Financial Review

A Date That Will Live in Infamy

Sinclair Noe — December 7, 2016

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DOW + 297 = 19,549
SPX + 29 = 2241
NAS + 60 = 5393
RUT + 11 = 1364
10 Y – .05 = 2.35%
OIL – 1.04 = 49.89
GOLD + 4.00 = 1174.30

Another record high close for the Dow Industrial Average – 3 in a row. The Dow is up in 18 of 22 sessions, but today was the first triple-digit gain since Nov. 10. Plus, records for the S&P 500 index and the Russell 2000 index of small cap stocks. The Dow Transportation Average gained 231 to close at a record high of 9371, taking out the old record high of 9217 set December 19, 2014.

For Dow Theorists, this is confirmation of the bull. Dow Theory holds that strength in the shipping and rail stocks needed to transport goods — a sign of healthy demand and production — is a prerequisite to strength in the broader market.

The transportation average often is a leading indicator for the economy. If we get everything in gear, it suggests everything is in harmony to the upside. From a recent low of 7885 on October 26, the Transports have jumped about 19%, which is just freakish strength. If you caught the planes, trains and shipping containers early, congratulations. The Transports are pricing in a high success rate for infrastructure not only passing, but happening right away and that should give you pause.

A lot is at stake this today as  Time Warner chief executive, Jeff Bewkes, and his AT&T counterpart, Randall Stephenson, answered questions at the Senate antitrust committee hearing about conflicts that might arise from the merger of a major media producer and a major distributor.

AT&T’s $108 billion acquisition would join America’s largest pay TV provider with a media and entertainment company that has a massive catalog of movies and TV shows. Critics charge it could give the telecom giant a huge advantage in the marketplace.

At issue is something called “zero-rate.” That means the ISP, in this case AT&T, won’t count a customer’s viewing of AT&T-owned content against his or her data allowance. Currently, AT&T has such a promotion with DIRECTV. AT&T wireless customers who also subscribe to DIRECTV can watch that content on their mobile devices without it counting against their data allowance.

If you are both an AT&T and DIRECTV customer, that’s a great deal. But if you are a small ISP trying to compete against AT&T, you may think the playing field has suddenly become a lot less even. So far, AT&T is batting one for two on proposed mega-mergers. Last year its deal to acquire DIRECTV got a green light from regulators. Before that, its deal to acquire rival T-Mobile did not.

President-elect Donald Trump continued to show the power of his fully operational Twitter feed yesterday as one tweet brought an offer of talks from Boeing on the cost of a plane order, while another saw shares in SoftBank Group rally to their highest level since August 2015.

While there is disagreement over whether Trump’s tactics will prove effective over the long term, and even if the investments he flags are possible, this Twitter feed seems likely to continue to be one of the most important in markets.

Meanwhile, Trump has picked Scott Pruitt, the Oklahoma attorney general to run the Environmental Protection Agency. Pruitt has been a close ally of the fossil fuel industry and a staunch opponent to environmental regulations. So, it’s kind of like picking an atheist to be the next Pope.

Time magazine has named its Person of the Year – Donald Trump. Trump is the magazine’s 90th person of the year. The runner-up is Hillary Clinton. Trump, in an interview with the Time magazine, said he would bring down drug prices. The S&P 500 healthcare index swiftly lost 1.6 percent, while the Nasdaq Biotechnology index dropped 3.8 percent – set for its worst day in nearly two months.

Pfizer was hit with a $107 million fine by British officials for an epilepsy drug price increase of as much as 2,600 percent. In the UK, branded drug prices are regulated. Pfizer figured out a way to raise the price – sort of through the back door. Pfizer sold the UK distribution rights to Flynn Pharma, debranding the drug and making it generic.

Because generic drugs are generally available to customers at cheaper prices than branded products. The drug was no longer subject to price regulation, leaving Pfizer free to sharply increase the price it charged Flynn, which in turn further raised the price it charged the National Health System. Pfizer jacked up the price from £2.83 to £67.50. Pfizer says it will appeal the fine.

The European Commission has fined three banks for manipulating a key interest rate, known as the Euribor, or European Interbank Offered Rate. The commission levied $520 million in fines against JPMorgan, Credit Agricole, and HSBC. JPMorgan faced the largest fine at $360 million. Euribor is used to set rates on everything from home loans to complex derivatives. Major banks submitted information daily to set the rate. The regulator said the banks had acted as a “cartel.”

Citi is being investigated for its role in the pound’s “flash crash. “Citi’s Japanese trading operation is being investigated by the Bank of England for exacerbating the pound’s October flash crash by placing many sell orders after the initial fall began

Shares in Italian banks continued their recovery after falling sharply on Monday in response to Prime Minister Matteo Renzi’s referendum defeat. La Stampa newspaper had reported that Rome would be asking for €15-billion-euro from the European Stability Mechanism to help the Italian banking system.

At the same time, Reuters quoted unnamed sources as saying that the government would take a €2-billion-euro controlling stake in Monte dei Paschi. The Italian government plans to buy junior bonds to boost its stake to 40%, although there are concerns this might amount to state aid, in violation or Eurozone regulations.

Traffic at U.S. fast-food restaurants fell 1% in the third quarter to mark the sector’s first traffic decline in five years. The industry tracker NPD Group said total restaurant visits were also down 1%, hurt by the now familiar list of factors that have weighed this year, ranging from the higher costs of eating out, changing consumer behavior and higher bills for items such as rent and prescriptions.

Eating out has become more expensive even as the cost of at-home dining has fallen. The cost of food purchased for home use — that is, groceries — has fallen 2.4% in the past year, according to the October consumer price index. That’s the biggest decline over a 12-month period since the end of the Great Recession in 2009

Sometimes it seems there is a Starbucks on every corner, but not every intersection has been caffeinated. Starbucks hopes to change that. The coffee retailer plans to open 12,000 new stores in the next five years.  The company also said it would open an outlet of its high-end coffee chain, Reserve Roastery and Tasting Room – for the real coffee connoisseurs, or at least someone crazy enough to pay $10 for a cup of Joe, or should we say Josephus.

Today, is of course, December 7^th, a date which will live in infamy; 75 years ago, today the United States was suddenly and deliberately attacked by the naval and air forces of the Empire of Japan.

It is a hallowed site. About 15 minutes into the attack at Pearl Harbor, the Arizona was destroyed, killing 1,177 sailors and Marines on board. And there the Arizona remains to this day.  On December 6, 1941, Arizona took on a full load of fuel – nearly 1.5 million gallons – in preparation for its scheduled trip to the mainland later that month. The next day, much of it fed the explosion and subsequent fires that destroyed the ship following its attack by Japanese bombers.

However, despite the raging fire and ravages of time, some 500,000 gallons are still slowly seeping out of the ship’s submerged wreckage: 75 years after its demise, Arizona continues to spill up to 9 quarts of oil into the harbor each day. They call the leaking oil, the “tears of the Arizona.”

Some people believe the oil will continue to leak until the last Pearl Harbor survivor dies. We will know if that is true soon.

Financial Review

Bargain Bloodhounds

Sinclair Noe — November 13, 2015

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DOW – 202 = 17,245
SPX – 22 = 2023
NAS – 77 = 4927
10 YR YLD – .04 = 2.28%
OIL – .99 = 40.76
GOLD – 1.10 = 1084.90
SILV – .03 = 14.38

The S&P 500 moved into negative territory year to date, for the first time since Oct. 22. The Dow Industrial Average is also down year to date, moving below the 200-day MA, with a weekly loss of more than 650. Commodity prices are weighing heavily on the markets, following yesterday’s report showing crude oil stockpiles were 4 times higher than market expectations. Still, the IEA predicts that supplies outside OPEC will decline next year by the most since 1992 as low prices take their toll on the U.S. shale industry.  Meanwhile, the dollar index is trading just above 99. That would put it within striking distance of 100.40, its highest level in 12 years.

Retail sales rose a seasonally adjusted 0.1% last month. Sales were revised lower in September to show no gain. Sales were also flat in August. In October, sales were held down by lower spending at auto dealers, gas stations and grocery stores. Although the number of autos sold last month was quite strong, sales fell a seasonally adjusted 0.5%, perhaps suggesting heavier discounting. Stripping out gas and autos, U.S. retail sales rose a somewhat better 0.3%. Shoppers have used some of their gas savings to go out to eat more. Spending at restaurants climbed 0.5% in October.

The third quarter of 2015 was rough for American department stores. Macy’s, the nation’s largest department-store chain, had such a bad quarter that it cut its year-end forecasts across the board, lowering earnings, revenue, and same-store sales projections. And upscale competitor Nordstrom followed suit after reporting a 42% drop in profits, which caused shares to drop 15%.

But it’s not all retail doom and gloom. JC Penney reported same store sales were up 6.4%, and that helped boost net sales nearly 5% to $2.9 billion. The retailer also dialed up its year-end outlook for adjusted earnings before interest, taxes, depreciation, and amortization. All that said, JC Penney still isn’t turning a profit, but its net loss shrank 23% to $137 million. Shares were still down 16% today. Seriously, we should see some major bargains this holiday season.

Consumers were in a good mood. The University of Michigan’s consumer sentiment index rose to 93.1 in early November from a reading of 90.0 in October. The survey showed an improvement in buying plans for large discretionary purchases, especially vehicles. Lower-income households also were upbeat about their prospects in November.

The producer price index fell 0.4% in October. The index, which measures prices at the wholesale level, has been flat or lower for four straight months, contributing to a record 1.6% decline over the past year. The overall cost of services dropped 0.3% last month, reflecting lower revenue generated by wholesalers and retailers. The cost of goods declined 0.4%. Lower energy costs and cheaper imports have pushed prices down. Core producer prices that exclude the volatile categories of food, energy and trade fell a smaller 0.1% in October.

So, to recap: consumers are feeling good, wholesale prices are down (not just going up slowly, but actually down), and retail sales are flat lining right before the holiday shopping season. Here’s a thought; maybe consumers who were slammed by the Great Recession and were forced into squeezing every dime out of a dollar aren’t ready to go back to just throwing their cash at high priced department stores. We learned how to sniff out deals, we learned how to use technology to beat big margins.

The downturn turned us into bargain bloodhounds. Maybe this is the beginning of the end of department stores and malls as we know them. And maybe wage growth hasn’t yet been enough to warrant abandoning our newfound thrift. Maybe there’s even a little saving going on. The savings rate has been stubbornly high (by American standards). Or maybe everybody maxed out their credit cards. Maybe the economy is headed off the recessionary cliff. Or maybe it’s just a little statistical noise in the long term uptrend. Who knows? The salient point is that it isn’t really tough to spot the winners and losers in this market.

The federal government ran a budget deficit of $136 billion in October, up 12% or $15 billion from the same month last year. Spending in the first month of the fiscal year was $348 billion, up 4% from October 2014. Total receipts were $211 billion, a 1% decrease.

Eurozone economic growth was slower than expected in the third quarter. Eurostat said the gross domestic product of the 19 countries sharing the euro expanded 0.3 percent quarter-on-quarter for a 1.6 percent year-on-year increase in the July-September period. This outcome is lower than the ECB’s staff projections, which would add to the already strong case for the ECB to step up monetary stimulus in December.

China is moving to contain leveraged wagers on its stock market, cutting in half the amount of borrowed money investors can use to buy shares. Margin requirements will be raised to 100% from 50% starting on Nov. 23. The rule change means that an investor with 1 million yuan in their account is limited to borrowing another 1 million yuan from a broker to buy more shares. Previously, they could borrow as much as 2 million yuan. That should curtail speculation.

British prosecutors charged 10 former Deutsche Bank and Barclays employees with manipulating a benchmark interest rate, with an 11th facing indictment as soon as next week. Six traders from Deutsche Bank and four from Barclays were charged with conspiracy to manipulate the Euribor benchmark. Banks and other financial institutions have paid about $9 billion in fines tied to Libor and other key rates. So far, we are expected to believe that upper management was nothing but a bunch of overpaid, out of touch, incompetent morons who had no clue about trillions of dollars of trades resulting in billions of profits. At some point, prosecutors will have to figure out that someone in the C-suite knew what was going on and put their seal of approval on all this rigging.

The Group of 20 summit gets underway this weekend in Turkey. The primary purpose of the meeting is to look for ways to stimulate the global economy. A secondary agenda has been raised by Turkish President Erdogan to use concerns in the Eurozone over the refugee crisis to bolster support for military intervention in Syria. And while there will certainly be some lively debates at the G-20 meeting, the most likely outcome is a very nice photo-op.

Mylan failed to attract a majority of Perrigo shareholders by a Friday deadline for its $26 billion unsolicited offer to acquire the over-the-counter drugmaker. About 40 percent of Perrigo holders tendered their shares, short of the 50 percent needed to move ahead. Mylan now can’t try again for a year. Mylan offered $75 in cash and 2.3 Mylan shares for each Perrigo share, a bid that Dublin-based Perrigo had rejected as inadequate.

Cisco had a mixed quarter. The network-technology giant reported better-than-expected revenue and earnings. But guidance was a little light. Management expects to deliver $0.53 to $0.54 per share in earnings, which is below the $0.56 expected.

Hulu may sell a stake of itself to Time Warner as part of a deal that would value the streaming-video service at more than $5 billion and advance its efforts to compete with Netflix and Amazon.com. The Wall Street Journal reports, “The companies have been in talks about Time Warner becoming an equal stakeholder in Hulu alongside Walt Disney, 21st Century Fox and Comcast.

Shares of BHP Billiton fell close to a decade low today as a drop in commodity prices overnight compounded investor worries about the fallout from a dam-burst at its jointly-owned Brazilian iron-ore mine operation last week which killed nine people. Brazil President Dilma Rousseff has slapped preliminary fines of $96 million against the Samarco mine where two waste dams burst, spilling sludge and mine waste over 2 states. The fines could go much higher. Prosecutors are investigating possible crimes that could have contributed to the disaster at the mine

The Supreme Court has agreed to hear a challenge to a Texas law that would leave the state with about 10 abortion clinics, down from more than 40. The court has not heard a major abortion case since 2007, and the new case has the potential to affect millions of women and to revise the constitutional principles governing abortion rights. The case concerns two parts of a state law that imposes strict requirements on abortion providers. One part of the law requires all clinics in the state to meet the standards for “ambulatory surgical centers,” including regulations concerning buildings, equipment and staffing. The other requires doctors performing abortions to have admitting privileges at a nearby hospital. Other parts of the law have already caused about half of the state’s 41 abortion clinics to close. If the contested provisions take effect, the brief said, the number of clinics would again be halved.

The challengers’ brief said that the law “would delay or prevent thousands of women from obtaining abortions and lead some to resort to unsafe or illegal methods of ending an unwanted pregnancy.” The remaining clinics would be clustered in four metropolitan areas: Austin, Dallas-Fort Worth, Houston and San Antonio. The case, Whole Woman’s Health v. Cole, could provide the Supreme Court with an opportunity to decide whether the law interferes with its 1992 decision in Planned Parenthood v. Casey, which said states may not place undue burdens on the constitutional right to abortion before fetal viability. The court said undue burdens included “unnecessary health regulations that have the purpose or effect of presenting a substantial obstacle to a woman seeking an abortion.” The justices will hear arguments in the case within the next few months and hand down a decision by June.

Tuesday, May 20, 2014 - Protected Species

Financial Review with Sinclair Noe

DOW – 137 = 16,374
SPX -12 = 1872
NAS – 28 = 4096
10 YR YLD - .02 = 2.51%
OIL + .87 = 102.98
GOLD + 1.70 = 1295.30
SILV + .05 = 19.49

Today is Tuesday and that means that General Motors has announced another recall; this time 2.6 million more cars. Last week, GM recalled 3 million vehicles. So far this year, GM has announced 29 recalls affecting more than 15 million cars globally. The list of recalled vehicles is long. It’s easier to list the vehicles that haven’t been recalled; they have recalled 58 versions of Chevrolet and GMC pickups.

Last week the Dow hit a record high; since then it has been floundering. For the fourth straight session, the Nasdaq Composite has posted more 52-week lows than 52-week highs; 55 lows versus 38 highs. The Russell 2000 Index of small and mid-cap stocks hit a high on March 4^th and since then it has dropped almost 10%.

Meanwhile, interest rates have been moving steadily lower despite winding down of large scale asset purchases under the Fed’s quantitative easing, and the talk about raising interest rates at some point down the road. With yields on the 10-yr Treasury note dipping down around 2.5%, that means somebody is buying Treasuries, but if not the Fed, then who?

Well, it’s certainly not Russia. Putin sold off more than $100 billion in Treasuries in March; he was probably expecting Treasury prices to tumble, but that didn’t happen. The most likely buyer is Belgium; from November of last year through January 2014, Belgium bought approximately $142 billion in US Treasuries, which is quite a bit considering the Belgian GDP is about $480 billion; so their bond buys were equal to about 30% of GDP.

As a member of the Eurozone, Belgium can’t just print new money. So, something is rotten. Or maybe the Fed has opened up a branch office in Antwerp.

Anyway, Putin is in China today to talk up the virtues of Russian natural gas. Putin met with Chinese President Xi Jinping at a start of a two-day meeting on Asian security with leaders from Iran and Central Asia. Putin is hoping to extend his country's dealings with Asia and diversify markets for its gas, which now goes mostly to Europe. Russia has been negotiating for more than a decade on a proposed 30-year deal to supply gas to China. Officials said they hoped to complete work in time to sign a contract while Putin is in Shanghai, but they have not yet announced a signed agreement. Putin told Chinese reporters ahead of his visit that China-Russia cooperation had reached an all-time high.

Russia is worried about its European gas market, seeing lackluster European demand and political efforts, intensified since the Ukrainian crisis, to diversify away from Russian gas constraining future sales to the West. At the same time, the shale gas phenomenon, with possible US and Canadian liquid natural gas exports to come, has Moscow concerned about what prices it can hope to attain from the European market. Developing new, potentially lucrative markets in the east seems to be the answer to Russia’s European gas concerns.

China also feels a new impetus for a deal. Despite a slowing of the domestic economy, future demand for energy, the key to both growth and political stability, will be robust. Efforts to develop China’s domestic shale resources are promising, but are unlikely to produce consequential volumes until the next decade. Meanwhile, China has been meeting growing energy consumption with coal powered plants, and they are literally choking on that decision, as the air quality has been nearly destroyed.

Tomorrow we will get the minutes of the last Federal Reserve FOMC meeting. Today we had Fed heads giving speeches. William Dudley, the president of the New York Fed is saying the Fed will take its time raising interest rates.  Noting both market and Fed expectations that the first hike will come some time near the middle of 2015, Dudley said, “if the economy is stronger than expected, causing the excess slack in the labor market to be absorbed sooner and inflation to rise more quickly than forecasted, then lift-off is likely to be pulled forward in time. If, instead, economic growth disappoints, inflation stays unusually low and the labor market continues to exhibit evidence of considerable excess slack, then lift-off will likely be pushed back in time.”

As for the over $4 trillion worth of bonds on its balance sheet, Dudley expects them to be reduced via “automatic pilot”; in other words, as Treasury securities mature and mortgages are repaid. Dudley offered his two cents on why the housing sector’s contribution to the economy has “stalled out” over the past few quarters.  While he said some decline in activity was to be expected following the jump in mortgage rates last year, “the extent of the slowdown has surprised me given that the recent pace of housing starts, roughly 1 million per year, is far below what is consistent with the economy’s underlying demographics.”

Dudley said mortgage credit is still unavailable to borrowers with lower credit scores. Also, student debt has delayed the entry of new first-time home buyers; that could make it harder even for existing homeowners to sell their homes and trade up, slowing the traditional turnover of the housing market. Dudley said he expects the housing recovery to continue, “the pace will likely be slow, especially relative to past economic recoveries.”

The online real estate site, Zillow reports 18.8% of US homeowners with a mortgage, or 9.7 million households, were underwater on their mortgages at the end of the first quarter. That's an improvement from the end of last year when this figure was 19.4%, and it's a large improvement from a peak of 31.4% in 2012, but it shows that negative equity is still an issue in the housing market.

What's more, there is an additional 10 million households that have 20% or less equity in their homes. For those homeowners, it would be difficult to sell without coming up with some money to cover the broker fees, closing costs and the down payment for the next home.

European Union regulators have charged banks JPMorgan, HSBC and Credit Agricole with colluding to manipulate the price of financial products linked to interest rates.

The European Commission's regulator said the banks will now have a chance to respond to the preliminary findings. If the Commission ultimately concludes they have broken the law, it can impose a fine of up to 10% of their annual revenue. In December 2013, the Commission levied fines totaling $1.4 billion on Barclays, Deutsche Bank, RBS and Societe Generale as part of the same case, which covers financial derivatives linked to a benchmark interest rate called Euribor in the period 2005-2008. Barclays escaped fines for having notified the Commission of the existence of the cartel, and the others were granted a reduction in their fine for cooperating in a settlement.

Late yesterday, Credit Suisse entered a guilty plea for conspiring to help US customers evade taxes, the first such guilty plea by a major financial institution in years. Today Credit Suisse shares rose almost 1%. Apparently a felony conviction is a good thing. And why not? Top bank executives will get to keep their jobs, the bank can pin the whole thing on a handful of underlings, and it won't have to give up a list of client names to the government. Credit Suisse will have to let an independent monitor keep an eye on it, but that's a minor inconvenience at worst. The guilty plea could cost the bank some clients here and there, but investors and analysts are betting there won't be much impact. The most painful part of the deal, the $2.6 billion in fines, is manageable, less than one quarter's revenue.

For the most part, the mainstream media is dutifully accepting the spin of the Department of Justice, that this case is significant by virtue of being the first plea of this sort made by a bank in over two decades. The fact that those intervening years saw regulators generally take a very hands off approach to banks, and that we had a global financial crisis with no measures of this sort taken against the perps somehow escapes mention.

Let me return to one critical issue: why no individuals were prosecuted or even fined. This case, like so many we have discussed, seems ideally made for at least a civil action under Sarbanes Oxley against the CEO and CFO, since they must certify the adequacy of internal controls. The most charitable coloration you can put on what looks an awful lot like obstruction of justice (although Credit Suisse was not charged with that) was that it was a failure of internal controls. And Sarbanes Oxley is designed so that a civil action can easily tee up a criminal case on the same control deficiencies.

Credit Suisse was in many ways the perfect major financial institution from which to demand a guilty plea. Although its investment banking and wealth management operations are global, the commercial banking operation in the United States is largely confined to its New York branch. It does not own a subsidiary in this country providing bank services to local customers, so it really only had to negotiate with the New York authorities and the federal government to resolve the case. That meant the effort to mitigate potential collateral consequences of a guilty plea was confined to just a few agencies. So, if you think the Credit Suisse case will become the template to go after American banks, well, yeah, that’s not going to happen. The banking class remains a protected species.