Financial Review

Honey for Bears

Sinclair Noe — February 8, 2016

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DOW – 177 = 16,027
SPX – 26 = 1853
NAS – 79 = 4283
10 Y – .11 = 1.74%
OIL – .80 = 30.09
GOLD + 15.50 = 1190.00

This was just an ugly session from the start. The Dow opened about 200 points down and then trickled lower; at one point down more than 300 points. The S&P 500 index broke down through the key level of support at 1860 that I warned you about in January and again last week, taking out the August 2015 lows and the October 2014 lows.

The S&P 500 not only took out support from January, but now we look to minor support at 1815, and then, well there isn’t really any support. In other words, the charts look very dangerous here.

And if you prefer fundamentals over technicals; this is what FactSet had to say in its recent report: “For Q4 2015, the blended earnings decline is -3.8%. If the index reports a decline in earnings for Q4, it will mark the first time the index has seen three consecutive quarters of year-over-year declines in earnings since Q1 2009 through Q3 2009.”

The difference this time versus 2009 is that valuations are much higher. FactSet data show expectations for first-quarter per-share earnings have collapsed to a decline of 5.5% as of today. Back in September, that forecast was for growth of 4.8%. By the end of December, it had fallen to growth of just 0.8%.

Chinese stock markets are closed for trade all week to celebrate the Lunar New Year, providing little direction for European stocks at the open. However, data out over the weekend showed China’s foreign-exchange reserves fell to the lowest level in more than three years last month, in another sign of capital flight as the yuan weakens.

European stocks opened lower, extending last week’s losses. The Stoxx Europe 600 index had its lowest close in more than 15 months; banks in the Stoxx Europe 600 Index have dropped about 39 percent since a peak in July. Their slump this year is the worst of any other industry group.

Oil prices kicked off the week in the red. Data on oil demand in the world’s two largest markets, the U.S. and China, has taken a sharp turn lower. U.S. demand for oil products in January fell 3.9% compared with January 2015. In China, although overall oil demand was flat in December and an improvement on November’s outright decline, it still represented the second weakest reading for the year.

Meanwhile, hopes about an agreement between producers within and outside of the Organization of the Petroleum Exporting Countries to cut output and support prices have also faded in recent days. A meeting between Saudi Arabia and Venezuela on Sunday ended without any plans for a production cut. Iran plans to sell 300,000 barrels of crude oil a day to European customers now that Western sanctions are lifted. And within the next few months, Iran wants to ramp up production to 500,000 barrels a day, with the remainder going to Asia.

Chesapeake Energy, the natural gas driller that’s been cutting jobs and investor payouts to conserve dwindling cash flows, lost more than half it stock market value today after a report that it hired a restructuring law firm. The company’s bonds led losses among high-yield debt. Chesapeake’s notes due March 2016 (about $500 million in bonds) tumbled to a record to 74.5 cents, from 95 cents last week, while its bonds maturing in 2017 fell to an all-time low at 34 cents.

Exchange-traded funds that hold US junk bonds slid to their lowest levels in almost seven years. BlackRock’s iShares iBoxx High Yield Corporate Bond exchange-traded fund and SPDR Barclays High Yield Bond ETF both fell to the lowest levels since 2009. In high yield, energy, communications and health care fared the worst. Banks and insurers in Europe led a surge in the cost of insuring corporate bonds to the highest levels since 2013.

European financial firms are taking a beating amid fears of “a chronic profitability crisis that makes it impossible for banks to build up barely-adequate capital bases. None of the fresh wave of selling stems from new news, but the list of negatives is long. Fears surrounding non-performing loans and other deep-rooted issues in the Italian banking sector have driven nerves, while a slew of weak earnings from large banks such as Credit Suisse and Deutsche Bank have added to concerns. The worst of the lot is Deutsche Bank, Germany’s biggest, down about 10% today, and down 40% year-to-date, as its credit default swaps spiked to their highest levels since 2012.

Bank credit default swaps, or contracts that offer protection against the risk of a bond defaulting, have also surged in price, indicating intensifying fears for financial groups’ credit. Deutsche bank’s 5-year senior CDS has jumped 11bps today to a three-and-a-half-year high of 212bps, up from 134bps just over a week ago. The cost of protecting the company’s subordinated debt from default for five years using credit-default swaps has more than doubled since the end of 2015, rising to 438 basis points, a four-year high, from 187. That is just a very, very big selloff.

And what makes it crazier still, is that it looks like Deutsche Bank has more than sufficient reserves set aside for its debt and the interest on its debt, exclusive of operating results. But for now that doesn’t matter; share price has dropped, which increases expectations for more turmoil, which pushes the cost of hedging, which frightens shareholders, who then sell, pushing prices even lower. If it all sounds a bit over-done, it is, but it still demands we pay attention.

And the situation is not unique to Deutsche Bank, which is just one of the extreme examples. Basically all the banks are seeing their credit default swaps trading at the highs of the year. And here in the US, the large cap financials are down almost 12% year-to-date. That means there has been some panic selling. Today, the mega-banks, including Bank of America, Citi, and Wells Fargo all moved to new lows intraday or at the close.

The KBW Bank Index, which consists of 24 banks, is approaching 2008 and 2011 lows relative to the S&P 500. So, the question of the day is: Are the large cap financials cheap or is the rest of the market still overpriced? We may need more time to answer that one, but for now the big banks distress is honey for the bears.

If Congress does not act soon, Puerto Rican officials say major defaults are likely this spring. They are trying to make their case for a law that would allow a broad restructuring of the territory’s multibillion-dollar debt. The officials also said they knew that any legislative help would come at a stiff price: Puerto Rico would have to submit to a federal control board, something viewed by some on the island as colonialist-style interference.

Argentina has offered to pay about $6.5 billion in cash to U.S. holdouts that refused debt restructurings after its 2001 default, implying a haircut of about 25% on the amount bondholders say they are owed. If accepted by all the holdouts, which are led by billionaire Paul Singer’s Elliott Management, the deal would clear the way for Argentina’s return to the international capital markets.

Washington is vowing to ensure the United Nations Security Council imposes serious consequences on North Korea after it launched a space rocket in a purported satellite program widely considered to be a cover for developing ICBMs. The latest launch, which follows North Korea’s Jan. 6 nuclear test, may kick off a rapid buildup of American missile defenses in Asia.

Apollo Education Group, the parent company of the University of Phoenix, will be taken private as it is acquired by a group of investors for $1.1 billion. The investors will pay $9.50 in cash per share, which is 30% above the company’s trailing 30-day volume weighted average stock price. Tony Miller, chief executive of The Vistria Group, one of the investors, will become chairman of the board for the Apollo Education Group once the transaction is completed. The other investors included Apollo Global Management, LLC and Najafi Companies.

The agreement arrives weeks after the company reported a decline in revenue and another round of layoffs at the for-profit college. Phoenix, like other for-profit schools, has been battered by poor enrollment, government investigations and heightened federal regulation.

Chipotle closed its more than 2,000 restaurants today for a few hours to address employees about the food-borne illnesses that have led to lawsuits and a federal investigation. Chipotle used the event to review new food safety protocols and explain the steps the company is taking to improve food safety.

Ford is planning to build a new assembly plant in Mexico to sharply increase output from the country, representing the latest shift of investment abroad by a Detroit automaker following the signing of a costly new labor deal. Ford expects to add 500,000 units of annual Mexican capacity starting in 2018 (more than double what it built in 2015), by constructing a new assembly complex in San Luis Potosí and expanding an existing factory near Mexico City.

You don’t see this every day…Credit Suisse CEO Tidjane Thiam has asked the company’s board to reduce his bonus, days after the Swiss bank reported a fourth-quarter multibillion-dollar loss that sent its share price tumbling. Thiam, who joined the bank in July, did not indicate the size of the cutback, but said his was the largest bonus reduction within the management team.

Financial Review

Confidently Waiting

Sinclair Noe — September 14, 2015

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DOW – 62 = 16,370
SPX – 8 = 1953
NAS + 26 = 4822
10 YR YLD un = 2.18%
OIL – .49 = 44.14
GOLD – .30 = 1109.40
SILV – .21 = 14.51

The story that will be leading markets throughout this week will be Thursday’s Federal Reserve interest rate decision. While market expectations of an increase in rates have fallen to 28 percent, down from over 50 percent a few weeks ago, economists insist the decision is still too close to call. The Fed has been saying they will hike interest rates; this may be one of the most telegraphed rate hikes in the Fed’s history, but circumstances keep changing.

Since the last Fed meeting, oil prices have dropped by 15%, the dollar has strengthened, China has slowed, emerging markets have softened, and there is little to no sign of inflation despite a Fed target of 2%. By the way, we’ll get one more report on inflation Wednesday, with the release of the CPI, or consumer price index. So, there are many reasons why the Fed might not raise rates, but then if they do stand pat, they risk coming across as timid, or worried that the recovery is in trouble.

If they hike rates they can give the impression they are confident, and confidence begets confidence. And so some clever folks think the Fed might try and split hairs by announcing one small increase and then saying they are done for a while.

We don’t know what the Fed will do, and whatever they do, raising the target for interest rates is not the only tool in the tool box. Keep in mind that there are several ways to influence interest rates, including interest paid on reserves banks hold with the Fed in the overnight repo market. If the Fed wants to reign in speculation, or slow the velocity of money – it’s an easy step. And it is a safe bet that whatever the Fed does with the headline announcement on Thursday, they will have a counteracting Plan B to go along with it.

The more difficult dance step is to try to raise rates only to have to turn around and cut them again. This has happened: central banks in the Eurozone, Sweden, Israel, Canada, South Korea, Australia, Chile and beyond have tried to raise rates in recent years, only to reduce them again as their economies stumbled – not exactly a confidence booster. The lesson is clear; there needs to be a really, really strong case for raising rates.

China’s investment and factory output missed forecasts in August, raising the chances that China’s third-quarter economic growth may dip below 7 percent for the first time since the global crisis.

Germany announced on Sunday night that the country could no longer cope with the unending flow of asylum seekers coming into the country, and would re-instate border controls with Austria. The move particularly surprised Austria, as just last week the two countries had worked together to freely let refugees enter their countries as tens of thousands have been arriving through Hungary and other Balkan countries.

After a long summer of financial and political upheaval, Greeks will vote next Sunday in the second general election this year. The snap elections were called last month after the resignation of Prime Minister Alexis Tsipras, who came to power in January on a pledge to stop austerity, but capitulated to creditors’ demands after months of negotiations that destabilized the economy and led to the imposition of capital controls on Greek banks.

The worst wildfire in a devastating season in California has destroyed more than 400 homes and businesses and forced 10,000 people to flee — some with only minutes to escape. At least one person was known dead and four firefighters were taken to the hospital after battling the Valley Fire, which has scorched about 62,000 acres, about 50 miles west  of Sacramento. The blaze broke out Saturday, and as of this morning, it was declared zero percent contained.

Whole blocks were destroyed in the town of Middletown. Governor Jerry Brown declared a state of emergency in areas ravaged by the blaze, and officials expanded mandatory evacuations. There are actually 3 major blazes that have consumed a combined 270,000 acres, and they remain largely out of control.

One reason why this wildfire season has been so difficult is because the state is still in an extreme drought. A new study published online says the Sierra Nevada mountain range is experiencing the lowest snowpack in 500 years.  The shrinking snow levels, linked to the state’s devastating drought, will likely take a toll on the water supplies of farms and cities, reduce the amount of hydroelectric power available, in addition to making wildfires more likely and extreme. California gets 80% of its precipitation during winter, and the Sierra Nevada snowpack plays a vital role, providing 30% of the state’s water supply. At the start of April, the snowpack was just 5% of normal.

Sales of Apple’s new iPhones were on pace to beat the 10 million unit sales it logged during the first weekend of sales last year. Apple did not disclose the specific number of preorders it received. Analysts had expected the company to log about 4.5 million preorders during the first 24 hours, in comparison with 4 million during the first day last year. The iPhone 6S and iPhone 6S Plus will begin shipping Sept. 25.

Airbus, the European airplane maker, formally opened a jet assembly plant in Mobile, Alabama today; its first such factory in the United States. The move into the heart of Boeing’s home turf is part of a long-term strategy by Airbus aimed at doubling its share of the American market for 150-seat airplanes, which is currently dominated by Boeing’s top-selling 737. Airbus plans to build as many as 36 of its competing A320 and A321 models a year by 2018 and says the Mobile plant has the capacity to double that production.

Mylan NV  said it launched a tender offer to acquire fellow generic drugmaker Perrigo for about $27 billion – an offer Perrigo has rejected so far. Perrigo urged shareholders to take no action, pending a board review.

Solera Holdings, which provides technology services and software to insurance companies, said it agreed to be acquired by an affiliate of private-equity firm Vista Equity Partners for $3.74 billion in cash.

Deutsche Bank aims to cut roughly 23,000 jobs, or about one quarter of total staff, through layoffs mainly in technology activities and by spinning off its PostBank division.

Large banks are preparing to pay $1.8 billion to settle accusations that they conspired unfairly to control credit default swaps derivatives market; CDS is a type of financial contract that allows investors to speculate and hedge against losses and that figured prominently in the crisis. Lawyers for several large investors, including a Los Angeles pension fund, argued in a suit filed in 2013 that the 12 banks — essentially all the largest ones in the world — conspired to keep competitors out of the market, allowing the banks to charge higher prices.

According to a new study by three academics at the University of Notre Dame, there is a correlation between generous stock option grants for executive pay and the incidence of serious product recalls. The study looked at the size of stock options in proportion to a chief executive’s total pay and calculated a two-year average, finding that recalls tended to be more prevalent at companies with higher option payouts. Stock options carry little downside risk if the company’s underlying shares fall but outsized upside if the underlying shares rise; so, an options package can lead to extra risk taking among executives.

Fiat Chrysler CEO Sergio Marchionne has canceled plans to attend the Frankfurt International Motor Show in Germany tomorrow, possibly an indication that the company may be getting close to a contract agreement with the United Auto Workers union. The company says Marchionne is staying in the U.S. to deal with business matters but gave no further details. The union said Sunday that it had picked Fiat Chrysler as its target company in the contract talks. Deals with Fiat Chrysler, Ford and General Motors expire at midnight.

The average price of a gallon of gasoline in the United States fell 27 cents in the past three weeks as refiners and retailers gave up some of their profits margins to sell more fuel. According to the Lundberg survey, regular grade gasoline fell to $2.44 per gallon in the Sept. 11 survey from $2.71 on Aug. 21. Part of the reason for the

The Organization of the Petroleum Exporting Countries, OPEC, has given the clearest signal yet that it believes it is winning its oil price war with the US shale industry. The oil cartel says that output from outside the cartel in 2016 will be over 100,000 barrels per day lower than it had previously predicted, as lower prices shut down more production. In its closely-watched monthly market report, OPEC said: “There are signs that US production has started to respond to reduced investment and activity. Indeed, all eyes are on how quickly US production falls.”

The report said that the number of oil drilling rigs in the US declined in the week ending September 4, down by 13 units to 662 rigs. The overall rig count in the US – which is seen as a key barometer for the industry – is now down 864 units year-on-year. But OPEC did not go as far as the International Energy Agency, which on Friday said lower oil prices would force non-OPEC to cut output by the steepest rate in more than two decades next year.

US shale oil producers could also be more resilient than they appear despite high levels of indebtedness. Around 4,000 untapped wells have been drilled in the country waiting to be fracked, and are able to start producing in a matter of weeks if conditions improve. If prices go up, they’ll get back in the field and start pumping. The price decline certainly has an impact but the demise of US oil producers might be a stretch.