FINANCIAL REVIEW

Earnings Season Kickoff

Sinclair Noe — January 12, 2015

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

DOW – 96 = 17,640
SPX – 16 = 2028
NAS – 39 = 4664
10 YR YLD – .06 = 1.91%
OIL – 2.58 = 45.78
GOLD + 10.00 = 1234.40
SILV + .09 = 16.71

The drop in the price of oil has been amazing; the daily moves are big: 3%, or 4% or more on any given day (5% today). Eventually prices will bottom out but we get no indication of where that bottom is. Today, Goldman Sachs made sharp cuts to its oil price projections. The bank’s energy analysts revised down their three-month forecast for WTI crude to $41 a barrel from a previous estimate of $70. They see WTI at $39 a barrel in six months and $65 a barrel in a year, versus previous price forecasts of $75 and $80, respectively. They see Brent at $42 in three months, $43 in six months and $70 in 12 months versus previous estimates of $80, $86 and $90, respectively.

When oil is trading at $45 and falling, it really isn’t shocking to say it could drop to $41. Goldman Sachs is playing catchup, and today’s revisions clearly show that their earlier estimates were grossly inaccurate.

In an interview with Maria Bartiromo of Fox Business News published in USA Today, Saudi Prince Alwaleed bin Talal said: “If supply stays where it is, and demand remains weak, you better believe [the price of oil] is gonna go down more. But if some supply is taken off the market, and there’s some growth in demand, prices may go up. But I’m sure we’re never going to see $100 anymore.”

Alwaleed said the Saudi government and other oil producers were caught off guard by the steep drop in oil prices. A lot of people were caught off guard, and right now all the forecasts amount to nothing more than guesses. Your guess is as good as Goldman’s or the guess of a Saudi prince.

The collapse in oil prices is set to crimp one of the few fast growth areas for banks since the financial crisis – lending to the energy industry. Banks have been underwriting bonds, advising on mergers, even financing the building of homes for oil workers. All of this has provided a boon to banks that have been struggling to find more companies and consumers wanting to borrow. When times are good, the capital-intensive oil business is a banker’s dream. From new wells dug in North Dakota and Texas to the oil patch of Alberta, oil producers have turned to Wall Street and local banks to help them sell billions of dollars in bonds, raise equity and arrange lines of credit. As oil prices drop, some energy companies will be unable to service their huge debts, and defaults are likely.

We know that the energy sector is a big part of the investment banking revenues of several big banks; nearly 12% of investment banking revenue for Citibank, 20.2% for RBC Capital Markets, 34.6% for Scotiabank, 14.9% for Wells Fargo Securities. These revenue sources are likely to dry up. A precipitous drop in oil prices can quickly turn loans that once seemed safe and conservatively underwritten into risky assets. The collateral underpinning many energy loans, for example, is oil that was valued at $80 a barrel at the time the loans were made. As oil has dropped well below that price in recent months, the value of the banks’ collateral has sunk. Many oil companies have bought hedges on oil prices, which are providing lenders with additional cushion. But when those hedges expire, and if oil prices remain low, the banks may need to reserve money against the loans.

It’s not a crash right now but it is a slowdown and we’ll find out more as the banks report quarterly earnings later this week. You can bet that analysts and investors will be asking about the pain of that slowdown and demanding forward guidance. Investors in the junk bond market, of which energy companies account for an estimated 18%, are not so optimistic. Junk bonds issued by energy companies are signaling a significant increase in the number of defaults in the coming months. Yields on energy junk bonds appeared to be predicting that 6% of the bonds would default this year, and even more in 2016.

The sidebar story is that banks always chase hot money, whether it’s the housing market or the energy market. So as credit in the oil patch slows down, the bankers are likely to move their fast money. Where? One possibility is to consumer businesses. The less cash consumers have to spend filling up their gas tanks or heating their homes, the more emboldened they may feel to sign up for a credit card or take out a mortgage. The banks have already put us in their crosshairs.

Make no mistake, low oil prices are good for the US economy. The banks are going to have to weather this mess on their own – no bailouts this time. Meanwhile, the good stuff is not just more money left in your wallet when you fill the tank. Low oil prices have declawed the Russian bear, and this all seems more than just a bit coincidental, coming on the heels of Russia’s invasion of Ukraine. This weekend, Venezuela’s president Nicolas Maduro stood beside Iran’s Hassan Rouhani as they urged OPEC members over the weekend to “neutralize schemes by some powers against OPEC and help stabilize an acceptable oil price in 2015.” Heavily relying on high prices to drive their economies, the current plunge in oil has placed a severe strain on the two countries.

Alcoa kicked off the earnings reporting season after the close of trade today. Yes, we have had a few scattered earnings reports over the past week or so, but Alcoa was always considered the first major company to report. It used to be one of the Dow 30 Industrial stocks and the ticker symbol is AA, so it was just an alphabetical distinction, but the tradition carried over. Alcoa reported a net profit of $159 million (or 11 cents per share) compared with a loss of $2.3 billion a year earlier. Excluding restructuring costs, Alcoa’s net profit was $432 million or 33 cents per share, beating estimates of 27 cents. Revenue grew by 14%. Alcoa shipped a record volume of automotive aluminum sheet in the quarter. Auto companies such as Ford Motor, which started making its lightweight, aluminum-bodied F-150 pickup in November, are using more of the metal to boost fuel efficiency.

The energy sector is expected to whack overall profits. Forecasts for first-quarter profits in the Standard & Poor’s 500 Index have fallen by 6.4 percentage points from three months ago, the biggest decrease since 2009. Reductions spread across nine of 10 industry groups and energy companies saw the biggest cut. Either there is nothing to worry about and crude bottoms out real fast, or we have entered an earnings down cycle for an appreciable portion of the market. American companies are facing the weakest back-to-back quarterly earnings expansions since 2009 as energy wipes out more than half the growth and the benefit to retailers and shippers struggles to play catch up.

Profit is forecast to have grown 2% in the final three months of 2014 and increase 2.8% for the current quarter, down from analysts’ October estimates of 8.1% and 9.2%, respectively. Without energy companies, profit gains would have been 4.7% and 7.8%, the most recent projections show. Of course, you and I have been around long enough to know that part of this is a game played by the companies and the analysts to lowball earnings estimates, and then beat the diminished expectations. Companies are fairly pessimistic, or lowballing more than usual, as 81% of those providing an earnings outlook for the fourth quarter have given one that has fallen below the Wall Street consensus. And we can probably look forward to a new phrase to justify weak results: earnings “ex-energy”; in other words, the company could have had a nice earnings report except for one excuse or another.

On Friday we covered the jobs report; the numbers for December were pretty good, the economy added 252,000 jobs and the unemployment rate fell to 5.6%; it was the 51st consecutive month of job gains. That’s all good. But unfortunately, it’s still nowhere near where it needs to be.

According to recent analysis from the nonpartisan Economic Policy Institute, the U.S. economy is missing about 5.6 million jobs. That’s the number of additional jobs there would be if the economy regained all jobs lost in the recession and the job market kept pace with the natural increase in job seekers. Each year, the population keeps growing, and along with it, the number of people who could be working. To get back to the same labor market we had before the recession, we need to not only make up the jobs we lost, but gain enough jobs to account for this growth.

If the economy continues to expand at a rate of 353,000 jobs per month — that’s the number of jobs added in November 2014, which was the best month for job growth last year — the job market will be fully recovered in August 2016. If the job market improves at the same rate it did last year, adding an average of 246,000 jobs per month, the labor market won’t be fully recovered until August 2017. The EPI analysis did not say how much we would need to make up for the slow growth in wages.

After we wrap things up today at the old radio ranch, I’ll head home to watch the national college football championship game between Ohio State and Oregon. If you watch the game be sure to take note of the end zone. Rather than end zones painted in each school’s colors, as is typical for bowl games and the now-defunct BCS National Championship Game, the end zones in AT&T Stadium will be black, with merely the College Football Playoff logo and each school’s name. Next to the team names, it will feature a gold football logo on a black field. That football logo matches the football on the championship trophy, also gold and black. In fact, that gold on black logo is all over the place. And that is today’s lesson in branding.

Wednesday, June 04, 2014 - An Airtight Defense

Financial Review with Sinclair Noe

DOW + 15 = 16,737
SPX + 3 = 1927 (record close)
NAS + 17 = 4251
10 YR YLD + .01 = 2.60%
OIL - .27 = 102.39
GOLD – 1.30 = 1244.60
SILV - .01 = 18.90

Eight times a year the Federal Reserve gathers economic updates from the 12 districts and publishes the information about two weeks before its FOMC meetings. The data is published in a beige folder, and that is why it is called the Beige Book, although it might actually refer to the writing style. Anyway, economic activity expanded all across the country, with most districts reporting moderate or modest growth. Consumer spending expanded across almost all districts. Tourism was another bright spot and manufacturing activity expanded across the country. Home sales were described as “mixed across the country” even as home prices continue to rise. Labor markets were described as steady. Inflation was tame, with a slight exception for higher food prices in some areas.

In other words, when the Fed meets in a couple of weeks, there won’t be any big changes in monetary policy.

The Institute for Supply Management said its services index rose to 56.3%, its highest level since August, from 55.2% in April. That’s the number and they’re sticking with it.

The US trade deficit grew to $47 billion in April, up from $44 billion in March. Exports slowed in April, down slightly to $193 billion. Imports, meanwhile, surged by nearly $3 billion to $237 billion, mainly driven by increased spending in consumer goods and cars.

A new survey from the MacArthur Foundation finds 70% of Americans still feel a housing crisis remains today and the worst is yet to come; that’s down from 77% a year ago, but still it doesn’t look like there’s much confidence in a housing recovery. Half the respondents think housing represents a good long term investment, while 43% says that’s not the case; two-thirds say it’s harder to build wealth through home ownership than 20 or 30 years ago. Over half of Americans, 52%, have had to make at least one major sacrifice in order to cover their rent or mortgage over the last three years.

In line with the survey on housing, a new poll from CNN and ORC International finds 59% of adults think the American Dream has become impossible for most to achieve, up from 54% in a poll conducted in 2006. What’s more, 63% of those surveyed believe most children in the US will grow up to be worse off than their parents. While most Americans say they’re better off than the prior generation, they also feel gains in living standards are grinding to a halt. One problem is that the survey didn’t define exactly what the American Dream is supposed to be.

ADP, the payroll processing firm, issues a monthly payroll report ahead of the Labor Department each month. The ADP report is not always an accurate predictor of the government report but it is still closely watched for any hints. ADP says the economy added 179,000 private sector jobs in May; that’s significantly below the consensus estimate of 200,000 to 215,000 jobs for the Friday jobs report.

According to the latest revisions from the Labor Department, productivity in the first quarter declined at a 3.2% annual rate, the worst in six years, as workers spent more time on the job producing fewer goods during an unusually stormy weather.

A new research study published today from the Economic Policy Institute shows a sharp disconnect in the late 1970s between the overall productivity of the US economy and wage gains for the average worker. Normally, when workers make more things during a work day, they get paid more for that day’s work. From 1948 to 1979, both hourly wages and productivity roughly doubled. But from 1979 to 2013, productivity rose 65% while average hourly compensation rose just 8%; those at the bottom and middle of the income ladder saw little of those gains.

Wages for everyone at or below the 30th percentile of the income distribution have essentially been flat, while wages for the poorest 10% of workers have fallen during that time period. At all income levels, women earn less on average than men do.  Most wage growth has flowed to the top 1% of earners, posting a 153% increase in wages. Since wages for the lowest income group have fallen while wages at the highest income group have grown, income inequality has also increased.  Piketty was right.

The S&P 500 index hit another record high close today, and even at that it’s just up about 5% year to date. The best performing market year to date is in Dubai; posting a 56% return since the start of the year and posting a 117% return for the past 12 months. The strongest S&P 500 subsectors this year include oil & gas equipment and services, which is up 17%; oil & gas exploration and production, up 15%; real estate investment trusts, up 15%; natural gas utilities, up 21%; and electric utilities, which have risen 14%, largely on the back of some big mergers.

The top performing stocks in the S&P year to date include: Forest Labs, up 60%, a takeover target; Nabors Industries, a contract oil driller based in Bermuda is up 54% year to date; Electronic Arts, the video game developer is up 51%; Keurig Green Mountain has returned 50% this year, this is the coffee company that makes those little single serve containers of coffee; Newfield Exploration, an oil and gas exploration and development company out of Texas is up 49% since the start of the year; Delta Airlines is up 47% after rejoining the S&P 500 index; and Pepco, the Washington DC based utility is up 47% YTD, after agreeing to be acquired by Exelon. Probably nobody picked those stocks as the top performers at the start of the year.

After the close of trade today, comes word that Sprint is nearing an agreement price to acquire T-Mobile for about $40 a share, or around $32 billion, a 17% premium to the closing price today. There will be regulators to deal with. An announcement and an actual deal are still down the road. If you are unhappy with the service and price you pay for your mobile phone, this won’t help.

A federal appeals court has overturned a decision by Judge Jed Rakoff to reject a federal settlement deal with Citigroup. Judge Rakoff had considered the Citigroup-SEC settlement to be little more than a slap on the wrist. The original case accused Citigroup of duping investors into buying tainted CDO’s, Collateralized Debt Obligations. The bank agreed to pay $285 million to settle the civil fraud case, without admitting wrongdoing.

Judge Rakoff called the fine “pocket change” for the bank and said the settlement deprived the public “of ever knowing the truth in a matter of obvious public importance.” And now the court of appeals decision is going to rein in judicial discretion even more. The ruling essentially says that a judges job is not to search for the truth.  One small victory for Judge Rakoff: the SEC last year reversed its longstanding yet unofficial policy of allowing companies to neither “admit nor deny wrongdoing,” signaling that it would force admissions in particularly egregious cases.

If only the SEC had the backbone to pursue a particularly egregious case.

The G-7 or Group of 7 is meeting today and tomorrow; it used to be the G8 until Putin invaded Crimea, and so Russia was kicked out of the clubhouse. A draft of the G7 communique calls on Russia to "accelerate withdrawal of military forces from the eastern border with Ukraine" and "exercise its influence among armed separatists to lay down their weapons".

More important is how Europe will deal with energy security as the continent relies on Russia for about a third of its oil and gas, a fact that gives Putin considerable leverage over the EU. The G7 draft communique says: "The use of energy supplies as a means of political coercion or as a threat to security is unacceptable." Euro leaders say they are committed to diversifying energy sources away from Russia, but it won’t happen overnight. Complacency on the energy front seems like a really big mistake.

As the G7 meeting wraps up, the various leaders will head to France on Friday to mark the 70^th anniversary of the D-Day invasion at Normandy. Putin will be there. No negotiations or diplomatic level talks are planned but it should make for some interesting photo ops.

And before the D-Day anniversary there will be an uncomfortable dinner between President Obama and French President Hollande, who will make the case that the French bank, BNP Paribas should not be fined $10 billion for money laundering. Naturally, this has BNP clients nervous about what all this means for business, and the upper echelons of BNP management nervous about how their employees might respond to questions about money laundering.

Once upon a time BNP thought they could beat the rap. BNP showed prosecutors a memo that the bank thought would explain and possibly mitigate the conduct. The memo, drafted around 2004 by an outside law firm, essentially authorized the bank to process certain transactions for Sudan, as long as BNP’s employees in New York were not involved in the arrangement. BNP argued that it lacked the intent to commit a crime, saying that it followed the law firm’s directive. That legal argument, known as the “advice of counsel” defense, prompted prosecutors to pore over the single-page memo and weigh the bank’s argument. Ultimately the prosecutors concluded that the memo alleviated only a small fraction of the wrongdoing. Apparently hiring lawyers to tell you that you can do whatever you want turns out to be a little bit less than an airtight legal strategy.