Financial Review

Muppets in the Lobby

Sinclair Noe — August 13, 2015

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

Subscribe: iTunes | Android | RSS

DOW + 5 = 17,408
SPX – 2 = 2083
NAS – 10 = 5033
10 YR YLD + .06 = 2.19%
OIL – 1.07 = 42.23
GOLD – 10.80 = 1115.70
SILV – .12 = 15.52

So, stocks closed basically flat, but it was a roller coaster ride. The major indices started the day in negative territory, then recovered, only to slide into the close. This was a very busy day for economic reports.

Sales at US retailers were solid in July and stronger than previously estimated for May and June. Retail sales rose a seasonally adjusted 0.6% last month, or by 0.4% excluding the auto sector. In the retail sales data in July, the gains were led by the auto sector, where sales jumped 1.4%. This was expected as the light vehicle selling rate rose to a seasonally adjusted 17.5 million units, the second best result since early 2006. And just a quick reminder that many auto sales are imports. But the sales gain in July was broad based. All sectors showed increases except electronics and general merchandise and department stores. In the past year, retail sales have risen 2.4%.

A side note here; it may seem strange that consumers are spending less on electronics, after all it seems like everybody has smartphones and other electro-gadgets; the reality is that we are buying this stuff but paying less for it. We are buying online and finding deals (we are not doing much shopping at department stores like Macy’s), and technology tends to get cheaper over time thanks to innovation (remember Moore’s Law). In fact, since the recession ended in mid-2009, the price of electronics is down 33%, by far the largest decrease of any category tracked by the Commerce Department.

Consumer spending is a huge part of the overall economy. This morning’s retail sales data was watched as a barometer of whether the Federal Reserve would be able to make the case that the economy was performing well enough for a rate hike in September. Of course you can choose any number of other economic indicators to push the barometric pressure one way or another. The Fed has not lifted its zero bound range for rates since it was set in December 2008; a challenging 7 years for retirees attempting to live on fixed income investments like US Treasury notes and bonds which have seen their yields cut in half, or more.

And this Zero Interest Rate Policy raises the nagging question of why the Fed has maintained an emergency posture on interest rates if the economy has actually improved. The Fed finds itself in a dangerous quandary: no ability to cut rates to stimulate the economy if growth starts to tank again because the Fed is already at the zero bound range; while conversely running the risk of setting off a global financial asset selloff that destabilizes markets further if it raises rates.

The prices the US paid for imported goods fell 0.9% in July, the biggest drop in six months. The price drop was led by a drop in fuel prices. However, excluding fuel, import prices declined by 0.3%. In the past 12 months import prices have dropped 10.4%, mostly because of lower oil costs. Import prices are down a smaller 2.6% excluding fuel in the same span. Lower import prices have helped keep a tight lid on US inflation.

US business inventories in June posted their largest gain in 2-1/2 years as sales rose marginally. The Commerce Department said that business inventories increased 0.8 percent, the biggest gain since January 2013, after an unrevised 0.3 percent rise in May. In the second-quarter GDP report published last month, inventories made no contribution to the second-quarter GDP annualized growth pace of 2.3 percent. Today’s report would suggest that second quarter GDP will be revised higher.

In the latest week, the number of people who sought new US unemployment benefits rose by 5,000 to 274,000. The level of applicants remained below 300,000 for the 23rd straight week. Claims hit a low of 255,000 in mid-July, the lowest level since the fall of 1973, but have since rebounded a bit.

Mortgage rates rose for the first time in four weeks. Freddie Mac reports the 30-year fixed-rate mortgage averaged 3.94% in the week ending Aug. 13, up from last week when it averaged 3.91%. A year ago, the 30-year averaged 4.12%. The 15-year fixed rose to 3.17% from 3.13%.

The Mortgage Bankers Association, which represents mortgage lenders, said that the foreclosure starts rate was 0.4% in the second quarter, down slightly from the first quarter and on par with the rate seen during the housing boom. The delinquency rate, which includes loans that are past due but not in the foreclosure process, fell to 5.3%, after adjusting for seasonality, its lowest point since the second quarter of 2007.

The rent is too damn high. Americans living in rentals spent almost a third of their incomes on housing in the second quarter, the highest share in recent history. According to a new report from Zillow, a renter making the median income in the US spent 30.2 percent of her income on a median-priced apartment in the second quarter, compared with 29.5 percent a year earlier. The long-term average, from 1985 to 1999, was 24.4 percent. While mortgages remain relatively affordable, landlords have been able to increase rents because demand for apartments remains strong. Meanwhile, historically cheap mortgage rates are keeping the cost of homeownership low. Buyers devoted 15 percent of their income to mortgage payments, which is less than the historical average of 21 percent.

China intervened in the currency market Wednesday in the final moments of trading, after the yuan weakened nearly 2%, the daily limit; that move helped spur a late recovery on Wall Street. Today, the People’s Bank of China set the yuan’s fixing only marginally lower, a sign it wants to let the yuan depreciate but only in a measured way. The country’s central bank has pushed the value of the currency lower for three consecutive days. Since Tuesday, the currency has fallen 4.4 percent, the biggest drop in decades. While China said the move was aimed to make the currency more market-oriented, it has raised concerns that the already slowing economy was in deeper trouble. The sharp and sudden fall has also prompted questions about whether the country’s leadership can manage the slowdown.

The US imports more goods from China than any other country. Through June of this year, the US had imported $226 billion in goods from China versus $150 billion from Canada and $145 billion from Mexico. The Federal Reserve has been struggling to avoid importing deflation into the US; this devaluation move now means that Chinese goods flowing into the US just got cheaper and the ability of US exporters to compete in global markets just got a lot harder. Today, the dollar rose against a basket of currencies as currency war anxiety faded.

Oil prices slipped to a 6 year low today. The yuan’s devaluation this week has driven down oil and industrial metals amid speculation the weaker Chinese currency will hurt demand by making dollar-denominated imports more expensive. Goldman Sachs Group estimates the global crude oversupply is running at 2 million barrels a day and storage may be filled by the fall. About 170 million barrels of crude and fuel have been added to storage tanks and 50 million to floating storage globally since January.

The iPhone 7 release date is thought to be on September 18. Samsung is trying to play the role of disruptor. They presented 2 new phones today; the tech giant hopes the Galaxy Note 5 and Galaxy S6 edge+ will help it regain momentum in the smartphone market. They’re set to arrive on August 21st. It doesn’t look like there are any major upgrades to the new phones; a few minor changes; bigger screens and a pay system to match up with Apple Pay.

Brokerage firm Edward Jones has agreed to pay $20 million to settle charges that it overcharged clients in new municipal bond sales. The SEC said the case was its first against an underwriter in connection with alleged pricing-related fraud in the primary market for municipal bonds.

Investors suing various banks for rigging prices in the foreign exchange market have reached settlements with nine banks that have brought their total recovery to more than $2 billion. HSBC, Barclays, BNP Paribas and Goldman Sachs are among the latest banks to reach settlement in the class action litigation.

Goldman Sachs Group will pay $272 million to settle a lawsuit that claimed the Wall Street bank defrauded investors about the safety of about $6 billion of residential mortgage-backed securities they bought in 2007 and 2008.

Meanwhile, Goldman Sachs Bank USA, a unit of Goldman Sachs, has agreed to buy GE Capital Bank’s online deposit platform, which includes about $8 billion in online deposit accounts and another $8 billion in brokered certificates of deposit. Goldman Sachs Bank will acquire no financial assets in the deal other than cash associated with the deposit liabilities.

Just a refresher, back in 2008, when Goldman was defrauding investors in residential mortgage backed securities, the global financial system had a meltdown. Goldman converted from an investment bank into an FDIC insured bank, which then took billions in bailout money. Many people wondered how that could happen when Goldman didn’t actually hold customers’ deposits, but now, 7 years later, they have bought deposits.

You can’t actually go into a Goldman Sachs office and use an ATM, or deposit a check or cash, because it’s all online accounts. It just wouldn’t do to have the Muppets in the lobby.

Financial Review

How to Eat a Bank

Sinclair Noe — April 10, 2015

 

Podcast: Play in new window | Download (Duration: 13:14 — 6.1MB)

Subscribe: iTunes | RSS

DOW + 98 = 18,057
SPX + 10 = 2102
NAS + 21 = 4995
10 YR YLD – .01 = 1.95%
OIL + .99 = 51.78
GOLD + 13.80 = 1208.30
SILV + .34 = 16.59

For the week, the Dow is up 1.6 percent, the S&P is up 1.7 percent and the Nasdaq is up 2.3 percent. Both the Dow and S&P notched their second straight week of gains.

Oil posted its fourth consecutive weekly gain. The oil rally coincided with a stronger dollar, which weighs on dollar denominated commodities. In March, the prices the U.S. paid for imported goods and services fell for the eighth time in the last nine months, even though the cost of foreign oil actually rose for the second straight time. Import prices dropped 0.3% last month, or an even steeper 0.4% excluding fuel.

The sharply lower cost of imported goods is a double-edged sword. We may pay less for commodities and all sorts of goods such as cell phones and electronics; and that can stretch paychecks. Next Tuesday the Commerce Department reports on retail sales and we’ll find out if shoppers are in a spending mood or a savings mood. A strong dollar is also great if you plan to travel abroad; they say April in Paris is pretty nice. Yet the strong dollar also makes US goods and services more expensive for foreigners to buy, reducing demand for American-made exports. That’s cutting into corporate profits and could even cost American jobs, potentially slowing the nation’s pace of growth. The Labor Department will report on both producer and consumer prices next week, prices at the wholesale and retail levels. Economists expect both the CPI and the PPI to be up in March compared to February, but maybe not enough to move into positive territory.

Earnings season kicked off this week. The corporate earnings outlook for 2015 is ugly, as first-quarter earnings for the S&P 500 index are expected to come in 4.7% lower , while second-quarter earnings are expected to be 2.1% lower, according to FactSet. Meanwhile, Thomson Reuters says profits of companies on the S&P 500 are projected to have declined by 2.9% in the first quarter. So, that should give you a range.

The big banks start reporting earnings next week, with JPMorgan and Wells Fargo posting results on Tuesday. Mortgage lending is expected to prop up bank earnings, as lower mortgage rates have spurred applications to refinance home loans. Financials have the best outlook among sectors, with analysts projecting first-quarter 2015 earnings to have surged 10% from a year ago, according to Thomson Reuters data. Meanwhile, energy is expected to be the worst performing sector; companies may see first-quarter earnings plummet 64% from the same quarter a year ago.

If you were hoping to be one of the first people to sport the new Apple watch, yea, that ship has already sailed. At one minute after midnight, Apple started taking orders for delivery of the watches in June. Within 6 hours they were sold out. It’s hard to believe we’ve all survived so long without one of those watches.

Also this coming week, we might see a plea deal in the long running investigation into manipulation of the London Interbank Offered Rate, or Libor. The NY Times reports Deutsche Bank is close to a deal with New York financial regulator, federal prosecutors, plus regulators in Washington and London to pay a penalty (somewhere in the neighborhood of $1.5 billion) and accept a criminal guilty plea. The bank also faces investigations into currency manipulation and violations of United States sanctions against countries like Iran. Several other banks have already reached settlements on interest rate rigging, but Deutsche was a holdout.

General Electric plans to sell most of its $30 billion real estate portfolio over the next two years as it gets back to its industrial roots; GE also set a share buyback plan of up to $50 billion – the second-largest ever. Blackstone Group and Wells Fargo are buying most of the assets of GE Capital Real Estate in a deal valued at about $26 billion. GE said it had letters of intent to sell an additional $4 billion of commercial real estate to other buyers that it did not identify. The total deal is the biggest in the commercial property market since Blackstone’s acquisition of office landlord Equity Office Properties Trust in 2007 for $39 billion.

GE’s deal to sell off real estate and get out of most of the finance business will result in an after-tax charge of $16 billion in the first quarter, and up to $4 billion worth of taxes on repatriated earnings. Right now, US-based multinationals are not taxed by the US government on what they earn overseas, until they repatriate or bring that money back to the US. According to a report in March by Credit Suisse, the cumulative earnings parked by S&P 500 companies overseas is over $2 trillion, and there’s at least $690 billion in overseas cash. It’s not like the money is lost overseas; it is sometimes used for foreign acquisitions; another trick is to borrow against the cash pile to pay for dividends or share buybacks; not exactly a path to productive, organic growth.

To console investors about the costs, GE authorized one of the largest buybacks ever, second only to Apple’s $90 billion buyback plan. General Electric has the potential to return more than $90 billion to investors through 2018 in the form of dividends, buybacks and other measures. The exit of most of GE Capital businesses is expected to release about $35 billion in dividends to GE, which would be allocated to its planned $50 billion share buyback.

CEO Jeff Immelt has been scaling down GE Capital since the financial crisis, when GE Capital almost wiped out the entire company. What was once seen as a way for GE to help finance sales to its own clients had grown into a financial behemoth that stretched into subprime lending among other areas. For years, Jack Welch had used reserves that GE Capital maintained against problem loans to smooth out the books at GE; adding to reserves in strong quarters and reducing them in weak quarters, when the income was needed. GE Capital became a black box of financial complexity that baffled even experts but allowed Welch to “deliver” remarkably consistent earnings, almost as if he could produce numbers out of thin air. At the same time it managed to suck the life out of research and development at the parent company. Who needs research and development and innovation on the industrial side when you can cook the books on the financial side?

In September 2008, GE Capital was on the verge of collapse, only revived by an infusion of cash and confidence from Warren Buffett (and yes, Warren pulled down a sweetheart deal). That seems to have been the point where Immelt recognized the need for a new direction, back to its industrial roots. The only financial operations to be retained will be the leasing operations that are directly tied to GE’s manufacturing businesses, which make equipment ranging from aircraft engines to medical scanners. GE anticipates that the industrial operations will generate 90% of revenue by 2018.

The finance arm still has $500 billion in assets, making GE Capital the country’s 7^th largest bank; that position also earned GE Capital the designation of a “systemically important financial institution” or SIFI. The designation as a so-called “SIFI” brings with it tougher oversight by the Federal Reserve. GE wants to lose the designation and the regulatory oversight that goes with it. They will still have a financing arm, but it will be greatly scaled down.

So far four non-bank firms, including GE Capital, have been designated as a SIFI. The others are insurers American International Group, Prudential Financial, and Metlife.   Metlife is suing the federal government over the label. Just yesterday, Jamie Dimon of JPMorgan bemoaned the burdens of regulation. Some of the SIFI firms have privately griped that regulators haven’t provided them with a clear path on how to shed the designation. The Wall Street Journal calls it the “Hotel California” of Fed oversight; it’s a clever line, and I wouldn’t be surprised if the marketing team at Metlife or JPMorgan came up with it, but it is also incredibly stupid and a lie. It is easy to drop the SIFI designation; all a bank has to do is get smaller; sell off parts, spin off parts – simple. And the path was laid out in the Brown-Vitter bill. The legislation presented the mega banks “with a clear choice: Either have enough of your own capital to cover your own losses or downsize until you are no longer a risk to taxpayers.” The banks managed to squash that legislation because they still like the old business model of privatized profits and socialized losses.

For Metlife the whole idea of SIFI regulations was just too much to bear. When the insurer was designated too big to fail, they sued; because nothing says you are not big like taking on the entire US government. The Metlife argument might be better if the company didn’t tout, in its own advertising that it is indeed a huge, global company with tens of billion in revenue and trillions in life insurance in force. They just don’t want to be forced to hold extra capital in reserve because it might bring down their profits. So, Metlife thinks that is terrible. But the government thinks it might be a good idea to have some reserves just in case something goes wrong; it would be like a cushion against a catastrophe, some type of safeguard against disaster, some protection from a meltdown, you might even call it insurance.

So, what today’s deal shows is that there is a way out of the “too big to fail” problem with the mega banks; just cut them into small bite sized pieces that can be easily digested, and the American taxpayer need never be forced to choke on bailouts again. That is how you eat a bank. In that regard, the GE deal might be the most important restructuring of the American banking system to happen under the Dodd-Frank Wall Street reform law.