Financial Review

Stormy Weather

Sinclair Noe — October 23, 2015

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

Subscribe: iTunes | Android | RSS

DOW + 157 = 17,646
SPX + 22 = 2075
NAS + 111 = 5031
10 YR YLD + .05 = 2.08%
OIL – .65 = 44.73
GOLD – 1.90 = 1165.00
SILV – .03 = 15.91

After Thursday’s closing bell Microsoft, Amazon, and Alphabet all reported very strong third quarter earnings, and these companies are big enough to lift the entire market; today they added $80 billion in market cap. Amazon and Alphabet hit all-time highs, and Microsoft moved to its highest levels since 2000. Toss in a little central bank easy money and you’ve got one of the best two day rallies in a long time.

The S&P 500 gained 2.1% for the week; its fourth straight weekly gain; moving into positive territory year to date. For the week, the Dow rose 2.5 percent and the Nasdaq gained 3 percent. Oil capped its biggest weekly decline since August as expanding U.S. crude stockpiles exacerbated a global glut, and the dollar moved higher, especially against the euro.

China’s central bank cut interest rates today for the sixth time in less than a year (down 25 basis points to 4.35 percent) , and it again lowered the amount of cash that banks must hold as reserves. Monetary policy easing in the world’s second-largest economy is at its most aggressive since the 2008/09 financial crisis. The People’s Bank of China said it was freeing the interest rate market by scrapping a ceiling on deposit rates; which will, in theory, allow banks to price loans according to their risk, and remove a distortion to the price of credit that analysts say fuels wasteful investment in China.

At a rate review next week, the Bank of Japan will cut its growth and inflation outlook for this fiscal year but only slightly tweak its projections for 2016. The BOJ can still maintain it’s on course to meet its inflation goal of 2% next year without needing to step up its massive asset purchase scheme.

While the Eurozone’s composite PMI unexpectedly increased to 54 in October from 53.6 in September, signaling a pickup in activity, forward-looking indicators point to a risk of a slowdown, according to Markit Economics. Service-sector expectations for the year ahead fell to a 10-month low.

Stocks across the globe extended a rally from the previous session, as central banks exert their dominance on markets. Yesterday, ECB President Mario Draghi signaled his willingness to add more stimulus to the Eurozone’s flagging economies, possibly at the next ECB meeting in December. The euro dropped for a second day versus the dollar, down 2.8% for the week. The euro is down more than 8 percent against the dollar year-to-date, and has fallen by 12 percent over the past year. Call it an accidental devaluation of the euro. The ECB claims it is not their intention to devalue the euro, but there simply doesn’t seem to be much evidence that QE and zero rates have done much to drive inflation higher. Still, the market salivates and sells euros when Draghi says QE.

Against a backdrop of ongoing stimulus in Japan, a big burst of new stimulus in China, and anticipated extension of stimulus in Europe, it becomes increasingly difficult to imagine the Fed will be able to go against the grain and hike interest rates any time soon. Fed funds futures rates show almost no chance next week when the FOMC meets, and less than a 50% chance when they meet in March.

This has implications across the board. The Federal Reserve’s decisions about interest rates will affect every single person and company in the United States. Walmart will like having cheap imports. Boeing won’t like that its planes cost more to foreign buyers. Family farmers won’t like it; big agribusinesses, like Cargill, will. For banks, a Fed rate increase can be good and bad news: In a recent report on the subject, Goldman Sachs argued that some banks, like M&T and Wells Fargo, are going to be in a bit of trouble, while others will make more money from interest rates on loans. On an individual level, Fed rate increases are better for older people who live on savings and worse for younger people who tend to borrow more.

If the Fed added up all the ways a rate increase helped people in the short term and subtracted all the ways it hurt them, they would never raise rates. While there are winners and losers, on balance a Fed rate increase means the economy will slow down, which on average is worse for everybody. Of course Wall Street loves easy money from the Fed. Global markets are as well trained as Pavlov’s dogs.

This week the People’s Bank of China announced easy money, although most of that stays in China, and the European Central Bank announced it would continue with its QE asset purchases; currently the ECB is buying a little over $90 billion in government bonds each month, and Draghi hinted there might be more coming in December. And the funny part is that all this extra money being pumped into the system should result in inflation, but the opposite is happening. Rates in the Eurozone are near zero, and this week the Italian 2 year government note went negative, as did the US Treasury 30-day bill. So where is all that money going?

Well, it’s going into government bonds. And where are the government bonds going? Well, they are being used as collateral for the $700 trillion dollar derivatives market where they are tucked away as collateral. And the lower the central banks pegs interest rates, the more the banks are forced into taking risks to generate returns, and that means risk, and risk is mitigated (at least in theory) with derivatives, backed (again theoretically) by the collateral of government debt.

And so, some off the biggest news of the week that nobody noticed was a new ruling from a couple of regulators, which will greatly reduce the collateral requirements the big banks must set aside in derivatives deals. The rules are still in draft form, but they would cut in half what the companies must post in transactions between their own divisions. The proposed rules are coming from the FDIC and the Commodities Futures Trading Commission, backed by the financial industry and the rules are apparently being drafted by the financial institutions as well.

It’s difficult to estimate how much is at stake for banks, but the derivatives market is estimated at $700 trillion nominal value; the collateral involved is likely in the hundreds of billions in non-cleared swap trades. The banks think this might free up collateral for other purposes. I’m guessing riskier purposes, but time will tell. What this also might address is the remarkable lack of supply of government debt – how else to explain Italian notes going negative?

Best guess is that we will see continued growth in structured financial assets that made synthetic swaps where the casino banks sold protection based upon bonds, rather than actually investing in bonds, and then called it collateral that could be sold as insurance to guarantee payment on insurance contracts. Sure – what could go wrong?

Analyst sentiment on overall third-quarter earnings has improved following the string of strong results from blue chips. S&P 500 earnings for the period are now expected to have declined a more modest 2.8 percent, compared with a decline of 5.5 percent forecast at the start of the reporting season.

American Airlines reported earnings of $1.9 billion, or $2.77 a share; beating estimates. American realized big savings from lower fuel costs. American’s board authorized a new $2 billion share repurchase program to be completed by year-end 2016. They still face an air fare war. American said it will discount tickets in a bid to win market share.

The Environmental Protection Agency regulatory package known as the Clean Power Plan officially became law today. It was immediately challenged by 24 states, led by West Virginia, in a U.S. appeals court filing in Washington. The states are asking for a court order blocking the measure until the lawsuit is resolved. It’s at least the third time the initiative has come under legal fire. Earlier challenges were rejected by federal judges as premature because the measure hadn’t been published.

The U.S. government no longer has that defense, leaving the regulations open to attack. The Clean Power Plan aims by 2030 to reduce power plant carbon emissions 32 percent below where they were in 2005. The rules require states and utilities to use less coal and more solar power, wind power and natural gas. States are required to submit their initial plans for meeting those objectives by Sept. 6 of next year. Final plans must be submitted two years later. EPA Administrator Gina McCarthy, issued a statement saying the Clean Power Plan is based upon “strong scientific and legal foundations” and is within the authority granted to the agency under the Clean Air Act.

Hurricane Patricia is moving onshore right now around Manzanillo on the Pacific Coast Mexico. It is being called the most powerful storm in recorded history, with winds clocked at 200 miles per hour, which makes it a Category 5. The only good news is that this area of Mexico is not heavily populated. Evacuations have been ordered along the coast. The US National Hurricane Center said Patricia was on track to make a “potentially catastrophic landfall.” Storm surge could top 30 feet. The storm is also expected to bring about 20 inches of rain.

So the storm surge will hit the coast, and then a couple of hours later, the rains will wash down from the mountains. The hurricane is expected to head northeast over Guadalajara, then dissipate as it hits the Sierra Madres, and over the next 2 or 3 days, it should make its way to Texas with heavy rains, and that’s on top of flooding in Texas happening now as the result of another storm system.

FINANCIAL REVIEW

Catch a Falling Star

Sinclair Noe — November 12, 2014

Podcast: Play in new window | Download (Duration: 13:20 — 6.1MB)

DOW – 2 = 17,612
SPX – 1 = 2038
NAS + 14 = 4675
10 YR YLD un = 2.36%
OIL – 1.19 = 76.75
GOLD – 2.80 = 1161.10
SILV – .04 = 15.76

Stocks have been on a run lately, with the Dow Industrials and the S&P 500 hitting record highs yesterday, and the Dow Transports closing at a new high today. Yesterday, the S&P 500 marked its 40th new closing high of the year, versus 45 in 2013. The last five-day streak of record highs was in May 2013, and the next longest was eight days in June 1997. The Dow also hit a record yesterday, marking 6 consecutive record highs, its longest since June. The S&P 500 has closed above its 5 day moving average for the 19th consecutive session, a streak that has only occurred seven times in the past 20 years. And today did not reverse the trend.

Typically, after a rally like this you might expect a pullback; not necessarily a correction, but a pullback; a pause to catch your breath. And so, now would not look like a good time to buy, but you also haven’t seen a signal to sell, at least not yet. Meanwhile, the advance has been so straight and fast that it hasn’t left any support levels in its wake. You might look at S&P 2000 as a round number, but that is meaningless; there was a little consolidation last week around 2001, but that is not much. Beyond that, you look at another weak support at 1925, and then the real strong support at 1820. Working off trend lines, the 50 day moving average is at 1972. In other words, this rally has outrun its support.

Over the past month, you would be hard pressed to find a sweeter chart than the Dow Jones Transports, which hit another record high close, up 30 at 9091. Those trains just keep on rolling down the track.

Yesterday and today seemed more a pause in the markets. Earnings season is winding down, and it looks like a very good quarter for companies. Only about 40 of the S&P 500 companies are left to report, and it looks like 75% of companies that have reported beat expectations, and overall earnings growth is around 10% from the year ago quarter. That’s about as good as it gets.

Time now for another edition of “Banks Behaving Badly”. Today it was announced that 5 banks are being fined for manipulating the foreign exchange market; this is the $5.3 trillion dollar a day market for currencies, also known as the Forex Market or FX. The investigation was led by the US
Commodity Futures Trading Commission, Britain’s Financial Conduct Authority, and the Swiss Financial market Supervisory Authority. The 5 banks that reached a settlement are: Citigroup, UBS, JPMorgan Chase, Royal Bank of Scotland, and HSBC; the usual suspects.

UBS agreed to pay the largest fine at $800 million, even as regulators acknowledged the bank was first to cooperate on the probe. Separately, the Office of the Comptroller of the Currency has assessed an additional $950 million against Bank of America, Citigroup and JPMorgan for “unsafe or unsound practices” tied to their foreign exchange trading. The total fines are $618 million for HSBC, $634 million for RBS, $1 billion each for JPMorgan and Citi, and $250 million for BofA.

Basically the Forex traders would get together or phone other traders or instant message or plan their schemes in chat rooms to manipulate prices to improve their trades, even if it meant screwing their customers. The instant messages left a digital trail of incriminating evidence. The traders knew they were breaking the law and they did it anyway. The evidence released today included transcripts that the fraud and collusion was taking place within the last year; this is not some scam from 2007. Now, remember that all these banks have a long list of transgressions that resulted in deferred prosecution agreements. Supposedly they are on parole, and they have violated their parole, again.

Tim Massad, chairman of the CFTC, issued a statement, saying: “Today’s enforcement action should be seen as a message to all market participants that wrongdoing and foul play in the financial markets is unacceptable and will not be tolerated.”

What a crock.

It is tolerated. It has been tolerated in the past, and there is nothing to indicate that today’s fines will change much. We’ve seen similar behavior in interest rate markets; the Libor, London Interbank Offered Rate, is manipulated; the ISDA fix in the derivatives markets is manipulated; the precious metals markets are manipulated; the US stock markets sell special high speed access to allow certain firms to manipulate the stock markets. The list goes on. And with every manipulation, the banksters steal a little bit more; they just walk right up and take it out of your wallet.

And the fines today will not deter illegal activity. Several traders have been fired or suspended; many are still trading. And just who goes to jail for this fraud? Not one person, although we hear that there are criminal investigations; which means there will be a few junior level traders that will be thrown under the bus. But today’s fines are mainly another slap on the wrist. Part of the punishment today comes from the Swiss regulators who state that the manipulators at UBS must limit bonuses for traders of foreign exchange and precious metals to 200% of their base salary for two years. Which means the bank will now have to raise the base salary for traders. That’ll teach them.

This purportedly groundbreaking settlement is characteristic of the other ones that have come before it: there’s no mention as to whether an actual legal process was pursued, whether depositions were taken or whether an expert came up with a number for total damages. The settlement is supposed to placate the public, but when the rate controls the trading of over 5-trillion dollars on a daily basis, is 4 billion enough?

The combined fines calculate to be $4.25 billion. The banksters named today trade $5.3 trillion on the foreign exchange each day of the week. The fines calculate to be a 0.08% penalty on what these banks trade daily on the exchange. Again, not eight percent, but 0.08%. These aren’t fines against the banks. $4.25 billion is not punitive. It’s their pocket change.

Despite banksters’ protestations that things are changing, there is evidence published today suggesting that, before the official investigation, whistle-blowers were ignored by banks and complaints from customers (the global businesses and pension funds that rely on foreign exchange markets) pushed aside.

President Obama is in Asia, on his way to the G-20 conference, and at a state visit in China last night China and the US announced new pledges on greenhouse gas emissions. The US will try to reduce US levels between 26% and 28% by 2025, compared to 2005 levels. President Obama’s offer is based on cuts in carbon emissions from coal power. China did not set a specific target, but said emissions would peak by 2030, and that 20% of the country’s energy would come from emission-free sources by then. The two countries also agreed to reduce the possibility of military accidents in the air and sea. It is the first time China has set an approximate date for emissions to peak. The two countries together produce about 45% of the world’s carbon dioxide.

Setting a 2030 target for peak carbon emissions is a first for China, but most analysts expected China’s emissions to peak about that time anyway. Beijing has recently shown it is serious about cleaning up its emissions by strengthening environmental laws, toughening regulations, and stepping up oversight of factories and power plants. They had to do something because the air was thick as soup, and causing health problems. They either had to clean up or watch people stop breathing. The bigger challenge for China may be satisfying the pledge to get 20% of its energy from non-emissions producing sources. That promise will require an additional 800-1,000 gigawatts of nuclear, wind, solar and other zero emission generation capacity; an amount roughly equal to the entire US electricity capacity today.

Under the Kyoto plan, developed economies, including the United States, were supposed to cut their fossil fuel emissions, while developing countries like China were exempt. The United States refused to ratify the treaty, while China went on to become the world’s largest carbon polluter. Many other governments also refused to change pollution standards because the world’s two largest polluters were not acting, so why should they.

The agreement is not binding. If they take the actions to meet the targets, then it’s meaningful, but for now it’s a paper promise. And since physics is uninterested in spin, all the hard work lies ahead.

NATO officials say Russian troops and military equipment including tanks, artillery, air defense systems, and combat troops have been sighted entering Ukraine. Russia’s defense ministry denied that its troops were in eastern Ukraine to help pro-Russian separatists there. However, the rebels have admitted being helped by “volunteers” from Russia. The United Nations Security Council is convening an emergency session on Wednesday to discuss the reported sightings. Fighting and artillery fire have been reported around the cities of Donetsk and Luhansk.

The Rosetta mission has achieved something quite remarkable; the combined effort of the European Space Agency and NASA has landed an unmanned spacecraft on a comet. After flying for 10 years and traversing some 317 million miles the Rosetta orbiter touched down on Comet 67P at 11:00 AM Eastern time. The spacecraft that landed on the comet is about the size of a dishwasher and it has already sent back photos of the comet. The craft has about 2 days of battery life left, and then it will try to operate on solar powered backup batteries, with a little bit of luck.

The point of Rosetta is to gain insight on the universe’s infancy. Comets are the perfect subjects for such study: unlike stars and planets, whose chemistries evolve slowly but significantly, comets are pretty much the same ice balls they were a few billion years ago. By analyzing this comet’s composition, the Rosetta landing craft will help researchers determine the role that comets played in the nascent days of our solar system and the earth; if their ice brought us water, and if the organic matter in their crusts provided the crucial ingredients for life. And what it also tells us is that we are still capable of incredible accomplishments.