Financial Review

Batten Down the Bonds

Sinclair Noe — November 14, 2016

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DOW + 21 = 18,868
SPX – 0.25 = 2164
NAS – 18 = 5218
10 Y + .10 = 2.22%
OIL + .26 = 43.67
GOLD – 7.60 = 1221.00

Another record high close for the Dow.

U.S. bond yields are sharply higher across the board following a public market holiday on Friday. The yield on the benchmark 10-year Treasury note topped 2.25%; they surged 37 basis points last week, the most in three years, amid speculation Trump’s plans to boost spending and cut taxes will widen the budget deficit and stoke inflation.

The 30-year Treasury bond yield is over 3% for the first time since January. The two-year yield crossed the 1.00% threshold for the first time since January.

The movement has also lit a fire under the greenback, with the U.S. dollar index up more than 1%, hitting 100 for the first time in almost a year.

The global bond rout is intensifying. Long-dated bonds are getting hit hardest in Europe. The selloff wiped a record $1.2 trillion off the value of bonds around the world last week. Investors rotated into stocks, as global developed-market shares beat investment-grade debt by the most since 2011 amid concern the stimulus will stoke inflation and lead the Fed to increase rates.

President-elect Donald Trump has made the first official appointments to his White House administration after a shake-up on Friday that saw VP-elect Mike Pence replace Chris Christie as the head of his transition team. RNC Chairman Reince Priebus has been selected as Chief of Staff, while Trump’s campaign Chairman and former head of news outlet Breitbart, Steve Bannon, will lead as Chief Strategist and Senior Counsel.

The common view is that the inflation trade has been reignited by the election results. If this were so, the two major inflation markers in the commodity market, gold and oil, would have rallied strongly. Instead, gold sold off approximately $70 or over 3% from its level a week before the election, while the price of oil has been slightly weaker. Industrial metals, especially copper, did see major rallies.

This was not across the board, however. Aluminum, which has almost as widespread commercial use as copper, fell about 3%, while copper was up 17% in the days immediately following the election. Tin was up around 6% and nickel 9% from a week earlier. The inflation argument came mostly from action in the global bond markets.

While it is true yields soared, they have been at unsustainably low rates for years now. Still, it looks like the bond market is sending a message about a fiscally expansive, deficit spending growth agenda – there will be price to pay.

And while the Dow and the S&P rallied following the election, the big winner was the Russell 2000 index of smaller stocks. And while small-cap stocks can outperform in inflationary environments, this rally is probably provoked by the idea that small-cap companies are less likely to do business internationally and more likely to get most of their sales domestically. The companies that tend to have most of their sales overseas are tech companies, and the tech-heavy Nasdaq hasn’t rallied at all. So, the stock rally has been selective and not broad-based.

Next, consider that the Federal Reserve will probably raise rates sooner and later. Fed funds futures rates are pricing in an 84% probability of an interest rate increase at the Fed’s meeting in December. PIMCO said the central bank may move three times by the end of 2017. Those rate hikes will hit the markets much sooner than any legislative action, which tends to move very slowly.

Japan’s economic growth handily beat expectations in the July-September period, expanding for a third straight quarter as exports recovered, but weak domestic activity cast doubt on hopes for a sustainable recovery. While GDP grew at an annualized 2.2% pace, household spending and capital investment were flat on quarter.

Mixed Chinese economic data for October came out overnight, released by the National Bureau of Statistics. Retail sales rose a weaker-than-expected 10%, slowing from the previous month’s 10.7% growth, while industrial output expanded 6.1%, matching September’s pace but remaining a hair below expectations.

After gathering in Brussels to discuss the future of Europe-U.S. relations, EU foreign ministers said the bloc would stand by its key foreign-policy positions on issues including the Iran deal, Russia’s annexation of Crimea and climate change, but vowed to work with the Trump administration. Not everyone attended the emergency meeting. Britain’s Boris Johnson called it “unnecessary.”

Colombia’s government and Marxist FARC rebels have agreed on a new peace pact to end a 52-year war, six weeks after the original was narrowly rejected in a referendum amid objections it was too favorable to the rebels. The new accord, which will be presented to Congress for a vote, includes several new provisions – from requiring FARC to surrender money and holdings to infrastructure development for the countryside.

Just one day after the IEA warned the world could drown in oil if production does not fall beneath demand sometime soon, OPEC released a new market whammy, offering up the cartel’s production figures, which largely jive with figures reported by the IEA yesterday: OPEC has increased its oil production. OPEC’s Monthly Oil Market Report revealed daily oil production for the cartel of 33.64 million barrels for October—up by 240,000 barrels per day in September—largely confirming the IEA’s report.

A little over 90% of S&P 500 companies have reported their quarterly results, and it’s become clear that the recession in corporate profits has come to an end. Since the second quarter of 2015, S&P 500 earnings reports have shown a decline in profits – year-over-year. A decline for two consecutive quarters indicates an earnings recession.

Based on the companies that have reported so far this quarter, S&P earnings will be up 2.75% from the prior year’s third quarter. Leading the comeback is the financial sector, which posted growth of 13.1% in profits from the third quarter of last year. According to FactSet, 71% of companies that have reported beat their estimates, higher than the five-year trailing average of 67%.

Samsung Electronics is buying Harman Industries for $112 a share in cash, or a total equity value of about $8 billion, placing the company in the vanguard of the auto industry. The deal – Samsung’s largest acquisition in its history – will reshape the pecking order in the global automotive supply chain.  Samsung could combine its display and semiconductor operations with a business that already provides sound, electronics, and other smart components for a new generation of digitally connected cars.

In Europe, Novartis AG is said to be in talks to acquire U.S. generic-drugs maker Amneal Pharmaceuticals in a deal which could value the closely-held company at as much as $8 billion. Siemens, meanwhile, agreed to buy software company Mentor Graphics for $4.5 billion, a premium of 21 percent on Friday’s closing price.

American Apparel files for bankruptcy. The retailer filed for Chapter 11 bankruptcy protection for the second time in just over a year, (so maybe we should call it Chapter 22) listing assets and liabilities in the range of $100 million to $500 million. The company exited court protection in early 2016 but quickly encountered trouble again.

Toyota will pay up to $3.4 billion to settle claims that some of its trucks and SUVs lacked proper rust protection, leading to premature corrosion of vehicle frames. The proposed settlement covers about 1.5 million Tacoma compact pickups, Tundra full-size pickups and Sequoia SUVs and estimates the value of frame replacements at around $15,000 per vehicle. However, Toyota admitted no liability or wrongdoing in the proposed settlement.

Hedge fund filings will give investors a chance to see what they were betting on when the third quarter ended. Hedge funds have had a tough time of it recently with some $50 billion flowing out of the industry this year. Hedge fund managers are required to disclose their holdings to the SEC in a Form 13F. Filed four times a year, the reports show which sectors these traders were betting on when the quarter ended, roughly 45 days ago.

Out of 13 western states, California and Texas have the highest number of single-family residential homes in extreme risk wildfire areas, per a new report from CoreLogic. CoreLogic’s scale has four categories: low, moderate, high and extreme risk, and 1.8 million homes across 13 western states fall into the high and extreme risk category.

While only a small percentage of the millions of homes that fall somewhere on the scale, these 1.8 million homes represent a combined total reconstruction value of nearly $500 billion. The other 27 million homes on the scale — those at low and moderate risk — have an estimated reconstruction cost value of $6.7 trillion.

Financial Review

Mylan Digs a Deeper Hole

Sinclair Noe — August 25, 2016

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW – 33 = 18,448
SPX – 2 = 2172
NAS – 5 = 5212
10 Y + .02 = 1.58%
OIL + .61 = 47.38
GOLD – 2.20 = 1322.60

The number of Americans who applied for unemployment benefits last week fell by 1,000 to 261,000 and remained near post-recession lows. Claims fell below the key 300,000 threshold in early 2015 and have remained there for 77 straight weeks, the longest streak since 1970.

Orders for durable or long-lasting goods made in the U.S. surged 4.4% in July to mark the biggest gain since last fall. Higher demand for passenger jets led the way as expected. The Pentagon also put in a bunch of new orders. Stripping out the volatile transportation sector, orders rose a smaller 1.5%. Still, that matches the biggest increase of the year.

Kansas City Fed President Esther George said Thursday she thought it was time to raise interest rates. George, who is a voting member of the Fed’s policy committee this year, said she didn’t know if anything would cause her to change her mind at the Fed’s meeting next month. But she indicated that decision-making remains data-dependent. George has a hawkish track record. Still, she joins Dallas Fed President Robert Kaplan, FOMC Vice Chair Stanley Fischer and New York Fed President William Dudley on the list of Fed officials calling for rate hikes.

Fed chair Janet Yellen delivers a speech at Jackson Hole tomorrow; she is expected to address possible rate hikes. Fed Funds futures are currently predicting only a 53% chance of a rate hike in calendar year 2016, which, of course is only a bit higher than coin flip. So, given the current overbought condition and the complacency seen in many indicators, the bears tell us that stocks are now “set up” for disappointment if Ms. Yellen’s speech takes on a more hawkish tone than expected tomorrow.

Central bankers sit down with their critics. In what is a first for the high-profile policy conference at Jackson Hole, Wyoming, eight central bankers, including William Dudley, president of the New York Fed, will meet with 120 activists from the Fed Up Campaign, which wants to see change at the Federal Reserve.

Mylan is responding to backlash over price increases for its EpiPen emergency allergy treatment by promising to reduce the costs that some patients pay, though the drug maker stopped short of saying it would roll back prices or limit future increases. EpiPen is a lifesaving treatment for millions whose allergies can send them into severe shock, including many schoolchildren who are advised to keep an injector handy at all times. The price has increased 548% since 2007. After widespread criticism recently, Mylan will “double eligibility” for its EpiPen patient assistance program to 400% of the poverty level, saying that a family of four making $97,200 would now pay nothing out of pocket for a prescription.

What the discount does change is how much people with commercial insurance and a high deductible pay. If you were at on the hook for about $600 before, that will now be cut to about $300. For people without insurance, however, the card won’t apply; they’d fall under a separate patient assistance program. It also won’t apply to people under government insurance programs such as Medicare or Medicaid.

Mylan CEO Heather Bresch, who happens to be the daughter of US Senator Joe Manchin, was making the rounds of TV business interviews today, trying to explain that there was nothing she could do about the price increases; she claimed the health care system is broken; she claimed she can’t lower the price because there are many layers, or middlemen, each taking a cut along the supply chain; even if Mylan cut the price, it wouldn’t result in lower prices for consumers. Well, she’s partially correct – the health care system is broken. The rest is pure hogwash.

The cost of a two-pack of EpiPens – shots of epinephrine that relieve symptoms from severe allergies that restrict breathing and can cause death – has risen from $103.50 in 2009 to $608.61 today, despite no changes in the chemical formula. Two vials of the proper dosage of epinephrine and manual syringes would cost only $20; some put the cost of the dosage in each EpiPen at as little as $1.

In 2012, the company behind the EpiPen settled a lawsuit by agreeing to allow a generic competitor into the market in 2015, potentially cutting into a big part of its business. Mylan had already been steadily increasing the price of EpiPen, an injector containing a drug that can save people from life-threatening allergy attacks. After the settlement, it started to raise the price even faster. The increasing price hikes reek of a greedy last grab for profits and an attempt to subvert the court’s ruling.

Bresch can lower the price, just as easily as she raised the price; or for that matter, even easier than the corporate “inversion” merger with Abbott Labs that moved Mylan’s headquarters to the Netherlands last year, so the company could dodge US taxes.

Brazil’s Senate has started the impeachment trial of suspended President Dilma Rousseff for violating budget laws, with the chances strong that she will be removed from office. Brazilian markets have rallied lately over the prospect of the Vice President Michel Temer permanently taking over from the Rouseff, although Temer was recently found guilty of violating campaign finance limits, a case that could make him ineligible to run for office for eight years.

Colombia’s government and the Marxist rebel group the Revolutionary Armed Forces of Colombia (FARC) have reached a peace deal after 52 years of war that has killed over 220,000 people. In return for giving up its arms, FARC members will be allowed to reintegrate into civilian life and stand for elections. The agreement will be put to a referendum in October, when it is expected to pass.

As one war ends…, Turkey has launched its first major ground assault into Syria since the country’s civil war began, sending in tanks and special forces backed by U.S. airstrikes to help Syrian rebels retake a border town from ISIS. The assault marks a dramatic escalation of Turkey’s role in Syria’s war, but there is more to the move than just fighting ISIS in Syria. Turkey is also aiming to contain expansion by Syria’s Kurds, who are also backed by the United States and have used the fight against ISIS and the chaos of the civil war to seize nearly the entire stretch of the border with Turkey in northern Syria.

Phoenix-based ON Semiconductor has won antitrust approval to buy Fairchild Semiconductor International. ON will sell its Ignition IGBT business to Chicago-based manufacturer Littelfuse. ON Semi and its rivals’ power-management circuits are used in everything from aircraft to home appliances and automobiles to computers. The deal was valued at about $2.4 billion. The FTC, in a statement, said that without the sale the merged company would have controlled more than 60 percent of the market for insulated-gate bipolar transistors, or IGBTs – a type of semiconductor used in automotive internal combustion engines’ ignition systems. That likely would have driven up prices and curbed innovation.

HP Inc., the hardware business of the former Hewlett-Packard Co, reported higher-than-expected quarterly revenue and profit as demand recovered for its notebooks. However, HP forecast current-quarter profit below analysts’ estimates, reflecting weak sales of its printers as companies cut costs across industries.

Sears Holdings is in really bad shape as its earnings report shows. The struggling owner of Sears and Kmart reported a staggering second-quarter loss of $2.03 a share. Same-store sales at discounter Kmart fell 3.3%, representing the seventh straight quarterly decline. Same-store sales at discounter Sears fell 7%, representing the eighth straight quarterly decline. And Sears is running out of money to stay afloat. Cash and equivalents declined to $276 million from $1.8 billion a year ago.

The ride-hailing giant Uber Technologies is not a public company, but every three months, dozens of shareholders get on a conference call to hear the latest details on its business performance. Uber’s losses in the first half of 2016 totaled at least $1.27 billion. For a private business to raise as much capital as Uber is unprecedented. It is also tough to find a tech company that can lose this much money this fast.

The first driverless taxi began work today in a limited public trial on the streets of Singapore. Developer nuTonomy invited a select group of people to download their app and ride for free in its “robo-taxi” in a western Singapore hi-tech business district, hoping to get feedback ahead of a planned full launch of the service in 2018. The trial rides took place in a Mitsubishi i-MiEv electric vehicle, with an engineer sitting behind the steering wheel to monitor the system and take control if necessary.

Over 300 Airbnb hosts have opened up their homes for free to people wracked by earthquakes, floods and fires in central Italy, Louisiana and California. Homes in central Italy, hit by a 6.2 magnitude earthquake Aug. 23, are on free offer on the website’s urgent accommodation page between Aug. 23 and Sept. 11. Airbnb accommodation could serve as an alternative to temporary relief camps for the 1,000 residents, whose homes were destroyed. Accommodation is also available to those affected by floods in Louisiana and prolonged wildfires threatening two Californian counties.