Financial Review

91 Days

Sinclair Noe — February 22, 2017

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DOW + 32 = 20,775
SPX – 2 = 2362
NAS – 5 = 5860
RUT – 6 = 1403
10 Y – .01 = 2.42%
OIL – .76 = 53.57
GOLD + 2.50 = 1238.90

Another record high for the Dow. S&P and Nasdaq, not so much.

91 straight trading days — that is how long the S&P has gone without closing lower by 1% or more. The S&P 500 ended 1.2% down on Oct. 11 — more than four months ago — and hasn’t clocked out on such a negative note since then.

The result has been a slow, steady slog to record highs. Hardly the stuff of investor euphoria or irrational exuberance; more like climbing a wall of worry. Stocks are expensive by almost any measure, and Mom and Pop investors seem skeptical, but the reality is that they have few good options but to stand on the edge of the cliff.

In mid-December, Bloomberg polled Wall Street analysts for their full-year predictions.  The average forecast for 2017 was calling for growth of 5.2 percent. The S&P 500 is already up 5.5 percent year-to-date. The average estimate was 2,364. The index touched 2,366 yesterday.

The Federal Reserve’s Federal Open Market Committee held a meeting January 31 – February 1. The Fed stood pat at that meeting, and today they released the minutes from that meeting. Policymakers seemed confident that the labor market was strong, and even though there were signs of inflation, that didn’t seem to worry them.

Fed officials wrestled with uncertainty on issues ranging from the Trump administration’s fiscal stimulus plans to the headwinds a rising dollar may pose. A few participants “noted that continuing to remove policy accommodation in a timely manner, potentially at an upcoming meeting, would allow the committee greater flexibility in responding to subsequent changes in economic conditions.”

The minutes included several references to “downside risks” to the economy. However, the meeting was held before data releases on jobs and inflation early in February that crushed estimates. The takeaway is that they seem ready to raise rates “fairly soon”.

The next policy meeting is March 14-15, and the more likely chance for a rate hike is the policy meeting in June. Still, the Fed is holding to the idea of 3 rate hikes for 2017, so March is on the table.

The National Association of Realtors reports existing home sales jumped 3.3% in January to a seasonally adjusted annual rate of 5.69 million.  January’s sales pace is 3.8 percent higher than a year ago. The median existing-home price for all housing types in January was $228,900, up 7.1 percent from January 2016 and marks the 59^th consecutive month of year-over-year gains.

Total housing inventory at the end of January rose 2.4 percent to 1.69 million existing homes available for sale, but is still 7.1 percent lower than a year ago, and has fallen year-over-year for 20 straight months. And of course, tight inventory combined with higher mortgage rates, means less affordable housing.

Not surprising that lower-price, or starter homes were a sweet spot for buyers. First time buyers rose slightly to 33% of sales in January. For Phoenix, the median listing price was $307,000. And the average time on market was 66 days. Compared to an average of 50 days nationally.

The US has approximately 200,000 unfilled construction jobs, which represents an 81% increase over the last two years, according to estimates from the National Association of Homebuilders. Home-builders like Lennar and Toll Brothers have cited a shortage in construction workers as a major reason they’ve had to slow down home construction.

Toll Brothers reported quarterly profit of 42 cents per share, 7 cents above estimates, while the luxury homebuilder’s revenue beat forecasts by a wide margin. However, overall profit was down 3.8 percent from a year ago, impacted by lower average selling prices.

Shares of Fannie Mae and Freddie Mac plunged by more than 30 percent on Tuesday following a ruling by a US appeals court dismissing hedge funds’ claims that the government seized Fannie’s and Freddie’s profits after their taxpayer bailout.

Fannie and Freddie went into conservator-ship during the 2008 financial crisis, receiving a nearly $188 billion bailout from the federal government. In return, Fannie and Freddie were required to pay a 10 percent dividend to the government. In 2012, the terms of the bailout were amended — the Third Amendment — forcing Fannie and Freddie to forward all their profits to the U.S. Treasury.

On Friday, Fannie and Freddie announced they were sending a combined $10 million in dividends to the U.S. Treasury. Fannie reported a $5 billion profit for the fourth quarter, while Freddie reported a $4.8 billion fourth-quarter profit. Because Fannie and Freddie’s profits have been going to the government, there was nothing left for the investors, who cried foul.

OPEC and Russia will need to prolong their production-cut deal in order to trim the global inventory that is keeping a lid on prices. ABN Amro Bank warned that crude prices could plunge towards $30 a barrel if the cuts are not extended beyond the first half of this year.

Saudi Aramco names 3 underwriters for its IPO. JPMorgan Chase & Co, Morgan Stanley, and HSBC have been selected as the lead underwriters for what is expected to be the world’s largest initial public offering of all time.

Facebook is in discussions with Major League Baseball to air one game a week. Social networks believe their platforms are a “second screen” that sports fans rely on while watching games, and are eager to test the popularity of combining the viewing of video and the commentary that takes place on social networks into a single feed.

Lloyds reported its highest annual profit in a decade, helped by a reduction in payment protection insurance provisions. Pre-tax profits increased by 158%, a level last seen in 2006 before the financial crisis. The UK government’s stake in Lloyds has also fallen below 5% and it wants to return the bank to full private ownership sometime in May.

First Solar  beat fourth-quarter estimates by 27 cents with adjusted quarterly profit of $1.24 per share, and the solar company’s revenue also beat estimates; even as sales fell to $480 million in the quarter from $942 million a year ago. Tempe-based First Solar also tweaked higher its expectations for 2017 sales to between $2.8 billion and $2.9 billion.

First Solar said the more than 300-megawatt Tribal Solar project, which was planned for the Fort Mojave Indian Reservation in Arizona, would not be built. The company’s contract to sell the power to California utility Southern California Edison was canceled. Executives described the cancellation as a one-time event due to the unique concerns of the Fort Mojave Indian Tribe and said the company had several opportunities to offset the impact of the cancellation, including new business in Japan.

Verizon Communications says it will offer its high-speed wireless 5G network to certain customers in 11 U.S. cities in the first half of 2017. Verizon will begin pilot testing 5G “pre-commercial services” in cities, including Atlanta, Dallas, Denver, Houston, Miami, Seattle and Washington, D.C. – Phoenix is not on that list.

New 5G networks are expected to provide speeds at least 10 times and up to maybe 100 times faster than today’s 4G networks, with the potential to connect at least 100 billion devices with download speeds that can reach 10 gigabits per second.

That got me thinking about how the US compares with other countries for internet speed on mobile devices, and the results are not good. South Korea has the fastest mobile internet speeds, followed by Norway and Hungary. The US ranked 36^th on the list, just a bit slower than Romania and Slovenia.

In a big win for rural delivery, UPS just tested a delivery drone on a farm outside of Tampa, Florida, with the Unmanned Aerial Vehicle, or UAV, returning to the roof of the truck. The big feat? The vehicle already moved 2,000 feet down the road. UPS says the “Drones won’t replace our uniformed service providers,” just provide extra assistance. The company also announced it would roll out Saturday ground delivery starting in April.

If you were planning to make a purchase from Amazon.com, today might be good. For today only, Amazon is offering $8.62 off orders of $50 or more. To take advantage of the discount, just enter the promo code “BIGTHANKS” when you check out.

A discount of $8.62 might seem super random, but Amazon has a good reason for that seemingly arbitrary figure. The company ranked No. 1 in the annual Harris Corporate Reputation Poll, earning a score of 86.27 percent, so it’s offering the discount as a thank you to customers.

Watch your mailbox, early-bird filers: Your tax refund should be arriving soon.  So far, the IRS has distributed more than 14 million refunds as of the week ending Feb. 10. The average amount has been $2,058. Both figures are expected to rise as the agency processes more returns.

However, if you will owe tax this year, well…, the current Powerball jackpot is worth $403 million. If you choose the lump sum option, the cash payout is $243.9 million, minus taxes of course.

Financial Review

Spotting Highs and Lows

Sinclair Noe — February 22, 2016

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

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DOW + 228 = 16,620
SPX + 27 = 1945
NAS + 66 = 4570
10 Y + .02 = 1.77%
OIL + 1.84 = 31.48
GOLD – 17.70 = 1209.30

Stocks across the globe rallied today, sending Dubai shares into a bull market, as oil rebounded and metals advanced. The pound slid as a split in the U.K.’s ruling party over European Union membership increased the potential for an exit from the bloc. The U.K. currency weakened the most in almost seven years against the dollar after London’s Conservative Mayor Boris Johnson said he’ll campaign for Britain’s exit from the EU, opposing Prime Minister David Cameron.

We all know the old saying, “Buy low and sell high.” The problem is picking the highs and lows. John Stoltzfus, Oppenheimer’s chief market strategist has noticed a trend; in a report this morning he looked at the lows over the past year; there were 7 major lows and they all happened as the S&P 500 dipped down to 16.5 to 17 times earnings. That is when stocks looked cheap and buyers stepped in. Of course, this is not a hard and fast rule; it only works until it doesn’t.

The IEA says, “Today’s oil market conditions do not suggest that prices can recover sharply in the immediate future.”  The IEA says oil markets will begin to re-balance in 2017 thanks to falling U.S. production but that decline will prove short-lived as efficiency gains will push U.S. output to new records by the beginning of the next decade. Production of U.S. shale oil is expected to drop by 600,000 barrels per day this year, and a further 200,000 barrels per day next year before gradually recovering.

Within weeks, two low-profile legal disputes may determine whether an unprecedented wave of bankruptcies expected to hit US oil and gas producers this year will imperil the $500 billion pipeline sector as well. In the two court fights, U.S. energy producers Sabine Oil & Gas and Quicksilver Resources are trying to use Chapter 11 bankruptcy protection to drop long-term contracts with the pipeline operators. Pipeline operators have argued the contracts are secure, but restructuring experts say that if the two producers manage to tear up or renegotiate their deals, others will follow.

Exactly how major asset sales and defaults are handled will be a big part of figuring out where oil prices go from here. We really haven’t seen much in the way of major assets sales in the oil patch... yet. There have been some distressed sales and some defaults, and when the banks take over, they are quick to unload assets. Those banks are motivated sellers and will likely keep the market for energy assets depressed for at least a year.

Of course for the big private investors with a long-term time horizon like Blackstone or KKR, this could create a major opportunity. Yet private equity firms are being very disciplined with their capital and are only slowly starting to enter the market for such assets. We haven’t seen much M&A activity, probably because sellers have been clinging to the hope that prices will come back and they will be vindicated for sitting on their assets.

But that might change this year as more sellers are forced by defaults to accept any price they can find, or alternately lose the asset to BK. It will take some time to work through the carnage, probably another year at least. Clearly these are dangerous times for equity investors in the oil patch.

As the U.S. farming sector enters the third year of a downturn caused by a global glut of grains and slumping commodity prices, bankers across the Midwest are starting to tighten lending conditions and even cutting some clients off. Many corn and soybean farmers already are trying to adjust by selling off grain stockpiles, and begging bankers to restructure debt and give them more time to pay it back. Farm sector debt soared past $364 billion last year and is forecast at over $372 billion in 2016.

The flash manufacturing purchasing managers index from Markit fell to 51.0 from 52.4 in January. This matches the lowest level since September 2009. Economists had been expecting a reading of 52.5. While a reading above 50 represents expansion, softer rates of output, new business and employment growth all weighed on the index.

Manufacturing output fell for the third time in the past four months. Markit’s chief economist said: “U.S. factories are reporting the worst business conditions for over three years. Every indicator from the flash PMI survey, from output, order books and exports to employment, inventories and prices, is flashing a warning light about the health of the manufacturing economy.”

CNBC reports that Honeywell and United Technologies have held talks about a merger. A deal would create a company with combined sales of more than $90 billion. It is not a done deal; terms have not been worked out, and there would be some anti-trust hurdles as well.

Sysco has agreed to acquire the Brakes Group, a European food distributor, for $3.1 billion. The deal comes less than a year after Sysco terminated its $3.5 billion deal with US Foods after regulators determined that the combination would be harmful to consumers by leading to higher prices and lower service.

The private banking and asset management firm EFG International has agreed to acquire BSI, the Swiss private-banking arm of the Brazilian investment bank BTG Pactual, for about $1.3 billion; and creating one of the largest private banks in Switzerland with 170 billion francs under management.

HSBC Holdings posted a loss of $858 million, falling far short of analyst expectations for a profit of $1.9 billion. The profit miss is not the only problem facing the bank, the SEC is investigating the company’s Asia Pacific hiring practices. The investigation concerns the bank’s hiring of people that have close government ties.

Fannie Mae is at risk of needing a government bailout that could shake up confidence in the housing finance market, so says the Financial Times.  The reason is because the government does not let Fannie Mae retain profits, its capital buffer (which has dwindled from $30 billion before the financial crisis to $1.2 billion today) is on track to disappear by January 2018. At that point it would be unable to weather quarterly losses and would need to draw on Treasury funds to avoid being placed into receivership.

Highlights from the Mobile World Congress: Samsung Electronics and LG Electronics unveiled their latest flagship devices, seeking to revive sales momentum and buck slowing industry growth. The new Galaxy S7 comes with an improved camera, memory storage, water resistance and a longer battery life, while the LG G5 showed off a similar range of new features.

The biggest news, however, was the firms’ big jumps into virtual reality. Samsung is teaming up with Facebook to push VR elements into phones and social networking, and the two companies unveiled 360 degree recorders, cameras and viewers.

Payment card operators are also taking part in Mobile World Congress. MasterCard is bringing facial recognition services dubbed “selfie pay” to the U.K. to improve identity verification for mobile phone payments. British users will be able to scan fingerprints or snap selfies to validate their identities for completing online purchases. Meanwhile, Visa wants to turn your car into a mobile payments platform, showing off a concept app that will let drivers pay for fuel and parking without leaving their vehicles.

Also on display at the Mobile World Congress in Barcelona: 5G, or the fifth generation of wireless technology, offering mobile Internet speeds that will let people download entire movies within seconds, and it may pave the way for new types of mobile applications. Under plans for 5G, carriers will most likely offer mobile Internet speeds of more than 10 gigabits per second, or roughly 100 times faster than current networks (and significantly quicker than existing broadband). That would allow you to download high-definition movies almost instantaneously, even if you’re on the go.

Such technology will not come cheap. Carriers and telecom equipment makers will have to install new hardware like cellphone towers in rural areas and tiny mobile hot spots in dense urban areas to reach the 10 gigabits per second target. They will also have to increasingly rely on sophisticated software to manage the expected exponential jump in mobile data traffic.

AT&T is partnering with Intel to test and optimize how drones perform on LTE connections beyond line of sight, at higher altitudes, or when faced with external interference. The collaboration is designed to show how a network that has primarily been designed to connect devices (such as smartphones) on the ground can be re-worked for unmanned aerial vehicles.

Apple CEO Tim Cook has sent a new memo to all Apple employees explaining why the company is resisting an FBI request to decrypt an iPhone used by one of the San Bernardino shooters. In the memo, Cook says the FBI should withdraw its demand to force Apple to develop a tool to help it break into the iPhone.

He writes: “At stake is the data security of hundreds of millions of law-abiding people, and setting a dangerous precedent that threatens everyone’s civil liberties.” A court last week ordered Apple to comply, but the company is challenging the order. Apple is calling for the government to launch a commission of experts to examine the effects of encryption technology on law enforcement.

Lumber Liquidators’ flooring, tested for formaldehyde, was found to have a three times higher risk of causing cancer than previously stated. A report released Feb. 10 used incorrect ceiling heights, lowering by about three times the airborne concentration that should have been examined and reducing the danger. According to the Centers for Disease Control and Prevention the estimated risk of tumors is six cases to 30 cases per 100,000 people, and not the two to nine cases in the earlier report.

US auto safety regulators are examining whether an additional 70 million-90 million Takata airbag inflators should be recalled because they may endanger drivers, according to Reuters. That would nearly quadruple the 29 million inflators that have been called back so far. New recalls would translate into billions of dollars in additional costs for the company and also add years to the replacement process.

US authorities have asked Volkswagen to produce electric vehicles in the U.S. as a way of making up for its rigging of emission tests. The plan would see VW manufacture electric cars at its plant in Tennessee, and help build a network of charging stations for electric vehicles. A VW spokesman said, “Talks with the EPA are ongoing.”

Financial Review

Magnitude of Falsity is Enormous

Sinclair Noe — May 12, 2015

 

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DOW – 36 = 18,068
SPX – 6 = 2099
NAS – 17 = 4976
10 YR YLD – .03 = 2.25%
OIL + 1.50 = 60.75
GOLD + 9.50 = 1194.00
SILV + .21 = 16.58

The Treasury market continued to sell-off this  morning, pushing the yield on the benchmark 10-year Treasury up to 2.35% intraday, the highest point since Nov. 21. The selling eased by the afternoon, sending the yield down to 2.25 percent. The intense selling in the Treasury market was fueled by a similar meltdown in the Eurozone’s government bond market which has been going on for more than two weeks. Germany’s 10-year bund yield is 14 times higher than a month ago.  The yield on the 10-year benchmark German bond known as the bund increased 12 basis points to 0.71% intraday and European peripherals, such as Spain, Italy and Portugal, also saw their yields jump between 10 and 13 basis points.

At a panel discussion in Zurich this morning, NY Fed President William Dudley outlined that he does not know when interest rates will rise but repeated recent comments that the policy tightening will depend on the US economy. In other words, the Fed won’t send out engraved invitations and you will need to stay alert but the markets shouldn’t be surprised when the Fed raises rates. Dudley said the conditions that will determine the timing of the Fed raising rates from their current near-zero levels are “well specified” and “market participants should be able to think right along with policymakers, adjusting their views about the prospects for normalization in response to the incoming data.” Dudley went on to say that when the Fed raises rates it “will have implications for global capital flows, foreign exchange valuation and financial asset prices even if it is mostly anticipated when it occurs.”

The National Federation of Independent Business said its small-business optimism index rose 1.7 points to 96.9. It’s the second-worst reading since October. Overall business investment has sagged, with energy companies slashing capital expenditure budgets and laying off thousands of workers as lower energy prices undermine exploration and drilling activity. Nine of the NFIB index’s 10 components rose last month, with the exception of sales. The NFIB said despite the turmoil in the energy sector, “the shale states exhibited stronger capital spending and hiring than the rest.”

Oil production from seven major U.S. shale plays is expected to fall by 86,000 barrels per day in June. According to the latest report from the Energy Information Administration Oil output at the Eagle Ford shale play in South Texas is forecast to see the biggest decline, down 47,000 barrels per day, while production at the Bakken shale play, centered in North Dakota, is expected to drop by 31,000 barrels per day.

Job openings at US workplaces declined to 4.9 million in March from 5.1 million in February. The Labor Department’s JOLT survey measures the number of job openings in the economy, a measure of how aggressively employers are looking to hire, and more job openings indicates a labor market turning in favor of employees over employers. The number of hires in March, however, rose to 5.07 million from 5.01 million in February, while total separations also rose to 4.98 million from 4.79 million in February. The numbers of people quitting their job ticked up slightly in March, to 2.78 million from 2.72 million in February. Quits are seen as a sign of strength in the labor market, as workers wouldn’t be quitting their jobs unless they were reasonably confident they could find another one. It might also signal the possibility of higher wages in the not so distant future.

The US budget surplus in April rose to the highest level since 2008 on record revenue as hiring improved during a month when Americans file tax returns. The Treasury Department reports revenue exceeded spending by $156 billion last month, compared with a $106 billion surplus a year earlier. The April surplus was the fifth-highest on record for any month. So far this fiscal year, which began Oct. 1, the deficit declined to $282 billion compared with $306 billion in the same seven-month period a year earlier. Even though spending increased 6%, more people had jobs (the unemployment rate dropped to 5.4% in April) and that added to the Treasury’s coffers. So, it looks like one of the best ways to cut the deficit is to grow the economy. Who knew?

The Trans-Pacific Partnership faced its first test with a critical vote in the U.S. Senate today. Senate Democrats staged a last-minute rebellion against one of President Barack Obama’s top legislative priorities by blocking a test vote on a trade measure that didn’t include companion measures they sought. The vote, 52-45, effectively delays fast-track legislation Obama wants to expedite approval of trade accords. Supporters needed 60 votes to advance the bill to a final vote. Senate Majority Leader Mitch McConnell said the Democrats’ opposition was “pretty shocking” and vowed to keep working to reach an agreement he could bring back for a vote later. TPP would create a free trade zone covering 40% of the world economy – making it the biggest trade deal since NAFTA.

Verizon is buying AOL for $4.4 billion. The biggest U.S. wireless carrier will gain access to AOL’s mobile video platform and content. AOL bought Time Warner for more than $160 billion in 2000 in what turned out to be one of the most disastrous corporate mergers in history. AOL was spun off from Time Warner in 2009 at a value of about $3.4 billion. It’s easy to think of AOL in terms of an epic acquisition failure, or for the catch phrase “you’ve got mail”, or not at all. Actually, AOL has built up a decent infrastructure for the online ad marketplace, particularly for video and mobile platforms. And they have been making money; and they are growing; revenue is up 39% in the past year; profit is up 19%. It even brought in $600 million in revenue last year from 2 million customers dialing in for internet access.

In a separate matter, Sprint and Verizon will pay a total of $158 million to resolve nationwide allegations that they engaged in mobile cramming, a practice in which cell phone providers place unauthorized third-party charges on customers’ bills. Sprint will pay $68 million and Verizon will pay $90 million. Of those amounts, $50 million will be refunded to Sprint customers and $70 million will be refunded to Verizon customers. The rest will go to the 50 states that brought suit against the mobile phone carriers. The carriers also agreed to take steps to ensure that they only bill customers for third-party charges that have been authorized by the customers. The carriers have set up phone lines for customer questions about refunds.

Many on Wall Street have long argued that the banks did not generally break the law when they packaged shoddy mortgages and sold them to investors in the lead-up to the financial crisis of 2008. But yesterday a federal judge dealt a strong blow to that version of history. She ruled that two banks misled Fannie Mae and Freddie Mac in selling them mortgage bonds that contained numerous errors and misrepresentations. “The magnitude of falsity…is enormous,” declared U.S. Judge Denise Cote, adding, “The origination and securitization of these defective loans not only contributed to the collapse of the housing market, the very macroeconomic factor that defendants say caused the losses, but once that collapse started, improperly underwritten loans were hit hardest and drove the collapse even further.”

The two banks, Nomura and RBS, have been the only ones out of 18 financial firms that took their case to trial, arguing that it was the housing crash, and not deceptive loan documents, that caused the bonds to collapse. The other firms – including Goldman Sachs and Bank of America – settled, together paying nearly $18 billion in penalties.

More than seven years after the financial crisis, Congress is still fretting that some megabanks might be “too big to fail.” Yesterday, the House Financial Services Committee subpoenaed three federal agencies (the Department of Justice, the NY Fed, and the Treasury) citing “extraordinary stonewalling” from the agencies and lingering questions as to whether regulators went easy on banks deemed to be too large to prosecute. One case in particular got the attention of lawmakers; when the DOJ settled with HSBC despite overwhelming evidence the bank laundered money for terrorists and Mexican drug cartels.

Another for-profit college is in trouble. ITT Educational Services was charged with fraud today. The Securities & Exchange Commission said the company’s chief executive and chief financial officer misled investors and auditors with “outright misstatements” and “half-truths” about its student loan program. ITT Educational Services allegedly created a fraudulent scheme to show that it was doing better financially than it really was. Students had been defaulting on their loans in droves, but the SEC claims that CEO Kevin Modany and CFO Daniel Fitzpatrick hid the real cost from investors. More than 51,000 students take online courses or attend the 135 ITT Technical Institute campuses located in 39 states. ITT also runs the Daniel Webster College in New Hampshire.

After the financial crisis, student loans started to dry up.To entice lenders, ITT offered to back the loans if student loan defaults rose over a certain threshold. When defaults started rising in 2012, the company had to pay third party lenders to make good on its guarantees. ITT also started making student loan payments on its own to mask the default rate. Shareholders were kept in the dark about all these payments. The company is also being sued by the Consumer Financial Protection Bureau over alleged predatory student lending. The CFPB has also taken Corinthian College to court for the same issue. Corinthian filed for bankruptcy last week and abruptly closed all of its remaining campuses.

FINANCIAL REVIEW

Too Much Pie

Sinclair Noe — December 1, 2014

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

DOW – 51 = 17,776
SPX – 14 = 2053
NAS -64 = 4727
10 YR YLD + .02 = 2.22%
OIL + 3.22 = 69.37
GOLD + 44.30 = 1213.80
SILV + .88 = 16.56

Last week I said that you can never eat too much pie. I would like to amend that statement.

That was a long weekend. While we were gone, the Dow hit another record hit on Friday, the 31st of the year. Dow stocks are still up about 7% for 2014; with all these record high closes, you might think it would be more, and you might think you could just throw a dart at any of the Dow 30 stocks and hit a winner. Unfortunately, not all Dow stocks were able to revel in the year’s rallies. In fact, nearly one-third of the market’s companies had negative returns this year. Big names that are down, including: Boeing – down about 7% despite fairly strong sales of airplanes, IBM – down 13% as they try to figure out what their business is, General Electric – is off about 6%, United Technologies – down about 3%, and Chevron – down about 6% for the year as oil prices have been sliding.

The oil companies are about the only ones not happy with lower oil prices. On Thursday, as we were enjoying turkey and way too much pie, OPEC was meeting in Vienna and they decided to leave oil production unchanged. That sent oil prices down big on Friday. Then early today, prices dipped all the way down to 63.72 a barrel before recovering to finish up 3.22 at 69.37. Earlier this year, most oil companies expected prices would remain above $90 a barrel; wham bam, next thing you know oil was under $80, and now there are more than a few oil related companies on the ropes and trying to figure out how low prices can go, and how they can survive.

Energy is a cyclical business, and adjusting production to lower prices and lower demand is not uncommon; companies did that in 2008 and 2009, when oil prices collapsed during the recession. Oil companies will have to adjust to lower prices. Right now we don’t know how low the bottom is, and it doesn’t make sense to try to catch a falling knife. Wait and let the market tell us.

The Federal Reserve is welcoming the sharp drop in global energy prices, with two influential policymakers saying today that it should provide a boost to American pocketbooks and shrugging off any pressure on already low inflation, with the thinking that any dis-inflationary problems will be temporary.

Someone’s income is someone else’s expense. Losers are those who were dependent on rising or steady oil prices. Winners are those who benefit from lower oil prices and lower prices for all the things whose cost is driven in part by the cost of oil. High-yield bonds dependent on higher energy prices are now at greater risk. You might consider separating energy-dependent flows supporting bonds from those that are not tied to the energy sector.

In the geopolitical arena, low oil prices have an enormous impact. Budgets of many foreign countries are coming under duress. Civil unrest is likely to increase in those countries due to their inability to fund subsidies that have acted to bribe the population. Look for more geopolitical turmoil worldwide and regime change in some countries. In others, dictators suppress the population with machine guns, so the unrest is below the surface until it explodes. Certainly lower prices tend to target oil producers such as Russia, and today Putin shot back by scrapping a major natural gas pipeline project scheduled to run through Bulgaria, in favor of a pipeline through Turkey. Putin said he was punishing Bulgaria for siding with the European Union. Meanwhile, the Ukrainian military accused Russian special forces of taking part in attacks on the strategically important Donetsk airport in eastern Ukraine, where fighting has intensified in recent days despite a September ceasefire deal.
The drop in oil prices is good news for most other businesses; great news for manufacturing firms and transportation companies; it might lift GDP by about 0.3 to 0.5 percentage points. And low prices are a real boon for most families. The cost of regular gas sank to a nationwide average of $2.82 a gallon from as high as $3.70 five months ago. In some areas gas prices have dropped to as low as $2.50 a gallon. By most estimates, lower oil prices put about $75 billion to more than $100 billion back in consumers’ pockets; it works out to more than a $1000 dollars for a typical household.

What are we doing with all that extra money? Well, we are not driving to the mall. Sales, both in stores and online, from Thanksgiving through the weekend were estimated to have dropped 11 percent, to $50.9 billion, from $57.4 billion last year, according to preliminary survey results released yesterday by the National Retail Federation. Sales fell despite many stores’ opening earlier than ever on Thanksgiving Day, or maybe sales fell because so many stores were opening earlier; it might have been backlash for trying to intrude on our holiday, and in support of retail workers who most likely wanted to spend a little time away from the store; or maybe it just smacked of desperation. American shoppers have keen instincts, and if we suspect retailers will buckle, we have the patience to wait them out; maybe shoppers smelled blood.

Whatever the case, sales were down big. Overall, 133 million people shopped or planned to shop at stores or online over the four-day weekend, 5.2 percent fewer than last year. And shoppers spent an average of $380.95 over the four days, 6.4 percent less than the $407.02 they spent last year.

And though many retailers offered the same aggressive discounts online as they did in their stores, the web failed to attract more shoppers or spending over the four-day holiday weekend than it did last year. The average person who shopped over the weekend spent $159.55 at online retailers, down 10.2% from last year. At least that’s the best guess. The survey of shoppers is subject to revision, and has not always been the most reliable indicator. Still it doesn’t look good.

And now, Cyber Monday, well, we’ll just wait and see. One of the twists this year is that more people will make Cyber Monday online sales with their smartphones. On Cyber Monday in 2013, 38% of shoppers said they used smartphones to shop, up from 23% in 2012.

If you really want to find a deal, try a mortgage. New guidelines go into effect today aimed at making mortgage lending easier. The new standards stem from an agreement in October put in place to clarify when banks would be penalized for making mistakes on mortgages they sell to Fannie Mae and Freddie Mac. Banks became more risk averse after the mortgage meltdown, and very conscious of exactly what they are allowed to do and how they are supposed to treat loans. They apparently had very unclear guidance from Freddie and Fannie about the rules of the road, in terms of which types of mortgages were going to be acceptable for Fannie and Freddie to buy. Lenders have said this lack of clarity is why credit is tight and many consumers aren’t qualifying for loans. Demand for loans and the credit worthiness of borrowers have also forced banks to pull back on lending.

Banks are expected now to relax some of their credit requirements and give prospective borrowers more consideration, particularly those whose credit score took a hit because of one-off events, like loss of a job or a single large medical bill. Fannie Mae and Freddie Mac will soon give guidance to banks requiring only a 3% to 5% down payment from borrowers.

By now, we’ve all heard stories about how hackers have infiltrated major retailers and banks, and they are ready to steal your credit card numbers, and account numbers, and anything digital. Now comes word that hackers are trying to game the stock market. Security researchers say they have uncovered a cyber-espionage ring focused on stealing corporate secrets for the purpose of gaming the stock market, in an operation that has compromised sensitive data about dozens of publicly held companies. Cybersecurity firm FireEye says that since the middle of last year the hackers have attacked email accounts at more than 100 firms, most of them pharmaceutical and healthcare companies. Victims also include firms in other sectors, as well as corporate advisors including investment bankers, attorneys and investor relations firms.

The hackers only targeted people with access to highly insider data that could be used to profit on trades before that data was made public. They sought data that included drafts of Securities and Exchange Commission filings, documents on merger activity, discussions of legal cases, board planning documents and medical research results. The victims ranged from small to large cap corporations. Most are in the United States and trade on the New York Stock Exchange or Nasdaq. The cyber-security firm declined to identify the victims. It said it did not know whether any trades were actually made based on the stolen data.

Looking forward, lawmakers returned to Capitol Hill today; they have less than 2 weeks to figure out how to keep the government funded. With government funding set to expire Dec. 11, top Democrats and Republicans had hoped to pass a so-called omnibus measure that would tie together tailored spending bills to fund the government through September 2015, the end of the fiscal year. So, they will try to cram 2 years of business into the next 2 weeks. Just a reminder that they had some temporary extensions on tax cuts that are scheduled to expire at the end of the month, assuming that the government is still open for business.

Friday brings the monthly jobs report. The economy has settled nicely into a hiring groove since the early spring, adding more than 238,000 jobs a month and putting the US on a path to produce the strongest employment gains in 15 years. Friday’s report is expected to show another 230,000 jobs added to the economy in November.

FINANCIAL REVIEW

Fluctuations

Sinclair Noe — October 1, 2014

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Financial Review

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

DOW – 238 = 16,804
SPX – 26 = 1946
NAS – 71 = 4422
10 YR YLD – .10 = 2.40%
OIL – .43 = 90.73
GOLD + 4.30 = 1214.00
SILV + .20 = 17.28

Yesterday, we talked about third quarter results. Most of the stock indices were down in September but still slightly positive for the third quarter. Today wiped out the third quarter gains. Why? Well, that’s always fun; the headlines offer a plethora of reasons, including “global worries” or maybe it’s a “market top” or “geopolitical hotspots” or “commodity crash” or maybe it’s just the start of a “rocky October”. I don’t claim to know why the markets dropped today, or any given day. I can read a chart, and I can identify patterns, but there are no guarantees. We follow macroeconomics and we analyze company P&Ls, but there are no guarantees. We do not get stuck in cheerleader mode like the talking heads on TV business shows, nor do we follow the perma-bears.

Markets fluctuate; to paraphrase a line from J.P. Morgan, or maybe John Rockefeller. “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” That’s a quote from Warrant Buffet. We don’t yet know whether this is folly or a trend. We’ll just have to listen to the markets.

The Institute for Supply Management’s index of national factory activity dropped to 56.6 last month, its lowest level since June. A reading above 50 indicates expansion. The gauge of new orders fell to 60% from 66.7%, but that’s still very strong. Production edged up a tick to 64.6%, marking a four-year high. Fifteen of the 18 industries tracked by ISM reported growth in September. A similar survey put out by the private-research firm Markit was just slightly off a four year high in September.

And compared to the rest of the world, American manufacturing is red hot. The JPMorgan global manufacturing index edged down to a four-month low of 52.2% in September while the rate of expansion was the weakest since April. Growth was near-stagnant in the Eurozone and Asia, and the global index is being propped by the United States.

On Friday, we’ll get the monthly jobs report from the government. I always consider this one of the most important economic reports. The warm-up for the report comes from ADP, a private payroll processing firm. Each month they gather data and make their own estimate about the labor market. ADP is not always a good predictor of the Labor Department’s report; for example, last month ADP predicted the economy added 202,000 jobs, and the official number came in at 142,000. In defense, the government numbers for August are typically subject to upward revisions, more than other months; so after revisions, ADP’s estimate might turn out to be pretty close.

That’s a fairly long setup to let you know that today, ADP estimates the economy added 213,000 private sector jobs in September. Most estimates call for the government’s report to show that total nonfarm employment rose by 220,000 jobs in September. Weekly readings on jobless claims are near lows hit before the recession, signaling that employers are laying off few workers. And if the economy continues to add about 200,000 net new jobs each month; it would be consistent with about 3% GDP growth. Not shabby.

Job growth has been steady since 2009, but it has also been uneven. The Labor Department reports today nearly a quarter of the metropolitan areas in the country had fewer jobs in August than 5 years earlier; 92 regions have experienced net job loss since August 2009. The Tucson region recorded the largest total decline with 23,500 fewer jobs there in August compared with the same month in 2009. The Pine Bluff, Arkansas region saw the steepest decline, down 9.4% from 5 years earlier. The hardest hit areas are more lightly populated; indicating rural America has not really recovered. Los Angeles added the largest total amount of jobs during the five-year span, almost 390,000; Houston, Miami and Dallas followed.

In a separate report, the Commerce Department says construction spending dropped 0.8% in August to a seasonally adjusted rate of $961 billion. Looking at private outlays, spending fell 1.4% for nonresidential projects and dropped 0.1% for residential projects. For overall public construction projects, spending fell 0.9%. In addition, July’s rise was revised lower to a 1.2% rise from an initially reported 1.8% gain.

Fannie Mae and Freddie Mac are the giants of mortgage financing; they are government sponsored entities that issue and guarantee mortgage-backed bonds. Between those companies and Ginnie Mae, which guarantees loans insured by the Federal Housing Administration, the government backs nearly 97 percent of US mortgages.

And today, they crashed. Fannie and Freddie shares each dropped 37%. And preferred shares were down more than 60%. A federal judge on Tuesday threw out a lawsuit brought by Fannie Mae and Freddie Mac investors to stop the government from seizing most of the profits at the mortgage finance twins.

Let’s set the stage. In 2008 Fannie and Freddie were placed into conservatorship to avoid bankruptcy. Congress originally authorized Treasury to collect 10 percent dividend payments from Fannie and Freddie every quarter as a condition of the government’s $188 billion bailout of them. Treasury amended the terms of the agreement in 2012 to make Fannie and Freddie give the government most of their profits, a move known as the “sweep amendment.” And earlier this year, Fannie and Freddie paid off their bailout, and taxpayers recouped the $187 billion that was used to prop up the two GSEs. A couple of big institutional investors in Fannie and Freddie, including Perry Capital and Fairholme Funds, sued, claiming that the dividend sweep was tantamount to a purchase of new securities, which Treasury did not have the authority to make. It also claimed the FHFA failed to conserve the assets of Fannie and Freddie by allowing Treasury to take most of their profits.

The hedge fund argued that Treasury’s arrangement caused irreparable harm to all private investors, saying they have been shortchanged as Fannie and Freddie returned to profitability. In its original complaint, the hedge fund said the government “maneuvered to ensure that Treasury would be the sole beneficiary of the companies’ improved financial position.” Basically, the hedge funds were upset that the taxpayers that bailed out Fannie and Freddie got paid back before they could suck out profits for their hedge fund.

In Tuesday’s ruling, the judge expressed sympathy for the plaintiffs, but it wasn’t enough to reverse course. He found that Treasury and FHFA were well within their rights, as dictated by Congress; and if the hedge funds didn’t like it, they could take it up with Congress. What’s still unclear is how and when and if Fannie and Freddie will emerge from conservatorship.

Bill Gross’s surprise departure on Friday from Pacific Investment Management Co., or Pimco, shook up the $42 trillion bond market. The most-traded assets quickly recovered but the less-traded ones are still feeling the effects. And it may have exposed an Achilles’ heel: the lack of liquidity in the bond market. When you get a dislocation like this, it tends to exacerbate price movements maybe more than what you’d have seen 10 years ago.

One person pushing around borrowing costs for nations and companies worldwide, however briefly, shows the increasing fragility of credit markets. Average daily trading in the US bond market fell to $809 billion in 2013 from $1.04 trillion in 2008, according to data compiled by the Securities Industry & Financial Markets Association. Debt still largely changes hands off exchanges, through telephone calls and e-mails. And in September Pimco’s Total Return Fund was hit with $23.5 billion in withdrawals, or right at 10% of assets.

Bill Gross does not rule the bond markets; any effect from him changing jobs will be temporary. The Fed will soon unwind QE, and that has been and will be a much bigger story. Gross’ departure serves as a reminder that fluctuation should not be confused with liquidity. Bond markets fluctuate all the time but things get scary when prices stop fluctuating.

We’re pretty sure the bond market will feel a bit uneasy about the end of QE, but what about the energy markets? And what is the connection between the end of quantitative easing and raising interest rates, and energy? The oil and gas industry is extremely capital intensive, with billions of dollars required in some cases to suck hydrocarbons from the ground. That means that companies need to sell a lot of debt to financial markets to finance their projects. But if interest rates rise, it will significantly raise borrowing costs for oil and gas operators.

Increasing interest rates should strengthen the US dollar relative to other currencies; and we’ve already seen the dollar at 4-year highs in recent trading. Higher interest rates makes holding dollars more attractive, which increases demand for the currency. Oil is priced in dollars, so a stronger dollar pushes down oil prices, along with other commodities priced in dollars. Lower oil prices mean lower revenues for oil companies.

Higher interest rates will make debt more expensive, making it more expensive to borrow money to drill an oil well. Moreover, the problem becomes worse still because so much of the oil growth in recent years has come from shale, which has rapid decline rates after initial production. Companies have to keep borrowing to drill new wells, but will run into trouble if the cost of debt rises too fast. So, high interest rates mean higher expenses and a stronger dollar means a lower price; and that means some of the marginal players won’t manage, and that means a pullback in production growth.

So far this year, oil prices have been moving lower; production is strong, inventories are high. The Fed says it will be a “considerable time” before they raise rates. Best guess is that sometime next year the Fed will end the era of easy money; they will tighten the spigot of stimulus, and that will tighten the spigot on oil and gas output, especially for companies that have high levels of spending. There are other factors at play, including global production and the impact of renewable energy, but the formula is in place. Higher borrowing costs will likely necessitate higher revenue and if oil prices don’t rise the industry will need to pare back production; not today, but over the next year or two, and America’s oil boom will fizzle.

The End of US Capitalism

History will point back at September 2008, as the beginning of the final economic decent into the first global depression of the 21^st century. If, the natural world’s symbol of the Great Depression was the dust bowl and drought throughout the 1930’s, then, hurricane and flood will become its substitute.

 America’s total world hegemony is indisputably on the wane.  Evidence to support this theory includes the nationalization of Freddie Mac and Fannie Mae, the bankruptcy of Lehman Brothers, and the surrender of Merrill Lynch to Bank of America.  Additional exhibits offered for the record includes the near drowning of the U.S. cities of New Orleans and Houston.  

 Metaphorically, the bull, Merrill Lynch’s signature mascot and Wall Street’s icon of capitalism’s vitality and unparallel economic period of prosperity in America, is corralled under duress, and, which may signify a coming collapse of middle class opulence, which might never be duplicated.

Weekly Review and Outlook: Deleveraging's Not Just for I-Banks

Like a wild jungle creature forced into a confrontation, but unsuccessful, this past week's stock market limped into the weekend, stunned, pensive, and little changed with Dow Jones Industrial Average [DJIA] closing at 11370.69, the Standard & Poor's 500 ending at 1256.76, and NASDAQ finishing its week at 2310.53. The Dow lost 125.88 for the week. Likewise, the S&P 500 dropped 2.92 and NASDAQ subtracted 27.75, respectively.

The CNBC midday rowdies strained themselves lifting a Hubble sized telescope looking for positive data points in the housing numbers. Existing home sales came out Thursday; they were down 2.4 percent in June, at a seasonally adjusted annual rate of 4.86 million units. New home sales for June, appearing Friday, was lower by .06 percent, on a seasonally adjusted annual rate of 530,000, from a revised upward May figure of 533,000.

I can imagine the rowdies on an express elevator to hell remarking that our destination has dry heat, that it's a gated community, and that it's a Christian neighborhood with few trespassers.

In the second quarter, 739,714 foreclosure filings were recorded. Also, 220,000 homes were lost to bank repossession, according to RealtyTrac. That is up 14 percent from the first quarter and up 121 percent from the same quarter in 2007.

A report published on Friday, by an International Monetary Fund economist, concluded U.S. housing prices were still overvalued, in the first quarter this year, perhaps, 14 percent, within a range of 8 percent to 20 percent. According to Reuters, IMF economist Vladimir Klyuev's report "What goes up must come down? House price dynamics in the United States", examined the inventory-to-sales ratio, foreclosure rates, market inertia, and other data points, formulating this opinion. That would mean at least an additional $1 trillion in lost asset value. The government debt market is still comatose.

The 2 year and 10 year US Treasury Notes, as well as the 30 year US Treasury Bond ended the week with higher yields, paying 2.71%, 4.10%, and 4.68%, versus 2.64%, 4.85%, and 4.65, respectively. August is a major refunding month with auctions scheduled for the Two, Five, Ten, and Thirty Year Treasury obligations, in addition to the weekly T-Bill The brightest spot in the market was the Nymex Light Sweet Crude Oil September contract; it closed Friday at $123.26 per barrel, extending its reprieve to cash strapped motorists from its recent high of $147.20.

Online retail analysts are reporting double digit growth in sales among several retailers because of consumers passively boycotting higher gasoline prices. Who would have thought that one day we would be happy seeing oil prices heading towards $100 a barrel?

Late Friday afternoon, the Office of the Comptroller of the Currency closed First National Bank and the FDIC was named receiver of another two banks, one California-based and the other Nevada based, First National Bank of Nevada with $3.4 billion in assets, and First Heritage with $254 million in assets. Both were owned by undercapitalized First National Bank Holding Co., of Scottsdale, Arizona. First National lost $140 million in the first quarter. They reported $4.6 billion in assets and $4.3 billion in liabilities. Nine point four percent of it $3.7 billion in loans were non-current, ending March 31. Mutual of Omaha Bank acquired the deposits of the two banks from the FDIC for a 4.41 percent premium. The new Mutual of Omaha Bank branches will open Monday morning.

There are currently 8,494 institutions holding $13.4 trillion assets insured by the FDIC. The FDIC said the failures would cost its deposit insurance fund roughly $862 million. This brings the total number of bank failures in 2008 to seven. You can learn more about the status of a particular bank here

Game Changer : The really, really, big news this week came from Chrysler LLC. It announced Friday afternoon that its financing arm would discontinue offering leasing deals to its U.S. customers beginning August 1; the same date when their $30 billion credit facility is up for renewal. The rising cost of capital is making leasing terms less attractive to consumers. This is another aftershock resulting from stifling energy prices and an economy that's deleveraging.

Declining SUV and lease values forced Ford to take a $2.1 billion charge at its finance division last week. Although, third party banks and credit unions will step in to fill the void, expect some slippage in the approval rates for leasing transactions. The same market pressures compelling Ford (F) to exit this market will certainly continue to present as a business factor for any entity looking to make a profit leasing vehicles. The cost of capital is important, however, the residual value of the underlying asset is monumental. The percentage of Chrysler sales attributed to leasing is greater than 20 percent.

It will be very interesting to see if this extemporaneous admission becomes evolutionary inside America's automobile industry. Americans divine right to drive automobiles has been an unconditional assumption since the end of WWII. In 2008, it's a fair question to ask given this extraordinary economic environment of failing banks, growing home foreclosures, stagnant incomes, evaporating jobs, personal and business credit contraction, a runaway federal budget, an aging infrastructure, an expensive endless foreign war, a fractured financial system, rising worldwide demand for limited resources, and a demonstrable shifting of global wealth. Plus, the third generation of Americans, exposed growing up around an enlightenment concerning the ecology and global environmental issues, is being handed the task of running our economy. They will shape and modify our society's habits in the future.

The U.S. Senate actually gaveled a rare Saturday session passing landmark legislation to triage a metastasizing bankrupted residential real estate market. Highlights of the bill include; a new regulator for Fannie Mae (FNM) and Freddie Mac (FRE) and up to $300 billion to insure refinanced mortgages for the next 18 months; $4 billion to states to buy and rehabilitate foreclosed properties, a 10 percent tax credit up to $7,500 dollars for first time home buyers purchasing a home between April of this year and June of next year; increase the federal debt limit to $10.6 trillion, and more.

We now have a de facto nationalized residential real estate market. The reversal by the White House to withdraw a veto threat and sign a passed bill into law would create tears of joy on the face of Scottish economist John Law and Louis the XIV of France. Welcome to the new depression. France has succumbed to capitalism. In between fist bumping with the Democratic presumptive nominee Barack Obama and checking out his Italian-born former model turned pop star wife's, Carla Bruni-Sarkozy's new music album, "Comme si de rien n'etait"(As if nothing had happened), President Nicolas Sarkozy of France bullied his National Assembly into radically reforming their 1958 Constitution. Passage of the reform package includes limiting Presidential terms, strengthening the power of the legislature, weakening the position of Prime Minister, and repealing the 35 hour per week cap for workers.

It is an indication that the global downturn will affect everyone. The French are now more aware than ever of prioritizing work and leisure to enhance income and productivity. Calling national strikes on idealistic principles was an industrial age luxury. Cash flow is paramount in the beginning of the 21st century. Welcome to the club.

The year 2008 will record the resignation of Fidel Castro of Cuba, as its President, and the abandonment of immense leisure time by the average French worker; two aging symbols of 20th Century socialism. I wonder if Hank Paulson and Ben Bernanke are erecting the first 21st century's symbol of socialism. Tonight, I shall pour a very, very, nice XO Cognac and contemplate the upcoming Consumer Confidence figure on the 29th; the Employment and Crude Inventories figures on the 30th; the GDP-Advanced, Initial Claims, and Chicago PMI, on the 31st; and August 1st, Auto and Truck Sales, Average Workweek, Hourly Earnings, Nonfarm Payrolls, Unemployment Rate, Construction Spending, and the ISM Index. Maybe two drinks, au revoir!