Financial Review

Halftime

Sinclair Noe — June 30, 2017

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DOW + 62 = 21,349
SPX + 3 = 2423
NAS – 3 = 6140
RUT – 0.84 = 1415
10 Y + .03 = 2.30%
OIL + 1.40 = 46.33
GOLD – 4.20 = 1242.20
BITCOIN + 0.39% = 2509.80 USD
ETHEREUM – 6.64% = 279.09

I’m not sure we established a trading pattern this week. Down, up, down, up. We did see a return to volatility. The indexes saw big moves, much sound and fury amounting to very little. It might just be window dressing to finish out the quarter and heading into a long holiday weekend.

The markets will be open for a half day on Monday, but, this is the beginning of a long holiday weekend.

As we wrap up the second quarter and the first half of the year, let’s check where we stand.
For the month: the Dow gained 1.6%, the S&P gained 0.5%, the Nasdaq lost 0.9% for the month, and the Russell gained 3%.

For the second quarter: the Dow gained 3.3%, the S&P up 2.6%, the Nasdaq up 3.9%, and the Russell up 3.9%.

For the first half: the Dow is up 8%, the S&P up 8.2%, the Nasdaq up 14%, and the Russell up 6.1%.

So, the Nasdaq is the big winner so far, this year, but seemed to lose momentum in June. The S&P 500 recorded its biggest percentage first-half gain since climbing 12.6 percent in the first six months of 2013. The Nasdaq posted its biggest first-half gain since 2009.

Oil is down 14% from the start of the year and down 5% for the month of June. OPEC and certain other oil-producing countries agreed to extend their production cuts, originally set to expire at the end of June, by nine months (ending March 2018). They didn’t count on US shale producers ramping up production to fill the void.

The count of working oil rigs in the US fell this week for the first time in 24 weeks, breaking the record streak of increases. After several upward revisions, the International Energy Agency currently expects U.S. crude production to end the year 0.8 mmb/d higher than year-end 2016; although some traders are expecting closer to 1 mmb/d.

As such, the rapid U.S. shale growth in the back half of the year could meaningfully increase U.S. oil supply. Meanwhile, when OPEC cuts fall off in early 2018, look for the global oil glut to come roaring back.

The yield on the 10-year Treasury note has dropped 14 basis points from the start of the year, however the yield has been climbing in the past week or so, after hitting a low for the year at 2.13%.

This is still the most contrary move among major asset classes because the Federal Reserve has raised interest rates twice in the first half, and promises another cut in the second half plus plans to trim its balance sheet.

US 10-year yield has now moved above 200-day moving average, and broke the down trendline from March.

Second-quarter corporate results are set to begin in earnest in the coming weeks, with S&P 500 companies expected to post an 8-percent rise in earnings. Investors have been looking for earnings to support historically high valuations, with the S&P 500 trading at about 18 times earnings estimates for the next 12 months compared to the long-term average of 15 times.

We’re bumping right along the top end of historic valuation levels. It’s getting harder to find undervalued stocks with so much optimism factored into stock prices.

The U.S. dollar recovered slightly today, but posted its biggest quarterly decline against a basket of rival currencies in nearly seven years after hawkish signals from foreign central banks this week pressured the greenback further. The dollar index declined 4.6% in the second quarter to mark its steepest quarterly percentage drop since the third quarter of 2010.

The euro accelerated more than 7 percent against the greenback for its biggest quarterly percentage gain since the third quarter of 2010.

In late May, we told you the Midwest experienced flooding that damaged corn and wheat crops. Since then, the northern Plains states have experienced a drought that left crops withering in the field. Spring wheat, traded on the Minneapolis Grain Exchange, has soared 32 percent in June. Spring wheat is a thinly traded commodity, but it was a big winner, especially considering futures contracts are leveraged, this was a killer trade.

As we wrap up the first half we are once again reminded that the heavyweight champion of traders is still Warren Buffett. Warren Buffett is set to pull in $12 billion in profits on a single deal with Bank of America. Buffett invested $5 billion in Bank of America in 2011. That move came at a critical time for Bank of America with the company trying to leave behind the financial crisis with its new CEO Brian Moynihan.

Buffett negotiated a favorable deal with the bank, due to his investment acting as a public vote of confidence in the company’s future. His $5 billion investment in preferred shares came with the option to convert those to common stock shares until 2021. The preferred shares paid $300 million annually in dividends.

Buffett’s common stock shares are currently worth about $17 billion, $12 billion more than the purchase price. Warren Buffett’s Berkshire Hathaway is now the biggest owner of two of the world’s largest banks: Bank of America and Wells Fargo.

Consumer spending rose modestly in May and inflation cooled, pointing to a slow-but-steady economic expansion. Consumer spending rose 0.1 percent last month. Consumer prices excluding food and energy rose 1.4 percent on a yearly basis, compared to a 1.5 percent gain in April.

The Fed’s preferred gauge of inflation, the personal consumption expenditures (PCE) price index fell 0.1 percent in May from April, dragged lower by drops in prices for consumer goods and energy. When food and energy were excluded, the index was up 0.1 percent.

The slowdown in inflation has boosted consumer spending power. After-tax personal income adjusted for inflation rose 0.6 percent in May, the largest gain since April 2015.

Even so, the University of Michigan’s consumer sentiment index fell to 95.1 this month, its lowest since November, according to a final reading for the gauge published today. The index has been rising steadily since 2008 and in November it hit its highest level since before the 2007-09 recession.

Senate Republicans still don’t have a healthcare deal. Senate Republicans headed home for a week-long recess without coming to an agreement on their bill, named the Better Care Reconciliation Act. This represents another delay for the Trump agenda.

Illinois is poised to enter its third straight fiscal year without a budget. The Illinois House adjourned on Friday, the last day of the budget year, without enacting a plan and will reconvene at 11 a.m. local time on Saturday. While negotiations continue, it signals the legislature will blow the midnight deadline and extend the unprecedented impasse that’s left Illinois without a full-year budget since mid-2015.

Without a deal around July 1, S&P Global Ratings has warned that the nation’s fifth-most-populous state will likely get downgraded again, losing its investment-grade status. The state of Illinois will be rated junk. Without a spending plan, the state has effectively been on autopilot, leaving it with a record $15 billion of unpaid bills as it spent over $6 billion more than it brought in over the past year.

The impasse has devastated social-service providers, shuttering services for the homeless, disabled and poor. The lack of state aid has wreaked havoc on universities, putting their accreditation at risk. If the standoff isn’t resolved, Illinois officials have said they won’t be able to pay contractors and road construction will shut down, putting thousands out of work.

The yields on the state’s bonds have risen as investors anticipate a downgrade. Without a budget that includes borrowing to pay down the bill backlog, Illinois by August will run out of money for key expenses. That means school funding, state payroll, and pension payments could be affected. This won’t jeopardize debt-service payments. Illinois hasn’t missed any bond payments and state law requires it to make monthly deposits to its debt-service funds.

President Trump says he is “sending in Federal help” to Chicago to help curb gun violence. The president tweeted early Friday that crime in Chicago has reached “epidemic proportions,” citing more than 1,700 shootings in the city so far, this year.

So, the Feds are sending in a strike force of 20 Alcohol, Tobacco, and Firearm, or ATF agents for what officials called a “laser focus” on the illegal trafficking of weapons. They join 41 ATF agents already in Chicago. The force will also focus on investigating and prosecuting repeat gun offenders. Don’t hold your breath.

This week saw a couple of important anniversaries. 20 years ago, the British handed over rule of Hong Kong to the Chinese. 10 years ago, the first iPhone was sold. Apple sold more than 50 million iPhones in the first three months of 2017 alone, bringing in $33.2 billion.

Drivers are set to pay the lowest Independence Day price for gasoline since 2005 — and for the first time on record, the Fourth of July holiday per-gallon cost will run below the price from New Year’s Day, according to GasBuddy.

Motorists on the road for the Fourth of July holiday weekend are expected to pay an average of $2.21 a gallon for gasoline, well below the 10-year average of $3.14. If you are driving, be careful out there, and have a great Independence Day.

Financial Review

Bad Things in the Midwest

Sinclair Noe — May 14, 2015

 

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DOW + 191 = 18,252
SPX + 22 = 2121.10
NAS + 69 = 5050
10 YR YLD – .04 = 2.24%
OIL – .77 = 59.73
GOLD + 6.30 = 1222.40
SILV + .35 = 17.55

The Standard & Poor’s 500 Index closed at an all-time high, taking out the previous closing high of 2117.69. The Dow is still about 36 points shy of its record closing high. The dollar is on track for its longest weekly losing streak since October 2013. The bond market rallied, just a little, which is at least a change from the past couple of weeks. The earnings season is winding down, and it was ugly, but it looks like there will be positive earnings growth coming from the first quarter numbers. The economic data has been tepid.

The number of Americans who applied for unemployment benefits in the first full week of May fell by 1,000 to 264,000. New claims have registered less than 270,000 for three straight weeks, only the second instance in which that’s happened since 1975. Continuing jobless claims, people already collecting benefits, were unchanged at 2.23 million in the week ended May 2.

Producer prices, or prices at the wholesale level, fell a seasonally adjusted 0.4% in April to mark the seventh decline in the last nine months, mainly because of lower gasoline and food costs. Core producer prices that exclude the volatile categories of food, energy and trade rose 0.1% last month; the increase was mainly due to higher prices for drugs. Over the past year overall producer prices have fallen a record 1.3% on an unadjusted basis. Yet the core rate has risen 0.7% in the same span.

U.S. corporate spending on capital projects could fall this year to the lowest level since 2011, with steep reductions by the energy industry and companies in other sectors cutting spending amidst broad concerns about global growth. Among the S&P sectors, only the materials and financials sectors expect to spend more in 2015 than they did last year. They’re not spending at a pace that would suggest a global recovery. According to data from Thomson Reuters, estimates from analysts show that total S&P 500 capex spending could dip to $641 billion in 2015 from actual spending of $718 billion for 2014, marking the lowest level since 2011.

And it’s not just businesses that are holding on to the purse strings; yesterday we had a report showing retail sales were flat last month. It was widely believed that lower oil prices would put extra money in shoppers’ wallets and they would rush out to spend. Oil prices remain more than 40% below the highs reached in mid-2014, which equates to a roughly $150 billion ‘tax cut’ to consumers.

One reason for the lack of spending might be middle class debt. According to the Federal Reserve, as of 2013, the average debt of middle-class families, those that fall within the middle three-fifths of the population by earnings, amounted to an estimated 122 percent of annual income. That’s down from 2010, but still higher than 2001. Consumers have been trying to save more because they realized that gas prices could go higher, and it is happening; consumers also realize that interest rates could go higher, and for a typical household, higher rates could spell disaster.

Futures contracts imply that traders see the fed funds rate at about 0.3 percent rate by December. That’s the lowest estimate of the year, and about half the forecast for the overnight lending benchmark that the Fed gave in March. Fed policymakers have been saying that a rate hike will probably happen this year, with the caveat that any move will be data dependent. The economic data looks soft right now but the Fed has another motivation for a rate hike: financial stability. With interest rates near zero, the Fed is limited in their ability to deal with financial instability. They don’t have many tools in their tool belt.

So the Fed says rate hike, the futures traders say no; and this is setting up for another market-wide tantrum. Former Fed Chairman Alan Greenspan, speaking yesterday, said: “Just remember we had the ‘taper tantrum.’ And we’re going to get another one.”

If for no other reason than a blind pig can find an occasional acorn, Greenspan is probably right about this; traders are almost certain to complain about higher rates, even if rates have been abnormally low for a very long time; which will then give them an excuse to trade with higher volatility. Higher volatility equates to bigger profits, or losses if they get it wrong. The start of a tightening cycle typically causes some rise in volatility, but rarely a bear market, provided the Fed doesn’t surprise the markets. The extent of the impact is likely to be influenced by two other conditions: changes in equity valuations and the direction of inflation.

For now, inflation remains moderate but that can change; and one big factor will be energy prices. The fact that equity multiples have been rising suggests that markets are at greater risk for at least a modest correction; not a crash but enough to get your attention. And when we talk about rising multiples, we generally think of momentum stocks, and the usual suspects in this area would be biotech and social media stocks. The flip side to this line of thinking is that stocks climb a wall of worry. Momentum stocks typically represent areas of growth in an otherwise stagnant economy.

For now, volatility remains at low levels, the VIX, or volatility index is trading just under 13, almost half the level from back in December. It kind of feels like the calm before the storm.

Bad things are happening in the Midwest.

Deadly avian flu viruses have affected more than 33 million turkeys, chickens and ducks in more than a dozen states since December. On Tuesday, agriculture officials confirmed that the bird flu outbreak that has spread throughout the Midwest for months had reached Nebraska, making it the 16th state affected. Today, South Dakota reported its first possible infection on a chicken farm with 1.3 million birds in the eastern part of the state. The Iowa Poultry Association says there is no food safety risk for consumers. Chickens, turkeys and other poultry infected with bird flu will be destroyed and will not enter the food supply. Still, Iowa Governor Terry Branstad declared a state of emergency on May 1 due to the avian influenza outbreak. The virus may pose no risk to humans, but it is already having an impact on prices at the grocery store.

Iowa, where one in every five eggs consumed in the country is laid, has been the hardest hit: More than 40 percent of its egg-laying hens are dead or dying. For now at least, the biggest impact of the virus is on egg prices. It is estimated that prices will rise 1.6% for every million chickens destroyed. About 90 percent of the more than 25 million chickens that are being destroyed in Iowa produced liquid eggs, and already the wholesale price for those eggs nationwide has nearly doubled from late April. Liquid eggs are used in everything from mayonnaise to cake mix and are a major product of Iowa’s poultry industry.

According to the Associated Press, the price of a carton of eggs at supermarkets has increased 17% over the last month, hitting an average of $1.39. Bulk prices paid for eggs by cake mix and mayonnaise manufacturers, meanwhile, have spiked 63% over the past two-and-a-half weeks. Turkey prices are up as well, with breast meat at delis rising 10% since mid-April. So far, chicken prices appear to be unaffected.

Certainly the avian flu affects chicken farmers but from there it ripples through the Midwestern economy to the support businesses, ranging from bank lenders and insurers to trucking operations, feed mills and farmers. It hasn’t hit corn and soybean farmers yet, but it means a smaller market for part of their crops.

Next stop:
Chicago,
“Hog butcher for the world,
Tool maker, stacker of wheat,
Player with railroads and the nation’s freight handler;
Stormy, husky, brawling,
City of the big shoulders.
They tell me you are wicked and I believe them.”
City of Junk.

Moody’s Investors Service dropped two other hammers on Chicago taxpayers today, downgrading debt on both Chicago Public Schools and the Chicago Park District to junk levels. For the schools this will apply to $6.2 billion in general obligation debt.

The action won’t necessarily prevent CPS from borrowing more. But it will make that more costly, and comes at a particularly sensitive time, as the district seeks to renegotiate hundreds of millions of dollars in currently-losing swaps contracts. Beyond that, the district faces a deficit of well over $1 billion in its budget for the school year that begins on July 1, and is in negotiations with the Chicago Teachers Union, which says the current financial woes are “manufactured.”

At the parks, $616 million in outstanding general obligation debt is affected. Yesterday, Moody’s downgraded the city’s credit rating to junk status. Moody’s said Chicago’s options for curbing its $20 billion unfunded pension liability “have narrowed considerably” after last week’s Illinois Supreme Court ruling invalidated a state pension reform law. Moody’s said spending cuts and tax increases may be needed, regardless of how the court rules. The state could force the city to pay retirees directly, possibly leading to another rating cut. Moody’s on Tuesday also cut ratings on Chicago’s sales tax, motor fuel tax, and water and sewer revenue bonds.

Cities don’t get to play by regular bankruptcy rules. Cities don’t really have the choice of liquidating and going out of business. So when they can’t keep up with pensions, payrolls, services, and other obligations, they get temporary bankruptcy protection under Chapter 9. But they know that sooner or later they need to come up with a plausible matching-ends-with-means plan for coming out of bankruptcy. How will this all play out? I don’t know. But I’m guessing there might be a new nickname for Chi-town. City of big haircuts.

Monday, July 07, 2014 - Small Steps

Financial Review with Sinclair Noe

DOW – 44 = 17,024
SPX – 7 = 1977
NAS – 34 = 4451
10 YR YLD - .03 = 2.62%
OIL - .67 = 103.39
GOLD - .50 = 1321.00
SILV - .10 = 21.15

 

It was a long holiday weekend that was over way too fast. And the problems of the world haven’t gone away. Let’s get caught up on some of the big stories.

In Iraq, the situation is deteriorating. There had been muted hope for some sort of an inclusive government to hold the country together. Don’t count on it. Iraq’s new parliament has called a recess and they won’t meet again for 5 weeks. So Iraq is now politically paralyzed. Meanwhile, a Sunni Islamist insurgency killed an army general near Baghdad.  It looks like Prime Minister Maliki is digging in his heels, raising the risk that Iraq will fragment along ethnic and sectarian lines.

ISIS, the Sunni insurgents are holding territory in western Iraq and just north of the capitol. The Iraqi military, backed by Shi'ite militias and volunteers, has yet to take back any major cities but is trying to advance on Tikrit. Kurds in northern Iraq have taken advantage of the chaos to expand their autonomous territory in northern Iraq. Most Sunnis and Kurds walked out of the last parliament, saying they believed the prime minister and president should be chosen along with the speaker as a package, not one at a time. They could not resolve the impasse, so the acting speaker postponed the meeting.

In eastern Ukraine, pro-Russian rebels built barricades in the streets of Donetsk and it looks like they will try to make a stand. Although most shops and businesses in Donetsk were still open, some were shut, and residents are concerned that government forces could soon attack. Rebels have been barricaded into government buildings in Donetsk, which they declared capital of an independent "people's republic", but until now the city mostly functioned normally.

You may recall there was an election in Afghanistan last month. They announced preliminary results today. The losing presidential candidate is now saying the results of the election were improperly counted and he is describing it as a “coup” against the people. His rejection of the election results sets the stage for a possible bloody standoff between ethnic groups or even secession of parts of the fragile country, which is already deeply divided along tribal lines. The vote to pick a successor to Hamid Karzai was intended to mark the first democratic transfer of power in Afghan history, a crucial step towards stability as the US prepares to withdraw the bulk of its troops by the end of the year. Not so great.

Hamas stepped up rocket fire at southern Israeli towns and Israel called up reserve troops today in anticipation of a possible escalation of hostilities. Hamas has vowed revenge for what it saw as Israel's deadliest attacks in which six Palestinian militants died, though Israel denied any involvement. The surge in violence has raged since the kidnapping and killing of three Israeli youths last month and a Palestinian teen last week. Israel said more than 40 rockets were launched as militants' funerals were held in Gaza. Thirty struck inside Israel and the rest were shot down by rocket interceptors. Air raid sirens wailed as far north as the outskirts of Tel Aviv and Jerusalem.

And then there’s Chicago, where the Fourth of July holiday resulted in widespread violence that left 80 people wounded and 14 dead.

On the economic calendar, Alcoa will kick off the earnings reporting season after the close of trade tomorrow. Alcoa has long held the ceremonial role for starting earnings season because it was in the Dow Industrials and it had the ticker symbol AA. Alcoa is no longer one of the Dow 30 stocks, but the tradition holds. Actually, we’ve already seen about 25 companies from the S&P 500 report earnings.

Second-quarter profit growth is expected to come in at 6.6% for the Standard & Poor’s 500-stock index, which would be an improvement over the 5.6% growth in the first three months of 2014. Revenues are expected to grow 3%. While negative second-quarter profit warnings have outpaced positive ones by a 4.2 to 1 margin — well above the 2.6 to 1 negative-to-positive ratio since 1995 — the future outlooks from CEOs are far more bullish than the first quarter, when there were nearly 7 negative profit pre-announcements for every positive one.

With stocks at all-time highs and no longer cheap after a five-year bull run, Wall Street wants to see companies deliver profit and revenue growth in the coming second-quarter earnings season sizable enough to warrant the market’s big move. Indeed, the bull market’s continued health will hinge on vibrant corporate profitability. Whether or not stocks continue trending higher will likely depend on second-quarter earnings reports, as well as management’s guidance of full-year earnings.

Currently, the S&P 500 is trading at nearly 16 times its estimated earnings over the next four quarters, which is a tad above the long-term average. Heading into the season, analysts are upbeat, with more analysts’ raising profit forecasts than lowering them for the first time since the first quarter of 2012, but more upbeat analysts could result in a more downbeat market reaction.

On Wednesday, the Federal Reserve will release the minutes of its last meeting, held June 17-18. Wall Street will again be looking for any clues related to the timing of the first interest rate hike by the Fed. After the strong jobs report Thursday, some Wall Street firms revised their rate-hike timetables, warning that rates could start rising earlier-than-expected next year. However, the Fed might not be so positive about jobs. There’s been concern about the degree to which a falling unemployment rate is overstating labor-market strength.  You’ll likely see general agreement that the labor market has been improving, but there will be difference in opinion about the drop in the unemployment rate. Officials have also been eyeing tepid wage growth.

That’s one of the strange things about the jobs report; it does a poor job of measuring the strength of the jobs created. When we try to measure performance in the stock market, we don’t look at the number of new stocks available to investors, instead we measure the price of the stocks, the value of the stocks. But when we look at jobs, we don’t look at the value those jobs bring. One of the things we’ve seen is that many of the jobs being created are part-time.

So, it's interesting that the recent news of job market "improvement" doesn't mention that of the 10 occupation categories projecting the greatest growth in the next eight years, only one pays a middle-class wage. Four pay barely above poverty level, and five pay beneath it, including fast food workers, retail sales staff, health aids, and janitors. The job expected to have the highest number of openings is "Personal Care Aide" – taking care of aging baby boomers in their houses or in nursing homes. The median salary of an aid is under $20,000.

We’re starting to see some improvement as the job market gains traction; more than half the jobs the economy has added so far this year are in positions that pay higher than the hourly wage. Some 58% of the new jobs created in 2014 pay above the average hourly wage of $24.45. By contrast, about 48% of the new jobs created in 2013 paid above the national average. Businesses in 2014 are hiring more white-collar employees, construction is on the mend (at least compared to the first quarter), health care is going strong and even the long-downtrodden financial industry is finally getting into the act. About 42% of the new jobs, meanwhile, fall into categories that pay less than the average wage.

Still there is a general lack of upward wage pressure; workers demanding more money as the labor market improves and the pool of potential employees shrinks. Wages have risen just 2% over the past year and weekly wages have actually fallen in the past two months. Part of the problem is part-time work; part of the problem is that the good paying jobs are limited to certain sectors. The bigger problem is that the increase in the number of jobs is not translating to higher wages and that, in turn does not translate to faster economic growth.

This week’s economic calendar also includes reports on small businesses, job turnover, and consumer credit. There was a 10.2% surge in consumer credit in April. The growing dependence on debt could prolong consumer spending a few more months, but in the absence higher real wages, this type of consumption cannot last much longer, certainly not if we see both gas prices and inflation-driven interest rates edge higher later this year.

It’s unlikely we’ll get any big pronouncements from the Fed. They probably talked about how the economy has rebounded from the terrible slump of the 1^st quarter, but if you read the minutes for any major move on interest rates, don’t hold your breath. Neither short-term nor long-term rates will go significantly higher in the next few years. More likely, modest increases that might even be quickly reversed. The implications of another extended period of depressed rates would be bad news for savers and pension funds, but it should help the stock market.

After the Fed’s June meeting, they made clear that they expected to finally begin lifting their benchmark rate in 2015, if the economy continues to expand and unemployment continues to decline. Even so, 12 of the 16 members of the policy committee expected the Fed's rate to be no higher than 1.5% by the end of 2015 — a full 18 months from now. Asked for their rate prediction for the end of 2016, the majority of the Fed panel expected 2.5% or less. And because the Fed's rate influences all other interest costs, that would suggest still-low rates across the board.

What we are learning about this version of the Fed is they move slow and in small steps.