Stocks Able to Avoid 4-day Losing Streak

Charles Schwab: On the Market

Posted: 3/9/2017 4:15 PM ET

Stocks Able to Avoid 4-day Losing Streak

After a brief dip into negative territory, the U.S. equity markets were able to notch slim gains and avoid a fourth-straight session of losses, as investors await tomorrow's jobs report, and as political uncertainty on both sides of the pond persisted. Meanwhile, Treasury yields inched higher, following a rise in jobless claims, but crude oil, gold and the U.S. dollar lost ground.

The Dow Jones Industrial Average (DJIA) ticked 2 points higher to 20,858, the S&P 500 Index gained 2 points (0.1%) to 2,365, and the Nasdaq Composite added a shade over a point to 5,839. In moderate volume, 881 million shares were traded on the NYSE and 1.9 billion shares changed hands on the Nasdaq. WTI crude oil fell $1.00 lower to $49.28 per barrel and wholesale gasoline lost $0.03 to $1.62 per gallon. Elsewhere, the Bloomberg gold spot price declined $6.67 to $1,201.64 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was 0.2% lower at 101.89.

Staples Inc. (SPLS $8) reported a 4Q loss of $0.94 per share, or earnings-per-share (EPS) of $0.25 ex-items, versus the FactSet estimate calling for a profit of $0.26, as revenues declined 2.9% year-over-year (y/y) to $4.6 billion, below the projected $5.0 billion. 4Q same-store sales decreased 0.9% y/y, compared to the estimated 2.6% drop. SPLS issued 1Q EPS guidance that bracketed analysts' expectations. Shares were lower.

American International Group Inc. (AIG $63) announced that its President and Chief Executive Officer (CEO) Peter Hancock has notified the Board of his intention to resign. He will remain as CEO until a successor has been named, which the Board will conduct a comprehensive search for. AIG gave up an early advance and finished lower.

Shares of Tailored Brands Inc. (TLRD $16) tumbled over 30% after posting a 4Q net loss of $0.62 per share, or $0.19 ex-items, missing the projected shortfall of $0.12 per share, as revenues decreased 3.9% y/y to $793 million, south of the forecasted $811 million. 4Q same-store sales at Men's Wearhouse and K&G declined, while sales at Jos. A. Bank dropped sharply. The company said the challenging retail environment resulted in soft traffic, which drove lower-than-forecasted 4Q net sales and gross margins. TLRD issued current year EPS guidance that missed estimates.

Jobless claims jump ahead of February labor report

Weekly initial jobless claims (chart) jumped by 20,000 to 243,000 last week, above the Bloomberg forecast of 238,000, with the prior week’s figure being unrevised at 223,000. The four-week moving average rose by 2,250 to 236,500, while continuing claims declined by 6,000 to 2,058,000, south of estimates of 2,062,000.

The larger-than-expected rise in jobless claims doesn’t appear to be causing too much concern, given that they hit a 44-year low in the prior week, per Bloomberg, and as data has shown the labor market remains solid. This sets the stage for tomorrow's key February nonfarm payroll report, expected to show an increase of 200,000 jobs and a rise of 210,000 jobs to private sector payrolls (economic calendar). The unemployment rate is forecasted to dip to 4.7% from 4.8%, and average hourly earnings are projected to rise 0.3% month-over-month (m/m). The report likely will have little impact on Fed rate hike expectations for next week that have surged to almost a certainty, but the data, notably the wage growth figure, could cause some volatility as the markets grapple with what it means for the frequency of rate hikes for the rest of the year.

As noted in the latest Schwab Market Perspective: "Phenomenal" Expectations, the bar is now set higher for policy action to support the rhetoric, setting up the possibility for a market pullback and/or a pickup in volatility. The economic picture continues to look good, but inflation is heating up, which has put a March rate hike by the Federal Reserve firmly on the table. An earnings growth recovery has helped fuel a global rally, but there are risks that expectations and valuations have gotten a bit extended. Read more at www.schwab.com/marketinsight and follow Schwab on Twitter: @schwabresearch.

The Import Price Index (chart) increased 0.2% m/m for February, compared to projections of a 0.1% increase and January's upwardly revised 0.6% gain. Compared to last year, prices were higher by 4.6%, above forecasts calling for a 4.4% jump, and following January's upwardly revised 3.8% increase.

Treasuries were lower, as the yield on the 2-year note ticked 1 basis point (bp) higher to 1.36%, while the yields on the 10-year note and the 30-year bond increased 3 bps to 2.59% and 3.18%, respectively.

Stocks avoided posting a fourth-straight session of losses that has pulled them back from record highs, while Treasury yields regained some upward momentum, amid festering global political uncertainty and boosted expectations of a Fed rate hike next week. Amid this backdrop, see our article, End of an Era: Why Volatility May Return to the Stock Market and video from Schwab’s Chief Investment Strategist Liz Ann Sonders and Vice President of Trading and Derivatives, Randy Frederick titled, Stock Rally Continues, but Is It Time for Markets to Take a Breather?, at www.schwab.com/insights. Follow Liz Ann and Randy on Twitter: @lizannsonders and @randyafrederick.

For analysis of the Fed and President Trump's highly-anticipated reflationary policies, see Schwab's Chief Fixed Income Strategist, Kathy Jones' article, What would a shake-up at the Fed mean for bond investors? at www.schwab.com/onbonds, and Vice President of Legislative and Regulatory Affairs, Michael T. Townsend offers his latest article, Presidential Reset: What Does Trump's Speech Mean for His Agenda?, at www.schwab.com/insights. Follow Kathy on Twitter: @kathyjones.

Europe turns higher after ECB's Draghi offers upbeat tone, Asia mixed on China data

European equities overcame early losses and finished mostly higher, despite oil & gas issues falling as crude oil prices extended yesterday's drop that ensued after some bearish oil inventory reports. The markets digested the expected unchanged monetary policy decision from the European Central Bank (ECB). Stocks got a boost from ECB President Mario Draghi's relatively upbeat tone about the economy, noting that the cyclical recovery may be gaining momentum, though he reiterated the need to continue its stimulus measures as underlying inflation pressures remain subdued. Political uncertainty continued to linger, as the key French Presidential election continues to nudge closer as discussed by Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, and Randy Frederick in the video, Why Should the French Presidential Election Be Important to Investors? at www.schwab.com/insights. Also, be sure to check out Jeff's articles, Five Reasons to Stay Invested Despite Heightened Uncertainty and The future of Europe: EU 2.0 and its impact on the markets at www.schwab.com/oninternational. Follow Jeff and Randy on Twitter: @jeffreykleintop and @randyafrederick. In other economic news, Spanish house transactions jumped in January, French business sentiment unexpectedly rose last month, and Irish 4Q GDP growth easily topped forecasts. The euro gained ground and the British pound dipped versus the U.S. dollar, while bond yields in the region turned to the upside to boost the financial sector.

Stocks in Asia finished mixed as traders digested some mixed February Chinese inflation data and crude oil's drop yesterday, while appearing to tread cautiously ahead of today's monetary policy decision from the European Central Bank and tomorrow's key U.S. labor report. Moreover, political uncertainty lingered and the markets continued to brace for the impact of a potential rate hike in the U.S. next week, which expectations of have jumped. Mainland Chinese stocks and those listed in Hong Kong dropped, following reports that showed the nation's consumer price index rose by a much smaller rate than expected, but producer price inflation accelerated more than anticipated. After the closing bell, China reported that its new yuan loans topped forecasts, while its aggregate financing—a gauge of total credit issued—was below estimates and its money supply figures were mixed for last month. Australian equities declined, bogged down by weakness in oil & gas and basic materials issues, while South Korea's markets also lost ground.

However, stocks in Japan bucked the trend, finishing higher, aided by some weakness in the yen, while Indian securities ticked higher, led by strength in auto stocks though gains were held in check as the markets awaited exit polls from five state elections, per Bloomberg. For insight on global investing, see Schwab's Director of International Research, Michelle Gibley's, CFA, articles, Currency Hedging: 5 Things You Need to Know and Emerging Markets: Why They Deserve a Place in Your Portfolio at www.schwab.com/oninternational, and be sure to check out our release, Why Your Portfolio Needs International Stocks—Despite 2017 Risks at www.schwab.com/insights.

Financial Review

A Hot One

Sinclair Noe — January 21, 2016

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DOW + 115 = 15,882
SPX + 9 = 1868
NAS + 0.37 = 4472
10 Y + .04 = 2.02%
OIL + 1.50 = 29.85
GOLD + .20 = 1102.40

The European Central Bank announced today that they will hold interest rates at record lows of 0.3%. Mario Draghi said the European Central Bank may need to provide more stimulus programs as soon as March to address concerns about the euro-area recovery. Draghi said, “Downside risks have increased again amid heightened uncertainties about emerging-market growth prospects. It would therefore be necessary to review and possibly reconsider our monetary-policy stance at our next meeting.” Now remember that the markets just love free money, and that was essentially what Draghi promised.

China’s central bank cranked up cash injections in its money-market operations for the third week in a row, trying to counter capital outflows. The PBOC added $60 billion to the financial system using reverse-repurchase agreements, the most in three years. The Shanghai composite dropped 3.2%.

Brazil’s central bank kept policy on hold. The Central Bank of Brazil held its benchmark rate at 14.25%, surprising the consensus, which was calling for a 50-basis-point hike to 14.75%. The bank has been under pressure from politicians and local businesses to raise rates in an effort to combat inflation that is running at a 12-year high, above 10%.

Oil prices moved higher today. Yesterday the API report showed a U.S. crude inventory build of 4.5 million barrels last week – about double trade expectations. Today the U.S. Energy Information Administration reported crude inventories rose by 4 million barrels for the week ended Jan. 15. Now normally, you might expect prices to drop on news that inventories are growing, but the best explanation I can offer is that oil was a little oversold; even with today’s gain, prices are still under $30 a barrel.

Russia’s ruble fell more than 5% overnight, to hit a new record low of 85.97 per dollar. The country is suffering from the slump in oil prices, which has sparked widespread predictions of a second straight year of recession. Russia’s central bank has indicated it will not intervene to support the currency.

The number of applications for unemployment benefits unexpectedly increased last week to a six-month high. Initial jobless claims climbed by 10,000 to 293,000 in the week ended Jan. 16. The four-week moving average increased to 285,000, the highest since mid-April.

The Philadelphia Fed’s manufacturing index was in negative territory in January for the fifth month in a row. The index rose to negative 3.5 from negative 10.2

The first Friday of each month brings the report on non-farm payrolls, or the shorthand is the Jobs Report; a couple of weeks later we get a state by state breakdown. Today, the Arizona Department of Labor Stats reported Arizona’s seasonally adjusted unemployment rate dropped two-tenths of a percentage point from 6.0% in November to 5.8% in December.

The US seasonally adjusted unemployment rate remained unchanged at 5.0% in December. A year ago, the Arizona seasonally adjusted rate was 6.6% and the U.S. rate was 5.6%. The biggest job gains were found in trade, transportation, and utilities; the biggest job losses were in government and construction. Arizona employment grew by 2.5% (65,700 jobs) over the year ending in December.

January 21, 1970 marks the day of the first commercial flight of a Boeing 747. Today, Boeing announced plans to report a $569 million after-tax accounting loss as it cuts production of the iconic 747 jumbo jet in half. Boeing announced that it would lower its production rate on 747-8 jets to match demand in the cargo market.

In other words, it does not want to overproduce for a market that’s not demanding a lot right now. But demand for flight from the consumer economy are running above their recent trend. And this is really the whole economic story in a nutshell. In short, the outlook for consumers is solid while things are falling apart for manufacturers.

United Continental Holdings’ fourth-quarter profit missed analysts’ estimates as a strong dollar and weak economies in energy-dependent markets hurt demand from travelers. Adjusted earnings were $2.54 a share, missing estimates by 2-cents. Revenue dropped 3%.

Southwest Airlines reported it nearly tripled its profit in the final quarter of the year. The No. 4 U.S. airline by traffic said its fuel and oil expense dropped 37% in the latest quarter. Overall, the company posted a profit of $536 million, or 82 cents a share, up from $190 million or 28 cents a share a year earlier. Revenue was up 7.5%

Verizon Communications added 1.5 million new subscribers and exceeded analysts’ profit estimates even as rivals pushed price cuts and promotions to lure customers away. Fourth-quarter earnings excluding some items were 89 cents a share, a penny better than estimates.

Schlumberger reported better-than-expected fourth-quarter earnings and quarterly sales in line with Wall Street consensus. The company said it earned an adjusted 65 cents a share in the quarter, down from $1.50 a share in the year-ago period. Revenue hit $7.7 billion, down from $12.6 billion in the year-ago period. The company faced a continued decline in rig activity, project delays and cancellations and other problems stemming from lower oil prices. The good news is that it wasn’t worse news.

American Express reported its fourth-quarter earnings fell to $899 million, or 89 cents a share, from $1.45 billion, or $1.39 a share, a year earlier. AmEx beat earnings estimates. Revenue dropped to $8.3 billion from $9 billion a year ago.

Union Pacific Corp. reported quarterly earnings that missed analysts’ estimates for the third time this year as a freight slump accelerated. Net income fell to $1.31 a share, 11 cents less than the average of estimates. Revenue decreased 15 percent to $5.21 billion compared with a forecast of $5.44 billion. It was the biggest miss in at least 10 years. The weakness in rail cargo probably will last this year as coal demand continues to drop and U.S. production lags.

General Motors said it sold 9.8 million vehicles in 2015. The results represent a third consecutive year of record global sales for GM. North American deliveries rose 6% to 3.6 million cars, trucks and crossovers, and it also delivered 3.6 million vehicles in China, an increase of 5% from 2014.

Sharp is leaning toward accepting a rescue by government-backed Innovation Network of Japan over a potentially larger offer from Foxconn Technology. A deal with INCJ would allow the firm to keep its technology within Japan and cooperate more closely with domestic companies. Sharp’s stock climbed as much as 25% in Tokyo after Foxconn offered $5.3 billion to take it over.

The next installment of the Star Wars franchise, originally slated to debut on May 26, 2017, is now scheduled to be released seven months later on Dec. 15, 2017. Disney did not cite specific reasons for the push, but did note the success of Star Wars: The Force Awakens. The film has garnered more than $861 million domestically and $1.9 billion internationally – the third largest global release ever.

If you believe in math and gravity and other such “theories” there appears to be precise evidence of a big, fat planet spinning far beyond the planetoid Pluto.  The clues started piling up when astronomers discovered a mini Pluto (aka, rocky Kuiper Belt object far out in the nether regions of the solar system) with an interesting orbital twist… literally. Astronomers then noticed other objects floating around in distance and in the angle of the orbit relative to the horizon of the solar system. So it was more than coincidence.

Using very sharp pencils two Caltech astronomers Michael Brown and Konstantin Batygin, not only have validated the existence of this mystery planet they’ve referred to as “Planet 9”, they have determined both its mass and exact orbit.  Planet 9 from Outer Space is apparently about 10 times the mass of Earth with an orbit 20 times farther out from the sun than Neptune. The only thing really missing from “9” is a fuzzy picture and a real name.

A blizzard watch has been posted from Virginia to New York, for a storm that threatens to bring high winds and heavy snow starting Friday and lasting through the weekend. The snow should begin falling in Washington before sundown Friday, with heavier amounts arriving overnight. In New York, the heaviest accumulations will come on Saturday, which is when Boston may get some snow as well.

Last year shattered 2014’s record to become the hottest year since reliable record-keeping began, according to separate sets of records kept by NASA and the National Oceanic and Atmospheric Administration; 2015’s sharp spike in temperatures was aided by a strong El Niño weather pattern late in the year that caused ocean waters in the central Pacific to heat up. But the unusual warming started early and steadily gained strength in a year in which 10 of 12 months set records.

NASA reported that 2015 was officially 0.23 degrees Fahrenheit (0.13 degrees Celsius) hotter than 2014, the prior record year. NOAA’s figures showed slightly greater warming, of about 0.29 degrees Fahrenheit (0.16 degrees C) hotter than 2014. A quarter of a degree may not sound like much, but on a planetary scale it’s a huge leap. Most previous records were measured by hundredths of a degree.

The El Niño weather pattern of 2015 produced some of the hottest temperatures ever witnessed across swaths of the equatorial Pacific. Across the globe, El Niño triggered powerful typhoons, spoiled cocoa harvests in Africa, and contributed to vast fires in Indonesia. California is getting pummeled with floods, and residents on the U.S. East Coast are bracing for an El Niño fueled snow dump this weekend. Because a strong El Niño still is in place, 2016 is expected to be an exceptionally warm year, and perhaps even another record.

Financial Review

Stormy Weather

Sinclair Noe — October 23, 2015

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Financial Review

Buckle Up

Sinclair Noe — March 17, 2015

 

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DOW – 128 = 17,849
SPX – 6 = 2074
NAS + 7 = 4937
10 YR YLD – .04 = 2.06%
OIL – .42 = 43.46
GOLD – 5.70 = 1149.60
SILV – .10 = 15.63

The FOMC will wrap up its two-day meeting on interest rate policy tomorrow. The key question: will the Fed give a hint about raising interest rates? IMF Director Christine Lagarde says even if the Fed is able to manage expectations about an interest rate hike, “the likely volatility in financial markets could give rise to potential stability risks.”

ECB President Mario Draghi says, “Most indicators suggest a sustained (eurozone) recovery is taking hold.”  Draghi is urging governments to use the brighter outlook to advance reforms that would improve the region’s long-term growth prospects. Draghi claims, “Confidence among firms and consumers is rising. Growth forecasts have been revised upwards. And bank lending is improving on both the demand and supply sides.”

Draghi sounds a little overly optimistic. A couple of weeks of bond buying have not changed the overall economies of the Eurozone. Unemployment is still rampant in Spain and Italy and Greece and Portugal and several other countries. No doubt QE is increasing liquidity in the sovereign debt markets; the private banking system are surely pleased with cheap money policy, but it hasn’t changed the jobs picture, it hasn’t resolved the underlying problems of the economy, and it hasn’t resolved the problem of deflation.

Many people thought that QE would result in inflation, or even hyper-inflation. Wrong. Just this year, 23 central banks have cut rates due to sluggish growth. In the process their currencies will weaken. The Bank of Japan maintained its massive 80-trillion-yen stimulus program today, and noted inflation could fall into negative territory because of the continued weakness in energy prices; however, it also said any return to deflation would not last long. A return to moderate inflation might just be wishful thinking.

Meanwhile, the euro is tanking against the dollar as the ECB buys covered bonds from the Euro-banks, while Greece is left to dangle from a short and sharp hook, locked out of the capital markets. Today, Greece began debate on emergency measures to deal with $2.1 billion in debt payments due Friday. Euro quantitative easing has nothing to do with helping Greece attain a stronger economy and everything to do with rewarding speculators and the Euro-banks that sold them bonds. Included in the amount due Friday, payments on a swap originally arranged by Goldman Sachs in 2001. The derivative, now held by the National Bank of Greece, masked the country’s growing debt, helping it meet European Union rules for entering the euro area.

There are only so many entities that can buy so many bonds and filter so much cheap capital into the system for so long. Eventually the ECB will quit QE. Eventually the Federal Reserve will raise interest rates. And then what? Well, the central bankers will look for new ways to finagle the financial sector, but we might reasonably expect more volatility. Maybe the Fed will give us a hint tomorrow.

When we think about volatility in the markets, we tend to default to the stock market, but don’t forget bonds. Consider that the 10 year US Treasury note yields 2.06%. The Japanese 10 year bond yields 0.41%. Germany at 0.28%, and Spain 1.25%. These are historic lows.  So, with the bond market appearing ripe for a dramatic correction, many are wondering whether a crash could drag down markets for other long-term assets, such as housing and equities.

According to Nobel economist Robert Schiller, long-term rates in the US should be even lower than they are now, because both inflation and short-term real interest rates are practically zero or negative. Even taking into account the impact of quantitative easing since 2008, long-term rates are higher than expected. The history of bond markets crashes have been relatively rare and mild. So, there should be no reason for bonds to crash from here… unless, there is a major spike in inflation, or the central banks tighten monetary policy very sharply by hiking short-term interest rates.

For now, the markets are trying to make sense of where everything is headed. The result has been volatility. The Dow Jones Industrial Average was down a bit over 100 points last week, but that hardly does justice to a week with multiple triple digit swings. Three of the last six trading days have seen a move of at least 1%. Today the Dow dropped 128 points, and that was just a move of 0.7%. Still, it can be a bit unnerving. Volatility in and of itself isn’t necessarily a bad thing as markets can continue to climb even as volatility does the same. A rising VIX doesn’t have to correspond with a lower stock market. The VIX (volatility index) trended higher from 1996 right to the end of the dotcom mania. Maybe that is not reassuring, but this is not the internet bubble.

One reason for the volatility is because earnings outlook has turned lower, but even more so because earnings outlook has turned very uncertain; and the reason behind the uncertainty is the volatility of the dollar. Yes, the dollar has been getting stronger; remember that volatility can apply in up or down markets. The strength of the dollar raises questions about whether companies have properly hedged earnings in other countries. Will a higher dollar create a debt crisis outside the US as it has in the past? What will central banks do in response? Which central bank will win the race to the bottom of currency valuations? How will that affect the US economy?

Economic data in the US has been on the weak side lately. A strong dollar doesn’t help. Inventory to sales ratios have now jumped to levels that are comparable to late 2008. Sales were down for the third month in a row led by declining auto sales (-2.5%). Sales were down across a wide swath of industries. The economic expansion since the 2008 crisis may have been disappointing, but it has been remarkably steady. Annual GDP growth has been eerily consistent, between 2 and 2.5% for years. The last time we had such a run of consistent growth was the late 90s; the growth rate was higher, around 4%, but very consistent.

Maybe the strange part of the past few years is just how consistent the recovery has been. Maybe the lack of volatility is a result of the accommodative monetary policy of the Federal Reserve, well balanced against a weak economy, just enough to push forward, but not enough to reach escape velocity. The one thing we know is that markets fluctuate, they don’t move in a straight line. So buckle up, it should be interesting.

Construction on new homes in the United States slumped 17% in February, mostly because of heavy snowfall that sidelined builders in the Northeast and Midwest. Housing starts sank to an annual rate of 897,000 in February from a revised 1.08 million in January. But nationwide permits for future construction rose, suggesting construction will pick up in the spring. The biggest increase in applications for new construction once again involved multi-dwelling projects such as apartment buildings and townhouse rows. Permits for projects of five units or more jumped nearly 20%, reflecting a post-recession trend in which more people are renting instead of owning.

Another factor weighing on housing is negative equity. According to CoreLogic, there are 5.4 million homes, or 10.4% of all homes with a mortgage, underwater in the fourth quarter of 2014. This is down considerably -18.9 percent, from a year ago-but it still keeps these borrowers from putting their homes on the market, because they would lose money. Additionally, of the 49.9 million U.S. homes with a mortgage, approximately 10 million (20 percent) have less than 20 percent equity, and 1.4 million have less than 5 percent. These homeowners also would have a difficult time selling because not only would they lose money in the process, but they also might not qualify for a new mortgage. Arizona is still one of the top 5 states for negative equity, with 18.7% of mortgaged homes underwater.

Exit polls show Israel’s elections are too close to call. Those waiting to find out who will be the next prime minister of Israel need to wait. Binyamin Netanyahu—the serving PM—won the same number of seats as Isaac Herzog’s Zionist Union according to several exit polls. Netanyahu is claiming victory, based on the idea that he can cobble support from other parties, but really, it’s too close to call right now.

American Airlines was added to the S&P 500. The airliner replaces Allergan, which has been taken-over by. The addition will take place after the close of trading on March 20.

Over the past few years we have talked about deferred prosecution agreements or non-prosecution agreements; a common tool used by the Justice Department in investigations ranging from sanctions violations to market manipulations. Such settlements require the banks to admit responsibility and cooperate with ongoing investigations. It is a bank or corporate equivalent of probation. The banks pay a fine and promise not to break the law for a few years, and if they can keep their nose clean, then all is forgiven. The problem is that the banks are repeat offenders.

For example, a few years back several banks were found to be rigging benchmark interest rates, the Libor scandal. Fines were paid and deferred prosecution agreement signed. Barclays, Royal Bank of Scotland, UBS, and HSBC are operating under such agreements. But now, the banks appear to have rigged the forex markets, or the currency exchange market, just within the past 2 or 3 years; which would be a violation of the agreement to stop breaking the law.

Leslie Caldwell, the head of the Justice Department’s criminal division, said in a speech Monday that the US is prepared to tear up settlements and charge banks for conduct covered by the settlements. “Where banks fail to live up to their commitments, we will hold them accountable,” Caldwell said. “The criminal division will not hesitate to tear up a DPA or NPA and file criminal charges.”

Of course prosecutors have talked tough in the past and then followed it up with the vicious pugnacity of a timid meter maid; the results have been predictable; the banksters’ recidivism rate has regularly topped 100%. So, don’t hold your breath.

FINANCIAL REVIEW

King Dollar and the Eurozone

Sinclair Noe — October 10, 2014

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Financial Review

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

DOW – 115 = 16,544
SPX – 22 = 1906
NAS – 102 = 4276
10 YR YLD – .02 = 2.30%
OIL – .25 = 85.52
GOLD – .60 = 1224.00
SILV + .05 = 17.50

The 10 year German bund has a yield that is 141 basis points lower than the US 10 year Treasury note. The yield on German debt will get you 0.89%. Standard & Poor’s lowered France’s credit outlook today, and you can still get a 10 year French note with a yield of 1.25%. A 10 year note from Spain will only get you 2.06%. Is this because the US debt is riskier than the Spanish debt? No, just the opposite.

The problem in the Eurozone is deflation, and it threatens to bring the economy to a grinding halt, and send the EU into a triple dip recession. The president of the European Central Bank, Mario Draghi, gave no indication of any further monetary stimulus beyond what was announced this summer, suggesting in a speech in Washington that governments needed to do more on the fiscal side. Draghi said in effect that Eurozone countries that have enough money should spend it, a clear reference to Germany. His comments echoed remarks this week from Christine Lagarde, the head of the International Monetary Fund.

Today, German Chancellor Angela Merkel said her government was examining how to encourage investment, particularly in the “digital sphere” and the energy sector. Merkel did not elaborate, but the hint was that Germany might use government spending to stimulate growth, a possible shift in position that could ripple across the entire Eurozone. Merkel’s remarks may have been less a declaration of policy change than a signal that her thinking on stimulus was evolving.

On Wednesday, the Federal Reserve released minutes from the September FOMC meeting, and they expressed concern about the global economy and the dollar. In the past 4 months the dollar has jumped about 8% versus the euro; that kind of swing can prove a threat to trade and to financial markets. The Fed normally focuses on the US economy, unless there are global developments that are important enough that they could intrude. Fed officials pointed with concern to the slowdown in China, Europe and Japan. They also worried that the concurrent strengthening of the dollar would add to the risk of price deflation.

We know that a strong dollar could weaken US export performance and hold back growth, but the recent global slowdown represents a more ominous problem. Global economic weakness would undermine the ability of the Fed to maintain financial asset prices well above the levels strictly warranted by the fundamentals. Of course this has been how the Fed has addressed the crisis and the recovery for the past 6 years, they pumped up Wall Street with easy money. A global slowdown threatens that tactic.

The events of the past week indicate the Eurozone and especially Germany might be closer to a move away from the single minded focus on budget austerity that has, to date been an absolute failure. The bigger question is whether the Eurozone countries and the ECB will take action, and if they can actually do anything before the continent slips into full-fledged deflation; and further, what role that might mean for the Federal Reserve.

Finance ministers and central bankers gathered in Washington for the annual meetings of the World Bank and International Monetary Fund and today, Treasury Secretary Jack Lew urged the Group of 20 major economies to refrain from competitive currency devaluations. Federal Reserve officials are hunting for new tactics to raise price increases to their target as slowing global growth, cheaper commodities and flat wages sound warnings that inflation is descending toward the danger zone.

With inflation at 1.5% according to the Fed’s preferred index, low-flation is getting to be a real issue again. We know a stronger dollar makes US exports overseas less affordable, but a strong dollar makes it cheaper for Americans to pay for imported goods. A 10% increase in the dollar versus currencies of major trading partners could trim inflation by a quarter percentage point, and the Fed has not yet communicated a plan for how they will lift inflation to their desired target of 2%.

An inflation rate approaching zero is bad for the economy because of its impact on behavior by businesses and consumers. Companies’ inability to raise prices hurts profits, and they rarely compensate by cutting wages, so they fire workers instead. Consumers anticipating falling prices may postpone discretionary purchases. This can combine to create a vicious circle of less spending and further downward pressure on prices. Think about your own situation; in the past couple of weeks you’ve seen prices at the pump drop. Were you tempted to drive another day or two before you fill up the tank in the hope that you might save a few pennies per gallon?

And what we are seeing in the Eurozone is that once low-flation becomes deflation, the central bankers don’t really have the tools to deal with the problem. It is known as pushing on a string. They can flood the markets with easy money, but they can’t create demand, because, you know, prices will be lower next week. As we are seeing in the Eurozone, and as we saw in Japan, if you let it go on for too long it becomes a lock-in, it reinforces a bad outcome.

Substantial rallies in the dollar have the power to slam the brakes on GDP growth in a way that Fed tightening even doesn’t. GDP growth could decline by a percentage point if the rapid move in the dollar continues through early 2015. That fall in GDP is even larger than what would occur as a result of a 50-basis-point rise in long-term interest rates, and it works with a lag, too. Even when the dollar rally tapers off, it would be expected to constrain GDP through early 2016.

And for now at least, you might reasonably expect the dollar rally to continue; there is a trend in place. The long dollar bets mean money is being parked in the US, and that means continued downward pressure on long-term interest rates, at least for now. And another thing, when there are very rapid and pronounced changes in the exchange rate there is a tendency for investors to lock in gains from previously accumulated US assets. In other words, there is a tendency to sell stocks, and companies with overseas exposure are more likely to experience a greater decline. And the selloff in stocks is yet another hit to US GDP. It’s a nasty cycle.

On Wall Street, stocks closed out a volatile week with another triple digit loss for the Dow, giving the market the worst week since May 2012. The Dow industrials have now turned negative year to date. Yes, that was fast. The Dow lost 2.7% for the week. The S&P 500 dropped 3.1% on the week. The VIX, the volatility index jumped 45% for the week. The Stoxx Europe 600, Europe’s benchmark stock index posted its biggest slide in 2 years, down 4.1% for the week. The S&P 500 is sitting right at its 200 day moving average. The Dow Industrial dropped below the 200 day moving average, about 40 points lower.

A moving average is simply an average of a certain number of data points. The 200-day moving average is calculated by summing the past 200 days and dividing the result by 200. The 200-day moving average represents the average price over the past 40 weeks. This helps to smooth out day to day volatility and give a longer-term look at the overall trend. The 200 day moving average is considered a very important level of resistance or support; in this case, support. When a stock or an index breaks down below this key level of support you sometimes see a bounce, because there will be some investors who think they are now able to buy stocks cheap. But the bounce can sometimes be misleading; that’s known as a dead cat bounce. If dropped from high enough, even a dead cat will bounce. So the next few days will be critical to see if the markets can bounce, and if they can bounce, will they rally, or will prices just keep falling from here. If we don’t see a turnaround, it would confirm a downward trend.

This week the Nobel Committee handed out prizes for a better lightbulb, the LED; a better microscope, that sees nanoparticles; and a French author that I had never heard of. Today, Malala Yousafzai and Kailash Satyarthi have won the Nobel Peace prize. If you have not heard the story of Malala or heard her speak, you should; she will inspire you. She is the daughter of a teacher, and she grew up in and around schools, at least until 2008, when the Taliban took control of the Swat region of Pakistan, where she lived. The Taliban tried to close down schools for girls. That year, her father took her to Peshawar where she made a speech in front of national press titled “How Dare the Taliban Take Away My Basic Right to Education?” She was only 11 years old. In early 2009, Malala started blogging anonymously for the BBC about what it was like to live under the Taliban.

Two years ago, armed men boarded the converted truck that Malala and her classmates used as a makeshift school bus and they shot Malala in the head. She survived. Nine months after she was shot, Malala gave a now famous speech at the UN, where she said: “They thought that bullets would silence us. But they failed.” She’s continued her high-profile campaign for girls’ education with The Malala Fund, which raises money to promote girls’ education.

At 17, Malala is the youngest winner of the Nobel Peace prize, which she will share with 60 year old Kailash Sayarthi. In 1980 Satyarthi founded the Save the Childhood Movement, and he has helped rescue more than 80,000 children from bondage, trafficking and exploitative labor in the past three decades; he also spearheaded a movement to make free and compulsory education a constitutional right for children in India in 2009.

The Nobel committee said it “regards it as an important point for a Hindu and a Muslim, an Indian and a Pakistani, to join in a common struggle for education and against extremism”.