networking equipment – so it might make a good fit.

Consumers boosted their spending in September at the fastest pace in three months, while their incomes grew by a modest amount. Consumer spending increased 0.5 percent, a significant rebound from August when spending fell 0.1 percent. The increase was led by a 1.3 percent surge in spending on autos and other durable goods. Incomes increased 0.3 percent in September, slightly faster than the 0.2 percent gain in August. With spending rising faster than incomes, the personal saving rate slipped slightly to 5.7 percent in September, down from 5.8 percent in August.

A key inflation gauge followed by the Federal Reserve was up a slight 0.2 percent in September, while core prices, excluding food and energy, rose only 0.1 percent. Over the past year, core prices are up just 1.7 percent, still below the Fed’s 2 percent inflation target. The Atlanta Federal Reserve’s GDP Now forecast model showed the economy is on track to grow at a 2.7% annualized pace in the fourth quarter.

Fed officials meet this week, but they are expected to its key policy rate unchanged at 0.25 percent to 0.5 percent, where it has been since December of last year. The FOMC will wrap up their 2-day meeting on Wednesday. Still, it looks like a rate hike will come in December, and so this week’s FOMC statement will likely include some sort of vaguely blunt Fedspeak sending a clear message to markets that, barring any unforeseen hiccups, the Fed is a go for a December hike.

On Friday, we have the October jobs report. The economy has been averaging 178,000 new jobs per month for 2016, and that is the estimate for the past month; however, the September numbers were off a bit – only 156,000. This will be the biggest economic report before next week’s election.

Bond markets around the globe are acting rattled by inflationary pressures and October was a bad month for bonds, down 3%; and even US Treasuries lost 1.2%. People are responding to this idea that central banks will be suddenly shifting away from their excess accommodation.

Commercial banks in the US have amassed $90 billion of Treasuries and non-mortgage debt from federal agencies this year alone, bringing the total to $754 billion, according to data compiled by the Fed. The 5 biggest US banks held a combined $206 billion of government debt at the end of the second quarter, according to the latest available filings. That’s a 74 percent increase over the past three years.

Including federally guaranteed mortgage-backed securities, banks now own $2.4 trillion of government bonds, which would be the most since the central bank began compiling data in 1973. Why are banks hoarding all that debt? One reason is tighter regulations; the other is banks aren’t lending more because the economy isn’t growing as fast as we’d like it to grow. A big reason banks are funneling so much money into safe assets is that deposit growth is outstripping loan demand.

Eurozone economic growth remained steady at 0.3% in third quarter, indicating 1.6% over the year and suggesting the bloc’s steady recovery has not so far been knocked off course by Britain’s vote to leave the EU. Inflation figures, released at the same time, saw a modest rise in October. The service sector helped boost the Flash Inflation figure to 0.5%, up from 0.4% in September, but the number narrowly missed expectations for a 0.6% rise.

Officials and experts from OPEC countries and non-OPEC nations including Azerbaijan, Brazil, Kazakhstan, Mexico, Oman and Russia met for consultations in Vienna on Saturday and they could not agree to a specific commitment to join OPEC in limiting oil output levels to prop up prices, suggesting they want the oil producing group to solve its differences first. On Friday, OPEC members failed to agree how to put in place a global deal to limit production, following objections from Iran which has been reluctant to freeze its output. The non-OPEC did agree to meet again in November before a scheduled regular OPEC meeting on Nov. 30.

Elon Musk has unveiled a new kind of solar roof that will be offered starting next year through SolarCity, the home solar installation company that he is seeking to merge into Tesla. Whether meant to emulate clay tiles on a Spanish-style house or shingles on a colonial, Musk said they have 98% of the ray-collecting power of a conventional solar panel, are durable and will last longer than the house itself. Tesla gave little detail on cost, except to say that the cost of the roof would be less than a conventional roof plus solar. The plan is to combine the solar roof tiles with a bank of batteries called Powerwall, and provide power to an electric car.

Moody’s Investors Services just issued a bond rating report explaining how and why it considers climate change risk in rating energy companies. Among the G20 economies, electricity production and central heating account for 45 percent of the country’s carbon emissions. This is, of course, the economic sector that can utilize renewables right now. The firms in the electric business are capital intensive and issue bonds often. If the rating agencies become negative on the sector and lower the bond ratings, companies will pay more to raise money and a few will not be able to raise money.

Moody’s argument could be boiled down to this. The cost of renewable energy is falling, and lower renewable prices will put pressure on wholesale energy prices just as carbon pricing adds to the costs of the carbon-fueled generators. Thus, margins will fall the most for the least efficient carbon-fueled facilities. Moody’s entitled its report, “Carbon Transition Brings Risks and Opportunities”. In sum, it appears that big money is beginning to speak, and it says, “Carbon emissions count and if you don’t believe that, you’ll pay dearly if you need money and you might not get our money at all.”

Volkswagen plans to cut more than 10,000 jobs in coming years as the German auto giant switches its focus to making electric cars in the wake of its Dieselgate scandal.

Prime Minister Justin Trudeau has finally signed Canada’s free trade agreement with Europe at a ceremony in Brussels. CETA will remove 98% of tariffs – and officials hope it will generate an increase in trade worth $12 billion a year. For a while it looked like the trade deal might not happen because Wallonia, a province in Belgium objected to certain provisions, which were ultimately changed.

But the Walloon intransigence has underlined the extent to which trade has become politically radioactive as citizens increasingly blame globalization for growing disparities in wealth and living standards. What about implications for the much-debated US –EU trade deal? EU Trade Commissioner Cecilia Malmstrom declared, “TTIP is not dead,” adding that negotiations will continue after the November election.

Putting the fizz back into its line-up, Coca-Cola Ginger was launched in Australia today, as the South Hemisphere country ushers in summer. Coca-Cola South Pacific noted that sales of ginger-flavored drinks were up 6% in Australia over the past year, and Bundaberg Ginger Beer has been a favorite since it was launched in 1960.

Sony Corp cut its annual profit outlook due to losses related to the sale of its battery business – disappointing a market that had been hoping for an upward revision on sales momentum for PlayStation 4 and the launch of its virtual reality headset. Sony will announce its first-half results tomorrow.

Happy Halloween to everyone. I hope you enjoyed my costume today –if you haven’t noticed, I’m dressed as a weary broadcaster, sick to death of this seemingly never-ending political campaign where issues have fallen into a bottomless abyss, never to see the light of day. Eight more days until the 2016 campaign is over. Unless … No we won’t even go there. It’s gonna be over. Anyone who mentions the 269-269 electoral vote scenario gets banned.

Financial Review

Puerto Rico Screwed

Sinclair Noe — May 2, 2016

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

Subscribe: iTunes | Android | RSS

DOW + 117 = 17,891
SPX + 16 = 2081
NAS + 42 = 4817
10 Y + .05 = 1.86%
OIL – 1.14 = 44.78
GOLD – 1.50 = 1290.90

Puerto Rico’s governor said Sunday that he had ordered a debt moratorium, blocking a $422 million payment due today.  The US Congress continues to debate a legislative fix for Puerto Rico’s $70 billion debt load. The default ratchets up pressure on Congress to find a legislative solution for Puerto Rico, which owes another $1.9 billion of debt on July 1, including about $777 million in general obligation debt backed by its constitution.

Meanwhile, Puerto Rico is battling the Zika virus, and hospitals and health clinics are forced to shut down because of debt. New York City has sent one million condoms to help combat the spread of the disease. There is some symbolism there.

The Institute for Supply Management (ISM) said its index of national factory activity fell to 50.8 from 51.8 the month before. A reading above 50 indicates expansion in the manufacturing sector and a reading below 50 indicates contraction. The employment index rose to 49.2 from 48.1 a month earlier. Expectations called for a reading of 49.0. New orders dropped to 55.8 from 58.3. The prices paid index rose to 59.0 from 51.5, compared to expectations of 52.0.

Construction spending increased 0.3 percent to the highest level since October 2007, following an upwardly revised 1.0 percent jump in February. Construction outlays were up 8.0 percent from a year ago. In March, construction spending was supported by a 1.1 percent surge in private construction. Public construction outlays fell 1.9 percent in March.

According to a Federal Reserve survey of senior bank loan officers, credit quality deteriorated in the first quarter on loans to businesses and consumers in energy dependent areas of the country. Low energy prices have led to declining activity in regions of the country where oil and natural gas extraction is a key driver of economic activity.

According to the survey 58% of the banks reported that loan quality is going to continue to deteriorate assuming energy prices remain low. About 15% of banks reported that credit quality had worsened on consumer credit card loans and 14% on loans outside of credit card and autos. Commercial real estate loans were a concern for 16% of the banks. And the hardest hit area is auto loans, where 23% of banks reported credit deterioration. Almost half of the banks surveyed said they were tightening lending policies on firms in the energy sector.

Baker Hughes and Halliburton are calling off their megamerger. Opposition from both US and European regulators has caused the two energy giants to call off their $28 billion deal. The deal’s cancellation means Halliburton must pay Baker Hughes a $3.5 billion termination fee by Wednesday. The cash-and-stock acquisition – valued at $34 billion when it was announced in November 2014, and now worth about $28 billion – would have brought together the world’s No. 2 and No. 3 oil services companies, raising concerns about higher prices in the sector.

Oil-and-gas producers Midstates Petroleum and Ultra Petroleum have filed for Chapter 11 bankruptcy protection, joining several companies that have been unable to meet debt obligations after a steep decline in energy prices. Oklahoma-based Midstates and Houston-based Ultra have a combined $5.8 billion in debt.

The two join dozens of U.S. oil and gas producers that have filed for bankruptcy since the start of 2015. Following this weekend’s bankruptcies of Ultra Petroleum and Midstates, the energy high-yield default has soared to a record 13% rate, surpassing the 9.7% mark set in 1999, according to Fitch Ratings.

Talks for a free trade deal between the U.S. and Europe face a serious impasse with “irreconcilable” differences, according to leaked negotiating texts discussing the Transatlantic Free Trade Agreement. The leaked documents come from the Dutch chapter of Greenpeace show that American trade negotiators had pressed their European counterparts to loosen important environmental, consumer protection and other provisions.

The deal, known as the Transatlantic Trade and Investment Partnership, or TTIP, would cover a huge range of goods and services between the world’s largest national economy and the world’s largest single market, spanning telecommunications, agricultural products, textiles, intellectual property, financial services and regulatory compatibility. The documents were shared in advance with several European publications. When you consider this latest document leak along with the recent Panama Papers, one thing is starting to stand out. Secrecy doesn’t exist in the digital age.

Sports Authority has decided to sell its remaining assets. Rather than attempt to re-organize under Chapter 11 bankruptcy protection, Sports Authority will hold an auction May 16. If a buyer emerges, some locations could be saved. There are 463 Sports Authority stores in 41 states employing more than 14,500. Sports Authority is $1.1 billion in debt and lost $256 million before taxes in fiscal year 2015. In January, Sports Authority failed to make a $20 million debt payment.

Takata shares plunged as much as 16% overnight on reports that the company, already at the center of the biggest safety crisis in automotive history, will soon get hammered by regulators. The NHTSA has told automakers that recalls will expand to all cars with Takata air bags lacking a moisture-absorbing desiccant that keeps the devices from deteriorating. There are more than 100-million such vehicles worldwide.

Verizon is deploying “thousands” of extra personnel, as a strike of nearly 40,000 wireline workers drags on in its third week with few signs of resolution. Some employees are on special assignment and others are coming out of Verizon’s technical training in Virginia. On Thursday, the company made a “last, best and final offer” to leaders of the CWA and IBEW, but union leaders responded that Verizon needs to “get serious about negotiations.”

Hulu is designing a subscription service that would stream feeds of popular broadcast and cable TV channels, in a move that would make the company a competitor to traditional pay-TV providers and other new digital entrants. Until now, Hulu has offered on-demand programming from major networks, similar to Netflix.

Hulu wants to offer what is known as a “skinny bundle” of broadcast and cable channels; in particular, those operated by 21st Century Fox, the Walt Disney Company and Comcast’s NBCUniversal. Those three media companies co-own Hulu. They hope to launch the service in the first half of 2017. While exact pricing details are still being determined, the new service is expected to cost about $40 a month.

Sony is developing a pair of intelligent contact lenses. The tech nerds are calling them “smart eyes,” and they’re supposed to measure a person’s blink, wink, and tilt of the eye to figure out when to record, save and delete video. Sony’s contacts include a camera, a wireless processing component and a storage unit, and differ from Samsung’s smart lenses patented earlier this month, which rely on a smartphone.

Last week I promised more on the old idea of Sell in May and stay away. Stock market returns are far worse from May through the end of October, than they are during the rest of the year. So as May starts, history suggests that (based on market performance as a whole) you might be smart to sell your shares now, and not bother with markets again until November.  Over the past 15 years, stock markets have performed far better between November of one year and April of the next, than between May and October.

MSCI Asia ex-Japan Index, Singapore’s STI, the Hang Seng, Malaysia’s KLCI, the Shanghai Composite and the S&P 500 (as well as the MSCI World) all perform significantly better from November 1to April 30, than from May 1 to October 31.

For example, the MSCI Asia ex-Japan posted a negative return of 1.7 percent, on average, during the May-November period in 2001-2015, and a 9.0 percent return from November through April. Since 2001, on average the STI has fallen 1.9 percent from May through October, and appreciated by 6.7 percent during the period from November to April.

The biggest difference in performance for the two periods was for the Shanghai Composite, where shares fell by 6.3 percent on average from May through the end of October, but rose by 10.4 percent during the other period.

The S&P 500 has a negative 1.4% from May through October and a positive return of 5.1% for November to May, for a difference of 6.5%. Over the past 50 years, the average gain for the Dow was less than 1% from May to October. In contrast, the average gain was more than 7% from November to April.

So, the idea was that you sold Friday, and now you can go on vacation until November 1^st. Is it really that simple? Well, yes. Since 1950, there have only been 9 years when the DJIA Best Six Months failed to delivery market gains. And if you want to get a bit more specific, there is an extra entry-exit strategy. Sy Harding made some minor adjustments to the six-month cycle and added MACD as a timing mechanism (MACD stands for moving average convergence divergence).

First, start the bullish cycle on October 16th, which is two weeks earlier. Starting the cycle, a little earlier makes sense because there have been several October bottoms in the S&P 500. Second, start the bearish cycle on April 20th. Third, add MACD to time signals near these cycle dates (October 16th and April 20th).

So, you would look for a bullish MACD any time after October 16 for you buy signal, or you would look for a bearish MACD any time after April 20 for your sell signal. The S&P 500 crossed its signal line last week on the 26^th. As always, momentum indicators and seasonality always takes a back seat to price action. The Sell in May idea is playing probabilities, not a guarantee. The other nice thing is that you can take a summer vacation and you don’t have to worry about the markets.

Financial Review

Bad Medicine

Sinclair Noe — April 6, 2016

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

Subscribe: iTunes | Android | RSS

DOW + 112 = 17,716
SPX + 21 = 2066
NAS + 76 = 4920
10 Y + .03 = 1.75%
OIL + 1.84 = 37.73
GOLD – 8.90 = 1223.30

The FOMC issued the minutes from its last meeting, where the Fed left rates unchanged and lowered its forecast for hikes this year from four to two. Policymakers debated whether to raise rates but a consensus emerged that risks from a global economic slowdown warranted a cautious approach. According to the minutes, many Fed members said they were concerned that interest rates were still so low that the central bank had limited firepower to respond to shocks from abroad.

The proposed $160 billion merger between US-based Pfizer and Ireland-based Allergan is dead. Changes in U.S. tax codes dealt a blow to the largest-ever heath sector deal. New regulations issued Monday by the Treasury Department targeted so-called inversions, under which a U.S. company moves its base to a country with a more favorable taxation environment. Pfizer is expected to pay Allergan a $150 million breakup fee.

With the deal behind it, Pfizer said it would decide this year about whether to split off its hundreds of generic medicines into a separate business. Allergan said it would move ahead with plans for its $40.5 billion sale of its generic drug business to Israel’s Teva Pharmaceutical Industries. It expects the transaction to close by June.

The chairman of the U.S. House Transportation and Infrastructure Committee has come out against Canadian Pacific’s proposed railroad merger with Norfolk Southern, dealing another blow to the likelihood of a deal. Bill Shuster noted that CP Rail had actively pursued some sort of merger in the U.S. since 2014, which he said “has done nothing but create uncertainty in the rail industry.”

The Justice Department has filed a lawsuit aimed at stopping Halliburton from merging with Baker Hughes, a deal that would combine the No. 2 and No. 3 oil services companies. The DOJ says the deal threatens to eliminate head-to-head competition in 23 products and services used in oil exploration and create a duopoly with market leader Schlumberger. A merger might still happen if they divest assets or make other accommodations, but more than likely, this kills the deal.

Oil prices are rallying on hopes that both OPEC and non-OPEC members will agree to an output freeze at upcoming talks in Doha on April 17. Fresh comments from Kuwait and Russia suggest that global producers could reach a supply agreement deal despite conflicting statements by participants Saudi Arabia and Iran. Crude is also getting a boost from API industry data that showed U.S. crude inventories falling by 4.3 million barrels last week.

Clean energy investment broke new records in 2015 and is now seeing twice as much global funding as fossil fuels. One reason is that renewable energy is becoming ever cheaper to produce. Government subsidies have helped wind and solar get a foothold in global power markets, but economies of scale are the true driver of falling prices.

Just since 2000, the amount of global electricity produced by solar power has doubled seven times over. Even wind power, which was already established, doubled four times over the same period. For the first time, the two forms of renewable energy are beginning to compete head-to-head on price and annual investment.  The reason for the strong growth in clean energy is that it’s a technology, not a fuel. As such, efficiency increases and prices fall as time goes on. What’s more, the price of batteries to store solar power when the sun isn’t shining is falling in a similarly stunning arc.

Global bond yields fell to a record, a warning sign for the worldwide economy. The yield on the Bank of America Global Broad Market Index dropped to 1.3%, the lowest in almost 20 years of data. A third of the world’s developed-market sovereign debt now has negative yields, after Europe and Japan cut interest rates below zero to counter deflation.

Investors rushed to higher-yielding debt, fueling the global rally. Japan’s economy contracted in the last quarter of 2015, while the Eurozone’s barely grew. China this month cut its growth target. Bond yields indicate investors expect inflation worldwide to be about 1.1 percent. The figure dropped to 0.89 percent in February, the lowest level in more than five years.

The “Panama Papers” have claimed their first casualty: Iceland’s Prime Minister, Sigmundur Gunnlaugsson said he stepped down from his post, insisting it was a resignation, after the leak revealed his wife’s ownership of a shell company set up in the British Virgin Islands.

Today, comes word that at least three of the seven people on the Chinese Communist Party’s most powerful committee, including President Xi Jinping, have relatives who have controlled secretive offshore companies. It is uncertain what will happen in China, where most people aren’t even aware of the leaked documents. Chinese government officials have blocked internet searches and online discussion that involve the words “Panama Papers”.

Apparently information about the leaked documents and the players involved will be dished out on a near daily basis. Names of US citizens are expected in about one month. It will take some time to devour 11.5 million documents and connect the dots between 14,000 clients of Mossack Fonseca and the 214,000 offshore entities they created.

Here is what we do know; the system is rigged, and unless you are part of the one percent, it is rigged against you. Legislatures don’t write laws for you, courts don’t secure justice for you. The taxes you pay are not paid by people who are much wealthier than you; they cheat the system and they get away with it.

It is hard to muster righteous indignation because rational thought and recent history tells us it is nothing more than an exercise in futility. We might reasonably expect a few indictments of minor players, sacrificial lambs for the slaughter.  We know the system is rigged and the elites are cheating the rest of us; the only surprise would be if they weren’t cheating us. The big question that’s circling around the Panama Papers scandal at the moment is why more Americans haven’t been implicated.

Rumors are swirling in the comments section that wealthy Americans have bribed their way out of mention in the documents. It might just be that Mossack Fonseca’s client base is largely Europeans, Asians, and Latin Americans, because US citizens can just set up an anonymous shell company in Nevada, or Delaware, or South Dakota; no need to deal with a Panamanian law firm. As the details from the Panama Papers are dribbled out for consumption, we will see more Americans named.

Puerto Rico’s financial crisis is escalating. The island has taken steps toward a unilateral moratorium on all government debt payments, a sudden move that surprised both Washington and Wall Street. The Puerto Rican legislature passed an emergency declaration authorizing the governor to suspend payments on $72 billion in public debt—setting up a dramatic showdown between Puerto Rico and hedge funds amid the island’s historic debt crisis.

The bill authorizes the Puerto Rican governor to “protect the health, security and public welfare … by using government funds first and foremost for public services.” The emergency measure was in response to a suit filed by hedge funds attempting to freeze the assets of Puerto Rico’s Government Development Bank in efforts to stop the bank from spending money on the island that the hedge funds want to go toward upcoming debt payments.

San Francisco has become the first U.S. city to mandate six weeks of fully paid parental leave (in companies with 20 or more workers), requiring employers to shoulder much of the cost and exceeding federal and state rules for private-sector employees. California’s governor Jerry Brown on Monday signed into law a bill raising the state’s minimum wage from $10 to $15 an hour by the year 2023.

A big change for investors today, as the Labor Department unveiled the final version of its long-awaited fiduciary rule, requiring financial professionals to put their customers’ interests ahead of their own. The language is tougher than an existing rule that only requires brokers to ensure products are “suitable.” The Labor Department made some concessions to the financial industry in the final version of its highly-anticipated fiduciary rule.

In one of the biggest changes from the initial proposal, the final rule simplifies the “best interest contract,” a provision that allows brokers to continue to get paid commissions so long as they make a variety of disclosures to customers.  Unlike the draft proposal, the final rule does not restrict brokers from pushing proprietary products, splitting revenue with creators of funds they promote, or recommending risky, high-fee investments in alternative assets and certain annuities.

Additionally, the final rule includes a “grandfather” provision that won’t require brokers to adhere to a fiduciary standard for their previous recommendations to customers. The rule also loosens previously proposed disclosure requirements for fees. While the initial rule required annual disclosure of fees, the final rule removes that requirement. The final rule also eliminates a requirement to provide clients with one-, five- and ten-year projections of fees at the point of sale.

BP will be able to deduct a big chunk of its $20 billion Gulf of Mexico oil spill settlement for tax purposes. Under U.S. law, companies are not allowed to deduct penalties they pay as part of a settlement, but only $5.5 billion of the $20 billion cost of the settlement is a fine. BP can classify the remainder as “ordinary business expenses,” which are deductible.

Forget Apple vs. the FBI, WhatsApp just switched on encryption for over a billion people. Every conversation on the messaging service, whether it be a private or group chat, will now have full end-to-end encryption, thus making the recipient the only person who can see the message. WhatsApp was bought by Facebook for $19 billion in 2014.

Financial Review

Patience For Now

Sinclair Noe — March 13, 2015

 

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

Subscribe: iTunes | RSS

DOW – 145 = 17,749
SPX – 12 = 2053
NAS –  21 =  4871
10 YR YLD + .01 = 2.11%
OIL – 2.05 = 45.00
GOLD + 6.50 = 1158.40
SILV + .12 = 15.64

At one point today, the Dow was down 250, so it could have been worse. For the week, the Dow was down 0.6% and the S&P 500 fell 0.9%. The Nasdaq was down 1.1% for the week. Today is Friday the 13^th. All I can say is pure coincidence. We looked at the market for 148 Friday the 13ths, going back to 1928, there is no particular trend.

 In the last week of January we saw oil prices drop to right around the $45 a barrel level, with intraday lows of $44.37, but the daily closing price hovering just a little above $45. And in February, prices popped up to touch $55.05; prices challenging $55 on 3 days, and could not break out. So, now we are back to challenging support at $45. And waiting to see if the trading range will break down.

The International Energy Agency says oil prices remain fragile due to unrelenting production by US shale-oil producers. There has been an expectation that oil producers would cut back production in response to lower oil prices, but the IEA  report shows oil production in the US has increased by 115,000 barrels, and now we’re running out of places to store the oil. The IEA says it doesn’t see cutbacks in production until the second half of the year; and for now at least, ballooning inventories combined with shrinking oil storage likely will drag prices lower.

Baker Hughes reported today that the oil rig count dropped by 67 last week to 1125, and that has been a trend in the oil patch, but it also means that existing wells continue to produce. At some point, the IEA says those discontinued wells could make a difference in the supply, and when it does it will make for some serious price disruption; but as of now, the cutbacks haven’t kicked in.

Meanwhile, Reuters reports a tentative deal has been reached between the United Steelworkers and oil companies to end the largest US refinery strike in 35 years. The reported deal would last four years and “wage increases would be 2.5% the first year, 3% each in years two and three, and 3.5% in the fourth year.” The strike affected 12 refineries representing a fifth of US refining capacity. The deal still needs approval from the rank and file, but it will likely lead to more refined products making the way to your local gas station, which should open up some of the storage facilities for crude oil.

Next week, European leaders meet to consider whether to prolong economic sanctions on Russia. The thinking is that they will allow most, or all of the sanctions to expire in July, and they will not be looking to add new sanctions.  And while Russia has continued to supply oil to the world markets, an easing of sanctions is likely to result in a fresh wave of Russian oil supply hitting the market; you know, to make up for lost revenue. Also, today Russia’s central bank cut its key interest rate one percent to try to stimulate its economy. That’s the trend these days; cut rates to give a jolt to the economy; it’s also a battle to devalue currencies.

Now, toss in a strong dollar. Over the past 14 sessions, the S&P has had a correlation of -0.96 to the dollar index, meaning that stocks consistently fall on days when the dollar gains. Perfect inverse correlation is -1.0.

Tokyo stocks surged through the 19,000 level today to record their highest close since April 2000. The Nikkei currently leads all major Asian markets with a 10.5% year-to-date gain. The Japanese stock market has been sparked by Bank of Japan stimulus, (known as Abenomics), which has pushed the yen down to the lowest levels against the dollar in 8 years.

And of course, the European Central Bank started its version of QE this week, and they will be buying about $66 billion dollars of bonds per month. In addition, concerns about Greece’s status in the euro bloc have weighed on the common currency. The dollar pushed to a new 12 year high today against the euro.

Also, investors are wagering that recent solid jobs data from February will persuade the Fed to send signals for a coming rate increase, perhaps as early as midyear, at its two-day Federal Open Market Committee meeting next week. The pace of the dollar’s rise against worldwide currencies suggests a number of undesirable outcomes for the US economy. First, there’s the loss in export competitiveness. In fact, the U.S. trade deficit just hit a record high (excluding oil). Secondly, corporations have to endure the disintegration of profits made in foreign currencies. Indeed, forward earnings estimates for the initial two quarters of 2015 have turned negative. But the Fed is looking at something different, and they are likely to hint at raising rates, even as it becomes harder to justify a rate hike. Still, no one wants to be short dollars going into FOMC. The Fed meets Tuesday and Wednesday, and until then we’ll just have to be patient.

One of the side effects of a strong dollar is disinflation, or maybe we could even call it deflation. Producer Prices dropped 0.5% in February. Despite the first rise in gasoline costs since last summer, US producer prices, or prices at the wholesale level, fell in February for the fourth straight month. Wholesale gas prices climbed 1.5% in February, the biggest increase since last June. Yet food prices retreated 1.6% to mark the biggest pullback in almost two years. Trade prices sank a record 1.5%. Excluding the volatile categories of trade, food and energy, core prices were flat on the month. Over the past year overall producer prices have fallen by 0.6%, the first 12-month decline on record.

The University of Michigan’s consumer sentiment index dropped to 91.2 in March from 95.4 in February. That’s the worst reading since November. We get cranky when we have to pay more for gas.

The Feds are looking into hedge fund manager Bill Ackman’s assault on Herbalife. Neither Ackman nor his fund, Pershing Square, has been served a subpoena. But The Wall Street Journal reports: “Prosecutors in the Manhattan US attorney’s office and New York field office of the FBI have conducted interviews and sent document requests in recent months in connection with the investigation, which is looking into whether people, including some hired by Mr. Ackman, made false statements about Herbalife’s business model to regulators and others in order to spur investigations into the company and lower its stock price.”

This week we learned that Wall Street bankers are struggling, and the bonus pool paid to security industry employees in New York City – that’s just in New York City – was $28.5 billion. It works out to an average bonus of $172,860. So somebody at the Institute for Policy Studies pulled out their calculator and figured that if you take 1.03 million full-time workers paid an hourly wage of $7.25 or less, the minimum wage, and multiplied by 50 hours of work per week; the total compensation would be about $15 billion dollars, more or less. A 40 hour work week would put the compensation at about $14 billion. So, the sum of Wall Street bonuses just for New York City is roughly twice the total amount paid to all the full-time workers paid minimum wage in the entire country.

It has been a busy week, which included news that most of the big banks had passed a stress test, and you might think that means the banks haven’t been getting into trouble. Not exactly. It’s time for today’s edition of “Banks Behaving Badly”. We start with Commerzbank, one of Germany’s largest lenders, which agreed to pay nearly $1.5 billion and dismiss some of its employees to resolve an array of charges in the United States. Commerzbank was accused of sending tainted money through the American financial system; siphoning funds to sanctioned Iranian corporations, facilitating accounting fraud at Olympus, the Japanese camera company; charged with Bank Secrecy Act criminal offense and institutional anti-money laundering. Eight regulatory agencies investigated the bank.

Leslie Caldwell, head of the Justice Department’s criminal division, which prosecuted the criminal part of the case said, “Financial institutions must heed this message: Banks that operate in the United States must comply with our laws, and banks that ignore the warnings of those charged with compliance will pay a very steep price.” And of course, we all know that means there were no indictments, just a fine; but in a rare breach of prosecutorial etiquette, the bank was not allowed to deny wrongdoing.

Meanwhile Bloomberg reports the Justice Department is about to get tough on banks that rigged the foreign exchange markets. Prosecutors are reportedly pressing Barclays, Citigroup, JPMorgan and the Royal Bank of Scotland to plead guilty, which would mean a fine, and the starting point for rigging the global currency markets is $1 billion, more or less. In keeping with prosecutorial etiquette, prosecutors are seeking a simultaneous settlement with the banks, which would enable the lenders to avoid being singled out for industrywide conduct.

Two weeks ago the FCC voted to approve rules on net neutrality and today they released the text on the actual rules. A couple of key points, the new rules will ban paid prioritization – so the internet cannot be divide into “haves” and “have nots”, or fast lanes and toll lanes; also the rules would ban blocking, meaning consumers must get what they pay for, unfettered access to any lawful content on the Internet.

The 400 pages of the FCC rule aren’t exactly beach reading, but if you are still trying to understand the importance of the ruling and the need for it, the first two sentences offer a nice summation: “The open Internet drives the American economy and serves, every day, as a critical tool for America’s citizens to conduct commerce, communicate, educate, entertain, and engage in the world around them. The benefits of an open Internet are undisputed.”

FINANCIAL REVIEW

Up, Down – Take Your Pick

Sinclair Noe — February 4, 2015

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

DOW + 6 = 17,673
SPX – 8 = 2041
NAS – 11 = 4716
10 YR YLD + .02 = 1.80%
OIL – 4.49 = 48.56
GOLD + 8.80 = 1269.90
SILV + .06 = 17.43

ADP reports private-sector employment gains slowed in January as employers added 213,000 jobs. ADP revised December’s gain to 253,000 from a prior estimate of 241,000. The non-farm payroll report (that’s the government’s big monthly jobs report) comes out Friday morning; it is expected the economy added about 245,000 jobs in January, down from 252,000 in December.

The Institute for Supply Management said its nonmanufacturing index edged up to 56.7% in January from 56.5% in December. Readings over 50% signal that more businesses are expanding instead of contracting. The good news is that new orders remained very healthy. The index measuring fresh demand rose a few ticks to 59.5% and remained close to a post-recession high. On the downside, the employment gauge fell 4.1 points to 51.6%, marking the lowest level in 11 months. It was also the second worst reading in 20 months. So, on the jobs front, we should still see gains, just not as strong as the past few months.

Gallup’s Job Creation Index came in at plus 28 for the month of January. This is nearly identical to the plus 27 found in December, and just below the seven-year high of plus 30 reached in September. The index has experienced six years of incremental progress after bottoming out at minus 5 in February and April 2009. Gallup says workers’ perceptions of hiring at their places of employment are the most positive Gallup has recorded in any January since Gallup began tracking this in 2008. Americans’ confidence in the economy has improved significantly since early December, and over the same period, Americans have become much more optimistic when asked if it is a good time to find a quality job. Whether these sentiments prove to be advance indicators of hiring that is more visible across U.S. workplaces may partly depend on whether they help fuel more consumer spending.

Oil prices were down today following a rally that pushed up prices by about 22% over the past four sessions (which would technically qualify as a bull market). Drilling activity plunged in the US and oil companies deepened spending cuts to more than $40 billion since Nov. 1. US crude stockpiles increased last week from the highest level in three decades, adding an extra 6 million barrels to inventory. And prices dropped 8% today. So, the question is where are prices headed? I’ve been reading stories all day about the direction of oil prices. Some say the past few days are nothing more than a dead cat bounce or a short squeeze; others claim this is the start of a “V” shaped recovery and prices are going back to triple digits. Up, down – take your pick. I don’t know, the people writing the stories don’t know.

One reason oil prices have dropped is because the dollar has been getting stronger and oil is purchased in dollars; a strong dollar means it requires fewer dollars to purchase the same amount of oil. The Dollar Index is up about 20% since last summer. Oil prices are down about 50% over the same time. It doesn’t quite match. Another thing that doesn’t quite match is all the other stuff we buy that is imported. We’re buying imports with strong dollars.  Why isn’t all that stuff, not made in America, lower in price?

The thing is, the dollar index is measured against a basket of six currencies including the euro and the Japanese yen. If you look at the stuff Americans buy, they’re from countries that aren’t represented in the dollar index; such as: China, Mexico, India, Vietnam and Israel. Almost 80% of U.S. consumer-goods imports, excluding autos, come from countries that aren’t in the dollar index. Comparing against those countries, the dollar is up about 7% and import prices are down about 5.5% So, a strong dollar is just a small part of the reason for lower oil prices.

Even if prices went up from here it might not be enough to save some of the producers and their creditors. And if prices go lower, it might not affect production as you might imagine. Two weeks ago, Baker Hughes announced it was cutting 12% of its workforce and 15% of its output, but previous downturns have resulted in 40% to 60% cuts. At the same time BHP Billiton announced it was cutting the number of rigs it operates in US shale oilfields from 26 to 16, but it would take a few months to cut back, and even after the cutbacks “the company does not expect the slowdown to have an immediate effect on its oil and gas production, which it still expects to average about 700,000 barrels of oil equivalent per day.”

Yes, over time, lower prices will affect production, but over the intermediate term, creditors will demand payments and that means the pumps keep pumping, even at little to no profit. Revenues will have to cover obligations. Debt must be serviced.

Over the last five years, oil and gas companies have issued bonds and taken out loans that are together worth $1.2 trillion, according to data from Dealogic. Back in the 1980s oil crash about 700 banks failed, mainly smaller, regional banks in Texas. Now, there are some smaller Canadian banks and a few Texas-based regional banks with concentrated exposure to the oil patch, but losses are not expected to approach the 80s, and the other creditors are the mega banks that can withstand a few billion in losses.

Still, the sharks are already smelling blood. Several private equity firms such as Carlyle, Blackstone, and KKR are taking on large positions in indebted oil companies. There are already examples of these firms providing emergency loans at very high rates plus an ownership stake. At the recent Davos World Economic Forum, David Rubenstein, co-founder of the Carlyle Group said “The single best opportunity to invest is distressed debt in energy.”

But the energy companies are not going to give up easily. The squeeze is tightest when companies face a deadline to pay back money they have borrowed. And they may be forced to maintain or increase production.

And moving beyond the supply demand equation, yesterday, the New York Times reported that Saudi Arabia has been trying to pressure Russian President Putin to abandon his support for Syrian President Bashar al-Assad, using its dominance of the global oil markets at a time when the Russian government is reeling from the effects of plummeting oil prices. A Saudi diplomat was quoted saying, “If oil can serve to bring peace in Syria, I don’t see how Saudi Arabia would back away from trying to reach a deal.” None of this is a revelation; we talked about oil as a financial weapon back when Russia was first posturing in Ukraine. Any weakening of Russian support for Assad could be one of the first signs that the recent tumult in the oil market is having an impact on global statecraft.

Here’s the point: if anyone says they know what oil prices are going to be, they are wrong.

A funny thing happened today with Greece. The Athens General Stock Index closed up today by about 7%. Then this afternoon in New York, right before the close, the ETF that is based on Greece, the GREK, suddenly plunged about 11%. The European Central Bank announced that it will no longer accept Greek government debt as collateral starting next week. The ECB said it is presently impossible to assume a successful conclusion of the current Greek program. In other words, the ECB doesn’t see Greece complying with existing bailout rules.

But the governing council also approved the Greek central bank issuing Emergency Liquidity Assistance to the Greek banking system to cover any liquidity shortfall caused by today’s move. This means Greece could still get money, but they will pay more for it, and it is just a temporary Band-Aid. This also means that the money spigot could be turned off if Greece’s new government doesn’t behave the way the ECB wants. Unless the 15 billion-euro limit on short-term borrowing set by Greece’s troika of official creditors is raised, the government may run out of cash on Feb. 25. With Greeks yanking their cash from banks and withholding tax payments, it is thought the new Greek government would only be able to survive for a few more weeks by tapping social-security funds and withholding payments to vendors.

The Greeks may be able to survive this, provided there is not a run on their banks. It basically boils down to political hardball. The Greeks were hoping to rewrite their debt. The Troika has now slapped down that plan.

General Motors reported a 91% jump in its fourth-quarter profit, beating analyst expectations. GM said it plans to boost its dividend starting in the second quarter. Later this month, GM will pay about 48,000 U.S. hourly workers profit sharing checks of $9,000 based on its 2014 financial performance. Fourth-quarter profit earnings before dividends rose to $1.99 billion compared with $1.04 billion a year earlier. Excluding some charges, the company earned $1.19 a share, handily beating analyst estimates of 83 cents a share.

Ford is adding 1,500 workers across four plants to build the new F-150 pickup truck and plans on shifting hundreds of union-represented workers from entry-level wages to the pay veteran plant workers make, in the coming weeks.

Staples has agreed to buy Office Depot for $6.3 billion. The deal values Office Depot at $11 a share, a premium of 44% over the closing price of Office Depot shares as of Monday. Together, the two companies have roughly 4,000 stores and annual sales of more than $35 billion. A merger would almost certainly reduce competition, result in some store closings, and mean higher prices for consumers. A combination of the two likely would get a close look from antitrust regulators, who in 1997 sued successfully to block the same proposed merger.

FINANCIAL REVIEW

One Foot on the Gas, One Foot on the Brake

Sinclair Noe — January 30, 2015

 

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

DOW – 251 = 17,164
SPX – 26 = 1994
NAS – 48 = 4635
10 YR YLD – .08 = 1.67%
OIL + 3.25 = 47.78
GOLD + 25.00 = 1284.10
SILV + .31 = 17.33

GDP growth slows. The Commerce Department reports fourth quarter gross domestic product grew by 2.6%, down from a very strong 5% growth rate in the third quarter. The results were below consensus estimates of 3% growth. For all of 2014, the economy grew 2.4% compared to 2.2% in 2013.

Consumer spending advanced at a 4.3% pace in the fourth quarter – the fastest since the first quarter of 2006 and an acceleration from the third quarter’s 3.2% pace. The final read on the University of Michigan’s consumer sentiment index was 98.1, down a tick from the 98.2 in the preliminary estimate. That’s still above the 93.6 mark in December and the best reading in 11 years.

Just as consumers were stepping on the gas, businesses were tapping the brakes. Business spending on equipment fell at a 1.9% rate. It was the largest contraction since the second quarter of 2009. The fourth-quarter weakness could reflect cuts or delays to investment projects in the oil industry. But it could also be payback after two back-to-back quarters of robust gains.

A wider trade deficit, as slower global growth curbed exports and solid domestic demand sucked in imports, subtracted 1.02 percentage point from GDP growth in the fourth quarter.

That’s how it works when the rest of the world is moving to QE. Worldwide central bank stimulus now totals over $10 trillion dollars. The new buzz phrase is currency wars, or you could just call it competitive devaluation. Countries are competing against each other to achieve a relatively low exchange rate for their own currency. As the price to buy a currency declines, so too does the price of exports from the country and imports become more expensive. This allows domestic industry and employment to expand.

The downside of this is that price increases for imports can harm citizens’ purchasing power. A policy of competitive devaluation can also result in retaliatory action by other countries, which in turn, can lead to a general decline in international trade. For the US, the problem is that a stronger dollar is slowing GDP growth even as we see the benefits of lower oil prices to counter tougher export markets.

Inflation remains muted in the fourth quarter. In a separate report the Labor Department reports the personal consumption expenditures (PCE) price index fell at a 0.5% rate, the weakest reading since the first quarter of 2009. Excluding food and energy, prices rose at a 1.1% pace, the slowest since the second quarter of 2013. The strong pace of consumer spending in the fourth quarter was overshadowed by a drop in capital expenditure. The PCE is the inflation gauge used by the Federal Reserve, and it is telling the Fed not to rush into raising rates.

In Europe – Deflation. Eurostat today reported the largest decline in consumer prices in the eurozone since July 2009. Consumer prices were 0.6% lower than in January 2014, having fallen 0.2% on an annual basis in December.

European stocks slipped today on the deflation report, but the region’s equity benchmark was still on track for its best monthly performance in more than three years. The Stoxx Europe 600 is up 7.2% for the month of January, which would be its best since October 2011.

Russia’s central bank cut its key interest rate to 15% this morning, after announcing a surprise hike from 10.5% to 17% in December to shore up the weakening ruble.

European Union foreign ministers have extended existing sanctions against Russia, but held off on tighter economic measures for now. Last year’s travel bans and asset freezes will now continue until September. Any sanction require a unanimous vote by all the EU countries. There was some question about whether Greece would approve sanctions, but much of that was misreported. Greece did not oppose sanctions; the EU just never asked the Greeks, and the Greeks did not appreciate being neglected in that manner. It was really symptomatic of how the EU has dealt with Greece for several years now.

Meanwhile, Greece’s new, leftist government opened talks on its bailout with European partners today by flatly refusing to extend the program or to cooperate with the international inspectors overseeing it. Prime Minister Alexis Tsipras has repeatedly said he wants to keep Greece in the euro but he has also made clear he will not back away from election campaign pledges to roll back the terms of the bailout.

A funny thing happened today in the oil market, prices went up, and it was a fast move. There was a big drop in the number of US oil rigs. Baker Hughes reports petroleum producers took 94 oil-drilling rigs off the market in the United States this week as sub-$50 oil continued to wreak havoc on the oil industry. Prices jumped and then many traders probably decided to cover short positions on the last trading day of the month. This week’s drop left 1,223 oil units up, the lowest number in three years. It was the biggest one-week decline for oil rigs since 1987. That year, the oil industry had faced another oil bust that left hundreds of rigs idle or repossessed by banks, which sold them for scrap.

Earlier today, the Commerce Department reported investment in drilling rigs and wells climbed at an 8.9% pace in the fourth quarter after an 8.3% increase from July through September. Prices were going down in the fourth quarter and domestic oil producers were shrugging and pumping more. At least until just recently.

By the way, if you were wondering what lower oil prices mean for renewables, the quick answer is not much. Oil is for cars; renewables are for electricity. The two don’t really compete. The biggest limit to solar installations is the availability of panels. And even as gas prices have dropped, the price for electricity continues to go up. And that is the advantage of solar; as time passes, the efficiency of solar power increases and prices fall. It’s a technology, not a fuel.

And it would be crazy to believe oil prices will stay this low forever. The history of oil prices follows a golden rule: What goes down must come up. Goldman Sachs identified almost $1 trillion in investments in future oil projects that are no longer profitable with oil under $70 a barrel. American drillers are idling rigs faster than they have since 1991. Eventually, supply will shrink and prices will rise again.
Shares of solar and wind companies have been pulled down with oil prices. Still, global investment in clean energy increased 16% last year, to $310 billion. Fossil-fuel subsidies outpace renewable-energy subsidies by a factor of 6 to 1, and this represents a strain on government budgets, and not just here in the US. Reducing the subsidy gap is one of the cheapest ways to increase fuel efficiency and speed up the switch to cleaner energy.

And then that pesky problem of climate change isn’t going away. The U.S. and China reached a historic deal in November to rein in greenhouse gases. Pope Francis is preparing a papal encyclical on climate change, a letter to the world’s bishops that will formalize the church’s moral position on the issue for 1.2 billion Catholics.

With today’s move, oil prices are up 5.8% for the week, but still down 9.4% for the month.

For the week, the Dow was down 2.8%, the S&P was down 2.8% and the Nasdaq down 2.6%. For the month, the Dow was down 3.6%, the S&P fell 3.1% and the Nasdaq was off 2.1%. January marked the worst monthly performance for both the Dow and S&P since January 2014.The Dow has now dropped under support at 17,200 and the S&P has dropped under 2000.

Do you want to know how stocks might perform this year? A widely followed market theory, the January barometer, claims that as January goes, so goes the year. It worked two years ago; January 2013 was a positive month for stock prices, up 7%, and the market went higher for the year by 30%. January 2014, saw stock prices drop by 4%, and it didn’t work – prices were up last year by a little over 11%.

Interestingly enough, while an up January is generally bullish for stocks, a down January is not a reliable predictor of a weak year overall. In ten out of twenty-four weak January years, the stock market actually ended higher, often by a very substantial amount. Indeed, this has happened four times in the last decade alone.

Visa announced an 11.5% increase in profit during the quarter, as a strengthening U.S. job market and cheaper gasoline prices encouraged people to spend. Beating both top and bottom line estimates, net income rose to $1.57B from $1.41B, a year earlier. Visa also announced a four-for-one stock split, cutting its weight in the Dow from 9% to 2.5%.
(Here’s a little quiz. Q: Now that the weighting for Visa is dropping, which Dow Industrial stock has the highest price weighting? A: Goldman Sachs.) (Goldman Sachs and Visa both entered the Dow in September 2013, when the average was last reshuffled. Visa rallied 25% since it joined the gauge on Sept. 20, 2013, while Goldman Sachs gained 3.7%, compared with Dow’s 13% advance. So, Goldman has the highest weighting, due largely to underperformance.)

Shake Shack’s initial public offering priced well above expectations at $21 apiece, and in its first day of trading, the burger chain more than doubled to $48. Underwriters had set an expected price range of $17-$19 per share, up from an initial $14-$16 due to strong demand. At the IPO price, Shake Shack boasted a valuation of about $746 million. Following today’s gain, the market value is more than $1.7 billion. Shake Shack’s debut comes two days after a CEO change at McDonald’s Corp., which is mired in its worst US sales slump in more than a decade.
Next week brings more earnings reports including a slew of energy companies. Monday, we’ll get a report from the Institute for Supply Management. Auto sales are coming out on Tuesday. Next Friday we have the monthly jobs report.

FINANCIAL REVIEW

Work Hard and Invest in the Future

Sinclair Noe — November 17, 2014

DOW + 13 = 17,647
SPX + 1 = 2041
NAS – 17 = 4671
10 YR YLD + .02 = 2.34%
OIL – .37 = 75.45
GOLD – 2.00 = 1187.50
SILV – .18 = 16.24

Another day, another record on Wall Street. A record high close for the S&P 500. The Dow did not close above Thursday’s record close of 17,652.

The Dow Transports were down today, but Transportation stocks are the best performing names on the market over the past month. Since the market bottomed out on October 13th, the Dow Jones Transportation Average has soared an incredible 18%. So if you thought the S&P’s furious 11% rally has been a sight to behold, you clearly weren’t paying attention to the soaring plane, train and trucks.

Another Merger Monday; Halliburton agreed to buy Baker Hughes for about $34 billion. Actavis agreed to buy Allergan for $66 billion.

The Halliburton acquisition of Baker Hughes will unite 2 major oilfield services companies. Halliburton and Baker Hughes began discussions in mid-October; an interesting time as oil prices were falling, raising questions about the viability of expanding oil and gas exploration and development. The acquisition was on again, off again, and briefly turned hostile last week. The deal could still face regulatory scrutiny, even though Schlumberger is still the largest oilfield services company, bigger than a combined Halliburton/Baker Hughes. Halliburton has agreed to sell off businesses that generate up to $7.5 billion in revenue to appease the federal government.

Low oil prices tend to trigger consolidation, mainly because the big oil companies do not believe low oil prices will last, so they consider acquisitions as value plays. Buyers with cash to spend aren’t going to let the cheapest valuations in years pass them by and targets threatened by lower prices may become more willing sellers. So, the speculation ramped up with today’s announcement. Possible deals include General Electric going after National Oilwell Varco, and there is even speculation that someone might target BP. Some potential smaller targets include Oasis Petroleum, Pioneer Natural Resources, and Laredo Petroleum.

Allergan has agreed to sell to Actavis. The $66 billion deal, or $219 per share in cash and stock, ends months of speculation about a possible hostile takeover led by activist investor Bill Ackman, who had been working with Valeant Pharmaceuticals to court the Botox manufacturer. So, the Actavis deal would be the largest of the year; bigger than the $45 billion proposed acquisition of Time Warner Cable by Comcast; bigger than AT&T’s $48 billion purchase of DirecTV; and the third largest health care deal ever in the US. Combining Actavis and Allergan will create one of the 10 largest global drug makers, with about $23 billion in revenues expected next year.

Actavis was until recently based in Parsippany, N.J. But last year it agreed to acquire an Irish drug maker, Warner Chilcott, and relocate its headquarters abroad, striking one of the first big tax inversions. Actavis’s deal to move abroad and reduce its tax bill caught the attention of other drug companies, and set off a rush of similar deals. In September, the Treasury passed new rules to make it harder for companies to use inversions to skip town on taxes. But Actavis is like the cow that got out before the barn door was closed; Actavis completed its move overseas and is exempt from new inversion rules.

In economic news, industrial production fell a seasonally adjusted 0.1% in October, a bigger than expected drop and the second drop in the last three months. In October, manufacturing output rose 0.2%, but mining output dropped 0.9% and utilities output fell 0.7%. Capacity utilization fell to 78.9%. Oil and gas well drilling fell 0.8% in October, the first decline since February. Despite the drop, industrial production is up 4% over the last 12 months. Based on the recent weakness in manufacturing it is estimated that fourth quarter GDP may be running at about a 2% annual pace, down from 3.5% in the third quarter.
Separately, the Federal Reserve Bank of New York reported its Empire State manufacturing index rebounded a bit to 10.2 in November from 6.2 in October. The index had been up to 27.5 in September, so the readings over the last two months indicate a downshift in activity.

Last week was light on economic data; this week the big story will be Wednesday as the Federal Reserve FOMC releases minutes of the October 28-29 FOMC meeting, which was the meeting that ended Quantitative Easing 3. The minutes will be parsed for clues on labor markets, global weakness, a stronger dollar, and the inflation-deflation debate.

This week’s economic calendar will also include reports on homebuilders’ sentiment and home sales. Tomorrow we’ll look at inflation on the wholesale level with the Producer Price index. Lower oil prices will likely play a big role in tomorrow’s report. Wholesale gasoline prices were down 11% in October, which could knock 0.6 to 0.8 percentage points from the headline inflation number. In September, weakness in miscellaneous service prices drove a 0.1% decline. The Consumer Price Index, which measures inflation at the retail level, will be released on Thursday, and again energy prices will be an important component. Best guess is that inflation is running at a 1.8% annualized rate according to the CPI.

The general feeling seems to be that oil prices will rise. OPEC holds a meeting November 27 in Austria, and there will certainly be discussion about cutting production and supply. A decrease in global demand and the boom in US shale have pushed prices down more than 25% since June, but OPEC’s 12 member countries are not unanimous on production cuts. Last week, Kuwait’s oil minister said he didn’t think there would be a reduction in output. Over the weekend, Kuwait’s cabinet and Supreme Petroleum Council held a meeting to consider options to halt the slide in prices. It’s a sign the nation is becoming increasingly concerned. The Saudis have said they could live with lower prices, and they don’t want to lose market share if they do agree to a cut, so they won’t try to cut back production on their own, but if other nations agree to a production cut, the Saudis will probably go along.

Another question OPEC will have to consider is global demand, specifically in light of the economic weakness in Europe, announced last week and the news from Japan today. Japan Is In Recession. Unexpectedly poor GDP data confirmed Japan has been in recession, with a 1.6% rate of contraction in the third quarter when a 2.2% rate of growth was expected; this followed a 7.3% rate of decline in second quarter.

The Central Bank of Japan and Prime Minister Shinzo Abe has thrown everything but the kitchen sink at the Japanese economy. The problem is that certain parts of the government got worried, and decided they could not live with the debt, and they needed to raise taxes, which turned out to be a terrible idea. Japan was expected to hike tax rates for the second time this year. Given that the first tax hike has been blamed for this year’s economic woes that second hike is likely to be delayed. And it is now recognized that a Valued Added Tax, or VAT increase was the cause of the recession. Japan also tipped into a recession after a 1997 consumption-levy rise, leading to the fall of the government of the day. Today’s report comes two days before the Bank of Japan’s next policy meeting. Governor Haruhiko Kuroda last month led a divided board to expand what was already an unprecedentedly large monetary-stimulus program.

The unexpected shrinkage of the Japanese economy sent Japan’s major stock index, the Nikkei, tumbling 2.9%. The yen tumbled to a 117.05 per dollar, the lowest level since October 2007. Markets were down in Europe, and it was expected US markets would tumble on the news, but it didn’t really happen.

This is the sixth time in the past 20 years that Japan has dropped into recession and you might think there are a few things we could learn from the Japanese experiment. First, Japan’s famously stagnant economy may not be all that unique, and if it can happen to Japan, it can happen anywhere.

When the asset-price bubble first burst in Japan in the early 1990s, they did not pursue an aggressive fiscal stimulus program and they did not force banks to quickly recognize losses and recapitalize. Instead, Japan’s ill-timed effort to balance its budget with a consumption-tax increase in 1997 sent the economy into recession, and a paralyzed banking sector contributed to an extended period of stagnation that has done much more to worsen the debt burden than well-targeted government spending would have.

Japan’s problems in the 1990s look a lot like the problems facing the Eurozone today: undercapitalized banks, lethargic business lending, and rolling recessions that turn into extended periods of stagnation.

By the way, the 2-day summit of the G-20 wrapped up in Australia, and like most G-20 meetings, it was not very productive. It will likely be remembered for Vlad Putin’s boorish behavior, but there were a few things that might count as accomplishments. The G-20 managed to sign off on anti-tax-evasion measures and on anti-corruption guidelines. One of the biggest accomplishments might be agreement by leaders to boost their economies by a collective $2 trillion by 2018. IMF Managing Director Christine Lagarde told the leaders that in order to avoid the “new mediocre” of low growth, low inflation, high unemployment and high debt, all tools should be used at all levels.

The G-20 plan to boost global growth is long on ambition but short on specifics. The mostly structural policy commitments spelled out in each country’s individual growth strategy include China’s plan to accelerate construction of 4G mobile communications networks, a $417 million industry skills fund in Australia and 165,000 affordable homes in the U.K. over four years. So the plan to avoid stagnant economies is to invest in housing, education, and infrastructure. Now, whether any of this comes to pass remains to be seen, but really this economics stuff is pretty simple. Work hard and invest in the future.