Financial Review

Go Figure

Sinclair Noe — May 24, 2016

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DOW + 213 = 17,706
SPX + 28 = 2076
NAS + 95 = 4861
10 Y + .02 = 1.86%
OIL + 1.02 = 49.10
GOLD – 21.30 = 1227.90

Yesterday, Wall Street couldn’t figure out which way to go; today stocks rallied for their best day since March 11. The S&P 500 rallied back above its 50 day moving average; we’ll have to see if it can hold on.

What was behind the rally? Who knows? Jeffrey Gundlach, CEO of DoubleLine Capital, said the rally feels like a short squeeze and characterized U.S. stocks as “dead money.” Gundlach says the market is not healthy and earnings have come in weak. On the Federal Reserve, Gundlach says the odds of a rate hike in June are 50-50, and it is Janet Yellen’s opinion that matters the most.

Expectations are rising for a rate hike next month after Philly Fed President Patrick Harker reinforced the central bank’s message that it’s getting ready to act now that the U.S. economy has recovered from a weak winter. Harker says he “can easily see the possibility of two or three rate hikes over the remainder of the year,” he told an audience in Philadelphia. “If the data comes in… I think a June rate increase is appropriate.” Markets are also awaiting this week’s main event – a speech from Janet Yellen on Friday.

The Census Bureau reports New Home Sales in April increased to a seasonally adjusted annual rate of 619,000 – an 8 year high; that’s an increase of 16.6% from March, and a 23.8% increase from April 2015. The median price also jumped, rising 9.7% from 12 months ago to $321,100. The big increase in sales took supply sharply lower. At the current pace, it would take 4.7 months to exhaust all inventory.

French investigators raided Google’s Paris headquarters this morning as part of a tax evasion inquiry. Google has based its regional headquarters in Dublin where corporate tax rates are lower than elsewhere in Europe. The company, now part of Alphabet, has been under pressure in recent years over its practice of channeling most profits from European clients through Ireland to Bermuda, where it pays no tax on them.

The raid was part of an investigation to determine if Google Ireland Ltd has a permanent base in France and if, by not declaring parts of its activities carried out in France, it failed its fiscal obligations, including on corporate tax and value added tax.  The raid was carried out as part of an investigation into aggravated tax fraud and the organized laundering of the proceeds of tax fraud. If Google is found guilty, it could face fines up to 10 million euros or a fine of half of the value of the laundered amount involved.

Separately, attorneys for Oracle and Google presented their closing arguments in a lawsuit over Google’s use of Java APIs owned by Oracle in Android. Oracle accused Google of stealing a collection of APIs, while Google suggested that Android transformed the smartphone market and Oracle sued out of desperation when its own smartphone attempts failed to launch. If the jury finds that Google did indeed steal code from Oracle, it could disturb the way engineers at small startups build their products and expose them to litigation from major companies whose programming languages they use.

By the way, API refers to application program interface, which is the set of tools for building software applications. Google has argued that Sun Microsystems, which created Java, always intended for its programming language and accompanying APIs to be used freely. Oracle purchased Sun in 2010 and claimed that Sun executives believed Google had infringed their intellectual property and simply hadn’t brought legal action.

An appeals court has already decided that the Java APIs in question are copyrightable. This case, which has stretched over two weeks in a district court in San Francisco, aims to determine whether Google’s implementation of the APIs can be considered fair use. Now we wait for the jury.

The head of SWIFT will present a plan today to fight back against a wave of recent cyber thefts at members of the world’s top payments network. The speech follows three high profile hacks since the beginning of last year: an $81 million heist at the Bangladesh central bank, a $12 million theft from Banco del Austro in Ecuador, and an attack on a Vietnamese lender that was unsuccessful.

Deutsche Bank was downgraded. Moody’s cut Deutsche Bank’s credit rating to “Baa2,” down from “Baa1.” The credit-rating agency said the downgrade was a result of the bank’s difficulty in stabilizing itself amid a world of low growth and low interest rates. Moody’s said, “Deutsche Bank’s performance over the last several quarters has been weak, and substantial operating headwinds, including continuing low interest rates and macroeconomic uncertainty, will challenge the firm.”

Monsanto has rejected Bayer’s $62 billion takeover offer as too low while saying it’s still open to further deal talks. Bayer will likely come back with a higher bid. Buying Monsanto would create the world’s biggest supplier of farm chemicals and seeds, so even if they can agree on a price, they face regulatory scrutiny and will likely have a hard time making the case that this deal will make for a more competitive market. The consolidation of two big industry players may also limit farmer choice and bargaining power, with increasing seed prices expected to be passed on to the grocery aisles.

There is also a question about biodiversity and the potential risks to food safety. As Monsanto rejected the Bayer bid, they left the door open, saying they “believe in the substantial benefits an integrated strategy could provide to growers and broader society, and we have long respected Bayer’s business.”

ExxonMobil will face a revolt from some of its biggest and most influential shareholders on Wednesday as they fight to force the world’s largest oil company to open up about the effect of climate change on its future profits. Investors, including pension funds of the governments of Norway, Canada, California, New York, and even the Church of England are expected to vote in favor of a resolution calling on Exxon to “publish an annual assessment of long term portfolio impacts of public climate change policies.” The resolution is also supported by ISS and Glass Lewis, the world’s leading proxy advice services which advise institutional investors how to vote on such issues.

The resolution states that the company “should analyze the impacts on ExxonMobil’s oil and gas reserves and resources under a scenario in which reduction in demand results from carbon restrictions and related rules or commitments adopted by governments consistent with the globally agreed upon 2-degree target”. ExxonMobil has tried to block the resolution.

Exxon is currently under investigation by New York’s attorney general over claims that it lied to the public and shareholders about the risks of climate change. It follows reports that internal company documents from the 1980s and 90s show Exxon’s in-house scientists were warning company executives about the dangers of climate change, while Exxon was publicly claiming that climate science was not proven.

The strongest El Nino in nearly 20 years has ended, according to the Australian Bureau of Meteorology, as sea surface temperatures across the Pacific Ocean cool to their neutral levels. El Niño led to damaged crop production (such as wheat, palm oil and rice) due to scorching weather across Asia and east Africa, and heavy rains and floods in South America. A majority of climate models suggest that the climate pattern La Niña will develop in the wake of El Niño, according to the Bureau of Meteorology. La Niña—a climate phenomenon characterized by significantly below-average temperatures in the Equatorial Pacific—brings dry and warm weather to the southern U.S. and Mexico, and wet weather throughout much of the Pacific.

Mandatory evacuation orders were lifted yesterday for the last of Alberta’s oil sands production sites endangered by wildfires, starting the process of inspections by forestry and health officials to make sure the facilities are safe for workers to return. Since late Friday, Alberta has removed orders that had prevented all but critical staff from remaining on sites.

Deere & Co. is tightening conditions for renting equipment as a slump in farming incomes has led customers to prefer leasing rather than buying its agricultural machinery. In the face of lower crop prices, farmers in the U.S., South America and elsewhere have cut back sharply on equipment spending despite planting big crops.

For nine straight quarters, the slump has eaten into Deere’s sales and profits, and it is now bleeding into the company’s customer-finance arm. Leases now account for about a quarter of Deere’s customer-financing deals, compared with about 15% in the past. But Deere’s finance unit and dealers have been burdened with used equipment as customers walk away when short-term leases expire. That has forced the company to tighten the terms for renting equipment that has rapidly depreciated in value.

Deere took a write-down on used equipment in the latest quarter. It is restructuring leases to share more of the risk of further declines with dealers and new leases will likely cost farmers more as the company lowers residual equipment values at the end of the leases to reflect the depressed prices for used equipment.

Toyota is recalling almost 1.6 million additional American vehicles for front passenger side Takata air bag inflators that could rupture. Toyota said the new recall includes some but not all Corolla, Matrix, Yaris, 4Runner, Sienna, Scion xB, Lexus ES, GX and IS vehicles built between 2006 and 2011. Other reports from 17 automakers recalling Takata’s faulty devices are also due this week.

U.S. Economy Looks Shaky, Which Weak GDP Reading Would Confirm

Denying Denial

Sinclair Noe — October 26, 2015

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DOW – 23 = 17,623
SPX – 3 = 2071
NAS + 2 = 5034
10 YR YLD – .02 = 2.06%
OIL – .87 = 43.73
GOLD – 1.10 = 1163.90
SILV + .03 = 15.94

The U.S. economy has looked shaky of late, and an expected weak reading on third-quarter gross domestic product should confirm that. As a result, the Federal Reserve is again expected to keep interest rates near zero. The Fed decision, due Wednesday, and the GDP report, coming Thursday, will be the center of focus on this week’s economic calendar. Weak data almost certainly means the Fed will stick with its Zero Interest Rate Policy at this week’s meeting. The big question is whether the Fed will hint at a December move.

Also on the calendar this week is some sort of deal for the debt ceiling, which needs to be raised by November 3 in order to avoid default; and to meet the November 3 deadline, a deal needs to be reached this week. Talks have intensified between the White House and House Speaker John Boehner on a two-year budget agreement that would also increase the federal debt limit. Congressional leaders are said to be nearing an agreement, which would then need to win backing from most Democrats and at least several dozen Republicans for House passage. The deal raises the prospect that Boehner could resolve two of the thorniest fiscal hurdles before he resigns later this week.

If completed, the agreement would be the most significant spending accord in two years and perhaps since 2011, when the White House and congressional Republicans enacted deep spending cuts in exchange for an increase in the debt ceiling. Obama and some Republicans have been trying to undo part of those cuts, known as sequestration, ever since—GOP defense hawks want to lift budget caps for the Pentagon, while the president has refused to do so unless he can get an equivalent increase in domestic spending.

Under the emerging agreement, that’s what would happen. Money for defense and non-defense accounts would go up by about $50 billion this year and another $30 billion in fiscal 2017. The deal would also prevent steep premium increases for millions of Medicare beneficiaries, the House official said, in a win for Democratic negotiators. CNN is reporting that the spending increases would be offset by oil sales from the Strategic Petroleum Reserve, higher fees for telecommunications companies, and changes to the crop insurance program.

In political terms, the agreement would be a victory for three people in particular. Boehner would succeed in his stated goal of (mostly) clearing the deck of big issues for his successor. Ryan, who has barely won the support of hardliners in the House, would be spared the challenge of having to negotiate contentious fiscal agreements within weeks of assuming the speakership.

And, Obama would walk away victorious in his bid for Congress to relax spending restraints now that the economy has improved and the budget gap has shrunk (at least for the next few years). The president would also get relief in another respect: By removing the shadow of a possible government shutdown or default, he stands a better chance of seeing Congress act on his other priorities, namely criminal-justice reform, in his remaining 14 months in office.

A bipartisan group of House members will try to revive the Export-Import Bank, a federal government agency that finances exports. This is separate from the debt limit. Created during the Depression, the Ex-Im Bank provides insurance and loan guarantees to overseas buyers of American products. The Ex-Im Bank, essentially stopped doing new business on July 1, after House leaders let its charter lapse.

Opponents of the Ex-Im Bank claim it is nothing more than an example of corporate welfare, even though the bank paid the Treasury $675 million in fiscal year 2014. The bank says it supported $27.4 billion in exports and 164,000 American jobs last year. Nearly 90 percent of its loan recipients, the bank says, were small businesses, whose exports accounted for about 40 percent of those supported with Export-Import funding. Supporters in the House appear to have enough votes to re-authorize the bank, although it’s less clear it can pass the Senate.

The pace of new-home sales in the U.S. sank 11.5% in September to an annual rate of 468,000, marking the lowest level in 10 months. Sales for August were also revised down to a 529,000 pace from an original 552,000, which would have been a post-recession high. The median price of a new home in September was 13.5% higher compared to one year ago: $296,900 vs. $261,500. Despite the big drop in sales in September, new-home purchases are up 2% in comparison to September 2014.

Toyota has regained its crown as the world’s biggest car company by sales after releasing figures for the first nine months of the year. The Japanese carmaker sold 7.49 million in the first three quarters of 2015, beating Volkswagen’s 7.43 million and General Motors’ 7.2 million. The reversal could prove the tip of the iceberg for Volkswagen, which is engulfed in the worst scandal in its 78-year history.

Negotiators for the United Auto Workers and General Motors reached a tentative agreement on undisclosed terms for a new four-year labor contract, averting a threatened strike. The proposed deal will now go to a council of several hundred UAW leaders on Wednesday, and will then head to a ratification vote by UAW’s 52,700 workers.

FedEx said it expects shipments during the holiday period between the Black Friday and Christmas Eve to rise 12.4% above year ago levels to 317 million shipments. This holiday period includes one more day that last year. FedEx expects the holiday period to include three shipment volume spikes, including Cyber Monday and the first two Mondays in December. The package delivery service said it was adding 55,000 employees for the holidays, and will expand operations.

Valeant Pharmaceuticals has conducted an internal reviewed of the company’s accounting for its Philidor arrangement and has confirmed the appropriateness of the company’s related revenue recognition and accounting treatment. “In light of the recent allegations, however, the Board of Directors has decided to establish an ad hoc committee to review allegations related to the company’s business relationship with Philidor and related matters.”

Last Wednesday, Citron Research accused the company of using a network of pharmacies to create phantom sales of its products. Valeant said Philidor is independent and that the drugmaker’s accounting leaves no way for it to stuff inventory into the pharmacy. Valeant can’t remove the CEO or management of Philidor, and the drugmaker’s executives and board members don’t own any stake in the pharmacy. Valeant shares were down 35% last week, and even after the conference call today, shares dropped another 5%.

Duke Energy announced plans to buy Piedmont Natural Gas for $4.9 billion in cash. The boards of both companies have unanimously approved the buyout deal. Piedmont shareholders will receive $60 in cash for each share of common stock, representing a roughly 40% premium to Piedmont’s closing price on Friday.

Eating processed meats causes cancer, and red meat probably increases cancer risks. That’s the judgment of a panel of global experts assembled by the World Health Organization. Eating an extra 50 grams daily of processed meat increases the risk of colorectal cancer by 18 percent. The W.H.O. says that while the overall risk is small, it “increases with the amount of meat consumed.”

ExxonMobil has responded to mounting calls for a federal investigation into accusations that the company knew for decades about the risks of burning fossil fuels and the effects on climate change, but withheld the information and sought to sow doubt among the public. Exxon says the allegations are “inaccurate and deliberately misleading.” But there is more to the story than a simple denial and it goes back to former Exxon CEO Lee Raymond.

Beginning in 1977, Exxon scientists began to produce a decade of papers that described a general scientific consensus that the burning of fossil fuels was changing global climate. It was not yet knowable whether the planet was undergoing a heating trend, but if it was, temperatures could rise by three to 10 degrees Celsius, one early paper said.

In the late 1980s, however, Exxon abruptly embraced a message that scientists were exaggerating how much they knew, and that the risk was that they were utterly wrong. In full-throated public statements, Raymond himself said he did not believe the planet was warming.

The possible legal ramifications of the Exxon paper trail are that the company could potentially be shown in a court to have deliberately squelched scientifically based evidence that effectively accepted the consensus view. Science is rarely incontrovertible, but, as the tobacco industry was fined a decade ago for having lied about the dangers of cigarettes, Exxon could be liable for stiff penalties should it be shown to have purposely misled the public for corporate gain.

A former prosecutor in the successful 2006 US racketeering case against tobacco companies has asserted that similar charges might be warranted against ExxonMobil. Exxon under Raymond had not previously been seen to have maliciously distorted in-house scientific research. But now, the news reports, relying on previously little-known papers and documents, many of them housed in an ExxonMobil archive at the University of Texas, allege that the company knew much more than it owned up to. The scandal has implications beyond ExxonMobil, as other oil companies that conducted their own research could also face public scrutiny.

Internet Is Inherently Unstable. Move Along - Financial Review

Move Along

Financial Review by Sinclair Noe

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

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DOW + 33 = 17,548
SPX + 4 = 2051
NAS + 12 = 4922
10 YR YLD + .06 = 2.30%
OIL – .07 = 52.71
GOLD + 1.30 = 1160.30
SILV + .27 = 15.49

The major stock indices finished well off the highs for the day but still in positive territory. The New York Stock Exchange was open for business today, following a 3.5 hour shutdown yesterday. While yesterday’s outage stopped trading at the New York Stock Exchange, shares listed on that exchange continued to trade on other venues such as the Nasdaq Stock Market and Bats Global Markets. NYSE officials blame the halt in trading on a software update that didn’t work out. And they say it was just coincidental that United Airlines had computer problems that grounded flights for 2 hours.

And it just coincidental that the Wall Street Journal Website went down just before trading was halted. And it was just coincidental that the ZeroHedge website went down just before trading halted. And it was just coincidental 12 hours before the shutdown, the hacktivist group Anonymous sent a Tweet saying, “Wonder if tomorrow is going to be bad for Wall Street…. we can only hope.” And it was just coincidental that China’s stock market was going through its own meltdown, though much more fundamental in nature; and the Chinese were more than a little miffed at media coverage of their markets. Just a coincidence. Nothing to see here. Move along.

Remember the OPM hack? About a month ago, we heard the Office of Personnel Management had been hacked. The OPM is like the human resources department for the government. The first reports said the hackers gained access to files on 4 million people; that estimate was then raised to 18 million. Now the OPM says the hacks may have compromised the data of 32 million current, former and prospective federal employees.

The US Department of Agriculture’s home page and other parts of its website suffered an outage this morning, as several of the agency’s sites displayed an Error 404 message. The USDA restored access to its site after it was down for at least 30 minutes.

Maybe it’s just a big coincidence or maybe the internet is inherently unstable and we have substantially under-invested in key digital infrastructure. Move along.

China’s benchmark stock index bounced back today, posting the biggest gain since 2009 in volatile trading as the government intervened to stop the bleeding in a market that lost $3.9 trillion in less than a month. The Shanghai Composite Index jumped 5.8 percent to 3,709.33 at the close, erasing a loss of much as 3.8 percent. More than 1,400 companies voluntarily halted trading in their shares locking sellers out of 50 percent of the market. The government followed up by banning large shareholders with stakes of more than 5% in a company from selling stock over the next 6 months, and vowed to “punch back” against illegal market activities by investigating “malicious short selling.” Government regulators also ordered listed companies, state-owned enterprises, and their employees to buy stocks. And that is how they deal with a bear market in China. Time will tell if it works or not. Shenzhen +4.3%; ChiNext +3%.

Greece has a plan. According to a tweet from the spokesman for Eurogroup president Jeroen Dijsselbloem, a new Greek bailout proposal has been received. Greece is asking for a new three-year bailout from its Eurozone creditors. Greece’s stock exchange will also remain closed until July 13, after authorities decided to extend a bank holiday and capital controls. Greece has a debt payment due Monday, and about $4 billion due before the end of the month. They don’t have the money to pay. US Treasury secretary Jack Lew and International Monetary Fund chief Christine Lagarde put pressure on the EU to grant Greece debt relief and help it avoid a Grexit. Both implicitly urged Germany and others to drop their refusal to clear Greek debts, saying the country was in desperate need of a “restructuring”.

Desperate doesn’t begin to describe it. As Greece hurtles toward a Sunday deadline for either reaching a bailout deal or risking a hasty exit from the Eurozone, the one certainty is that its economy is already on the brink of collapse. Greece already has a humanitarian crisis, and default would be ugly, but a deal wouldn’t clean everything up, either. Even though Greece represents just 2 percent of the Eurozone economy, the implications of a country falling out of the euro currency union could be unpredictable, especially if it occurs at the same time as the steep decline in the Chinese stock market.

Betting against stocks has been a losing strategy since 2009 as the Standard & Poor’s 500 Index rallied more than 200 percent and all but 22 members climbed. Going short has been like going against the flow, until the past month or so. With stocks in China plunging more than 30 percent over four weeks and aid talks between Greece and its creditors breaking down, bears are perking up. The number of shorted shares increased 3.3 percent from a month ago to 16.2 billion in June, the most since September 2008

The IMF cut its forecast for global growth this year, citing a weaker first quarter in the US and warning that financial-market turbulence from China to Greece clouds the outlook. The world economy is now projected to grow 3.3 percent in 2015, less than the 3.5 percent pace projected in April and slower than the 3.4 percent expansion last year. Much of the global downgrade was driven by the U.S., which the fund now sees growing 2.5 percent this year, compared with 3.1 percent in April. The IMF this week reiterated its recommendation that the Federal Reserve hold off raising interest rates until the first half of next year, when wage and price inflation are expected to pick up.

More Americans than forecasted filed for unemployment benefits last week, representing a pause in the pace of labor-market improvement. Jobless claims climbed by 15,000 to 297,000 in the week ended July 4, the highest since February. Applications for benefits have been below 300,000 for 18 straight weeks.

IBM has announced a new kind of ultra-dense chip, which squeezes in four times as much computing power as the best silicon currently available. The new chips will usher in the possibility of creating 7-nanometer transistors (a strand of DNA in comparison measures 2.5 nanometers in diameter). IBM made the research advance by using silicon-germanium instead of pure silicon; and a new way to etch the chips, called extreme ultraviolet lithography. According to IBM, this could lead to a 50% performance and power boost over chips that are on the market today, effectively keeping Moore’s Law more or less intact for the time being.

Coty has sealed a deal to buy Procter & Gamble’s beauty business, which includes brands such as Clairol and Wella, in a $12.5 billion transaction that will make the perfume maker one of the world’s largest beauty companies. P&G will separate 43 of its cosmetics, fragrance and haircare brands and fold them into Coty under a “Reverse Morris Trust” transaction that will ultimately give P&G shareholders a majority stake in the new entity.

Charter Communications may be hitting the high-grade debt market tomorrow with a multibillion-dollar M&A bond for its Time Warner Cable acquisition. Charter’s issuance is still dependent on conditions – which have been shaky recently due to Greece and China weighing heavily on investors’ minds. “The investment-grade (portion) is expected tomorrow, the high-yield maybe next week,” said a source, stating the funding plan would likely come to $31 billion.

Honda is recalling  another 4.5 million vehicles worldwide due to faulty Takata air bags, bringing the total number of “Takata plagued” cars recalled by Honda to around 24.5 million. Separately, Nissan disclosed its first Japanese injury related to defective Takata inflators.

General Motors is also recalling nearly 200-thousand older model Hummer SUVs to fix problems that have led to three people being burned. GM shed the Hummer brand in 2009 when it underwent restructuring and a government-sponsored bankruptcy. In a separate recall, 50-thousand newer model Chevrolet Sparks will be recalled because of a software problem that may cause safety warnings not to work.

ExxonMobil knew as early as 1981 of climate change, seven years before it became a public issue, according to a newly discovered email from one of the firm’s own scientists. Despite this the firm spent millions over the next 27 years to promote climate denial.

The email from Exxon’s in-house climate expert provides evidence the company was aware of the connection between fossil fuels and climate change, and the potential for carbon-cutting regulations that could hurt its bottom line, over a generation ago – factoring that knowledge into its decision about an enormous gas field in south-east Asia. The field, off the coast of Indonesia, would have been the single largest source of global warming pollution at the time.

However, Exxon’s public position was marked by continued refusal to acknowledge the dangers of climate change, even in response to appeals from the Rockefellers, its founding family, and its continued financial support for climate denial. Over the years, Exxon spent more than $30 million on thinktanks and researchers that promoted climate denial. Asked about Bernstein’s comments, Exxon said climate science in the early 1980s was at a preliminary stage, but the company now saw climate change as a risk, and they no long fund climate denial groups.

Farm land is incredibly productive. You wouldn’t leave farmland idle unless something really bad happens. California has been experiencing a really bad drought, as you know; and as a result, the University of California Davis estimates 564,000 acres have been fallowed. Unused land, of course, triggers lower agricultural output. Based on estimates of 564,000 idled acres, farm revenue losses are forecast at $1.8 billion, and 8,550 fewer farm jobs because of the drought. And then there is a ripple effect: food processors cut production and jobs, transportation companies fire truck drivers. You get the idea. Spillover, statewide revenue losses are likely to reach $2.7 billion with 18,600 lost full-time and part-time jobs. A separate June report from the US Department of Agriculture says it could be worse; they estimate the total acreage idled to be closer to 900,000.

Financial Review

Goodbye Patience

Sinclair Noe — April 8, 2015

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

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DOW + 27 = 17,902
SPX + 5 = 2081
NAS + 40 = 4950
10 YR YLD un = 1.89%
OIL – 3.05 = 50.93
GOLD – 5.50 = 1203.20
SILV – .32 = 16.61

We start today with a big acquisition in the oil industry. Royal Dutch Shell agreed to buy BG Group for about $70 billion in cash and shares, the oil and gas industry’s biggest deal in at least a decade; since 2004 when Royal Dutch Shell was created. This is the biggest acquisition this year and the 10^th biggest M&A deal overall, and the fourth biggest deal overall in the oil industry. The merged company will boast a market value twice the size of BP, and even larger than Chevron. ExxonMobil is still the 800 pound gorilla with market cap north of $350 billion.

To win over shareholders, Shell pledged cost savings of $2.5 billion, asset disposals of at least $30 billion within four years and a giant buyback of $25 billion from 2017 to 2020. Shell investors reacted coolly to the deal. Shell’s B shares, the class of stock being used to finance the deal, fell about 7% percent in London. For BG it represents a 50% premium.

BG Group is the exploration part of the former state owned British Gas that was privatized by Margaret Thatcher in the 1980s. British Gas was split into BG and Centrica. The new company will be the largest producer of liquefied natural gas, or LNG, among international oil companies. Shell pioneered the process of liquefying gas for shipment aboard tankers decades ago, and rivals such as Chevron are betting LNG will play an increasing role in emerging economies seeking alternatives to dirtier energy sources such as coal. The deal will still need antitrust approvals from regulatory agencies in Australia, China, Brazil and the EU.

This is a very interesting deal for many reasons, not the least is the downturn in oil prices over the past year, which has been devastating for smaller or less strategically positioned companies in the oil industry. Case in point: Noble Energy just announced it is cutting 220 jobs across the U.S., with around 100 losses at the oil company’s Houston headquarters and another 100 or so at its Colorado operations. The cuts represent 10% of Noble’s 2,200 U.S. employees. The news comes after the firm said earlier this year that it was planning to slash spending by 40%.

The roughly 50% premium paid for BG Group would make sense with oil priced at $90 a barrel, which is not the current price. Of course we could see oil prices skyrocket; the situation in Yemen is a stupid mess and that is right at a chokepoint to the Red Sea; and that is just one of many potential hotspots. Absent a geopolitical flare-up, the price of oil is not likely to zoom in the face of excess supply and moderate demand.  Saudi Arabia is reporting it raised oil output to 10.3 million barrels a day in March, the highest in at least 12 years, and intends to keep producing 10 million barrels per day despite low crude prices. The Saudi oil minister says he believes oil prices will rise in the “near future”; maybe, but right now there is a glut.

America’s oil in storage just hit another record after rising by the most since March 2001. Stockpiles rose by almost 11 million barrels, or 2.3%. Analysts had expected an increase of 3.25 million barrels. The EIA report today showed the amount of oil the U.S. is cranking out also edged up slightly, to a rate of 9.4 million barrels a day. Investors have been closely watching the oil gather in storage tanks, which has been rising steadily since the oil-price crash started last year. U.S. crude production has been at the highest in decades even as drillers have made unprecedented reductions in the number of oil rigs out drilling new wells.

The last time we saw deals of this size was in 1999 when Exxon and Mobil merged at a cost of $83 billion and BP bought Amoco for $48 billion. Back in 1998, oil was priced closer to $12 a barrel, and the deal making marked a trough in prices. Shell CEO Ben van Beurden said the deal is “not a bet on the oil price.” You can believe that if you wish, but I doubt they would have made the deal if they thought oil was going to $30 a barrel for an extended period.

So oil prices are important but not the only thing. In the past 12 months, the oil majors have had to deal with the consequences of events in Ukraine and the Crimea as well as western government sanctions on Russia and the effects these sanctions have had on the profitability of their assets exposed to those sanctions. Shell was likely attracted by BG’s deepwater assets in Brazil and its LNG portfolio. BG Group is one of the world leaders in LNG and recently completed a $20 billion facility in Australia. The combination of Shell and BG will result in a portfolio that controls roughly 16% of the global LNG market. The LNG market is crucial for Europe; if Russia can’t or won’t meet Eurozone needs, this is an opportunity for Shell to seize market share. So, it looks like Shell is diversifying away from its core oil business, at a time when oil and gas exploration is becoming increasingly expensive in terms of profitability.

Earnings season is back. Alcoa unofficially kicks of quarterly earnings; a traditional thing; the aluminum company used to be one of the Dow 30 stocks; ticker symbol AA; they go first. Alcoa beat earnings estimates by a couple of cents per share but posted a slight missed on revenue projections. Overall, S&P 500 earnings for the first quarter are forecast to have dropped 2.8% from the year ago quarter, which would be the worst performance since the third quarter of 2009.

The Federal Reserve has released minutes from the FOMC policy meeting in March. That was the meeting where the Fed dropped the term ”patient” from the language surrounding policymakers’ approach to future interest rate hikes. At the time, Janet Yellen said that axing patient “does not mean we are going to be impatient.” Today’s minutes reveal that some policymakers are indeed impatient, ready to raise rates in June; others are very patient indeed, and a couple don’t like the idea of rate hikes at all. So, not much new in the minutes. As we suspected the Fed has not made up its collective mind about rate hikes even as they take a very small step closer to a hike. Uncertainty at the Fed is a recipe for volatility in the markets.

In other words, we could see markets moving in multiple directions, and some of the moves might even seem contrarian. While higher target rates from the Fed would likely slow economic activity by making borrowing costs higher, it would also signal that the economy is stronger and it would push the dollar higher. That would signal the world to bring their money to America – the safe haven play.

Switzerland today became the first country ever to issue 10-year debt that gives investors a yield under 0%. Several European countries inside and outside the Eurozone have sold government debt with up to five years of maturity at negative yields, which means investors effectively pay for the privilege of buying it. But no other country has previously stretched this out as long as 10 years. For Eurozone investors they have the option of paying Switzerland to park their cash, or coming to the US, letting the Treasury pay, plus arbitrage on a strengthening dollar.

So, it is possible that rates could move lower, even as the Fed moves closer to hiking rates. And some people argue that the Fed doesn’t really set interest rates, the bond market does. There is another old saying: “don’t fight the Fed.”

What does that mean for you? Well, if or when rates go up, investors will be able to buy newly issued bonds generating higher streams of income in the not so distant future. That means bonds go down in price, and bond funds go down.

It also means that personal debt becomes more expensive. Take a look at the makeup of your debt, too. Is your mortgage a floating rate loan? Do you have any other floating rate debt? If so, this might be the right time to lock it in place at a low rate. Mortgage rates are the lowest that many lenders have witnessed in their lifetimes; given the Fed’s clear signals, do you really want to delay acting on this? If you’ve been contemplating taking out a loan to make some home improvements, to buy a second home, or for some other purpose; and assuming that you’re in a financial position to handle the payments of course; this is probably a good time to think about the timing of your plans.

It might already be happening. The Federal Reserve reports consumer credit grew at a seasonally adjusted annual rate of 5.6%, for a gain of $15.5 billion in February. This is the fastest pace of growth since October. All of the increase came from non-revolving debt, like car and student loans, which grew at a 9.4% rate up – from a 5.8% rate in January. This is the fastest pace since February 2013. Revolving, or credit-card, debt declined at a 5% rate in February, after a 1.4% decline in the prior month. This is the biggest decline in credit card loans since April 2011. So, in a strange twist, the threat of higher rates is starting to cause increased credit activity; but that is likely temporary.

Over the longer term, higher rates mean less affordable homes and cars. Higher rates mean anything financed costs more. Higher rates mean a higher dollar and that means less profit for multinationals. The direction is clear, and most of us can see it. A CNBC All America Economic Survey shows 27% of Americans judge the economy as excellent or good, the highest level in eight years, up from 16% at this time last year. Looking forward, only 28% of Americans believe the economy will get better in the next year, well below the post-recession high of 36% in March 2012. Things are pretty good now but the road ahead is not so certain. Goodbye patience, hello uncertainty and volatility.

FINANCIAL REVIEW

Dow Up, Oil Down, Quit Your Job

Sinclair Noe — November 13, 2014

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

DOW + 40 = 17,652
SPX + 1 = 2039
NAS + 5 = 4680
10 YR YLD – .02 = 2.34%
OIL – 2.79 = 74.39
GOLD + .20 = 1162.90
SILV – .01 = 15.77

Record high close for the Dow Industrials.

The Nasdaq Composite hasn’t seen record highs since the spring of 2000, when it closed at 5048, which is just 368 points, or about a 7% move from here. If you were unlucky enough to have bought the PowerShares QQQ exchange-traded fund, an ETF that tracks that top 100 non-financial stocks in the Nasdaq, on March 10, 2000, you’d still be in the red on that investment.

Tech companies are once again in a leadership role. While Microsoft, Apple and several other tech leaders of today are trading at higher prices than 15 years ago, Intel and Cisco are still well below their 2000 peak prices. Of course the largest company in market cap is Apple at $660 billion. Apple shares have surged more than 40% so far this year, creating more than $160 billion in market value for shareholders, which coincidentally is about the same market cap as IBM, which was once considered the big player in tech. Today, Microsoft passed Exxon to become the second largest company in terms of market capitalization. Exxon has a market cap of $400 billion; Microsoft is worth $408 billion. Exxon’s declining fortunes can be tied directly to the price of oil.

Have you stopped by a gas station in the past few days? I did. I paid $2.78 a gallon. Gas prices have been falling for the past 48 days, and the nationwide average is now $2.92 a gallon, the lowest since December of 2010.

Crude oil prices were down again today after OPEC said demand for its oil will drop next year, and Saudi Arabia remained silent about a possible cut in production. There is another OPEC meeting in 2 weeks, and it is possible that OPEC members Venezuela and Nigeria will cut production, but today the Saudis merely reiterated their policy of stable global markets as they rejected rumors of a price war.

Global demand for oil from OPEC, which pumps a third of the world’s oil, will drop to 29.20 million barrels per day (bpd) next year, almost a million bpd less than what it currently produces. Oil production around the world has been strong in recent years. A boom in the US has pushed domestic production up 70 percent since 2008. At the same time, demand for fuels is growing more slowly than expected in Asia and Europe because of weak economic growth. The US economy is faring relatively well, but more fuel-efficient cars and changing driving habits are keeping domestic gasoline demand low.

Meanwhile, the International Energy Agency says the 30% drop in oil prices over the past 4 months will damage the US shale oil boom and cause supply problems down the road. The low prices could deter investment in production, which will eventually hurt supply. Deutsche Bank said recently that 40% of US shale oil production scheduled for 2015 would be “uneconomic” if prices drop below $80 a barrel; that might be what the Saudis are hoping for. It may be tough to shake out those domestic producers; technology has advanced dramatically.

Meanwhile, oil stocks, shares in oil companies, have not taken the same hit as oil. Sure Exxon-Mobil and Chevron are off their highs, but they have rebounded from mid-October lows; just not as much as the rest of the market. Oil broke a very important level of support at $80 a barrel, which is now the new level of resistance; and the next level of support is $75, broken today. Oil is now extremely oversold but almost nobody seems to think it will go much lower from here; and if it does, there will undoubtedly be production cuts. Of course, the contrarian in me says that nobody is expecting oil to go lower, so it probably will. The point here is nobody knows, so let the market tell you.

Today, the Energy Department revised its outlook for gas prices, saying the average price for gas in the US will be below $2.94 a gallon in 2015; that implies oil prices won’t move above about $84; that forecast included a few caveats about production and possible supply disruptions. The EIA also slightly lowered its prediction for growth in U.S. oil production because lower prices will force some drillers to cut back. Production is expected to reach 9.4 million barrels a day in 2015, down from a previous estimate of 9.5 million barrels per day. Still, that would be an increase of 4 percent over this year and the highest domestic crude production since 1972.

Still, $2.94 a gallon is a 44 cent drop from the outlook issued just a month ago; and that’s 45 cents a gallon less than the average price paid this year. And that works out to about $60 billion in savings. It’s almost like everybody will be getting a raise.

Lord knows we need a raise. This is the first “recovery” where median household income has dropped, and continues to drop. The unemployment rate has dropped to 5.8%. Jobs are coming back but wages aren’t. Every month the job numbers grow but the wage numbers go nowhere. Most new jobs are in part-time or low-paying positions. They pay less than the jobs lost in the Great Recession. And wages are less predictable. Most Americans don’t know what they’ll be earning next month and two-thirds are living paycheck to paycheck. When that is the case, workers who have a job tend to stay on the job, even if the wages are stagnant.

That may be changing. The Bureau of Labor Stats published the Job Openings and Labor Turnover Summary, or JOLTS, for September. There were 4.7 million job openings on the last day of September, down slightly from 4.9 million in August. But more employees quit their jobs: 2.8 million in September compared to 2.5 million in August. These are voluntary separations. This means workers have confidence they can leave their job for greener pastures. The number of job openings are up 20% year-over-year compared to September 2013. Quits are up 16% year-over-year.

It’s definitely good for wages. The unemployment rate comes down, but wage growth lags behind. When labor markets finally begin to tighten and the economy nears full employment, that’s when wage growth accelerates. And we are starting to see a shift in attitudes. Consumer confidence has been firming. More Americans are working, more people are changing jobs, and gasoline prices are down; so even if workers haven’t seen an increase in the paycheck, they have more money to spend, and that might fire up more consumer spending.

We are wrapping up earnings reporting season. Today, Walmart posted diluted earnings per share came to $1.15 in the third quarter, narrowly beating estimates of $1.12 a share, and above the $1.14 it booked in the same quarter last year. Total revenue for the quarter grew 2.9 percent from the previous year, to $119 billion. Same store sales were up for the first time in 2 years.

This has been another strong earnings season and US companies are now sitting on mountains of cash. Capital Economics and Audit Analytics figures companies now have $1.9 trillion in cash held in the US, and $2.1 trillion in cash held offshore.

A follow-up to yesterday’s news of $4.25 billion in fines for a half dozen banks involvement in rigging the foreign exchange markets. I know that sometimes it sounds like we repeat the news. The rigging of Forex markets sounds a lot like the rigging of Libor markets or derivatives markets, but the thing that really makes the Forex rigging a bigger problem is that it happened after all those other manipulations. The Forex investigations ran through October of last year. And that means there was absolutely zero deterrent impact from the billions of dollars in fines for Libor, or all those other fines. Did managements really not know, or even suspect, something was wrong? Did they just turn a blind eye? Or did they just not care?

In a rational world, the customers would move their business to firms with higher standards. That is not going to happen because investment banking is almost a closed shop. The six firms involved in the settlement are five of the biggest banks in the world. Clearly billion dollar fines have not altered bad behavior. No doubt criminal convictions would concentrate minds on the trading floor and in the executive suites. Maybe we should rethink the idea that banks have some inalienable right to control foreign exchange markets or interest rate markets with reckless abandon. Six years after the financial crash, some of the world’s biggest banks are still out of control. In other fields, firms with shoddy practices fear the loss of their license to operate. Big banks don’t, but should. At the very least, it should be time to consider suspensions; a six month ban on foreign exchange trading; maybe a three month ban on bond trading. That would shake things up, for the better.

FINANCIAL REVIEW

Halloween Treats

Sinclair Noe — October 31, 2014

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

Financial Review
DOW + 195 = 17,390
SPX + 23 = 2018
NAS + 64 = 4630
10 YR YLD + .03 = 2.33%
OIL – .44 = 80.68
GOLD – 25.90 = 1173.90
SILV – .28 = 16.28

Record highs, again.

Back on September 19th, the Dow hit a record high close of 17,279. And then we watched the market tumbled for nearly a month. On October 17th we told you about a bullish reversal pattern, and it has been a strong move to new highs; up 1,100 from when I called the reversal, and up 1,545 from the lows of October 15.

Also, a new closing high for the S&P 500, however, we did not take out the intraday high of 2019 from September 19. Let’s break down the moves for the month of October. The Dow is up 248. The S&P added 46 points. The Nasdaq is up 137 points for October to a 14-1/2 year high. In October we saw the yield on the 10 year note drop 18 basis points from 2.51%. Gold took a hard fall on Friday, at one point trading at levels not seen since 2010. And of course, a big move in oil down 10.75 a barrel. If you are looking for a really dramatic move, the Russell 2000 index of small cap stocks has bounced from a low of 1046 on October 13, to close today at 1173, a 127 point gain; and once again above the 50 day and 200 day moving averages.

For the week the Dow rose 3.5 percent, its best percentage weekly gain since January 2013. For the week, the S&P 500 was up 2.7 percent and the Nasdaq was up 3.3 percent.

And if you think the rally of the past two weeks is impressive you should see the 2-day rally on the Nikkei, up almost 5% today. The Bank of Japan announced it expand its QE purchases and will now buy about $720 billion worth of Japanese bonds each year. So, the Federal Reserve ended QE3 large asset purchases on Wednesday, but really they just passed the baton to Japan.

Here is what has happened in Japan. December 2012, Shinzo Abe was elected as Prime Minister in Japan. Abe appointed Haruhiko Kuroda as governor of the Bank of Japan, and they set out on a very aggressive stimulus campaign to lift the Japanese economy out of decades of funk. They called it Abenomics. It started with promise. In early 2013, the yen fell, and the Japanese stock market rallied. And then the politicians got involved and started making a mess of things; they raised a consumption tax to try and rein in budget deficits. The economy contracted and disinflation returned. This has now become a familiar pattern. We’ve seen it here in the US; the central bank tries to stimulate the economy; the politicians tighten the belt. We’ve seen it in the Eurozone; Draghi promises to do whatever it takes; the austerians slam on the brakes.

In Japan, Abe is going all out. International commodity prices have been falling, and so the idea is to weaken the yen. Japan’s public pension system will also step in with direct purchases of exchange traded funds to prop up the equity markets. The idea is to mitigate deflation risks while also creating price inflation in other asset markets. The target is 2% inflation, and Prime Minister Abe seems hell-bent to make sure it happens.

So, the Fed ends QE, The Bank of Japan doubles down on QE (literally, they don’t even call it QE, it’s called QQE2); next up is the European Central Bank; next week the ECB will likely announce something, exactly what is still a guess. The main refinancing rate is already at 0.05%, a level ECB boss Mario Draghi several times has described as the “lower bound”. And with deposit rates at -0.2%, consensus is also for no changes there. As for full-scale QE? Well, Draghi has said he’ll do whatever it takes, but Draghi doesn’t have the same clout in Europe as Abe does in Japan. Draghi will surely face opposition from the Germans. Earlier in the year, the central bank laid out plans to buy asset-backed securities and covered bonds, dubbed private or mini QE. It started purchasing covered bonds in October, but has yet to push the buy-button for ABS.

Today, the Commerce Department reported that inflation in the US remains subdued. The price index for personal consumption expenditures, which is the Fed’s preferred way to measure inflation, held steady at 1.4% in September. Excluding the often-volatile categories of food and energy, prices rose 1.5% on the year. Annual core inflation has been steady at that level since May. The PCE inflation index has been under 2% for the past 29 months. The Fed warned in its policy statement on Wednesday that “inflation in the near term will likely be held down by lower energy prices and other factors.” Still, the Fed said that the chances of inflation “running persistently below” the 2% target had “diminished somewhat since early this year.”

The final October reading on the University of Michigan/Thomson Reuters consumer-sentiment index rose to 86.9, the highest reading since July 2007, from a final September level of 84.6. Consumers have kept their focus on improved job and wage prospects, and lower prices at the pump don’t hurt.

In a separate report, consumer spending fell in September for the first time in eight months, as Americans spent less on energy; and because we were spending less of gas, fewer people felt the need to replace the old gas guzzler with a new, more fuel efficient model, and auto sales dropped. They spent more on services, however. Personal spending dropped a seasonally adjusted 0.2% last month to mark the first decline since January.

By the way, it is estimated that sometime tomorrow, the nationwide average price for a gallon of gas will drop under $3 a gallon. The decline in gas prices is estimated to help consumers save roughly $250 million a day.

Meanwhile, the Bureau of Labor Stats reports labor costs are up 0.7% in the third quarter, matching the gain in the second quarter. Wages increased 0.8%, while the cost of benefits rose 0.6%. Over the past year, employment costs are up 2.3%, the fastest growth since 2008. Real, steady growth in wages is the missing ingredient in the economy right now. For months, economists have been saying the steady decline in the unemployment rate would inevitably lead to higher wages, as employers would have to bid up the wages they offer to recruit and retain productive workers. That prediction was fine in theory, but it didn’t seem to be showing up in anyone’s paycheck, until now, and it is still too early to say that to say it is entrenched, but we are seeing signs. Wages for private-sector workers are up at a 3% annual pace over the past six months. Average hourly earnings for nonsupervisory and production workers (about 80% of workers) are up 2.6% in the past year. And with inflation running at 1.4%, this means workers are actually getting ahead, just a little.

And don’t forget we are in earnings reporting season. And earnings are looking good; data sources vary, but according to FactSet, of the 362 companies that have reported earnings so far, 78% have reported earnings that have beaten the mean estimate of analysts. The blended earnings growth rate for the quarter is 7.3%, well above the estimated growth rate of 4.5% that was expected by analysts as of Sept. 30.

Exxon Mobil said its third-quarter earnings edged up 2.5% as higher refining margins and improvements at its refining and marketing segment helped offset lower production. Shares rose about 2%.

Chevron reported a third-quarter profit that rose well above expectations, offsetting a bigger-than-expected decline in sales. Earnings for the quarter ended Sept. 30 came in at $5.6 billion, or $2.95 a share, up from $5 billion, or $2.57 a share, in the year-earlier period.

AbbVie posted net profit of $506 million, or 31 cents a share, in the quarter, down from $964 million, or 60 cents a share, in the year-earlier period. They beat estimates and raised guidance.

It was a very, very bad week for privatized space travel. On Tuesday, an Orbital Science Antares unmanned rocket blew up on the launch pad in Virginia. Today, one of Virgin Galactica’s spacecraft crashed during a test flight in Southern California, killing one pilot and injuring another. The company was testing a new rocket engine on the craft, which is eventually supposed to carry paying tourists on suborbital flights high above the Earth. The accident is a major setback to Virgin, which had aimed to start regular commercial flights in 2015.

Next week, we have two really big events: the mid-term elections on Tuesday, and the jobs report next Friday.

The Brute Economic Power of Oil

Financial Review with Sinclair Noe — September 12, 2014

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

 

DOW – 61 = 16,987
SPX – 11 = 1985
NAS – 24 = 4567
10 YR YLD + .08 = 2.61%
OIL – .58 = 92.25
GOLD – 11.90 = 1229.30
SILV – .06 = 18.71

For the week, the Dow was down 0.9%, the S&P 500 was down 1.1% and the Nasdaq was down 0.3%.

Let’s start with the economic data: Business inventories rose 0.4 percent in July vs a 0.8% rise in business sales that keeps the stock-to-sales ratio unchanged at a healthy and lean 1.29. In a separate report, retail sales and consumer sentiment pointed at an improving economy. The preliminary September reading on the University of Michigan/Thomson Reuters consumer-sentiment index rose to the highest level since July 2013 and topped consensus expectations. Sales at US retailers rose in August by the largest amount since April, sales were up 0.6%; raising confidence in the economic outlook for the second half of the year. Retail sales would have been higher, but the price of gas dropped; after excluding gasoline, spending rose 0.7% in August.

Of course, one of the reasons Americans spent more money going out and eating and shopping is because the price of gasoline has been low. Spending at gas stations declined an estimated 0.8% in August. That followed a flat July and another 0.8% drop in June. A separate report from the Labor Department on Friday showed that prices of fuel imports fell 4.6% in August, the largest monthly drop in more than two years. If you can save $10 or $20 at the gas station, you’re more likely to spend that money at the mall or a restaurant.

So, in a very strange twist, the volatile situation in Ukraine and the Middle East has actually been a good thing for American consumers as we go to the gas pump. And in another strange twist, the International Energy Agency noted another reason for the lower prices: demand is remarkably low, and falling; and this is due to the weak economic prospects, especially for Europe and China. The Financial Times concluded: The world’s appetite for crude oil slowed at a “remarkable” pace during the second quarter because of weak economic growth in Europe and China, prompting the International Energy Agency to revise lower its demand forecasts for 2014 and 2015. In its widely followed monthly report, the west’s energy watchdog said that global oil demand growth had slowed to below 500,000 barrels a day in the three months to June – the first time it has reached this level in two-and-a-half years. Slowing demand and plentiful supplies have together pushed down the price.

The United States has imposed new sanctions on Russia’s largest bank, and a major arms maker; also there will be sanctions on arctic, deepwater and shale exploration by its biggest oil companies.

Energy stocks were pressured after the Treasury department announced the new sanctions, designed to punish the country for its intervention in Ukraine. The S&P oil sector fell 1.4% today, continuing a downtrend that has taken the group down 3.6% this week.

The sanctions target companies including Sberbank, Russia’s largest bank by assets, and Rostec, a conglomerate that makes everything from Kalashnikovs to cars, by limiting their ability to access the US debt markets. They also bar US companies from selling goods or services to five Russian energy companies to conduct deepwater, Arctic offshore and shale projects. The Russian firms affected are Gazprom, Gazprom Neft, Lukoil, Surgutneftegas and Rosneft.

The energy sanctions are not designed to curb Russia’s current oil production but to hit future production by depriving Russian firms of the expertise of companies such as Exxon Mobil and BP. Exxon has a $3.2 billion deal with Rosneft to develop Arctic oil fields. BP owns 18% of Rosneft and has signed a deal to explore oil shale fields in the Volga and Urals.

The Euro-union has also imposed new sanctions restricting financing for 15 Russian owned companies, plus asset freezes against 24 Russians, mainly politicians. The combined US and EU sanctions effectively shut Russian banks out of the capital markets of the US and Europe for everything except short-term debt.

The United States stressed that the sanctions could be removed if Russia took a series of steps including the withdrawal of all of its forces from Ukraine. Russia denies sending troops into eastern Ukraine and arming the separatists. Russian President Putin called the new economic penalties “strange,” given his backing of peace efforts in eastern Ukraine, and Russia’s Foreign Ministry said it would respond quickly with retaliatory measures against what it criticized as another “hostile step.”

So, today, oil prices continued moving lower to the lowest levels in 2 years, but that might not be the case if the sanctions are extended. Russia’s ruble currency has already fallen to a historic low against the dollar as its economy is hit by sanctions. That increases the price Russians must pay for many imports, from vegetables to luxury goods. And the price of oil might be an even bigger economic weapon than sanctions.

Russia is heavily reliant on oil sales and faces budget shortages at current price levels. It is estimated that the cost of production combined with what the Russian government siphons off to prop up its budget, results in a breakeven price for Russian oil at about $110 to $117 a barrel. Russia may have designs on Ukraine but if they are locked out of the financial markets and if they can’t turn a profit in the global oil market, they will find it difficult to finance their ambitions.

Daily oil production in the United States has risen sharply in the past 5 years. In 2010 the country still imported half of the crude it consumed, but the US Energy Information Administration forecasts that will fall to little more than 20% next year. Increased production of oil in the US combined with weakening demand, has pushed prices closer to $90 a barrel than $100, and prices could drop a bit more.

While US oil output has been rising fast, part of the big jump in supplies has come from countries that remain at risk of supply disruptions, including Libya and Nigeria; and don’t forget Iraq and Iran. Meanwhile, Saudi Arabia and the rest of OPEC is expected to continue to supply oil as needed, at least as long as the price stays above $85 a barrel. The Saudis have long said that they like the price around $100. Meanwhile, US oil companies working the shale fields claim they need $100 a barrel oil to make it worth their while, but a friend in the oil business tells me their real breakeven is closer to $80. For other US oil producers, like those working the established fields in Texas, the breakeven is closer to $30.

Where will prices settle? Well, they won’t. Oil prices constantly fluctuate. In early 2008, speculators jacked up the price to $147 and a year later, after the financial crisis, prices dropped under $40. Oil prices always move and always have an economic impact. If we look back to the 1980s we can see how this played out in the collapse of the Soviet Union.

From 1973 to 1980, when the West went through huge economic problems due to oil price shocks, the Soviet Union did not appear to have any concerns and their economy was fairly strong. In the mid-1980, the Saudis stopped protecting oil prices, and instead increased production fourfold, which resulted in a drop in oil prices by about the same amount in real terms. The Saudis still got the same amount of payment, they just delivered four times as much oil. The price declines hit the Soviet Union hard, resulting in loses of more than $20 billion a year, which was big money back then – not just the price of a startup tech company that makes one stupid little app.

So, the Soviets had a choice; they could cut back food imports, which would have resulted in food rationing and an angry populace; they could stop the highly subsidized oil trade among the Soviet bloc countries and risk dissolution of the Union; they could make radical cuts to the military-industrial complex; or they could go into debt, big time. Like politicians everywhere, they chose the path of least resistance, and started borrowing money from abroad, and avoided actual reforms. They managed to borrow very heavily until about 1989, when the price of oil dropped into the low teens and Soviet oil production dropped by 30%, and the Soviet economy came to a grinding halt. And the international creditors demanded payment, and cut off the credit lines.

The only way that the Soviet Union could have possibly survived such an oil production decline crisis, not to mention a complete loss of oil export revenue for hard currency, as well as cut its internal consumption, and cut off Eastern European exports, would be to shift to a market economy. The Soviet Union did exactly that. First, the Soviet’s cut off Eastern Europe from receiving cheap Soviet oil and forced them to pay in hard currency prices. Then when that was not enough the Soviets themselves had to allow internal oil prices to rise. This forced the Soviets to follow the same transition that Eastern Europe did. Indeed, Soviet and post-Soviet oil consumption declined a staggering 50% from 1985 to 1995.

In November 1989, the Berlin Wall fell. The pictures on television and in the history books imply that the breakdown of the Communist system in 1989 was a result of the peoples’ longing for freedom and democracy, and certainly that is true. The Soviet Union was both corrupt and brutal, the military defeat in Afghanistan had been costly and demoralizing, and don’t forget Chernobyl, the Communists could not compete effectively in new technology. It wasn’t just one thing; but President Reagan’s call to “tear down that wall” would not have had the impact if oil prices had not been torn down first. The transition was not by choice but by brute economic force.

Timing is………..Everything

Financial Review with Sinclair Noe — September 10, 2014

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

 

DOW + 54 = 17, 068
SPX + 7 = 1995
NAS + 34 = 4586
10 YR YLD + .03 = 2.53%
OIL – 1.13 = 91.67
GOLD – 6.80 = 1250.00
SILV – .12 = 19.04

Later today, at 6PM local time or 9PM eastern, President Obama will address the nation and lay out his strategy to degrade and destroy the Islamic State insurgency operating in Iraq and Syria. This will likely involve significant escalation of the US military role in the area, but we aren’t sure about the intervention in Syria; probably a combination of airstrikes, and support for more moderate Syrian forces willing to carry out attacks on both ISIS and Assad; along with regional allies providing on the ground support.

The president has pledged there will not be boots on the ground. He said: “This is not the equivalent of the Iraq war. What this is similar to is the kinds of counter-terrorism campaigns that we’ve been engaging in consistently over the last five, six, seven years.” Which sounds like a distinction without a difference.

Earlier today an administration spokesman said: “The president will discuss how we are building a coalition of allies and partners in the region and in the broader international community to support our efforts, and will talk about how we work with the Congress as a partner in these efforts.”

That doesn’t mean Congress would actually vote on going to war. For weeks, the administration, and particularly the Pentagon, has urged Congress to approve $500 million in funding to train and arm Syrian rebels to fight ISIS. The legislation has been stuck on Capitol Hill since Obama first sought it in May, but it could provide both Obama and Congress with an opportunity to tacitly enlist congressional support for a war without a formal vote ahead of the November midterm elections, something many politicians this week indicated they wish to avoid.

As one geopolitical hotspot heats up, another looks to be cooling. Ukraine’s president said today Russia had removed the bulk of its forces from his country, raising hopes a ceasefire might hold. Ukraine’s military recorded at least six violations of the ceasefire overnight but said there were no casualties. And Russia conducted military tests of a nuclear capable intercontinental missile.

Ukrainian President Poroshenko said he would propose a bill next week offering “special status” to parts of the Donetsk and Luhansk regions of eastern Ukraine now controlled by rebels, but he was adamant in rejecting the separatists’ demands for full independence for their regions and the kind of “federalization” favored by Russia.

Meanwhile Russia faces the threat of further sanctions; the kind that could actually strike at the heart of the Russian economy, its oil industry. Proposed new sanctions would cut off Russia’s access to the technology to drill its richest oil fields. Bloomberg reports the sanctions would bar companies like ExxonMobil, Shell, and BP from using their resources—such as advanced drills and experts—to work in the Russian Arctic and an enormous Siberian oilfield. Neither the US nor Europe have decided whether to proceed, but a European decision could come at any time. If Europe goes ahead with the new penalties, the US would match them.

On Wall Street there seemed to be no worries about war. Apple bounced back. This remains an Apple-dominated market, especially in a week where we don’t have a lot of economic data. After a couple of down days, the S&P bounced back. The S&P 500 hasn’t posted a four-day string of losses in all of 2014. Crude oil futures fell to a 16-month low; there’s plenty of supply and demand has been constrained.

Today is Internet Slowdown Day. You may or may not have noticed certain websites with the dreaded spinning wheel of death loading symbol. Several websites have banded together to protest proposed changes to net neutrality rules, which would allow Internet service providers to charge high traffic websites more or essentially force them to create a “slow lane” for customers. The loading icons lead users to the “Battle for the Net” website where they can sign a letter to Congress, the Federal Communications Commission and the White House. The hope is that the campaign will inspire millions of people to submit comments to the FCC on net neutrality before the public comment period ends on Sept. 15.

Commerce Department reports wholesale inventories rose just 0.1% in July, and inventories excluding autos was flat. This is an interesting economic indicator because it gives us a hint at future economic activity; you have to have wholesale inventory before you make the retail sale. Inventories added 1.4 percentage points to GDP growth in the second quarter. The slow pace of inventory accumulation, however led several financial firms to lower their estimates for third quarter GDP, down to the 2.5% to 2.8% range. Of course, inventories ebb and flow; so, if inventories are light in the third quarter that might force some businesses to restock for the fourth quarter. Still, for all the stories about the economy being poised for big growth in the second half, most of the data points to a slow, steady slog.

Relapse is the rule of the recovery, and it’s a global relapse. The US, Japan, and Europe continue to see GDP growth falter. In the US we had a first quarter contraction; part of the blame was weather, but that was just part of the problem. Europe’s fragile economy has similarly failed to recover strongly enough to ward off periodic growth setbacks. As a result, annual growth in the 18-country eurozone slipped to just 0.4% in the first half of 2014. Earlier this week, Japan reported a 6.8% contraction in second quarter GDP.

The Bank of Japan has pushed a short-term interest rate below zero to try and stimulate the economy and fend off deflation. The BOJ bought three-month bills for more than their redemption value this week, essentially paying to lend money to the market. Giving away money, as the BOJ will be doing if it holds the paper to maturity, is basically subsidizing Japanese banks. Lenders that buy debt from the government stand to make an easy profit if the government pays above par for the paper.

The European Central Bank recently decided to go negative on reserve deposits held by banks, trying to push money back into circulation. Meanwhile, the Federal Reserve FOMC meets next week, and you have to wonder how they’ll respond to the negative rates from the ECB and the BOJ. It is pretty certain the Fed will continue to taper, and stop buying bonds in October; but the next question is when they will start raising targets on interest rates. For several months the Fed has been sticking with the somewhat vague guidance that it will be a “considerable time” before we see rate increases.

Next, consider the performance of the S&P 500; after the crash in 2008, the S&P bottomed in 2009, and then went on to double. For the past 34 months the S&P 500 has not seen a correction of 10%, the third longest correction free stretch in the past 25 years. A chart of the past five years is the very picture of a relentless uptrend. Some people have been lulled into believing that this is typical market behavior; it is not. If you are looking for a reason for the bull market, look no further than the Federal Reserve; they have thrown a lot of money at Wall Street. But now they are promising to stop the flow of easy money, and eventually raise rates. This is not a guarantee that the equity party is over, but just a reminder the party won’t last forever.

The stock market is near an all-time, but economic activity is not. Corporate earnings have been good but revenue has been weak; this reflects the distortions of stock buybacks, but even more, it shows a lack of demand. Weak demand does not bode well for earnings growth. Meanwhile, the global economy wobbles, with the EU and Japan propped up by negative interest rates; China seems doomed to repeat the mistakes that hobbled Japan’s economy for a decade, and emerging markets still suffer from the last beat down. The US looks good by comparison but that’s just the prettiest horse in the glue factory argument. So, you probably think the market is ready for a pullback at the very least, and maybe even a good old fashion crash. But, as always, timing is….. everything.

This is not the time to go short. Picking tops is more a matter of luck than science. There may be many indicators of a top, but it’s smart to listen to the market because you can’t dictate to the market. So, rather than going short, now seems like a good time to lock in some gains and take out some insurance, or hedge some bets.

There are several hedging techniques, including inverse ETFs and shorts. The problem is that the past five years have not been a good time to be short, and we don’t know if the bull market will end tomorrow, or next month, or next year. Shorts and inverse ETFs are great only after the uptrend ends and you see a clear indication of a reversal. Markets can sometimes defy gravity; markets can remain irrational longer than you can remain solvent.

Other popular hedges include options, which can be very effective, but you have to pay a premium for the option. Options are a form of insurance, but they are like term insurance, you pay the premium every month, and if the market doesn’t die, you have to pay again next month. If you stop paying, you lose your coverage.

Locking in gains just makes common sense. You are not in the market for the long haul, you are in the market to make money. The way you make money in the market is to buy low and sell high, and not lose money. It’s really not complicated. One of the easiest things you can do is use stops. If the price falls, you get stopped out, and you collect your profits. Another way is to harvest gains; the idea is that if you have doubled your original investment, sell part of it. Now you’re playing with the house’s money.