Financial Review

Quads

Sinclair Noe — July 19, 2017

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DOW + 66 = 21,640
SPX + 13 = 2473
NAS + 40 = 6385
RUT + 14 = 1441
10 Y + .01 = 2.27%
OIL + .69 = 47.09
GOLD – 1.00 = 1242.00
BITCOIN + 1.75% = 2334.63 USD
ETHEREUM – 2.36% = 209.06

The Dow Industrials, S&P 500, Nasdaq Composite and Russell 2000 all closed at record highs today. This is the first time all 4 indexes closed at a record high on the same day since March 1^st.

ETFs have seen net new inflows of $250 billion thus far this year, and more than half of that inflow has gone to just 20 ETFs, or about 1% of the ETF universe. The most popular ETF this year, in terms of flows, has been the iShares Core S&P 500 ETF (IVV), which has taken in $18.5 billion.

Two other iShares equity products—the iShares Core MSCI EAFE ETF (IEFA) a market-cap-weighted index of developed-market stocks in Europe, Australasia and the Far East, and excludes the US and Canada, and the iShares Core MSCI Emerging Markets ETF (IEMG), —rounded out the top three.

According to a Bank of America Merrill Lynch survey of 207 investors with a total of $586 billion under management, money managers are a net 20 percent underweight U.S. stocks. That’s despite the major averages setting new records on an almost weekly basis.

There are a few takeaways here, all supportive of equities. One is that the survey suggests there is lots of money that could be put to work in stocks. Another is that there aren’t a lot of natural sellers left, since anybody who wanted to sell has already done so. And finally, the most successful investors say that the time to buy is when everyone else is selling.

Investors will focus on quarterly earnings to see if high valuations are justified in the face of mixed economic data, tepid inflation and policy gridlock in Washington.

Analysts estimate an 8.7 percent rise in second-quarter earnings and a 4.6 percent increase in revenue for the S&P 500 companies from a year earlier. The S&P tech sector has been the best performing sector this year despite concerns about stretched valuations as investors look for growth sectors immune to policy uncertainties.

The exception is IBM, down 4.2 percent today to a one-year low after the company’s quarterly revenue came in below expectations – that’s 21 consecutive quarters of declining revenue for Big Blue. The stock was the biggest drag on the Dow and the S&P 500.

Wall Street has a new bond trading king. Morgan Stanley rose 2.1 percent after the Wall Street bank reported better-than-expected profit and bond trading revenue declines that were modest compared with arch-rival Goldman Sachs. Goldman was down 0.5 percent.

While revenue from fixed income fell during a quiet second quarter, Morgan Stanley still reported fixed income sales and trading revenue of $1.2 billion – and while that is down 4 percent from last year, it was better than the stunning 40 percent drop reported Tuesday by rival Goldman Sachs over the same period.

Morgan Stanley has bested Goldman in fixed income revenue for two quarters now, with $2.9 billion of fixed income trading revenue in the first half of the year versus Goldman’s $2.8 billion.

CSX fell 6.5 percent after the third-largest U.S. railroad operator’s forecast missed expectations. Other railroad companies such as Union Pacific fell 2 percent, while Kansas City Southern edged down 0.7 percent.

American Express’ profit fell less than expected in the second quarter, as higher spending by card members made up for increased costs from offering rewards. AmEx said card member spending was up 8 percent in the second quarter ended June 30. Revenue was flat and net income came in better than estimates. American Express dropped 1% in trading today.

T-Mobile beat revenue and profit estimates, and added more customers than expected in the most recent quarter. Shares gained 5%.

Vertex Pharmaceuticals jumped as much as 26 percent to an all-time high after the company reported positive results for its cystic fibrosis treatment. The stock was the biggest boost on the S&P and the Nasdaq.

Spices maker McCormick & Co has won the battle to buy Reckitt Benckiser’s North American food business, paying a higher than expected $4.2 billion. Reckitt said in April it was reviewing options for the unit, which includes French’s mustard and Frank’s RedHot sauce, to cut debt following its $16.6 billion purchase of baby formula maker Mead Johnson.

The Senate Republican plan to repeal and replace Obamacare could not muster enough support for a vote Monday. Yesterday, President Trump said he wanted to just repeal the Affordable Care Act, and come up with a replacement down the road. Today, the Congressional Budget Office released an estimate saying that just a repeal would result in 17 million more uninsured within a year, and 32 million more uninsured within 9 years.

Today, it is back to repeal and replace, and Trump wants the senators to stay in Washington until they get it done. Polling shows just 12% of Americans support the Senate healthcare bill.  Meanwhile, their counterparts in the House looked to reset matters with a fresh budget proposal.

The House Republicans’ spending plan aims to balance the federal budget within a decade, reducing the deficit by $6.5 trillion, partially by cutting billions of dollars from entitlement programs such as Medicare and Social Security. Like the proposal the White House released in May, the House proposal is a blueprint, not a bill set in stone. It also assumes the Senate health package will become law, an increasingly unlikely outcome.

But even if this budget is not passed as written, it puts House Republicans’ financial priorities on full display. The House budget proposes increasing the base national defense budget by $70 billion, from $551 billion in fiscal year 2017 to $621 billion in fiscal year 2018. That’s more than the $574 billion in base defense spending recently proposed by the White House.

Also included in the proposal is $75 billion to fight terrorism, as well as “significant funding” on resources for border security, which includes construction on a controversial border wall between the U.S. and Mexico.

The House budget proposes reducing spending on entitlement programs such as Medicare by $203 billion next year, instructing 11 House committees to find ways to reduce spending. These cuts would in part come from programs like Medicare, which could face $487 billion in cuts over the next decade, and Social Security, which faces $4 billion in cuts in that same time frame.

The proposal assumes that the Senate GOP health bill will become law, resulting in what the Congressional Budget Office estimates would be $834 billion in Medicaid cuts over the next decade.

The House proposal also recommends reducing funding for food stamp programs, noting that spending on such initiatives doubled between 2001 and the start of the financial crisis. Spending on the Supplemental Nutrition Assistance Program, or SNAP, increased from about $18 billion in 2001 to about $33 billion in 2009, according to the USDA.

The House proposal mandates that the chamber’s Ways and Means Committee pass a tax reform bill that does not increase the deficit, reduces overall tax rates and simplifies the tax code. The budget also stipulates that such a bill should repeal the alternative minimum tax and reduces the corporate tax rate. The budget instructs the committee to pass this reform through a process called reconciliation, which was primarily designed to pass budgetary laws.

This means that if a tax reform plan is passed by the House, it would only need majority support in the Senate, and won’t be subject to a filibuster. That gives the Senate’s Republican leadership additional wiggle room to pass the measure; with 52 Senators, the GOP can afford two defections.

However, the same strategy did not help avoid the internal party discord that derailed their efforts to repeal and replace the Affordable Care Act.

Supreme Court rejected parts of Trump’s travel ban. The three-sentence order by the justices,  widened the definition of which citizens from six mostly Muslim countries covered by the travel ban are still eligible to travel in the US. And that will include grandparents, cousins and other relatives of a person in the US.

The court plans to hear arguments on the travel ban on Oct. 10; the latest scuffle centered on the rules that will apply in the interim.

Crude closed above $47 a barrel for only the second time since early June as US inventories fell by 4.73 million barrels last week as measured by data from the Energy Information Administration. Gasoline supplies shrank 4.44 million barrels, the most since March.

Financial Review

Worse for Our Kids

Sinclair Noe — January 13, 2017

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DOW – 5 = 19,887
SPX + 4 = 2274
NAS + 26 = 5574
RUT + 10 = 1372
10Y + .02 = 2.38%
OIL – .54 = 53.30
GOLD + 1.80 = 1197.80

For the week, the Dow and S&P posted slight declines, but the Nasdaq rose nearly 1 percent; posting its sixth record high close of 2017.

The Commerce Department says retail sales increased 0.6 percent last month. November’s retail sales were revised up to show a 0.2 percent rise instead of the previously reported 0.1 percent gain. Sales were up 4.1 percent from December 2015. They rose 3.3 percent for all of 2016, up from 2.3 percent in 2015.

Excluding automobiles, gasoline, building materials and food services, retail sales rose 0.2 percent after being flat in November. For the 11th straight year, sales at department stores fell. They dropped 5.6% in 2016 to mark the second-largest decline since the government began keeping track in the early 1990s. They’ve dropped in 15 out of the last 17 years.

At the same time, sales at so-called non-store retailers soared 11.4% in 2016 — the largest gain in 10 years. That category also includes some fuel dealers that benefited from higher gasoline prices, but online sales have been growing rapidly since the late 1990s.

Wholesale inflation rose in December, and the yearly increase surged. The producer price index rose 0.3% in December. Compared to a year ago, the index rose 1.6%, the strongest gain since September 2014. Excluding food, energy, and trade, prices were up 1.7%.

China has stepped up efforts to restrict yuan outflows by asking some banks to stop processing cross-border payments until they’re balanced on both sides. Data released overnight showed that the country’s exports remain tepid, with overseas shipments dropping 6.1 percent while imports rose 3.1 percent, leaving a $40.8 billion trade surplus.

Federal Reserve Chair Janet Yellen said that she sees no serious short-term obstacles to the U.S. economy and that inflation is “pretty close” to policy makers’ 2 percent target. She also defended the 2010 Dodd-Frank act, which the incoming administration have said they will seek to dismantle.

The House voted 227-198 to instruct committees to draft legislation by a target date of Jan. 27 that would repeal Obamacare. The Senate approved the same measure early Thursday.

This earnings season marks a break with a long-held tradition: Aluminum giant Alcoa, (ticker AA) will no longer be the first company to post earnings, following its split into two companies. This is a big day for the big banks to report fourth quarter earnings. Thomson-Reuters tracked consensus estimates for the fourth quarter of 2016 are calling for a 6.1% year-over-year increase in S&P 500 earnings.

And while we still watch individual earnings reports, stock exchanges are increasingly getting out of the stock trading business. Individual shares no longer are the most actively traded securities in the market. That distinction goes to exchange-traded funds, which took in a record $400 billion in the past year to become a $3.8 trillion industry.

There are nearly 2,000 ETF listings, an all-time high. The SPDR S&P Bank ETF (KBE) rose 1.1 percent, helping lift the broader financial sector. That said, the most-traded security is a stock: 108 million shares of Bank of America change hands on average per day, more today.

Bank of America this morning reported adjusted quarterly earnings that beat estimates, but revenue that missed. BofA posted a near-50-percent jump in fourth-quarter profit due to cost cuts and higher trading revenue.

Dow component JPMorgan beat on earnings and revenue. Earnings per share rose to $1.71 from $1.32, on revenue of $23.95 billion. Revenue from fixed-income trading – JPMorgan’s most volatile business – rose 31 percent to $3.4 billion, while stock trading revenue increased 8 percent to $1.2 billion.

Wells Fargo posted fourth-quarter results that missed on the top and bottom lines. The bank is coming off one of the most difficult years in its 165-year history, posting its fifth consecutive decline in quarterly earnings. The bank has been dealing with multiple lawsuits and a sharp drop in account openings after it settled with regulators in September over charges that its employees created 2 million accounts without customers’ consent.

One troubling line from the earnings report showed December credit card openings fell by a whopping 43% from a year earlier, and a 7% drop from the previous month. This echoes the similarly bad third-quarter performance. On the deposit account side, checking account openings were similarly down 40% from December 2015.

Morgan Stanley lays off bankers and cuts bonuses. The investment bank laid off an undisclosed number of senior bankers and slashed bonuses by 15% because of a decline in revenue generated by deal making.

BlackRock, the world’s biggest asset manager, reported adjusted quarterly earnings the beat expectations, while revenue missed. Investors poured $88 billion into the company’s market-tracking index investments and its iShares exchange-traded funds during the quarter, while pulling $546 million from funds managed actively by portfolio managers.

What emissions cheating? Fiat’s shares rebounded. After dipping 16% on Thursday in the wake of a US regulator’s accusation that it had violated emissions laws. The EPA accused Fiat Chrysler of using software to allow excess diesel emissions. The notice affects over 100,000 cars, including trucks and SUVs, and the maximum fine that could be imposed would total $4.6 billion. Fiat Chrysler shares bounced back up by more than 6% this morning on the Stoxx 600.

Six current and former Volkswagen managers were indicted and arrested in the United States this week for their role in the German carmaker’s diesel test-cheating scheme. VW has a solution to the problem – they’re telling senior managers to stop traveling to the US.

Tesla announced in November it was doing away with unlimited free charging at its Supercharger stations, but it just revealed the new pricing guidelines for those who purchase vehicles after January 15, 2017. Tesla owners will get 400 kWh of Supercharging credits (about 1,000 miles) for free each year; however, pricing for anything more than that will be dependent on the state or country. A trip from San Francisco to LA would cost about $15, while LA to NY will cost about $120.

Tomorrow, SpaceX is hoping to get back to launching — and landing — its rockets again, a little over four months after one of its Falcon 9 vehicles exploded on a Florida launchpad. Last week’s planned launch was postponed due to inclement weather.

The Environmental Protection Agency is finalizing ahead of schedule Greenhouse Gas (GHG) emissions standards that call for automakers to achieve a fleetwide average of 54.5 mpg, which is only about 40 mpg in combined city or highway driving, by 2025. The mileage rules, which were issued initially by the EPA in 2012 in conjunction with the U.S. Department of Transportation’s Corporate Average Fuel Economy (CAFE) standards, were set to be subject to review by April 2018.

The new emission standards began to take effect with the 2017 model year. The final years of the mandate will see a required average of more than 55 mpg for cars and about 40 mpg for trucks in 2025.

Shares in the Japanese airbag maker Takata surged by 16.5% today as investors expect that the company is close to settling a case with the U.S. Department of Justice over its deadly airbags for $1 billion. The announcement could come later today. The company’s faulty airbags have led to at least 11 deaths.

CVS is now selling a rival, generic version of Mylan’s EpiPen at about a sixth of its price. You may recall, a few months ago, Mylan execs were called before Congress and ripped for price gouging on the life-saving allergy treatment. Mylan had raised the price more than 500% since 2007.

After the bad press, Mylan cut the price to $300 for a two-pack for its own generic version, but still charges $600 for the EpiPen version. CVS says it will charge $109.99 for a two-pack of the authorized generic version of Adrenaclick, and for some customers who still need financial assistance, they are offering a coupon for a $100 discount.

Baby Boomers: your millennial children are worse off than you. With a median household income of $40,581, millennials earn 20 percent less than boomers did at the same stage of life, despite being better educated. According to new research from the Federal Reserve: Millennials have half the net worth of boomers. Their home ownership rate is lower, while their student debt is drastically higher.

Financial Review

Do Computers Dream of Algorithmic Capitulation?

Sinclair Noe — August 28, 2015

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DOW – 11 = 16,643
SPX + 1 = 1988
NAS + 15 = 4828
10 YR YLD + .02 = 2.19%
OIL + 2.71 = 45.27
GOLD + 8.30 = 1134.80
SILV + .08 = 14.70

The week roared in like a lion and left like a lamb. For the week, the Dow gained 1.1 percent, the S&P rose 0.9 percent and the Nasdaq added 2.6 percent. Go figure. Panicked selling on Monday and Tuesday gave way to a rush to buy on Wednesday and Thursday.  And for many investors, it was just too much. Equity funds saw $29.5 billion head for the exits, the largest weekly outflow on record. On Tuesday, investors pulled out $19 billion, the biggest single day for outflows in the past 8 years.  Some traders would call that “capitulation”, a sign of a bottom in the markets.

The chaos of this week’s markets appeared to hit smaller investors especially hard, leaving yet another dent in their stock market confidence. The Monday flash crash resulted in smaller investors being locked out of their online accounts. Strange glitches appeared. Exchanges spit out the wrong prices for widely held funds. For example, the SPDR S&P Dividend ETF dropped 33% in 15 minutes, then shot right back up 30 minutes later, while the stocks tracked by the ETF never fell that far.

The QQQ, which tracks 100 of the biggest Nasdaq stocks, dropped 17% in a matter of minutes. The shares of the 100 companies that make up the PowerShares QQQ did not drop 17 percent. There is about $2 trillion held in 1,411 exchange traded funds in the US. Monday’s flash crash raised an interesting question: how difficult would it be to liquidate those ETFs in a period of stress?

The crash also raised questions about whether the exchanges offer a fair playing field. You probably already know the answer. So far we have heard next to nothing from the Securities and Exchange Commission. What we really saw was a market failure. A playing field heavily tilted toward High Frequency Traders and tilted away from the average investor. Some traders see the outflows as capitulation, but most Mom and Pop investors likely just rode it out; if you own Starbucks, you probably did not sell when it dropped 26%; first you probably didn’t realize it; second, you probably couldn’t log on to trade it.

And so most of the outflow can likely be attributed to the institutional investors and algorithmic traders; those folks, or maybe we should say “those machines”. Gillian Tett of the Financial Times wrote: “these machines are being programmed to link numerous market segments together into trading strategies. So when computer programs cannot buy or sell assets in one segment of the market, they will rush into another, hunting for liquidity.”

In Asia: Chinese shares rallied for a second day and the yuan gained the most since April on speculation authorities took several more steps to prop up equities. During this week’s wild ride, China became the epicenter of a global selloff, with a five-session crash starting last Thursday triggering steep losses in U.S. and European stocks – only to be followed by surges. The Shanghai Composite index closed the session up 4.9%, paring its loss for the week to just over 10%.

So far the situation in China has not lead to credit contagion, just volatility that spread globally. Of course the really big risk of extreme volatility in the markets comes from the possibility that the High Frequency Traders and the market makers and their algorithms just freeze up; and we saw some of that on Monday. Then the circuit breakers kicked in, and things normalized. But here’s where it gets tricky. When all those ETFs couldn’t figure out pricing, it was really a pretty simple problem; check the prices of the stocks in the basket, recalculate, and then reset the prices. Remember that ETFs are a very basic form of derivatives; a fund derived from the valuations of a basket of stocks.

For every market and every index, there are derivatives, and most of them are much more complex than a simple basket of stocks, and they are still largely unregulated. Remember back in 2008, when the derivatives trading unit of AIG collapse? AIG executive Joe Cassano had the famous quote that is was difficult to imagine “a scenario within any kind of realm of reason that would see us losing a dollar in any of those transactions.” And then of course, AIG collapsed when its credit default swaps defaulted and the financial world learned that they couldn’t cover their bets, and the government came to the rescue with a $180 billion bailout for AIG.

Now you may think that this problem was cleaned up following the near global financial meltdown of 2008; Dodd-Frank reform was supposed to make derivatives trading more transparent, but that didn’t happen. Wall Street firms successfully lobbied to have a huge loophole inserted into the Dodd-Frank Act that enables them to evade regulations on swap agreements. Now traders and firms can shift the location of the swaps to places like London and avoid the oversight that was supposed to be provided by Dodd-Frank. The trading affiliates of the largest banks remain largely outside the jurisdiction of U.S. regulators, thanks to a loophole in swaps rules that banks successfully won from the Commodity Futures Trading Commission in 2013.

The U.S. derivatives market has shrunk but remains large, with outstanding contracts worth $220 trillion at face value. And the top five top banks account for 92 percent of that. US banks are still trading derivatives as vigorously as ever. But their trades, booked through London affiliates, do not carry any credit guarantees, meaning that when the next credit contagion hits, they won’t be forced to pay off; meaning that all the financial institutions that purchased derivatives as a hedge against extreme volatility, kind of like what we saw on Monday; they don’t actually have insurance.

The final read of consumer sentiment was revised lower for August, to 91.9 from a preliminary tally of 92.9 and a July reading of 93.1. That was the first reading since the market turmoil.

Total incomes rose 0.4 percent in July for a fourth month.  Consumer spending increased 0.3 percent in July, matching the prior month’s gain. Because spending increased less than incomes, the saving rate rose to 4.9 percent from 4.7 percent. Today’s Commerce Department report also showed inflation remained tame. The personal expenditure index, or PCE, increased 0.1% from the prior month and was up 0.3 percent from a year earlier. The core price measure, which excludes food and fuel, also rose 0.1 percent from the prior month and was up 1.2 percent from July 2014, the smallest year-to-year gain in four years. Inflation hasn’t reached the Fed’s 2 percent goal since April 2012.

So what’s on the menu at Jackson Hole? The Federal Reserve’s annual economic policy conference kicked off late last night, and will run through Saturday. Fed policymakers have, in the past, used the conference to telegraph changes in monetary policy. In the past couple of days, we have heard from NY Fed President William Dudley, who seems split between hiking or waiting; KC Fed President Esther George is predictably hawkish; Minneapolis Fed President Narayana Kocherlakota is predictably dovish.

With Fed Chair Janet Yellen skipping the conference we probably won’t hear anything definitive, traders will be watching for signals about the likely timing of an interest rate increase from Vice Chairman Stanley Fischer. Today Fischer was playing it close to the vest, saying the Fed is watching the situation in China, but also acknowledging that the US economy has shown signs of strength.

There is little doubt that the Federal Reserve’s efforts to prop up the stock market since the 2008 financial crisis through monetary stimulus measures, like buying up government bonds and other assets, better known as quantitative easing, or QE, helped fueled one of the longest bull runs in history. But those who predict a cratering of the market with the cessation of QE have, so far, been proven wrong. At most, the market rally slowed, but it did not crater. The market anticipation of the end of QE, a taper tantrum, was far worse than the actual end of QE. We may be seeing something similar now.

And while QE and Zero Interest Rate Policy were certainly important parts in the market recovery from 2008, they were not the only parts, and it is probably misleading to make a direct connection when trying to gauge where the S&P 500 is headed or why it might go in a particular direction. In short, an interest rate hike in the not-too-distant future is not off the table.

Crude prices were up again today after bouncing back from six-and-a-half-year lows on positive U.S. growth numbers, recovering equities markets and reports of an emergency OPEC meeting. On Thursday, oil saw its biggest one-day bounce since 2009 with North Sea Brent and U.S. light crude rising more than 10%, tacking on 6.3% today. WTI crude posted its first weekly gain in nine weeks, ending its longest losing streak since 1986.

Carl Icahn has set his sights on mining company, Freeport-McMoRan. The stock surged almost 30% after announcing plans to cut spending and production, and lowering its 2016 capex budget by 29% from its $5.6B estimate issued in July. After the closing bell, Carl Icahn disclosed an 8.46% active stake in the company, sending shares up another 10% in after-hours trading. In a new 13D filing, Icahn said he plans to engage with Freeport McMoRan management and may seek board seats.

“For the first time ever, one billion people used Facebook in a single day – one in seven people on earth,” – that according to a blog post from CEO Mark Zuckerberg. With 1 billion users this past Monday, the 12-year-old company has become an online community that is bigger than the population of every country on the globe except China and India. Facebook has 1.49 billion average monthly users, and said it had an average of 968 million daily users in June.

I guess we really are all in this together.