Financial Review

No F8 but What You Make

Sinclair Noe — April 12, 2016

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Financial Review

Watching and Waiting

Sinclair Noe — October 13, 2015

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

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DOW – 49 = 17,081
SPX – 13 = 2003
NAS – 42 = 4796
10 YR YLD – .04 = 2.05%
OIL – .53 = 46.57
GOLD + 5.00 = 1169.90
SILV + .09 = 16.01

Anheuser-Busch InBev and SABMiller have agreed on terms for a takeover, with the world’s largest brewer set to pay $106 billion. The deal brings one out of every three beers sold worldwide under a single company. Under terms of the agreement, AB InBev would pay a $3 billion break-up fee to SABMiller should the transaction fail to clear regulatory hurdles or shareholders don’t approve of it.

If the deal goes through, it would be the biggest acquisition of the year, and the largest in British history. SABMiller’s two largest shareholders, Altria Group and Bevco Ltd., can receive cash and stock for their stakes, which account for 41 percent of the company. They won’t be able to sell the shares for five years; a move that might have tax benefits.

Dell’s $67 billion buyout of EMC appears to be a win for nearly everyone involved – except EMC bondholders. Investors in EMC’s $5.5 billion of bonds are down about $338 million since news of the deal first became public last week. Why’s that? Dell’s plan to raise about $50 billion in debt for the acquisition will push existing bondholders down the capital structure (the notes lack protections that would’ve allowed for early repayment in the event of an ownership change). Further, consider that Dell will now have to service that debt, to the tune of about $2.5 billion per year; money that won’t be going into capital expenditures or research and development.

Pepsi is competing against Coca-Cola for an investment in Chobani that could value the Greek yogurt maker at $3 billion including debt. Chobani is looking to sell a minority stake to someone who could help it with distribution and production. The company ran into liquidity issues last year before an investment from private-equity firm TPG.

Wells Fargo agreed to buy $32 billion in assets from General Electric and take on about 3,000 employees as GE retreats from financial services. The sale includes commercial-distribution and vendor-finance units, and a portion of the corporate-finance business from GE Capital.  The transaction is expected to be completed in the first quarter of 2016. Wells Fargo previously agreed to buy commercial real estate assets and GE’s railcar-leasing division.

This is part of a major shift for GE; from financial services to its manufacturing and industrial roots; to this end, GE has now divested $126 billion worth of financial operations. GE had previously said it would seek some time in 2016 to apply to remove its designation as a “systemically important” financial institution.

In the past 24 hours or so, we’ve seen more than $210 billion in acquisitions announced. Mergers and acquisitions are on track for a record year. So far in 2015, there have been nearly $3.5 trillion worth of transactions

China’s trade slump has extended into September, adding more evidence that the world’s second largest economy is stalling. Dollar-denominated imports plunged 20.4% Y/Y last month, while exports slipped 3.7%, translating into a trade surplus of $60.34B. In yuan terms, imports fell 17.7%, while exports dropped 1.1%. China’s official GDP data is due on October 19. Separate data shows auto sales expanding at the slowest pace in three years. Much of the import decline reflects this year’s commodity price slump. Miners and metals were coming under pressure again today, with Glencore dropping as much as 5.5 percent in London.

The U.K. inflation rate turned negative again last month, dropping 0.1% year-to-year due to a smaller than usual rise in clothing costs and falling gasoline prices. Although the Consumer Price Index rate has been at or close to zero for most of 2015, the last time it was in negative territory was April. The Bank of England said this past week it did not expect inflation to reach its 1% target until spring 2016.

The International Energy Agency, which represents some of the world’s largest oil consumers, is warning that oil markets would likely remain oversupplied next year, as oil demand growth slows and Iranian oil adds to supplies. The IEA cut its forecast for oil demand growth for next year by about 200,000 barrels a day compared to its previous assessment in September. The IEA said Iran’s production could ramp up towards 3.6 million barrels a day from 2.9 million barrels a day currently once international sanctions are terminated early next year.

Russia’s economy could shrink 3.8% this year on the back of lower oil prices and international sanctions. The country’s finance minister told CNBC that trade restrictions may not be removed any time soon. Despite a GDP contraction this year, the Russians expect their economy to turn to positive growth of 0.7% in 2016.

Investigators in the Netherlands have concluded that Malaysia Airlines Flight 17 was shot down by a Russian-made anti-aircraft missile, causing the jetliner to break apart in midair, killing all 298 people on board. The Boeing 777 was heading from Amsterdam to Malaysia when it was shot down on July 17, 2014, over Ukrainian territory controlled by pro-Russian separatists. The report does not say who fired the missile.

Small business optimism continues to be stagnant. The National Federation of Independent Business said its small business optimism index was little changed in September, edging up 0.2 points to 96.1. That’s still below the 42-year average of 98. Small business owners expect sales to decline and the highest share since 2007 say they cannot find qualified workers.

Switzerland’s finance ministry will require Swiss banks maintain capital reserves of 5% of total assets, in line with the U.S. leverage ratio for its biggest banks and above the 3 percent minimum set in a global agreement by the Basel Committee on Banking Supervision.

Since the summer, trading has been largely driven by negative reaction to growing evidence of a global slowdown. Last week, virtually every economically sensitive asset advanced despite a slew of evidence confirming everyone’s suspicions the global economy is indeed decelerating. Instead, investors looked past the soft data and focused on Fed reaction to that weak data, as expressed in the minutes from the September 17^th FOMC meeting. If the Fed obsession seems extreme, consider that fiscal policy is almost non-existent.

In a speech today at the National Association for Business Economics, Federal Reserve Governor Lael Brainard said that the risks to the U.S. economy are now to the downside and that it is important to “nurture” the recovery. Brainard said these risks “argue against prematurely taking away the support that has been so critical to [the U.S. economy’s] success.” Brainard said there was a risk-management argument in favor of a policy of “watching and waiting.”

Also today Federal Reserve Governor Daniel Tarullo said he doesn’t expect conditions to be appropriate to raise interest rates this year. We’ve heard several different Fed policymakers offering differing opinions on the state of the economy and the motivation to raise interest rates; and the only thing we know with any certainty is that Fed policymakers are not unanimous in their positions. And that means it is unlikely that we will see a rate hike at the October meeting.

Michael Novogratz, the CIO of Fortress Investment Group’s macro fund, will step down at the end of this year. His $2.3 billion fund will be closed down, and assets will be returned to investors. Investors redeemed $800 million from the fund at the end of fourth-quarter 2014, a quarter of its total assets. More redemptions followed throughout the year as key bets, like Novogratz’s long call on Brazil, went sour. Fortress’ macro fund was down about 17.5% through the end of September; still, Novogratz will leave with a $255 million golden parachute.

Earnings reporting season kicks into high gear this week, trying to avoid a second consecutive quarter of negatives. Earnings for S&P 500 companies are expected to have dropped nearly 5 percent year over year, which would be the worst quarter for earnings in six years.

Johnson & Johnson reported net income of $3.36 billion, or $1.20 per share, below $4.75 billion, or $1.66 per share, in the year-earlier period. Adjusted earnings per share beat estimates. The company said international sales decreased 13.7% and it had a negative currency impact of 15.8%. J&J also announced it would double its share buyback program to $10 billion. The company will finance the repurchases with debt.

CSX Corp., the third largest railroad in the country, reported third-quarter net income of $507 million or 52 cents per share, down from $509 million or 51 cents per share a year earlier. Results beat estimates, even as revenue declined on lower coal shipments; the company countered by cutting costs.

JPMorgan Chase said third-quarter profit rose 22% as the firm cut expenses and had $2.2 billion in tax benefits. Net income climbed to $6.8 billion, or $1.68 a share, from $5.57 billion, or $1.36, a year earlier. Adjusted earnings came in at $1.32 a share, six cents south of estimates. BofA and Wells Fargo report tomorrow; Citigroup and Goldman Sachs report Thursday.

Intel reported better than expected earnings and revenue, even though both profits and revenue declined. Net income fell to $3.11 billion, or 64 cents per share, from $3.32 billion, or 66 cents per share, a year earlier. Net revenue fell to $14.47 billion from $14.55 billion.

Financial Review

Slow to Patch

Sinclair Noe — April 15, 2015

 

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

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DOW + 75 = 18,112
SPX + 10 = 2106
NAS + 33 = 5011
10 YR YLD un = 1.90%
OIL + 2.67 = 55.96
GOLD + 9.60 = 1202.50
SILV + .18 = 16.41

The Federal Reserve reports industrial production dropped 0.6% in March. The biggest drop since August 2012. For the first quarter, industrial production was down at 1% annual rate, the first quarterly decline since the end of the recession.

The National Association of Home Builders/Wells Fargo index of home builder confidence increased to 56 in April from 52 in March. Readings over 50 indicate that more builders see sales conditions as good rather than poor. All three components of the index improved in the month: sales expectations, buyer traffic, and the component gauging current sales conditions all moved higher.

China grew at its slowest pace last quarter since the global financial crisis in 2009; GDP expanded 7% in the three months to March from the year ago period, down from 7.3% the prior quarter. Retail sales and industrial output data broadly missed expectations, however, with the latter expanding at the slowest pace since 2008.

Japan overtook China as the top foreign holder of US government debt for the first time since the global financial crisis. Each country holds a little more than $1.22 trillion in US Treasuries, but Japan has about $7 billion more than China.

Saudi Arabia pumped close to a record amount of crude oil last month, leading the biggest surge in OPEC output in almost four years just as the US shale boom shows signs of slowing. The International Energy Agency said average US oil production of 12.6 million barrels a day in the first six months of 2015 will slide to 12.5 million by the fourth quarter as companies curb drilling.

Meanwhile, Saudi Arabia and other OPEC producers raised output by 890,000 barrels a day to 31 million a day in March. Demand for oil will be higher this year than previously thought, according to the International Energy Agency report. The IEA’s expectation for a “notable acceleration” in demand for oil in 2015 comes as Iran called on fellow OPEC members to cut production. If you think you know where oil prices are going just consider the International Energy Agency’s conclusion to their Oil Market Report; they say, “The outlook is only getting murkier.”

There has been a lot of talk about oil prices and supply and demand; most of the talk is short-term and it can be confusing. We know that many drillers have shut down rigs but then we hear that North Dakota’s Bakken production is expected to surge in the second and third quarters of this year, as that state puts the screws on companies to complete wells and rolls out some new tax incentives.

According to the new annual energy outlook by the Energy Information Administration, the government appears to be even more bullish about U.S. oil production this year than it was last year. Despite a nearly 50% drop in the price of crude-oil since then, the government’s expectation for oil production growth is even more robust than in last year’s energy forecast.

Where it gets more interesting is in the long-term outlook; there we are seeing a fundamental shift. The EIA report says longer-term, US crude oil production will peak at 10.6 million barrels per day in 2020, a million barrels more than the high forecast a year earlier. Crude production will then moderate to 9.4 million barrels per day in 2040, 26% more than expected a year ago. Despite lower prices, higher production will result mainly from increased onshore oil output, predominantly from shale formations.

Perhaps the most interesting long-term idea is that the US could become a net energy exporter over the next 2 to 15 years. And it’s not just a result of more drilling, but rather advanced technologies that are reshaping the energy economy, including the greater use of renewable energy sources, along with conservation efforts, including more efficient cars and trucks. The report found that solar is the fastest growing source of renewable energy with an annual growth rate of 6.8%. The report predicts that 77GW of renewable generation capacity will be added up until 2040 with 44% of that (33.9GW) from solar. Of this 31GW will be solar PV. Only 9GW of nuclear and 1GW of coal capacity is expected to be added in the same period.

This afternoon the Federal Reserve published its Beige Book, a collection of anecdotal reports from the 12 Fed districts; the report is published 8 times a year, just a couple of weeks before the FOMC meetings to determine monetary policy. Once again, the districts reported that the economy continues to grow moderately or modestly.

Nonfinancial firms saw rising activity across all districts with demand picking up for high-tech services such as cybersecurity and web development. The Boston and Richmond Fed districts saw an increase in healthcare services, and Service providers in Boston, Philadelphia, Kansas City, and Dallas were optimistic about near-term growth trends for their firms. Many districts said that savings from lower gas prices was fueling consumer sales. Auto sales rose in most districts, and all districts expected corporate and leisure travel to be up in 2015. Most Fed districts reported a tight supply of residential real estate, and only New York reported softening conditions in the residential real estate market. In Chicago, inventories of homes were near historic lows, especially for lower-priced homes. And the Fed says banking conditions are generally favorable.

Agricultural conditions worsened slightly across the nation, thanks to wet fields, persistent drought, and a cold winter. Weather was an important consideration in the Beige Book, mentioned 71 times, and it was mostly bad weather.  Energy market conditions declined in the oil patch. Falling oil prices hurt new orders to energy supplier companies. Manufacturing activity was mixed, hurt by the soaring value of the dollar, which makes US goods more expensive overseas.

Another big day for earnings reports. Bank of America reported a better-than-expected first-quarter profit, reversing from a year-earlier loss, as legal costs fell to $370 million for the quarter. BofA has paid at least $70 billion so far to settle legal issues related to the financial crisis. It turns out that throwing away tens of billions of dollars on legal problems is a flawed business model. Who knew?

CSX beat estimates with earnings, while revenue was essentially in line. The rail operator also announced a $2 billion stock buyback, and raised its dividend by 13 percent to 18 cents per share.

Delta Air Lines posted better-than-expected earnings. The carrier said it plans to cut seating capacity later this year on international routes as the strong dollar and declining oil prices damps overseas travel demand.

Charles Schwab said its first-quarter profit fell 7.4%, as the company was hurt by higher one-time costs and a slowdown in trading.

Netflix, the online video-streaming service, reported revenue of $1.57 billion in its first quarter, on earnings of 38 cents per share. Analysts expected earnings of 69 cents per share, but share price moved higher in after-hours trading because they added 4.9 million new subscribers, topping estimates of 4 million.

Keep in mind that this week we’ve seen several of the big financial institutions reporting earnings, and they were expected to turn in good results. Starting next week, we’ll start to see other sectors reporting, and as we get into the energy sector or the manufacturing sector, we are more likely to see ugly numbers.

The European Union has accused Google of anti-trust violations; cheating competitors by distorting Internet search results to favor its shopping service; and regulators also launched another antitrust investigation into its Android mobile operating system. Google now has an opportunity to explain itself and the case might be settled by the company making commitments to change its products.  The EU regulator can demand sweeping changes to Google’s business practices and might impose fines up to $6.6 billion. Google plans to defend the charges.

Nokia has agreed to acquire telecom equipment company Alcatel-Lucent for $16.6 billion, in a deal that would solidify its ambitions to become a major provider of networking equipment. The deal is expected to close in the first half of 2016. The combined company will have about 114,000 employees and combined sales of around 26 billion euros. The new Nokia will have stronger exposure to the North American market, with key contracts with AT&T and Verizon.

With the FCC’s new net neutrality rules published in the Federal Register – let the lawsuits begin. AT&T and three industry trade groups representing cable companies and wireless carriers have filed separate lawsuits challenging the rules. AT&T is the first large individual challenger, joined by the National Cable and Telecommunications Association, wireless group CTIA and the smaller American Cable Association.

After months of negotiations, Target is close to a settlement with MasterCard that would reimburse banks with roughly $20 million for costs they incurred from its massive data breach two years ago. In 2013, Target said at least 40 million credit cards were compromised by a hack during the holiday shopping season, and the attack might have resulted in the theft of personal information. Target also faces a big payout in its negotiations with Visa.

Verizon has published its annual report on cyber security. The report was based on the details of 79,790 “security incidents” given to Verizon’s researchers by 70 organizations, and that’s just for the past year. Phishing may be the oldest trick in the hacker’s book, but it’s still the method behind many of the breaches we’ve seen in recent months. Nearly a quarter of people who receive phishing e-mails open them, according to the report, and 11 percent proceed to download file attachments.

The Verizon report also suggests that companies adopt “improved detection and response capabilities.” Put simply, companies rarely figure out on their own that they’ve been breached. Security professionals often fail to update their systems with patches for known vulnerabilities, and hackers take full advantage of those weaknesses. According to the report, “71 percent of vulnerabilities had a patch available for more than a year prior to the breach.” In other words, many paths hackers took to break into networks last year could have been rendered dead-ends if someone had installed these updates. Worse yet, the issuance of a patch may be a green light for hackers to attack, because it highlights a vulnerability and the hackers know most organizations are slow to patch.

FINANCIAL REVIEW

One Thing Is One Thing

Sinclair Noe — January 13, 2015

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

DOW – 27 = 17,613
SPX – 5 = 2023
NAS – 3 = 4661
10 YR YLD – .02 = 1.89%
OIL – .03 = 46.04
GOLD – 2.30 = 1232.10
SILV + .43 = 17.14

The stock market went south so fast. We started the day with a triple digit gain, up more than 250 points, then down by more than 100; there was a 425 point swing from high to low.

It is earnings reporting season. Shares of home builder KB Homes fell 16% after reporting softer demand in the fourth quarter hit gross margins, which will continue to lag prior-year results for some time.

CSX, the railroad company, today announced record fourth-quarter 2014 net earnings of $491 million, a 15 percent increase from $426 million for the same period last year. The company also generated record fourth-quarter earnings per share of $0.49, up 17 percent from $0.42 per share in 2013.
Tomorrow, JPMorgan and Wells Fargo will report earnings; Bank of America reports on Thursday, and Goldman Sachs on Friday.

MetLife wants the government off its back. The US’s biggest life insurer is going to sue to challenge its designation as “systemically important”. The institutions that receive the designation are expected to bolster their capital and liquidity and to submit to heightened monitoring by the Federal Reserve under the 2010 Dodd-Frank Act to prevent another financial crisis. MetLife is the first to sue.

The Justice Department and more than a dozen states attorneys general have accused Standard and Poor’s Credit Rating Agency of handing out, for a fee, highly inflated credit ratings to mortgage investments that then collapsed and helped to spur the financial crisis. The government is looking for a settlement of $1 billion. Still, S&P mounted a two-year campaign to defeat civil fraud charges, portraying them as retaliation for cutting the credit rating of the United States. But it turns out that one thing is one thing and the other thing is the other thing. S&P never really had a defense; there are hundreds of emails and memos and phone recordings clearly indicating that S&P was creating bogus ratings, for a fee. So, now S&P is looking to settle for $1 billion, which represents about one year’s profit.

Let’s take a look at today’s economic data. The federal government ran a budget surplus of $2 billion in December. The December figure brings the government’s budget deficit for the first three months of fiscal 2015 to $177 billion, which is 2% higher than the first quarter of fiscal 2014. The government spent $333 billion in December, up 44% from December 2013. Total receipts were $335 billion, an increase of 18%.

The World Bank cut its outlook for global growth, saying a strengthening US economy and falling oil prices won’t be enough to offset deepening trouble in the Eurozone and emerging markets. The drop in oil has bolstered the US recovery by giving consumers more money to spend, leading the bank to revise up its growth projection for the world’s largest economy by 0.2 percentage point to 3.2%. And the World Bank says the global economy is being pulled by a single engine, the US economy.

The copper market is saying that won’t be enough to eliminate a supply glut that’s lasted at least two years. Because of the drop in oil, there is just a general avoidance of raw materials. Falling oil prices also reduce mining companies’ energy costs, giving the producers an incentive to continue mining the metal, even as demand drops. Copper also may have been hit by technical selling when the price reached $2.72 a pound, which equals $6,000 a metric ton on the London Metal Exchange. The bottom fell out when we broke $6,000, and it’s been down ever since. Today, March copper dropped .12 to $2.60.

The Labor Department reports there were 4.97 million job openings in November, the highest level since early 2001, and up from 4.83 million in October. With 9.07 million unemployed people in November, there were about 1.8 potential job seekers per opening. The Job Openings and Labor Turnover Survey, or JOLT survey, shows the number of separations, such as quits and layoffs, fell to 4.62 million in November from 4.86 million in October. Meanwhile, the total number of hires declined to 4.99 million from 5.1 million. Now, let’s break it down; when workers are confident they can switch jobs, they are more likely to quit. Get a new job with more pay. We are starting to see that a little more than in the past 4 or 5 years, but workers generally lack the confidence to make that transition. Workers’ reluctance to quit means that employers don’t have to quickly ramp up pay for employees.

The Friday jobs report showed unemployment dropping to 5.6% but the problem is that wages also dropped. People aren’t quitting their jobs for better paying jobs, but there may be hope for better wages. ADP reports that people who stayed in their jobs in the third quarter scored an average 2.8% raise during the prior year, and that’s adjusted for inflation. The Labor Department’s employment cost index says much the same thing. The wage and salary part of the index, which excludes benefits, rose 1.6% for private-sector workers in the six months ending in September. And we are seeing some industry sectors paying more wages: restaurant workers got 3.3%, hotel workers 3.5%, construction workers 2.9%. Those numbers are not inflation adjusted and they are not big increases but they are increases. The next employment cost index, or ECI, which won’t be published until the end of the month, but the ECI has been rising throughout 2014. The third quarter ECI wage numbers were much stronger than the hourly earnings data. And that’s how it starts.

Meanwhile, the NFIB small-business-optimism survey rose to 100.4 in December, the highest reading since October 2006; and the report showed that 25% of firms reported compensation increases over the past three months, while 17% expected to increase compensation over the next six months. And the ECI tends to track with the NFIB’s optimism survey.

Of course, as the unemployment rate drops, it is not a guarantee that wages will go up. The thinking is that once we do get closer to full employment the picture for wages will change and the long awaited acceleration in labor compensation will finally materialize. The truth is that wages have been stagnant for more than 30 years, and we’ve had extended periods of low unemployment during that time. Inequality has been increasing for over three decades, and during that time we have been at or near full employment many times. Yet, wages over this time period have been flat. As noted by the Economic Policy Institute, “Since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline, even though decades of consistent gains in economy-wide productivity have provided ample room for wage growth.” The idea that market forces alone will increase wages sufficiently to offset increasing inequality is not supported by the evidence from these years.

Yields on Japanese government bonds hit record lows today. The yield on the five-year government bond hit zero for the first time, while the benchmark 10-year yield fell to a record low 0.25%. The Bank of Japan remains the dominant force in the domestic bond market, buying ¥8 trillion to ¥12 trillion a month of Japanese government bonds and driving yields lower as it seeks to flood the economy with cash to defeat more than a decade of deflation. Few investors are willing to bet against Japanese government bonds with the Bank of Japan buying at that volume. Also, last year the Swiss National Bank introduced negative interest rates on bank deposits; that followed a similar move by the European Central Bank. So, the central bank has been joined by foreign investors, who plowed a net ¥8.7 trillion last year into medium- and long-term Japanese debt, mostly government bonds.

It’s no secret that Europe is slowing down and that more stimulus is necessary. Euro zone government bond yields fell on the prospect of looser ECB policy and many Eurozone countries sold debt to lock in ultra-low borrowing costs. The euro dropped to a 9 year low against the dollar. The euro has fallen in seven of the last eight sessions and is on pace for a sixth straight week of losses. The ECB is expected to launch its own quantitative easing at next week’s meeting, as data out of the euro zone has become bleaker and bleaker by the day. Data from Greece showed its economy was mired in deflation while engineering orders in Germany fell 10 percent year-on-year in November.

Yes, oil was falling again today. Prices are down nearly 60% since peaking in June 2014—US crude futures for February touched $44.20 per barrel at one point today. Today’s drop was thanks to the UAE’s oil minister reiterating that OPEC has no plans to cut production, though all OPEC countries are losing money.

Remember the manufacturing renaissance? The idea was that China’s rising labor costs would make it more economical to keep manufacturing operations in the US, and maybe even some companies that had sent jobs offshore would send them back; they call it reshoring. Makes sense. Especially when you add in the idea of increased energy production in the US adding to lower production costs. And some of that has happened. Labor costs did rise in China, or at least some of the large, urban, coastal cities, such as Shenzhen. Some companies have already shifted facilities further inland in China, or even left China for Vietnam, Cambodia or (in the case of textiles) Bangladesh – just not back to the US. Energy costs have dropped, as we are all well aware. Both energy costs and shipping costs are volatile, and shipping costs only have a small impact on most manufacturers.

And there are examples of a renaissance. Dow Chemical does plan to invest $4 billion to expand its chemicals production on the Gulf coast; in the past two years, the aluminum industry has announced $2.3 billion of new manufacturing investments in the US. The US auto industry is alive and well. In 2014, 16.5 million vehicles were sold nationwide, making it the industry’s best year since the Great Recession, when sales plunged to hit a low of 10.4 million vehicles in 2010. And manufacturing has seen four straight years of growth, and we’ve added 520,000 new manufacturing jobs in the last 3 years. But we have to remember that we lost 2.5 million manufacturing jobs between 2007 and 2009. And we might never again employ the same numbers of people in manufacturing, in part because manufacturing is changing, and automating.

FINANCIAL REVIEW

Double Irish With a Side of Knowledge Box

Sinclair Noe — October 14, 2014

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Financial Review

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

DOW – 5 = 16,315
SPX + 2 = 1877
NAS + 13 = 4227
10 YR YLD – .08 = 2.20%
OIL – 3.76 = 81.98
GOLD – 4.90 = 1233.20
SILV – .11 = 17.49

The Dow was down slightly, while the S&P and Nasdaq snapped a 3 day slide, but this was almost a quiet day; call it neutral. A follow-up on yesterday’s discussion of the 200 day moving average. The S&P 500 dropped down to the 200 day moving average on Friday (right around 1905), and then fell right through the trend line yesterday. We talked about the possibility of a bounce; and I don’t think today’s minor move qualifies as a bounce, even though it was a positive move. So, we are still waiting for a possible bounce. The 200 day moving average is a lagging indicator, and so for now, the trend line is still moving higher; which increases the prospects for a bounce. When the price drops below a declining 200 day moving average, it is considered extremely bearish and the probability of a bounce is very low. So, we wait for confirmation.

It is earnings reporting season, and today’s reports feature the banks. We start with JPMorgan Chase, the nation’s largest bank by assets, reporting third quarter net income of $5.6 billion, or $1.36 per share, a big improvement from the same period last year, when the bank’s legal bills caused it to lose $380 million. JPMorgan Chase missed profit expectations of $1.38 per share, but the bank beat revenue expectations by reporting third-quarter revenue of $25.1 billion, as opposed to estimates of $24 billion.

CEO Jamie Dimon talked about the cyber threat, saying there is a need for greater coordination between banks and the government, and also saying, “It’s going to be an ongoing battle, and unfortunately battles will be lost.” Indeed, the mere act of reporting earnings is an example of a lost battle. JPMorgan Chase’s earnings release was posted earlier than scheduled this morning on the Internet site that hosts the bank’s earnings documents. Oops.

And a side note on cyberattacks; a hacker claims to have stolen 7 million usernames and passwords for Dropbox, the cloud based file storage and sharing service. Dropbox says their servers have not been hacked, but you might want to change your passwords. I’m just saying.

Wells Fargo, the nation’s largest bank by market capitalization, reported net income of $5.7 billion, compared with year-earlier profit of $5.5 billion. Per-share earnings were $1.02 versus 99 cents a year earlier. The quarter marked the 17th consecutive period of year-over-year profit growth. Earnings matched estimates. Revenue increased 3.6% to $21.2 billion.
Wells Fargo, the country’s No. 1 mortgage originator, said it made $48 billion in new home loans in the third quarter, up slightly from the prior quarter, and down 40% from the year-earlier period. Meanwhile, JPMorgan Chase, the second-largest mortgage lender, said its third-quarter originations hit $21 billion, up from $17 billion in the second quarter, and down 48% from a year earlier.

Mortgage originations have dropped over the past year for lenders across the country as interest rates rose, which dried up refinancing applications. Now the mortgage market is increasingly driven by borrowers who want to buy a home.

JPM – .17 = 57.99. WFC – 1.37 = 48.83.

Citigroup reported third quarter net income increased to $3.4 billion or $1.07 a share on revenue of $19.9 billion, beating estimates. And in addition to the earnings report we also get today’s edition of “Banks Behaving Badly”. Citi revealed that the private-security unit in its Mexican bank engaged in illegal and unauthorized activities that included working for people outside of the bank and using intercepted phone calls. The fraud at Banamex began around 2000 and continued through last year, and included misreporting of gasoline expenses to inflate reimbursements from the bank, and shell companies were used to launder proceeds. The fraud amounted to about $15 million. Citi has disbanded the group. The disclosure marks the latest setback for Citigroup in Mexico, where separate incidents involving fraud have cut earnings by $400 million.

After the close, Intel reported a third-quarter profit of $3.3 billion, or 66 cents a share, compared with $3 billion, or 58 cents a share a year ago. Revenue for the quarter rose to $14.6 billion. Intel beat expectations.

CSX, the railroad company reported third quarter earnings of 51 cents per share on revenue of $3.2 billion, topping estimates. Yesterday, CSX said it had been approached by Canadian Pacific Railway about a possible merger. A CP-CSX deal would give rise to an industry giant with a combined market value of about $62 billion and, potentially, an increased ability to exploit the North American energy boom. CSX-controlled rails run from the Midwest to refineries on the East Coast, but the railroad lacks direct access to North Dakota oil fields. CP does have access to North Dakota oil-loading terminals. A deal would potentially create a single railroad operator that could haul crude from oil fields all the way to fuel-making plants in the Northeast.

The National Federation of Independent Business‘s small-business optimism index fell to 95.3 in September from 96.1 in August. The report said, “Optimism can’t seem to get out of second gear.” The decline can be traced to steep drops in two components. The subindex covering hard-to-fill job openings fell 5 percentage points last month to 21%, while the capital outlays subindexes tumbled 5 points to 22%. In addition, small business owners are cautious about their sales activity. The positive earnings trend declined 2 points to -19%, while the sales expectation subindex fell 1 point in September to 5%.

And today’s disconnect comes from a survey by the New York Fed that shows most consumers are optimistic about income growth; the median household income growth expectations rose to 2.9% in September from 2.5% in August. That said, the same group didn’t plan to spend their anticipated wealth; median household spending expectations fell to 4.4%, the lowest level since at least June 2013, when the survey started.

The Swiss bank Credit Suisse issued a report on global wealth. The ratio of wealth to household income in the US is the highest it has been since just before the Great Depression. In the 64 page report the bank warned that “This is a worrying signal given that abnormally high wealth income ratios have always signaled recession in the past.”

The wealth to income ratio typically runs around 4 or 5; in other words, wealth is about 4 times greater than annual income, but sometimes the country’s wealth stockpile surges to even greater heights; right before the Great Depression, the ratio jumped to 7, and right before the dot-come and housing bubbles it jumped up to 6. Now, the ratio is about 6.5. The ratio tends to get out of whack when bubbles of one sort or another have been built up, and the correction usually takes the form of a recession. No guarantees.

The collapse in crude-oil prices continues. The International Energy Agency cut its forecast for oil demand growth. The IEA projects demand this year to rise by 700,000 barrels a day, down from its previous estimate of 900,000 barrels a day. Chinese crude oil imports plummeted by 63% over the last five months, from 800,000 barrels a day in April to 290,000 in September. Meanwhile, supply from the US and Libya has surged; Libyan production is up by more than a third since August, to 810,000 barrels a day, and the country aims to reach 1 million barrels a day by the end of the year. At the same time, America’s oil boom is well documented. Shale oil production has grown by roughly 4 million barrels per day since 2008.

A couple of weeks ago a leading Saudi oil official said US shale requires $90 a barrel prices in order to stay profitable. This morning’s report from the IEA, says oil prices could go as low as $80 a barrel and barely put a dent in US shale production: from 2.8 million barrels a day this quarter, shale oil production would fall to 2.7 million barrels, a drop of 4%. The IEA forecasts drillers globally would only slightly cut back high-cost projects, reducing worldwide production by just 2.8%. There is of course, the political side of the oil story; low oil prices hurt Russia even more than sanctions.

Germany cut its official growth forecasts to 1.2 percent for 2014 from a previous 1.8 percent, and to 1.3 percent in 2015 from 2.0 percent, blaming crises abroad, notably with Russia, and moderate global growth. Chancellor Angela Merkel says Germany will stick to its budget and will not spend more to try to stimulate growth.

Ireland moved closer to closing a tax loophole known as the “Double Irish” that allows corporations like Apple and Google and about 1,000 others to avoid paying taxes in the US. The change was included in Ireland’s budget, which was released today and for the first time in 7 years did not include new austerity measures. Apple pioneered a method of skirting taxes by funneling its money through small subsidiaries set up in states or countries with low tax rates. A 2012 report in the New York Times documented how an Apple office in Reno, Nevada saved it millions that it would have owed to California. Subsidiaries in Ireland, the Netherlands, Luxembourg and the British Virgin Islands, meanwhile, helped save the company billions of dollars.

The European Commission has issued a preliminary finding that a special deal Ireland negotiated with Apple to cap the company’s tax rate violates the common market’s rules about illegal domestic subsidies; if the final ruling agrees, billions in fines could follow. The new rule, which will take effect in January, won’t affect companies currently employing the tax structure until 2020. So, there is about 5 years to figure out some new way to avoid paying taxes, but we don’t have to wait that long. Even as Irish officials announced the closing of one loophole, they announced the opening of another: the country plans to develop a special tax regime for intellectual property (IP), called a “knowledge box.” Essentially, it will give a special, lower corporate tax rate to companies on profits derived from IP.