Financial Review

Immovable v. Unstoppable

Sinclair Noe — January 4, 2017

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DOW + 60 = 19,942
SPX + 12 = 2270
NAS + 47 = 5477
RUT + 30 = 1387
10 Y un = 2.45%
OIL + 1.02 = 54.31
GOLD + 4.80 = 1164.10

What happens when an unstoppable force meets an immovable object? The Federal Reserve released the minutes from its December meeting; that’s the meeting where the Fed raised interest rates for only the second time in a decade.

Almost all Federal Reserve policymakers thought the economy could grow more quickly because of fiscal stimulus under the Trump administration and many were eyeing faster interest rate increases to counteract.

Trump’s promises of tax cuts, infrastructure spending and deregulation could boost inflation and might set the stage for a confrontation between a president seeking to boost economic growth and the Fed, which is tasked with keeping the economy from overheating. The minutes showed policymakers might signal an even more aggressive path of rate increases if inflationary pressures rose.

At the same time, Fed policymakers “emphasized their considerable uncertainty” about future economic policy changes. The Fed expects Trump’s election might result in slightly faster economic growth over the next several years, but it won’t happen right away and they see little chance of the boom times Trump has promised – so business as usual; which is a trajectory of 3 rates hikes in 2017, perhaps the most hawkish FOMC minutes in the past few years.

As for the unstoppable force versus immovable object debate, relativity proves there is no such thing as an immovable object and since we do not have a source of infinite energy to stop an object, there are no unstoppable objects. So, what happens when two massively infinite unacceleratable objects approach each other on a collision course and neither changes its velocity? They must pass right through each other with no effect on each other at all.

Short-term interest rate futures rose slightly after the release of the minutes but not enough to suggest altered expectations for the central bank’s rate hike path this year. The dollar backed off 14-year highs.

The rate banks charge each other to borrow dollars for three months rose above 1 percent on Wednesday for the first time since May 2009. The London interbank offered rate, or LIBOR, is a global rate benchmark for $350 trillion worth of financial products worldwide.

Mortgage interest rates came down slightly to end the year, but not enough. Mortgage application volume plunged 12 percent for last week, seasonally adjusted, from two weeks earlier. The Mortgage Bankers Association said mortgage application volume typically drops sharply over the holidays.

However, this year, as mortgage rates continued their upward climb reaching the highest levels in more than two years, overall application volume fell even more than the holiday slowdown would suggest. The average interest rate for conforming 30-year fixed-rate mortgages decreased to 4.39 percent from 4.45 percent, plus points.

Meanwhile, President Obama exhorted fellow Democrats to preserve Obamacare, as Republicans launched their bid to scrap it in what Vice President-elect Mike Pence called the “first order of business” of Donald Trump’s administration.

Actually, it would be the second order of business for the 115^th Congress, following a failed attempt to gut the ethics office. Pence met Republican lawmakers to plot the path forward on scuttling the law. Pence said Trump will work in concert with congressional leaders for a “smooth transition to a market-based healthcare reform system” through legislative and executive action.

During two news conferences, Pence, Speaker of the House Paul Ryan and Senate Majority Leader Mitch McConnell offered few details on what a Republican-backed replacement for Obamacare would look like. And there’s the rub. Any attempt to repeal Obamacare will need a replacement stapled to that bill.

Auto sales for December trickled in through the trading day. US auto sales rose for an unprecedented seventh straight year in 2016, topping the record set in 2015. In December, sales rose at a seasonally adjusted annual rate of 18.4 million according to Autodata.

But the auto sales boom could be leveling off. Some automakers are trimming production because excess cars and trucks are sitting on dealer lots. Car prices are already at record levels. That is partly because buyers are shifting from less expensive cars to crossovers, SUVs and trucks, and partly because of demand for the latest safety and tech features, such as automatic braking and internet.

There is also growing concern about rising default rates on car loans, particularly among less creditworthy buyers. If lenders pull back, that will hurt car sales.

GM led year-on-year growth in December with an increase by 10%. GM said the average transaction price for its vehicles rose $740 from November to $36,386 in December, reflecting in part strong sales of large SUVs.

Ford said it sold 87,512 F-Series pickups in December, the lineup’s best overall sales month in 11 years. The F-series was the best-selling model line in the United States last year, for the 40th year in a row. Ford sales overall were up just 0.1% in December.

Fiat Chrysler sales slid 10%. Nissan sales rose 10%. Honda sales were up 6.4%. Toyota up 2%. Volkswagen posted a 20% gain in sales.

Tesla fell short of its goal for 80,000 auto deliveries in 2016. The electric car manufacturer delivered 76,230 cars in 2016. That’s still far more than the roughly 50,000 cars it delivered a year earlier. Tesla may face fresh competition; Faraday Future unveiled its “FF 91”, which it describes as the most technologically advanced luxury electric SUV. The car is expected to retail for $180,000 and you can reserve one with a $5,000 down payment.

Can you name the best-selling car in Sweden? (Volvo?) Wrong! For the first time in 54 years, the best-selling car in Sweden is not a Volvo. The Volkswagen Golf knocked Volvo’s most popular luxury models off the throne in 2016. Three of the top five models on the sales ranking were from Volvo, and the brand accounted for around one fifth of all vehicles sold in Sweden last year. Sweden is Volvo’s second biggest market after China.

Amazon.com delivered a record more than 2 billion items for sellers worldwide in 2016. Items shipped by Fulfillment by Amazon rose 50% in the holiday season, while deliveries to prime members numbered in the millions. The online retailer said active sellers using the Fulfillment by Amazon service increased more than 70% in 2016, and units shipped grew more than 80% outside the U.S. The number of sellers that reached $100,000 in sales rose by 30%. The company estimates that sellers have created more than 600,000 new jobs outside of Amazon.

Last week we reported that Sears had told employees to expect more store closures. Today Sears went public with the details. The company will shut down a total of 108 Kmart stores and 42 Sears stores by April – 150 stores total, although apparently, none in Arizona.

In the most recent quarter, Sears’ revenue fell 13%, to $5 billion, and its losses widened to $748 million from $454 million in the period last year. Same-store sales dropped 7.4%, including a 10% decrease at Sears stores and a 4.4% decrease at Kmart stores.

Both Kohl’s and Macy’s reported lower sales during November and December 2016 than the year before. Both retailers announced sales declines of 2.1% from the same two months in 2015. Additionally, both Kohl’s and Macy’s said that sales at owned and operated stores were down by 2.7% this holiday season. Following the news, Kohl’s was down over 10.5%, while Macy’s was down 5.5%.

A District judge in Texas almost halved the award in a December jury verdict that ordered Johnson & Johnson and its DePuy Orthopaedics unit to pay more than $1 billion to plaintiffs in six lawsuits who said they were injured by DePuy’s Pinnacle hip implants.

Around $500 million of punitive damages would be cut from the more than $1 billion awarded to the plaintiffs who are California residents that were implanted with the hip devices and experienced tissue death, bone erosion and other injuries they attributed to design flaws.

DCP Midstream Partners said it had acquired the assets of a joint venture between Phillips 66 and Spectra Energy, to create the largest natural gas liquids producer and gas processor in the United States. The combined company, which has an enterprise value of $11 billion, will be renamed DCP Midstream LP and will trade with the ticker symbol “DCP”.

A former Barclays trader pleaded guilty to US charges arising from a global investigation into the manipulation of foreign-exchange prices at major banks. Jason Katz’ plea came after Barclays and three other banks last year pleaded guilty to conspiring to manipulate currency prices. Barclays agreed to pay $2.4 billion to resolve various related U.S. and UK probes. Katz is the first person to admit criminal wrongdoing about the Forex rigging case.

According to a report quietly released by the U.S. Treasury’s Office of Financial Research “U.S. global systemically important banks (G-SIBs) have more than $2 trillion in total exposures to Europe. Roughly half of those exposures are off-balance-sheet…U.S. G-SIBs have sold more than $800 billion notional in credit derivatives referencing entities domiciled in the EU.”

When a Wall Street bank buys a credit derivative, it is buying protection against a default on its debts by the referenced entity like a European bank or European corporation. But when a Wall Street bank sells credit derivative protection, it is on the hook for the losses if the referenced entity defaults.

Regulators will not release to the public the specifics on which Wall Street banks are selling protection on which European banks. The OFR report also indicates that regulators still do not have access to adequate data from the biggest banks and insurers to assess the dangers in real time.

Financial Review

Ongoing Criminal Enterprises

Sinclair Noe — May 20, 2015

 

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

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DOW – 26 = 18,285
SPX – 1 = 2125
NAS + 1 = 5071
10 YR YLD – .01 = 2.25%
OIL + .77 = 58.76
GOLD + 1.80 = 1210.80
SILV un = 17.18

April 29 and 30 the Federal Reserve’s Federal Open Market Committee met to determine monetary policy; today, they published the minutes of that meeting. There were no surprises. Policymakers have no plans to increase interest rate targets in June. We all knew that. Officials in April “had increased uncertainty regarding the economic outlook,” the minutes showed. They had no good reason to explain why consumer spending was so weak.

“Most” Fed officials think the dramatic slowdown in growth in the first quarter was transitory and that a moderate rebound would resume in the second quarter. Inflation was also expected to move higher.  The international context isn’t helpful to the US economy. Fed officials deem “foreign economic and financial developments” as constituting “potential downside risks,” and they specifically mention Greece and China. Moreover, despite its recent partial retracement, the dollar’s appreciation is “likely to continue to be a factor restraining US net exports and economic growth for a time.”

This suggests that they see a rate hike coming sometime later this year. Only a “few” on the U.S. central bank questioned whether the Fed was providing enough stimulus for the economy at the present time and cautioned against any rate hike in the near future. This is an interesting point because the Fed really hasn’t provided much stimulus for the economy; they have provided stimulus to financial markets but not the broader economy in a direct fashion.

Indirectly, the Fed has provided stimulus to the broader economy through something known as the monetary transmission mechanism, which works largely through housing or other long-lived investments which are sensitive to interest rates. Interest rates don’t have strong impact on short-term investments or short-term capex. A lot of business investment is short-term; a lot of household spending is short-term. So Fed policy, by moving interest rates, normally exerts its effect mainly through housing. And interest rates do move housing. Remember the early 1980s when Paul Volker decided to tighten, interest rates jumped, and housing collapsed. And housing has come back from the lows, but not all the way back. One reason is because people who are most likely to buy houses got slammed in the downturn and couldn’t or wouldn’t jump back into that frying pan.

Today’s economic data backs up the relationship between housing and rates. Mortgage purchase applications fell 4.0 percent in the May 15 week though, year-on-year, applications are still up a very strong 11.0 percent. The ongoing run up in mortgage rates may be easing demand for mortgage applications just at the time that demand for purchase applications had been gaining steam.

And so the Fed is feeling like it has its back to the wall, and the wall is zero interest rates. If there is an economic problem the Fed can’t respond by lowering interest rates, or at least the impact of going into negative territory would be dangerous ground.

There was some debate about how to communicate any move to tighten rates. Some officials think it is important to give a warning to the markets, others worry that telegraphing intentions to hike rates will only result in a rate tantrum. The recent bond-market rout underscores that with bond yields near historical lows, even a moderate rise in yields would chip away the slim interest payments and inflict pain on bondholders. The Fed identifies this as episodes in which there were large monetary disturbances not caused by output fluctuations. Hopefully the Fed remembers the lesson from the Crash of 87; the markets respond violently to surprise rate hikes.

A mixed bag of economic releases this month has bolstered investors’ expectations that the Fed would wait until late this year to act. Fed Chairwoman Janet Yellen will make a speech on Friday that might provide further guidance.

Five global banks have agreed to pay $5.8 billion in combined penalties and will plead guilty to criminal charges related to manipulating foreign currency exchange rates, also known as Forex. Four of the banks, JPMorgan Chase, Barclays, Royal Bank of Scotland, and Citigroup, will plead guilty to conspiring to manipulate the price of US dollars and euros.

Barclays will pay $650 million, Citigroup $925, million J.P. Morgan $550 million and RBS $395 million. Barclays will pay another $1.3 billion to New York State, federal and U.K. regulators.

The fifth bank, UBS, received immunity in the antitrust case because they informed regulators about the Forex rigging as part of an earlier deal related to Libor rigging; UBS had signed a Non-Prosecution Agreement in 2012 on the Libor charges, and their misconduct in the Forex markets violated that earlier agreement even though they self-reported wrongdoing. So, they have immunity on Forex but they had to plead guilty to Libor rigging.  UBS will pay $545 million in fines to the Justice Department and Federal Reserve.

The five banks will pay a further $1.6 billion in fines to the Federal Reserve. Bank of America also faces a $205 million fine by the Fed, but no criminal charges. No bank employees have been criminally charged. The five banks will be under a three-year period of probation.

Between December 2007 and January 2013, euro-dollar traders at Citigroup, JPMorgan, Barclays, RBS and UBS gathered in an exclusive electronic chat room and used coded language to coordinate their moves in the U.S. dollar-euro market. They referred to themselves as the Cartel. By agreeing not to buy or sell at certain times, they protected each other’s trading positions. The big banks were the market makers, setting daily exchange rates, known as the fix. The fix became the price paid for billions of dollars of currency bought or sold on any given day.

And the Cartel managed to skim a little for their efforts. One Barclays trader in the chat room about adding secret mark-ups to the prices wrote: “If you ain’t cheating, you ain’t trying.” Ben Lawsky, New York’s superintendent of Financial Services explained it simply:  “They engaged in a brazen ‘heads I win, tails you lose’ scheme to rip off their clients.” Also, a side note, after the big settlement announcement Lawsky announced he will step down next month as New York’s top bank regulator after four years. To his credit, he is not going to work for JPMorgan.

I have not yet seen a figure for how much prosecutors think the Cartel stole, but the Forex market trades close to $5 trillion dollars a day, so today’s fines amount to about one/one-thousandth of daily volume. The rigging took place over more than 5 years. I’m guessing that the money they stole in rigging Forex might amount to more than the fines ordered today. And that raises another interesting question – how did they report that income? Will they now go back and amend their earnings reports?

Didn’t managers and Board of Directors sign off under Sarbanes-Oxley?

And remember that the Forex scandal follows on the heels of the Libor rigging scandal, and the ISDAfix scandal (that involved the $381 trillion market for interest-rate swaps and the $44 trillion market for options on swaps. Banks use it to set coupons paid for bonds tied to commercial real estate. And there is a mountain of evidence, and today Barclays agreed to a $115 million dollar settlement on the ISDAfix investigation. Other banks are also being investigated.)

And before that, the municipal bond rigging scandals, and scandals in commodity markets including precious metals, and tax evasion scandals, and money laundering scandals, and predatory lending scandals, and much, much, much more. Past performance is not a guarantee of future results, but based on past performance you have to figure that the banks have rigged all the financial markets.

FT has a running total of legal fines and settlements paid by banks to US regulators since 2007. According to their calculations, the tote board just touched $155 billion. In case you were wondering, over eight years that works out to $53m per day (including weekends, because client service is a 24 hour kind of business, right.)

The big news in today’s settlement was not the size of the fines, not the scale of the scandal, but that the banks actually admitted criminal guilt. UBS violated its 2012 Non-Prosecution Agreement, and we’re still just looking at a fine for a repeat offender. The banks will get to keep their charters; they can continue to conduct business; three years’ probation. They can still vote, or at least buy elections. The deal does not prevent the Department of Justice from going after individual criminal charges but for now, nobody goes to jail.

HSBC has become one of the biggest global banks to say it will begin charging clients on deposits in a basket of European currencies to prevent its profit margins from being crushed in a record low-interest rate environment. The unusual steps come after the ECB last year became the first big central bank to announce a negative deposit rate, in effect a penalty on banks parking their surplus cash.

The Japanese economy staged a comeback in first quarter, expanding at an annualized 2.4% vs. the previous quarter. Despite the positive figure, economists are still worried about Japanese growth and deflation as most of the expansion was due to a huge build-up of inventories. The Nikkei Stock Index finished the session at a 15-year high.

It is widely recognized that Greece is running out of money. The next questions are when they will run out money and what will happen when they run out of money. Nikos Filis, from the ruling Syriza party, told Greek television Greece will not be able to make a €1.5 billion repayment to the IMF that falls due on June 5 if there is no deal with its international creditors by then.

Financial Review

Inmates Run the Asylum

Sinclair Noe — May 15, 2015

 

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DOW + 20 = 18,272
SPX + 1 = 2122
NAS – 2 = 5048
10 YR YLD – .10 = 2.14%
OIL – .01 = 59.87
GOLD – 2.20 = 1223.00
SILV + .06 = 17.53

The S&P 500 index hit a record high close for the second day in a row. The S&P added 0.3 percent this week for its first back-to-back weekly gain in more than a month. The Nasdaq posted a small gain for the week.  The Dow Jones Industrial Average gained about 0.4 percent for the week. The Dow is close to another record. The old record is 18,288 from March 2.

So, to see if this little rally has legs, we can look at the Dow Jones Transportation Index, because according to Dow Theory, if the industrials are performing, they have to ship their products to market, so the Dow Transports should confirm any move by the Industrials. We are not getting confirmation. Transports topped out in November, and then there were 4 failed attempts to break through the high of 9310. And since March, the Transports have been consolidating lower. Now this doesn’t mean that the Industrials can’t hit a new record on Monday; after all the index is within spitting distance of the old record; but if the rally has legs, we would need to see Transports exhibit some signs of life. When we see a divergence, the we can expect the transports to drag down the broader market.

Industrial production fell a seasonally adjusted 0.3% in April.  Excluding autos, manufacturing was down 0.1%. As expected, mining and utilities output declined last month; that category includes oil exploration – which was down 14.5%. Capacity utilization dipped to 78.2% from 78.6% in March, indicating little cost pressure on goods prices. Meanwhile, the University of Michigan Consumer Sentiment Index fell to a preliminary May reading of 88.6, a seven-month low, compared with a final April level of 95.9.

A new study of labor market data by the Kansas City Fed concludes that since 2009, job growth has been strong for middle-skill and high-skill workers, but has remained weak for low-skill jobs. Middle-skill jobs rebounded in the first two years of the recovery and high-skilled jobs started to return in 2012. Growth in the upper two sectors has improved in each of the past three years. Low-skill jobs remain the one segment of the labor market that has yet to return to prerecession growth levels.

Note, the study talks about skill jobs, not about wages, although it may rightly be assumed that a highly skilled adjunct professor would make more than burger flipper – that is not always the case. Last week’s jobs report showed average hourly wages increased by only 0.1% in April and 2.2% for the past twelve months, which really means wages were flat after factoring inflation, and even in a recovering job market. What we have seen is wages fall in a recession, but remain flat in an economic recovery. Because wages remain sluggish, monetary policy doves are urging the Fed to hold off on raising rates. Yellen acknowledged that wages are not where they should be at her Congressional testimony last month.

So, where is the slack in the labor market? Much of it comes from workers who lost jobs in the downturn, and just left the labor pool; many of those workers were discouraged at prospects, and many others took a somewhat forced version of retirement. It is estimated that somewhere between 6 million to 17 million workers are under-employed, while another 6 or 7 million left the labor pool and are no longer counted. And don’t forget that new workers are added to the labor pool at the rate of about 80,000 per month. All those students in their graduation caps and gowns will be looking for jobs next week. So, there is plenty of slack (without even touching on globalization), and that is all reflected in wages.

The median weekly real income of men (including both wage and salary workers) working full time is an amazing $80 per week less today than it was 36 years ago in 1979, when converting to current dollars. That adds up to some $4,000 per year. And the median household income is down $5,000 per year over the past 15 years. And this is happening even as the jobs that are available demand a higher and higher skill set.

Dealmaking in the U.S. in 2015 has climbed 48 percent year-on-year to $565 billion, the highest level since 2007, following a string of multi-billion dollar acquisitions this week, including: Danaher acquiring Pall for $13.8 billion, Williams Companies acquiring Williams Partners for $13.8 billion, and Verizon acquiring AOL in a $4.4 billion deal. JPMorgan tops the list of U.S. M&A advisers with $153 billion from 52 deal. The New York Times is reporting that Visa, the credit card company is said to be in talks to buy its former subsidiary, Visa Europe, for as much as $20 billion. And the Wall Street Journal is reporting. Shutterfly, which is in a proxy fight with Marathon Partners Equity Management, said it would continue to consider “strategic transactions that provide compelling value”

Next week, four banks are expected to plead guilty to criminal antitrust charges in relation to manipulating the foreign exchange, or Forex, markets. The four banks are Barclays, JPMorgan Chase, Citigroup, and Royal Bank of Scotland. UBS will escape a guilty plea to fraud and antitrust charges related to foreign-currency rigging.

As required by the terms of a 2012 settlement, UBS self-reported the currency rigging and provided early cooperation which helped prosecutors in their investigation, so they felt they should have immunity for the fraud and anti-trust charges. But UBS is not off the hook; they will likely skate on anti-trust but still face fraud charges; and the reason is simple – they are a repeat offender. In 2012, UBS was under investigation for rigging the Libor, interest rates; the bank reached a settlement with prosecutors in which they agreed to “commit no United States crimes whatsoever” for the two-year term of the agreement. The 2012 settlement on rigging Libor followed on the heels of a 2011 settlement related to antitrust violations in the municipal-bond market. And that followed on the heels of a deferred-prosecution agreement in 2009 to resolve charges it helped American taxpayers hide money overseas.

So, now UBS is whining about not getting total immunity; apparently unable to distinguish between leniency and absolution. As a result, the bank is scrambling to continue to hold its charter in the US by obtaining waivers from regulators to allow it to continue operating certain businesses and access some benefits. UBS lawyers have been in marathon talks this week with prosecutors hammering out what court-filed documents will say about the bank’s alleged violations.

So, it sounds like the Justice Department is finally getting tough. According to the Murdoch Street Journal, the prosecutors were blowing up the 2012 deal. It sounds tough, right? Not so much. It is very likely that UBS will be allowed to continue doing business in the US, after they pay a multi-million dollar, slap on the wrist, fine. But what about the other banks that are expected to plead guilty to criminal anti-trust charges? Well, again, it’s a slap on the wrist fine and they will be able to continue doing business despite criminal charges.

But wait, there’s more. For example, what will happen to the foreign exchange market? Don’t worry, it’s in good hands. The New York Federal Reserve Bank is responsible for something called the Foreign Exchange Committee meets six to eight times per year and is responsible for establishing best practices in the Forex market. The committee members are commercial banks and investment banks. The Chair of the committee is a man named Troy Rohrbaugh, who is also the head of Foreign Exchange Trading at JPMorgan Chase, now and when the criminal activity was alleged. Before him, the chair was a man named Jeff Feig, who was from Citigroup. So, at the NY Fed, the committee charged with cleaning up the Forex market was chaired by a couple of guys from a couple of banks that are about to plead guilty to criminal charges in the Forex markets. And with guilty pleas expected next week, what has the NY Fed done about this arrangement? Nothing. Because the NY Fed is a captured regulator. Truly a case of the inmates running the asylum.

And that brings us to former Federal Reserve Chairman Ben Bernanke’s latest blog. The Bailout Prevention Act-a bipartisan bill introduced Wednesday-would seek to curb risk-taking from large banks by removing some of the Fed’s ability to bail them out. Bernanke thinks limiting bailouts is a bad idea. Bernanke says that in the 2008 crisis, the Fed served as a lender of last resort and he takes his bows for saving the global financial system from meltdown. And there is some truth to that. Then he says the Fed should still be able to bailout the banks if another problem crops up. And there he is wrong.

Bernanke says limiting the Fed’s ability to protect the economy in a financial panic would be a mistake. But we know the Fed has many other tools beside bailouts. What the Fed should do is fulfill its duty as a regulator. The Fed should set strong standards for banking activity; they should work with prosecutors to enforce the rules; if the laws are broken, the offending banks should have their charters revoked and the bank officers jailed. And if that happened, I suspect the banks would become the very picture of financial probity and we would never have to worry about a bailout ever again. And if they did slip up and try to destroy the financial system, we could chop them into small digestible pieces that could no longer pose a threat.

Financial Review

Hot Fun in the Summertime

Sinclair Noe — May 11, 2015

 

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

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DOW – 85 = 18,105
SPX – 10 = 2105
NAS – 9 = 4993
10 YR YLD + .12 = 2.27
OIL – .10 = 59.29
GOLD – 4.00 = 1184.50
SILV – .13 = 16.38

The S&P 500 Index went up to 2117.69, it sat there for a couple of seconds then fell; the reason this is important, or not, is because 2117.69 is the record high from April 24; also, last Friday, the S&P hit 2117.66 for an intraday high. It has been at or near this level several times in the past 3 months, but it can’t break through. Meanwhile, about $100 million in options on the VIX changed hands at 12:16:04 this afternoon; that’s a little more than a half day’s normal volume in a split second. The VIX is the Volatility Index. Just over 1 million contracts were traded. The trades were spread among four contracts that pay off at different dates and prices, say if the VIX rises to 17 by June or 23 by July. We don’t know who made the trade, but somebody is betting things will get hot this summer.

On Friday, the Jobs Report showed the economy added 223,000 jobs and the unemployment rate dropped to 5.4%. We’ll get more information on the labor market tomorrow with the JOLT survey, which takes a look at job openings and labor turnover; that should tell us whether workers are confident enough about their job prospects to quit their current job. On Wednesday, we’ll get reports on retail sales and inflation at the wholesale level.

The bond market tantrum that lasted for most of the past three weeks seems to be cooling off as signs of mixed global economic growth revive demand for the fixed-income assets. In that time frame, the amount of bonds trading with negative yields has dropped from $3 trillion to $1.7 trillion in a sign that borrowing costs may have hit their floor. Benchmark 10-year Treasury yields at today’s level of 2.27% have risen beyond the level many economists projected for mid-year, while German bunds remain little changed at 0.61%. And it may surprise you that short-term US bonds have been slipping in and out of negative territory.

The problem is there aren’t enough to go around. With supply at multi-decade lows, investors are signaling alarm as regulations intended to shore up banks and prevent a run on money-market funds exacerbate the bill shortfall. Financial institutions expect an extra $900 billion of demand for government securities during the next 18 months, putting pressure on a sizable chunk of the $1.4 trillion bill market. It might even put pressure on the Fed. What if the Fed raised its Fed Funds target rate, and short-term rates went down? The mismatch between supply and demand has been so acute that four-week bill rates fell to minus 0.0304 percent on April 29, the lowest on a closing basis since December 2008. Yields on three-month bills also turned negative. The consequences extend well beyond the fixed-income market as depressed rates in the $2.5 trillion money-market fund industry stand to deprive savers of income long after the Federal Reserve starts raising interest rates.

The Treasury says it will sell more short-term bills, but they haven’t offered details. Meanwhile, the government seems focused on longer-term debt. The average maturity of US debt outstanding has stretched to 69 months. One reason for the increased demand is that banks and other financial institutions have higher capital requirement; that makes deposits more costly for banks to hold, so they are discouraging some depositors from depositing cash; the logical place for cash not deposited is in short-term bills.

Now for the good news/bad news. The good news for the bond market is there isn’t much cash sitting on the sidelines. The bad news for the stock market is there isn’t much cash on the sidelines. Mutual fund managers have the lowest cash levels in history and money market fund levels are lower now than in 2007 and near a record low from 2000 relative to the capitalization of the stock market. This suggests that investors are heavily allocated in stocks. So what is propping up the stock market? Buybacks, mergers and acquisitions, and demand from foreign central banks; all of which falls under the category of financial engineering.

At least 30 countries have loosened monetary policy this year. On Sunday, China’s central bank cut its benchmark one-year lending rates by 25 basis points to 5.1%, its third reduction since November, as economic growth cools to levels not seen since the global financial crisis. The People’s Bank of China also reduced one-year benchmark deposit rates by 25 bps to 2.25%; it also gave banks leeway to offer up to 1.5 times the benchmark deposit rate, up from 1.3 times previously. Now you might be wondering why the PBOC would cut rates, which would encourage more lending activity, while at the same time increasing rates for people to park money in deposits, which takes money out of circulations.

Part of the problem for China is that they still peg the yuan to the dollar, and the dollar has been strong; if the yuan follows the dollar, it leads to effective monetary tightening despite two rate cuts so far.  Since mid-2014, China’s real effective exchange rate has appreciated by more than 15% against its peers. Also, as the PBOC is buying back its own money to protect the level of the yuan, this is again another form of tightening. And in a further counterproductive move, the more China cuts interest rates, the more it encourages capital to exit due to declining yields.  If that new money created is not leaking abroad, it is either going into servicing China’s large existing debt or else is flowing into the stock market rather than going to supporting real economic activity.

And while China has strong capital controls in place, smart investors follow the money. The problem for mainland Chinese authorities is they are not in control of how private holders of wealth move their money.  For example, only last week it was revealed Chinese investors and immigrants together purchased more than $6.3 billion in Australian residential property over the space of 12 months. And if the People’s Bank of China loosens monetary policy at the same time that the Federal Reserve tries to hike rates, this might trigger further capital outflows into the dollar.

China overtook the U.S. as the world’s biggest importer of crude oil in April, with purchases from overseas hitting a new high of 7.4 million barrels a day (equivalent to roughly one in every 13 barrels consumed globally) and topping U.S. imports of 7.2 million barrels per day. While China’s imports are not expected to consistently surpass those of the U.S. until the second half of this year, the move highlights how the U.S. shale revolution has cut the country’s reliance on oil from overseas – and how China’s demand has grown even as its economy slows.

Eurozone finance ministers met today in Brussels to discuss Greek debt. Athens has reportedly scraped together 750 million euro to pay the International Monetary Fund. However, the coffers in Athens are thought to be completely dry and it’s uncertain how Greece will make welfare payments in the coming days. The IMF is now working with national authorities in southeastern Europe on contingency plans for a Greek default.

Citigroup says the Justice Department declined to prosecute the bank after a probe into rigging of the London Interbank Offered Rate, or Libor. In 2013, Citigroup agreed to pay $78 million as one of six banks to settle with the European Union over allegations they rigged interest rates tied to Libor. Citigroup still has legal problems. In a regulatory filing, Citi said it could plead guilty to an antitrust charge to resolve a Justice Department investigation of its dealings in foreign exchange markets. And Citi might not be alone. The parent companies or main banking units of as many as five major banks, rather than their smaller subsidiaries, are expected to plead guilty to US criminal charges over manipulation of foreign exchange rates; deals could be announced this week. It would be unprecedented for parent companies or main banking units, rather than smaller subsidiaries, of so many major banks, to plead guilty to criminal charges in a coordinated action. The banks looking at a forex deal include JPMorgan, Citigroup, Royal Bank of Scotland, Barclays, and UBS. If parent companies of JPMorgan and Citigroup plead guilty, it would be the first time in decades that a major American financial institution has done so.

The Justice Department has been negotiating with the banks for months over how to resolve allegations that traders colluded to rig rates in the largely unregulated $5.3 trillion-a-day currency market. Authorities now may seek to limit the fallout from guilty pleas with assurances from various regulators that banking licenses will not be automatically revoked. Institutions may obtain waivers if the pleas would otherwise prohibit them from business activities such as participating in certain private offerings, or trading in government securities.

Noble Energy agreed to acquire Rosetta Resources for $2.1 billion in stock, giving the natural gas and oil producer a position in two of the largest areas of shale production in Texas. It’s the largest takeover of a U.S. oil and gas producer announced this year. Noble will also assume Rosetta’s net debt of $1.8 billion. The per-share offer is valued at $26.62, a 38 percent premium to the target’s closing price on Friday. The premium for Rosetta is below average for the sector over the past five years, suggesting there are more mergers to come.

DTZ, a commercial real-estate-services firm backed by TPG Capital, has agreed to buy Cushman & Wakefield, the largest closely held commercial-property brokerage, in a deal that values the company at about $2 billion.

The World Health Organization has declared Liberia free of Ebola, marking the end of a national outbreak that infected as many as 400 new victims a week at its peak. Liberia has now gone 42 days – twice Ebola’s maximum incubation period – since the burial of its last confirmed patient without discovering a new case. The disease is still spreading in Sierra Leone and Guinea, though at a slower pace. According to WHO statistics, more than 11,000 people have died from the virus, with about half of them in Liberia.

Financial Review

A Question for the New AG

Sinclair Noe — February 10, 2015        

              

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

DOW + 139 = 17,868
SPX + 21 = 2068
NAS + 61 = 4787
10 YR YLD + .04 = 1.99%
OIL – 2.10 = 50.76
GOLD – 5.00 = 1234.70
SILV – .06 = 17.01

Small-business sentiment slipped in January on a decline in optimism over sales growth and business conditions, according to a gauge released Tuesday. The National Federation of Independent Business said its small-business optimism index fell 2.5 points to 97.9, with seven out of 10 components declining.

Good news if you are looking for a job. The Labor Department said job openings surged to 5.03 million in December, the highest level since January 2001, from 4.85 million in November. Hiring jumped to a seven-year high and the number of job seekers for every open position, a key measure of labor market slack, fell to 1.73 in December, the lowest since 2007. The bad news is that there are still about 9 million people looking for a job.

Wholesale inventories barely rose in December, up just 0.1%. Together with data last week showing a 0.3% fall in manufacturing inventories in December, today’s report suggests the boost to GDP growth from restocking in the fourth quarter was probably not as large as initially thought.

Halliburton is cutting as many as 6,500 jobs. The oil company, facing up to the reality of crude oil prices, announced that it’s slashing between 6.5% and 8.5% of its global workforce. The cuts are doing little to assuage investors; Halliburton’s stock is down 3% today.

In the past 2 weeks oil prices bounced 20% from lows around $44 a barrel. The recent surge in oil prices is just a “head fake” and West Texas crude as cheap as $20 a barrel may soon be on the way, according to a new research report from Citigroup’s global head of commodity research. The prediction is that oil will drop to $20, then bounce back to $75, all this year. It’s the stuff of a commodity trader’s dream. Wall Street lusts for it. Hedge funds can hardly contain themselves at the mere thought of it. So whose book is Citi talking up?

If the price of oil stays in the current range, liquidity for much of the oil patch will run out in 2016, and that’s when waves of defaults will begin to cascade through bank and private-equity balance sheets. And beyond that, investment banks stand to lose a lot: in 2014, Citi earned $492 million in energy-related investment-banking revenues – more than any other bank; More even than JP Morgan. So Wall Street must have a V-shaped recovery in place by 2016, or else.

Tomorrow we will get a better idea of the direction of oil prices, at least for the short-term, when the Department of Energy releases its weekly report on inventories. US commercial crude-oil supplies stood at a record high of 413.1 million barrels in the week ended Jan. 30. Analysts are estimating that inventories will hit a new record high, up 4 million barrels for the week. Oil dropped, but closed above $50.

So, what are Americans doing with some of the money they’re saving from cheap gas? They are buying more fuel.  Demand is up. At the same time, faster economic growth and a big influx in hiring over the past year means more Americans are now taking part in the daily commute. According to Nicolas Colas chief market strategist of ConvergEx: “We’ve finally discovered where American consumers are spending some of the savings from lower gasoline prices: they are buying more gasoline.” Plunging prices are encouraging Americans to drive more often and buy more trucks. The best-selling vehicle in the US in December was the Ford F-150; SUVs were also popular. Apparently, when gas prices drop, we forget all about conservation.

The squeeze on U.S. farmers is getting worse as low crop prices and rising costs erode incomes that not long ago were the highest ever. Farm income in the U.S., the world’s top agricultural producer and exporter, is poised to drop for a third straight year in 2015. While raising livestock remains profitable, as tight meat supplies keep prices high, growers of corn, soybeans and wheat saw crop and land values fall faster than many of their costs.

Net-cash income from all farm activity will drop 22% to $89 billion, the biggest drop since 1932 and the lowest since 2009, the U.S. Department of Agriculture said in a report today in Washington. Last year’s slump was 12% to $115 billion. Net income, including the value of inventory and non-cash income, was forecast to drop 32% to $73 billion, with expenses at a record $370 billion.

The drought in California continues. We’ve been hearing a lot about extreme weather lately; historic snowfall in Boston, and last weekend saw more than a foot of rain in some parts of northern California. Water is water and anything can make some difference but the rain last weekend was of the tropical variety and it didn’t result in much snow. California meets most of its water needs from the snowpack; as the snow melts in the summer months, it replenishes the reservoirs. For now, the reservoirs remain far below capacity. And the rain in northern California didn’t make it down to southern Cal. Rainfall totals in the south are anemic, and falling further behind. California has two more months in the traditional winter rain season. Trends could flip and several warm tropical storms could barrel into Southern California, evening the score. But for now, residents of the Southland are getting nervous.

Europe is powering ahead with wind. Europe already has quite a lot of wind turbines, and it seems to be the preferred way to generate electricity. Across the 28 countries that make up the European Union, 11,791 megawatts of wind power was connected to the grid in 2014—worth up to €18.7 billion ($21.1 billion)—according to a report by the European Wind Energy Association. New coal added 3,305 megawatts, while new gas capacity totaled 2,338 megawatts—less than half of the wind installed. Germany and the UK accounted for 60% of the new wind installations. The EU could now produce 10.2% of the electricity it needs from wind, up from 8% the year before.

Hoping to defuse a standoff that has set Europe and financial markets on edge, Greek officials intend to propose a detailed compromise plan at an emergency meeting with creditors on Wednesday in Brussels. The plan will include the possibility of tapping part of a bailout loan disbursement of $7.9 billion, which Athens had been saying it would reject. Greece still plans to reject some of the harshest austerity conditions attached to Greece’s bailout loans, but will propose retaining about 70% of the terms. Now, the proposal was just tossed out there and there won’t be a meeting until tomorrow, but already Germany has shot down the idea.

Another big meeting in Europe tomorrow; in Minsk, Belarus, the leaders of Germany, France, Ukraine and Russia are due to meet to try to hammer out a peace agreement. Failure to reach an agreement will lead to further EU economic sanctions against Russia, which were delayed at yesterday’s EU foreign minister’s meeting to allow time for the diplomatic offensive tomorrow. Failure to achieve a negotiated peace might draw the US into the conflict, at least as an arms supplier to Ukraine.

Hopes of an orderly resolution to Puerto Rico’s debt crisis suffered a heavy blow after a court voided the island’s restructuring law, raising fears it may be heading for a longer, messier debt overhaul. A US federal judge ruled that the commonwealth’s so-called Recovery Act, which made some of Puerto Rico’s agencies eligible for court-supervised debt restructuring, violated the US constitution by allowing a state government to modify municipal debt. The decision will likely result in a resolution being dragged out over a longer period of time, having the administrative costs incurred eat into the ultimate recovery for the bondholders. Puerto Rico is expected to appeal the ruling, kicking off lengthy litigation with a hard to predict outcome and possibly delaying for months the matter’s final resolution.

In the final stages of a long-running investigation, the U.S. Department of Justice has recently informed Barclays, JPMorgan, the Royal Bank of Scotland and Citigroup that they must plead guilty to criminal charges that they manipulated the prices of foreign currencies, NYT reports. Last November, regulators fined five major banks a total of $3.4B for failing to stop traders from trying to manipulate the foreign exchange market, following a year-long global investigation.
In a separate probe disclosed today, the NY Department of Financial Services was reported to have sent subpoenas to Goldman Sachs, Credit Suisse, BNP Paribas and Societe General, expanding its investigation of whether the banks’ electronic forex trading platforms allowed them to front-run clients. At issue is a latency period between the time an offer is floated and accepted. The department is already probing Barclays and Deutsche Bank over similar concerns and installed monitors at those banks in recent months.

Reuters reports an unnamed official says HSBC could see its 2012 deferred prosecution deal with US authorities over anti-money laundering reopened as a result of separate, ongoing probes into the bank’s alleged role in manipulating currency rates and helping Americans evade taxes. Obama’s nominee for attorney general, Loretta Lynch negotiated a deal with HSBC two years ago that saw it avoid criminal charges but Lynch says DoJ still has powers to act. In the 2012 settlement HSBC was fined $1.9 billion over money-laundering with Mexican drug cartels, including the notorious Sinaloa Cartel, and breaches of US sanctions; it is the largest money laundering case in history; the fine equals about 5 weeks profits. No individual at HSBC was fined or charged. The harshest punishment appears to be partial deferral of some bonuses.

Lynch has sent a letter to Senator Chuck Grassley of the Senate Judiciary Committee, writing that the 2012 Deferred Prosecution Agreement (DPA) “addresses only the charges filed in the criminal information, which are limited to violations of the Bank Secrecy Act for failures to maintain an adequate anti money-laundering program and for sanctions violations. The DPA explicitly does not provide any protection against prosecution for conduct beyond what was described in the Statement of Facts.”

Lynch is scheduled to replace AG Eric Holder, who essentially avoided prosecuting big banks out of fear that it might create global uncertainty if a bank was criminally prosecuted and lost its charter. I’m not sure how being a bagman for drug cartels and tax cheats promotes global financial stability. Maybe that’s something the new AG can answer.

FINANCIAL REVIEW

Buckle Your Seat Belts

Sinclair Noe — January 5, 2015

Podcast: Play in new window | Download (Duration: 13:19 — 6.1MB)

DOW – 331 = 17,501
SPX – 37 = 2020
NAS – 74 = 4652
10 YR YLD – .08 = 2.04%
OIL – 2.82 = 49.87
GOLD + 15.40 = 1206.20
SILV + .40 = 16.29

If Santa Claus should fail to call, bears may come to Broad and Wall. That is the old saying and most people think the Santa Claus rally covers the month of December, or maybe the week leading to Christmas; actually, the rally time frame covers the last 5 trading days of the year and the first 2 trading days of the New Year, which would include today. And today the markets were down; the worst day in 3 months. The Santa Claus rally is really an indicator.

In 1999-2000 rally time-frame suffered a horrendous 4% loss. According to the Stock Trader’s Almanac, on January 14, 2000, the Dow started its 33-month 37.8% slide to the October 2002 midterm election year bottom. NASDAQ cracked eight weeks later falling 37.3% in 10 weeks, eventually dropping 78% by October 2002. Saddam Hussein cancelled Christmas by invading Kuwait in 1990. Energy prices and Middle East terror woes may have grounded Santa in 2004. In 2007 the third worst reading since 1950 was recorded as sub-prime mortgages and their derivatives lead to a full-blown financial crisis and the second worst bear market in history.

For the past 4 trading sessions, the S&P 500 is down. The S&P 500 hasn’t had a 4-day losing streak in 264 trading days. This is the longest such streak without a 4-day decline since 1928. Which means that over the past 87 years, we’ve seen a whole bunch of 4-day losing streaks; that is the norm, but since 2013 we’ve gone through a period where stocks just haven’t gone down. Maybe you’ve been lulled into a sense of complacency.

The S&P 500 finished 2014 up about 11%to post the sixth consecutive year of positive returns. Since 1927, there have only been two periods that the S&P has had longer winning streaks. From 1982 to 1989 the S&P rose for 8 straight years, and that includes the crash of 1987, where the S&P still managed a small gain for the year. Between 1991 and 1999 the S&P rose for 9 straight years, but only if you reinvested dividends in 1994. And if you want to use the entire month of December as an indicator, well, December 2014 was the third weakest December since the turn of the century; only 2007 and 2002 were weaker. Now, consider that both 2002 and 2008 were very weak market environments and 2014 was relatively strong.

So, the question is “can the S&P 500 post gains for a seventh straight year?” And the answer is that I don’t know and you don’t know, and the talking heads on TV and the internet bloggers don’t know. What history tells us is that a bull market doesn’t last forever. Eventually and inevitably, stocks will drop; it could happen this year, or not; maybe next year, or not. Maybe the bears are coming to Broad and Wall, or not.

What we do know with some certainty is that the bears have come to the oil patch. US crude dropped more than 5% today, dipping below $50 a barrel for the first time since May 2009. And even as prices have dropped, production remains high. Russia’s oil output hit a post-Soviet high last year, and Iraq’s oil exports in December were highest since 1980. ConocoPhillips announced it struck first oil at a Norwegian North Sea project. Saudi Arabia cut prices for European buyers.

Open interest for $40-$50 strike puts in US crude have risen several fold since the start of December, while $20-$30 puts for June 2015 have traded. Meaning there are some people willing to gamble that oil could hit $20; that is a big gamble, but some people are taking the bet, or at least they are buying some insurance against falling prices. And that brings us to the shale producers in the US. Saudi Arabia is trying to gain market share and edge out US shale producers with lower prices, calculating that the 50% drop in oil prices will force US oil companies to drill fewer new wells, causing US production growth to stall and putting a floor under oil prices. But the shale players have, by and large, hedged their positions and insured against lower prices. If prices continue to fall, the US oil producers will eventually be exposed to low prices, but for now they are like the little Dutch boy with a finger in the dike.

New hedging strategies are only likely to get disclosed in quarterly earnings reports in late January, so for now we don’t know how much hedging is really going on. A rough gauge of hedging activity is to look at net short positions of oil producers and other non-financial companies in the US crude oil futures and options markets, and those net short positions have grown from 15 million barrels in August to more than 77 million barrels last week. For many companies that set up “in the money” hedges prior to the slump, the downturn offers a chance to cash in or extend their protection.

For example, a company that had sold swap contracts to hedge a part of its 2015 production at $90 a barrel, essentially shorting forward oil prices to guard against a drop, could buy them back now at around $57 for a profit of about $33 a barrel. They could then roll that over to shield themselves against a further market slide by buying swaps and options pegged closer to current prices. With the December 2015 put option for $60 a barrel now trading at around $9 a barrel, swaps cashed in now could buy a producer nearly four times more protection at that price. There are, of course limits to this strategy. If prices continue to slide, it will eventually result in cutting off production. We just don’t know the “if or when or level” of the cut-off point.

Meanwhile, the lower prices are rippling out beyond the oil patch. Today, JPMorgan downgraded its rating on Caterpillar citing concerns about the company’s exposure to oil and gas, and indirect exposure to mining, construction and emerging markets. Caterpillar supplies turbines to offshore rigs, as well as reciprocating engines and transmissions for on-site drilling. It also provides construction equipment that is used in infrastructure development, along with aftermarket and other services. Caterpillar also has exposure to Canadian Oil Sands, which are susceptible to a significant slowdown in demand. Further, the analysis determined that construction equipment demand has been strongly correlated with the expansion of fracking. High oil prices helped spur the boom in fracking, which in turn triggered a boom in construction in places such as North Dakota and other shale oil rich states.

As the price of oil slumps, some companies in the energy industry will go out of business. Not only will that cost jobs in the sector, but it will also cut spending on things like plants and equipment. Today energy stocks led the drop on Wall Street, down about 4%.

Which all sounds rather ominous, but I’m not finding many people crying for the big oil companies. Yesterday I filled the tank on my car and paid $1.89 at the pump, saving about $20 or so compared to what it cost me to fill the tank in January of 2014. Repeat that transaction with millions of American drivers and pretty soon you’re talking about real money. Thank you very much.

The big economic news this week will come on Wednesday and Friday. Wednesday features the release of minutes from the Federal Open Market Committee meeting in mid-December. That will likely be secondary to the Friday jobs report. You will recall that last month’s jobs report showed a big spike in jobs in November. The first guesstimate for November came in at 321,000 new jobs. Friday’s report is expected to show somewhere around 220,000 new jobs for December; which would mean the economy might have generated nearly 3 million new jobs in 2014, the best performance since the US created some 3.2 million jobs in 1999. The economy added an average of 241,000 jobs a month through the first 11 months of the year, up 24% from a 194,000 pace in 2013. Over the past 3 years, the unemployment rate has dropped from 8.6% to 5.8%, and at some point you might imagine this would lead to some increase in wages, which have been flat lining. One reason for stagnant wages is that there are still a lot of people who want a full-time job but can’t find one, some 18 million people are in that category or long-term unemployed or underutilized; that’s down from a high of 27 million but still about 5 million from where it should be and where it would take the slack out of the labor market.

And I couldn’t finish out this first Financial Review of 2015 without another edition of “Banks Behaving Badly”. JPMorgan Chase has become the first bank to settle a US antitrust lawsuit in which investors accused 12 major banks of rigging prices in the $5 trillion-a-day foreign exchange market. Last November JPMorgan paid $4.3 billion to settle a separate lawsuit with US and European regulators (actually agreed to pay $4.3 billion but only paid about $600 million to date). The US Department of Justice is among the government agencies that are still investigating the issue. New York’s Department of Financial Services is also conducting its own probe.

Terms of today’s settlement were not revealed. Settlement papers are to be filed with the US District Court in Manhattan later this month. In their complaint, investors including the city of Philadelphia, hedge funds and public pension funds accused the 12 banks of having conspired since January 2003 in chat rooms, instant messages and emails to manipulate the Forex markets. The 12 banks held an 84% global market share in currency trading, and were counter-parties in 98% of US spot volume.

Meanwhile, the euro dropped to its weakest levels since 2006. ECB president Mario Draghi is looking at the prospect of deflation in the Eurozone which might lead to large scale sovereign bond purchases. Italy is experiencing a triple dip recession, France is struggling, Germany is being dragged down, in part due to their own intransigence, and Greece; well, nobody is even sure Greece will stay in the Eurozone. And this all affects the larger multi-national US corporations that do a substantial amount of business in Europe.

More on that in the coming days.

Happy New Year. Buckle your seat belts.

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.