Turkey Shoots

Sinclair Noe — November 24, 2015

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DOW + 19 = 17,812
SPX + 2 = 2089
NAS + 0.33 = 5102
10 YR YLD – .01 = 2.24%
OIL + .89 = 42.64
GOLD + 6.70 = 1076.40
SILV + .05 = 14.30

The US economy expanded at a faster pace in the third quarter than previously reported. Gross domestic product rose at a 2.1% annualized rate, up from an initial estimate of 1.5%. Nearly all of the improvement was because of revised data on inventories, which showed businesses restocking shelves at a faster pace than the government first estimated.

Still, company stockpiles remained elevated compared with sales, indicating that new orders and production will cool further to clear shelves and warehouses heading into 2016. Inventories grew at a $90 billion annualized rate from July through September, almost twice as much as previously estimated, but down from the second quarter.

The improvement in inventory levels was offset by a slight downward revision in consumer spending last quarter. Cheap gasoline is giving households a little extra money, and consumers are spending, just not quite as fast; consumer spending was revised down to 3% from 3.2% in the initial estimate for the third quarter. Consumption during the current fourth quarter, including the holiday shopping season, is expected to increase at an annualized rate of about 3%.

For all of 2015, the rate of economic growth is expected to be about 2.5%, not much different from the 2.4% rate in 2014. Not great but good enough. The GDP report was the one of the last big economic reports before the Fed FOMC meeting December 16^th; the other big report will be the November jobs report, which will be published on Friday, December 4^th. In reality, not much has changed since June or even October, when the Fed did not raise rates.

Corporate profits after tax, without inventory valuation and capital consumption adjustments, fell at a 3.2% pace from the second quarter, the biggest drop since the fourth quarter of 2014. On a year-over-year basis, corporate profit growth was 1.4%, compared with 8.5% year over year growth in the second quarter. That measure of corporate profits tracks most closely with what companies report in earnings statements. Profit data aren’t inflation adjusted.

The Conference Board reports that its index for consumer confidence fell to 90.4 from 99.1 in October. Despite a strong advance in hiring last month, consumers expressed more caution about the job market and future economic conditions in the most recent survey. The fall is in the expectations, not the current conditions, component. The decline in job expectations is dramatic and raises the question whether global effects, which have been negative for the US, are beginning to weigh on the American consumer, which would not be a positive for the holiday spending outlook.

Existing home prices rose in September. The S&P/Case-Shiller 20-city composite index gained 0.2%. Prices rose 5.5% for the year, up from a 5.1% yearly gain in August. The index is still about 12% lower than its 2006 peak. Phoenix home prices were up 0.2% in September, and up 5.3% over the past 12 months.

At the peak, prices in Phoenix were 127% above the January 2000 level. Then prices in Phoenix fell slightly below the January 2000 level, and are now up 54% above January 2000 (54% nominal gain in almost 16 years).

These are nominal prices, and real prices (adjusted for inflation) are up about 40% since January 2000 – so the increase in Phoenix from January 2000 until now is about 14% above the change in overall prices due to inflation.

Turkey has shot down a Russian military jet near the Syrian border. Turkish officials said the jet was downed after it knowingly violated Turkish airspace. The two Russian pilots ejected before the plane crashed but they were shot in their parachutes as they floated to earth. And then Turkish tribesmen reportedly destroyed a Russian helicopter with a TOW antitank missile as it tried to rescue the airmen. The Russian Ministry of Defense confirmed that one fighter pilot had been killed by ground fire and that a marine deployed on the search-and-rescue helicopter died but that the rest of the crew had managed to escape.

Russia’s retaliation so far has been largely symbolic. Russia’s foreign minister canceled a Wednesday visit to Turkey, and a large Russian tour operator announced it was suspending sales to Turkey. The two countries are also significant trade partners, or at least they were. A reminder that Turkey is a member of NATO. Today, French president Francois Hollande was in Washington and conducted a joint press conference with President Obama. They vowed to intensify their nations’ military attacks on ISIS in Syria and Iraq. They also announced that next week’s climate change summit in Paris would be a “powerful rebuke” to terrorists.

In the immediate aftermath markets reacted nervously, with the lira selling off, Russian stocks sliding and global government bonds climbing as investors move to safe havens. Meanwhile, a car bomb exploded outside a hotel housing judges supervising parliamentary elections in Egypt’s North Sinai, killing at least three people and injuring 14. The region is the main area of operations for the Egyptian affiliate of ISIS.

Citing “increased terrorist threats” from militant groups in various regions of the world, the US State Department has issued a global travel alert ahead of a busy Thanksgiving week. The department did not advise people against travel but said US citizens should be vigilant, especially in crowded places. The announcement comes as Brussels remains on lockdown and follows the discovery of an explosive belt near Paris and the mobile phone of a fugitive believed to have taken part in the November 13 attacks.

Ford is the latest automaker to say it will not equip future cars with Takata air bag inflators that use ammonium nitrate, the chemical propellant that has been linked to eight deaths and more than 100 injuries worldwide. Ford’s auto recalls with Takata airbags have so far affected about 1.5 million vehicles, including certain older model-year Ford Mustangs, Ford GTs and North American-built Ford Rangers.

Costco has an E. Coli problem. Nineteen people have been infected with E. coli in California, Colorado, Missouri, Montana, Utah, Virginia, and Washington. They have tracked the source to Costco’s rotisserie chicken salad. You might want to stick with turkey for the next few days.

Skyworks Solutions has withdrawn its agreed takeover bid for PMC-Sierra after an increased offer of $2.3 billion from Microsemi gained the backing of the target’s board. Skyworks said it won’t modify its bid and that the company is entitled to an $88 million termination fee from PMC. Semiconductor makers have pursued mergers at a record pace this year.

China’s securities regulator has canceled a requirement that brokerages must hold a net positive purchase position on daily proprietary trading as the nation’s stock market stabilizes following a summer slump. With the Shanghai Composite now having gained more than 20% from its August low, regulators are withdrawing from a government campaign to prop up shares.

New York Attorney General Eric Schneiderman is clamping down on “spoofing,” issuing subpoenas to interdealer brokers BGC Partners, TFS-ICAP, GFI Group, and Tullett Prebon Financial Services. The investigation is focused on placing offers with the intent to cancel them before they trade in order to trick other investors by creating the illusion of demand. Earlier this month, high-frequency trader Michael Coscia became the first person to be found guilty of spoofing in a criminal case.

National Football League player Dwight Freeney can proceed with his lawsuit alleging that Bank of America was complicit in a fraud scheme that caused him to lose more than $20 million and forced his Rolling Stone restaurant to close. The Arizona Cardinals linebacker last Thursday defeated a bid by the parent company and its Merrill Lynch unit to dismiss, among others, fraud and negligent misrepresentation claims stemming from the bank’s recruitment of him in 2010 to manage his assets. US District Judge Margaret Morrow in Los Angeles didn’t rule on the merits of Mr. Freeney’s claims but agreed that he alleged enough facts to move forward with the case.

Just in time for the busiest shopping week of the year – iSight Partners, a privately held cyber intelligence firm is warning retailers about what they call “the most sophisticated point-of-sale malware seen to date.” The firm had shared information about the malware, dubbed ModPOS, with clients in October, and briefed dozens of companies about its dangers. Some retailers have found digital evidence that linked threat indicators they had previously seen to ModPOS, though that does not necessarily mean they were victims of breaches. Just a reminder that if you are concerned about cyber security while holiday shopping, cash still works.

CalPERS, the California Public Employees’ Retirement System said it paid $3.4 billion in performance fees to its private equity managers since 1990 while the controversial sector generated $24.2 billion in profits for retirees. CalPERS has been hard-pressed to keep up with looming obligations to its 1.7 million current and future retirees.

The CalPERS fund, the largest pension fund in the country now at about $295 billion, is considered about 74% funded, down from 77% as of June 30, 2014, mostly because of weak performance from its global stock portfolio. The global stock portfolio posted returns of 1% for the last fiscal year, ended June 30. Private equity, by contrast, returned 8.9% for the year but not without risk and hefty fees.

Jeff Bezos’s space exploration company Blue Origin achieved a key milestone: sending a rocket into space and then landing it safely back on Earth. Making reusable rockets is a central goal for a generation of companies that are trying to cut the cost of space travel and exploration. A Blue Origin vehicle called New Shepard flew to space on Monday, reaching an altitude of 100 kilometers, and then landed back at its launch site.

FINANCIAL REVIEW

War, Inversions, and Climate

Sinclair Noe — September 23, 2014

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Financial Review

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

DOW – 116 = 17,055
SPX – 11 = 1982
NA – 19 = 4508
10 YR YLD – .03 = 2.53%
OIL + .06 = 91.62
GOLD + 8.10 = 1223.90
SILV + .05 = 17.88

First up: war. You’ve probably heard by now that the US launched several airstrikes against ISIS targets inside Syria and, separately, in potentially averting an imminent threat to the homeland from an al Qaeda group called Khorasan. Many of the targets were in and around Raqqa, Syria, believed to be an ISIS stronghold. Several Arab nations took part in the US-led operation: Jordan, Saudi Arabia, Bahrain, Qatar and the United Arab Emirates. A spokesman for the Pentagon said they are still assessing the effectiveness of the bombing campaign but the Pentagon believes they were “successful in hitting what we were aiming at.”

The airstrikes against Khorasan was in response to threats, however officials so far have provided no details about the terrorists’ planned attack or the credibility of the intelligence they had on it. A Pentagon spokesman said “the individuals plotting and planning it were eliminated.”

The Syrian government says the US told it of plans to carry out airstrikes. The State Department immediately denied that it gave prior notification. Reuters reports Iranian officials were informed of the airstrikes in advance, but not specific targets. Meanwhile, the Israeli military said that it had shot down a Syrian fighter jet that had “infiltrated into Israeli airspace,” the first such incident in at least a quarter of a century. It is thought that the jet wandered into Israeli airspace accidentally. Maybe, but it also illustrates the possibility of unintended entanglements coming out of the conflict.

In economic news: manufacturing activity is near a 4-1/2 year high in September and factory employment is up, but housing prices were sluggish in July.

Financial data firm Markit said its preliminary or “flash” factory purchasing managers index came in at 57.9, unchanged from August when it touched its highest level since April 2010. A reading above 50 indicates expansion. Manufacturing activity in the third quarter was the strongest since Markit started tracking it in mid-2007. Factory jobs rose for a second straight month, and new orders held steady above 60 for the third time in the last 4 months.

The Federal Reserve Bank of Philadelphia said its new general activity index for non-manufacturing firms in the mid-Atlantic region jumped sharply. The increase in activity reflected more new orders, sales and full-time hiring. Service sector employees also worked longer hours, while firms increased their capital spending.

The Federal Housing Finance Agency said home prices increased 0.1% in July, and 4.4% in the 12 months through July, the smallest gain since September 2012.

Further data showed euro zone business activity in September was the weakest this year, while factory activity in China picked up only slightly.

The Treasury Department today announced new rules to crack down on corporate tax inversions. The idea behind inversions is that a US business merges with or is acquired by a foreign company in a country with a lower tax rate; by redomiciling, or moving their headquarters to the lower tax rate country, they can lower their tax bill, even if they keep most of their business in the US. Obama applauded the Treasury for taking steps to reverse the trend of companies seeking to “exploit this loophole” to avoid paying their fair share in taxes. Yet he said he was still calling on Congress to pursue broader tax reform that would reduce the corporate tax rate, close loopholes and make the tax code simpler.

The new rules will mean little for companies that have already inverted, but for at least 10 companies in the midst of completing such deals, and for those considering inversions, the impact will be significant. Most pending deals could become more costly for the buyers, such as AbbVie, and its $54 billion deal to acquire Ireland’s Shire, as well as Medtronic and its $42 billion takeover of Covidien. Neither of these transactions, the biggest of the year, was expected to fall apart completely, partly because paying a break-up fee to walk away would likely be even more costly. AbbVie would have to pay Shire a $1.6 billion penalty if it were to renege on their merger agreement. Medtronic has a contract that lets it or Covidien walk away from their deal if the US Congress changes tax law. The Treasury’s new rules fall short of that, so a break-up fee likely would loom in this case, too, if the merger were called off. Burger King said it will proceed with its $11 billion deal with Canada’s Tim Hortons, stressing that the transaction was not about tax benefits.

There are also some new rules unveiled by the Treasury today, and some of these tax evasion schemes have names that sound like they came right off the playground. One rule will prevent inverted companies from using “hopscotch” loans that allow them to avoid dividend taxes when tapping tax-deferred foreign profits. Another rule will bar inverters from gaining access to offshore profits by using “decontrolling” strategies that restructure foreign units so they are no longer US-controlled. The Treasury is also tightening limits on the levels of ownership that the former US investors can have in an inverted company for it to qualify for foreign tax treatment under US law, a move that will make it harder to do the deals. And then there’s the “spinversion” which is a partial inversion where the US company transfers some of its assets to a newly formed foreign corporation. That corporation is then spun off to public shareholders. New rules would treat the spun-off company as a domestic corporation.

Ultimately, this is an issue that will require legislative action, but for now, it will be more difficult for companies to skip out on their tax obligations by moving offshore; more difficult but not impossible. I suspect there are a lot of tax attorneys working overtime today.

The United Nations Climate Summit kicked off today in New York. The summit was convened to lay the groundwork for nations to sign a binding emissions treaty late next year during climate negotiations in Paris. In speeches delivered at the summit, diplomats from 120 countries laid out a series of new, nonbinding climate commitments. Here is an overview of what world leaders have pledged so far: President Obama delivered an address at the summit this afternoon where he announced an executive order requiring federal agencies to take climate change into account when doling out dollars for international aid and investment abroad. The US has previously pledged to curb emissions 17% from 2005 levels by 2020.

The EU unveiled a new commitment to slash greenhouse-gas emissions 40% from 1990 levels by 2030. British Prime Minister David Cameron said that the U.K. is on track to cut emissions by 80% by 2050. Cameron did not, however, announce any new targets not already agreed to by the country. China’s Vice Premier repeated China’s previously stated goal of cutting carbon emissions by 40 to 45% from 2005 levels by 2020. Iceland said that it aims to power its economy entirely with clean energy, but did not set a date. Mexico announced that it aims to generate more than one third of its electricity from zero-emissions sources by 2018. Costa Rica will be powered purely from clean energy by 2016. And a whole bunch of countries pledged hundreds of million to the Green Climate Fund.

Sounds familiar, right? But maybe this time will be different, and the reason is because this time it might actually pay to go green. All things considered, the cost of curbing carbon emissions may be considerably cheaper than earlier estimates had suggested. For all the fears that climate change mitigation would put the brakes on growth, it might actually enhance it.

Last week, an international commission published the “New Climate Economy” report concludes that efficient investments could deliver at least half of the emission cuts needed by 2030 to keep global temperatures in check. And they could do so while delivering extra economic gains on the side. Side benefits include things like lower health costs.

And it looks like corporations are getting on the climate change bandwagon. Tim Cook, CEO of Apple was in New York, and he said: “The long-term consequences of not addressing climate are huge,” he said. “I don’t think anyone can overstate that.” Google executive chairman Eric Schmidt announced Google would stop funding the American Legislative Exchange Council, or ALEC, claiming the Council had been “literally lying” about the reality of climate change. Schmidt said: “The company has a very strong view that we should make decisions in politics based on facts — what a shock,” said Schmidt. “And the facts of climate change are not in question anymore. Everyone understands climate change is occurring and the people who oppose it are really hurting our children and our grandchildren and making the world a much worse place. And so we should not be aligned with such people — they’re just, they’re just literally lying.”

The basics of climate change have been understood for a long time, don’t seem to be budging much and yet remain challenged by many non-specialists. What’s significant then, in such a public debate, is who acknowledges those basics, as much as what is said. That’s why it was news when former Treasury Secretary Hank Paulson called for a carbon tax, when the Rockefellers, the first family of oil pulled out of oil sands or, the head of the world’s largest company by market cap endorses a brand new climate and business initiative by showing up and saying absolutely anything at all. Tim Cook also challenged the still-common fallacy that good business and environmentalism are mutually exclusive. “Too many people believe you can do this or that,” he said. “If you innovate and you set the bar high you will find a way to do both.”

The World Bank yesterday released a list of 73 countries and more than 1,000 companies that support a price on carbon dioxide pollution. Apple, which now powers 73% of its facilities with renewable energy and has raised its environmental profile, was not among the signatories.

FINANCIAL REVIEW

Keep Your Eye On The Ball

Sinclair Noe — September 22, 2014

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Financial Review

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

DOW – 107 = 17,172
SPX – 16 = 1994
NAS – 52 = 4527
10 YR YLD – .02 = 2.57%
OIL – .91 = 91.50
GOLD – 1.40 = 1215.80
SILV – .06 = 17.83

It’s not a huge week for reports, but we do get a couple worth keeping an eye out for. On Thursday, we’ll get the durable goods report for August; and on Friday, we’ll get the third and final revision to second-quarter Gross Domestic Product. This morning we saw the report on existing home sales.

The National Association of Realtors said existing home sales dropped 1.8 percent to an annual rate of 5.05 million units. The decrease was the first in four months, although the sales pace was still the second highest for the year. Investors had propped up the market by snapping up distressed properties and converting them into rental units, but last month they accounted for only 12 percent of transactions, which was the smallest share since November 2009; all cash sales made up 23 percent of transactions in August. First-time buyers accounted for 29 percent of sales, well below the 40% to 45% considered normal. The inventory of unsold homes on the market increased 4.5 percent from a year-ago to 2.31 million in August. At August’s sales pace, it would take 5.5 months to clear houses from the market, unchanged from July.

A new survey from CNBC called the Corporate Perception Indicator takes a look how individuals and business executives view corporations around the globe. Emerging markets tend to look at corporations more favorably than developed nations; 72 percent of the public in emerging economies saw corporations as a “source of hope, rather than fear”, compared with 52 percent in developed economies.

The survey also found that 57 percent of the general population and 53 percent of executives believed that corporations take advantage of tax loopholes to avoid paying their fair share of tax, including 70 percent of the general population and 67 percent of business leaders in the United States, agreed that it was important for corporations to pay their fair share of taxes.

Another survey, this one from Rutgers University, finds more than 20% of workers laid off in the last five years haven’t found new jobs. Among laid-off Americans who say they’ve found a new job, 46% said it came with a pay cut and 44% reported a drop in status. The survey also found increasing pessimism among the unemployed; 36% said the economy will never fully recover from the recession, up from 29% last January, when they were asked the same question. Likewise, 40% said that the availability of good jobs for those who want to work will never return to pre-recession levels, up from 34%.

This week’s economic calendar also includes a couple of high level conferences. The G20, or Group of 20 industrialized and developed countries just wrapped up a meeting in Australia, a test run for the November G20 leaders’ forum that will include Russia. The assorted and sundry finance ministers and central bankers at the weekend meeting think they’ve figured out a set of policies and initiatives to add an additional 1.8% economic growth, but they also issued a warning about a build-up of excessive risk in the financial markets.

It’s unusual for government finance ministers to comment on the direction of financial markets, but you would have to be blind to miss the fact that the S&P 500 has risen by about 200%, while overall US economic output has only risen by about 20%. Stock prices relative to earnings are above historical averages. Europe faces the risk of deflation; while the Federal Reserve is easing off the stimulus; Brazil is in a recession; Russia is mired in economic sanctions over Ukraine; and even China is projecting slower growth. The G20 also talked about the Ebola crisis in Africa, corporate tax evasion, and climate change.

In New York the climate change issue spilled into the streets yesterday and today. Yesterday, between 300,000 and 400,000 people turned out for the Climate March, ahead of the United Nations Climate Summit, which starts tomorrow. Organizers hailed the turnout as the largest climate change march in history. The organized Sunday march included celebrities and political figures including the Mayor of New York. Also, today, a much smaller group of protesters took their message to Wall Street; today’s protest did not have permits and ended with crowds being pepper-sprayed. By conducting a sit-in on the steps of the New York Stock Exchange, organizers say they are confronting “the system that both causes and profits from the crisis that is threatening humanity.”

Maybe they have a point; at least the Rockefellers seem to think so. In recent years, 180 institutions — including philanthropies, religious organizations, pension funds and local governments — as well as hundreds of wealthy individual investors have pledged to sell assets tied to fossil fuel companies from their portfolios and to invest in cleaner alternatives. In all, the groups have pledged to divest assets worth more than $50 billion from portfolios, and the individuals more than $1 billion. Today, the New York Times reports the $860 million philanthropic organization, the Rockefeller Brothers Fund, is joining the divestment movement.

Not everyone will divest completely or right away and some are divesting just from specific sectors of the fossil fuel industry, such as coal. Just how transparent the various funds and institutions will be about the progress of their asset sales is uncertain. The Rockefeller Brothers Fund has already eliminated investments involved in coal and tar sands entirely while increasing its investment in alternate energy sources.

The Rockefellers are especially noteworthy given their family history. Patriarchs John D. Rockefeller and William Rockefeller amassed their fortunes while working in the oil industry. The Rockefeller brothers were co-founders of the Standard Oil Company, the world’s largest oil refiner at the time.

The divestment movement began on college campuses, where it has met with mixed results. Harvard has refused to divest; Stanford has agreed to divest its holdings in the coal industry; Yale University is still studying the matter.

Divestment is not an easy thing to accomplish, especially for individual investors. Some of the biggest oil companies, such as ExxonMobil, Chevron, and ConocoPhillips are listed on the S&P 500 index. Many mutual funds and exchange traded funds mimic the S&P 500 by buying all the stocks in it or else use the index as a benchmark. That means anyone who has a stock mutual fund in their retirement portfolio probably owns some Big Oil.

And then there is a question of the impact of divestment, and whether that is the way to go, as opposed to shareholder activism. For the Rockefeller Brothers Fund, they tried activism with ExxonMobil, and say they were largely ignored, and they tried direct investment back in the 80’s without much success; so divestment is what remains. But divestment is just a small part of what is happening.

According to the Columbia Journalism Review, the debate has shifted from a science story to a business story. The thinking here is that all credible science has accepted manmade climate change, and now the question is how to apply a risk management approach to climate change. Risk-management analysis identifies likely financial losses due to things like legal liabilities, uncertainties in credit markets, and the probability of infrastructure failure.

The climate story has largely been locked in the story of rising sea levels and polar bears. That’s compelling but for most people it doesn’t address their bottom line. Sea levels are going to rise but at the edge of the water is someone’s home or business. Temperatures are rising but what impact does that have on the price and availability of the food you buy and eat? What does it mean for the construction industry and how we build buildings? What does it mean for the insurance industry and how we insure property? And insurance companies aren’t just evaluating coastal and flood prone areas; farmers in the heartland benefit from crop insurance and federal disaster relief when their fields wither under extended droughts and heat waves.

Extreme weather can also affect health. JAMA has just released a study showing the many ways climate change can make us sick; from heat related health problems to respiratory illness, to infectious diseases like West Nile and dengue fever, to waterborne diseases. As extreme weather events become more frequent and intense, there’s a growing understanding that the costs could be catastrophic.

So, for many in business, the question of climate change is coming down to understanding not only risk but pricing. Last week, more than 340 global institutional investors with at least $24 trillion in assets — including Swiss Re and the Unitarian Universalist Association — called on government leaders to adopt carbon pricing. The World Bank says 73 countries and more than 1,000 companies and investors support a price on carbon; that is, a carbon tax or buying permits to emit carbon. The list includes countries like No. 1 polluter China, and companies including Cisco Systems, IKEA Group and the Dow Chemical Company. Investors include BNP Paribas Investment Partners, the Illinois State Board of Investment and Rockefeller Asset Management. Absent from the list, however, are the world’s second- and third-largest polluting countries, the US and India.

Dozens of climate-related events will take place this week in the New York, but the summit itself starts tomorrow at UN headquarters. President Obama and leaders from more than 120 countries are likely to announce climate initiatives, and company CEOs will participate in talks or make their own commitments.

So, the UN Climate Summit kicks off tomorrow; it is expected to endorse a new international plan to cut deforestation in the world’s tropical forests – with conservation plans to be paid for by developed counties – and to underscore global efforts to share green technologies with the world’s poorer countries. Ideas for “pricing carbon” and financing efforts to reduce emissions – for example, by taxing internationally traded goods based on the carbon emissions those goods produce.

And today, just before the summit, one final report from the Global Carbon Project shows the world pumped an estimated 36 billion tons of carbon dioxide into the air last year; which is 706 million tons, or 2.3% more than the previous year.

And all of this means that there will be massive investments in developing technologies to deal with the issue of climate change. From a business and investment standpoint, it pays to keep your eye on the ball.