Monday, May 12, 2014 - More Milk and Cookies

Financial Review with Sinclair Noe

DOW + 112 = 16,695
SPX + 18 = 1896
NAS + 71 = 4143
10 YR YLD + .03 = 2.65%
OIL + .63 – 100.62
GOLD + 5.60 = 1296.70
SILV + .35 = 19.60

Record highs for both the Dow and the S&P 500. We celebrate when the Dow hits a record high; there is no specific celebration for the S&P, which doesn’t really make sense. We have a party with milk and cookies. Today we have some lemon zest cookies and I think they have poppy seed sprinkles, which means we would all fail a drug test for the next few days.

The latest thing to worry about is the market divergence. The Dow hit record highs but the Russell 2000 index of small and midcap stocks closed below its 200 day moving average last week. The idea is that small caps will drag down the blue chips, or maybe the blue chips will lift up the small caps, but one way or another, something has got to give. Another consideration is the number of NYSE stocks making new highs minus the number of NYSE stocks making new lows continues to look mediocre at best even as the Dow and S&P make all-time highs. You don't typically want to see large caps struggling at recent highs with less underlying participation by individual stocks because narrowing of participation at highs is how tops are formed. You also don't typically want to see new all-time highs for the S&P while the more economically sensitive small caps are in a correction. These things can resolve in either direction, but the historical bias is toward a resolution to the downside.

The basic truth is that not all stocks are hitting record highs. That’s not how it works; there are winners and losers, even in a bull market, even in a bear market. The other reality is that we don’t make record highs forever, 2013 being the exception to the rule. At some point this market will roll-over, we don’t know exactly when, but rather than sticking our head in the sand, we remain vigilant.

Yesterday was Election Day in Ukraine. A preliminary count from eastern Ukraine showed 89% of voters in the Donetsk region and 97% in neighboring Luhansk voted for greater autonomy; which is to say they are voting to split from Ukraine and be more closely associated with Russia. The Russian government did not even say that it recognized the results of the voting, which the authorities in Kiev and their Western supporters all declared illegal from the start. The Kremlin issued a statement saying only that it “respects the will of the population of the Donetsk and Luhansk regions,” and that the crisis should be resolved through dialogue.

As part of that dialogue, Gazprom, the gas company controlled by the Russian government, announced it would send Ukraine an advance bill for natural gas deliveries in June. So the dialogue is “pay up or no gas.” The Euro Union is slowly tightening economic sanctions on Russia, but slowly, hoping they don’t have to face Gazprom turning off the spigot on supplies to the continent. This entire conflict could turn ugly fast, but each day that goes on without a meltdown is a good day for the markets.

Meanwhile, the Department of Justice is reportedly getting closer to actually enforcing the law, at least with respect towards a big bank. There are signs and last minute meetings that point toward possible criminal charges against two large European banks. No giant bank has been found guilty of criminal charges in the US for at least 20 years. Lawyers for BNP Paribas and Credit Suisse have been meeting with prosecutors to try and wrangle a deal for leniency. BNP is suspected of doing business with countries like Sudan and Iran that were on a US sanctions blacklist; Credit Suisse is suspected of offering tax shelters to wealthy Americans.

There have been criminal charges against subsidiaries of big banks, but the parent companies have been spared. Credit Suisse recently set up a subsidiary to house their US offshore business; the idea being that they could create a subsidiary to serve as a sacrificial lamb. Word is that US prosecutors are unwilling to criminally charge the newly formed unit.

Criminal charges could prompt regulators to revoke a bank’s license to operate, the corporate equivalent of the death penalty. When HSBC faced criminal charges a couple of years ago, the bank set up a subsidiary in Asia to take the fall. That deal was apparently accepted because the Justice Department is afraid of a criminal charge of the parent company could wreak havoc on the broader economy, far beyond the boundaries of France or Switzerland. The BNP and Credit Suisse investigations could lay the groundwork for actions against American banks as well. We may see how this strategy develops within the week.

There were no significant economic reports today, there was a fairly important weather report from NASA and some scientists at the University of California – Irvine. They say that glaciers and ices shelves along the western part of Antarctica are melting, and as they melt they’re releasing roughly the equivalent of the entire Greenland ice sheet into the ocean every year; enough ice to raise the world’s sea level by about 4 feet, which means my dream of owning oceanfront property in Arizona is alive and well. Eventually, they say the oceans will rise by about 14 feet, but that’s a long way down the road. The scientists say the melting process has passed the point of no return.

Now, why do we talk about it here on the Financial Review? Because it is changing the financial landscape. John Nelson, the chairman of Lloyd’s of London has posted an article in the Guardian explaining how climate change is changing the insurance industry’s catastrophe modeling. “According to the World Bank, weather-related losses and damage have risen from an annual average of about $50bn in the 1980s to close to $200bn. Lloyd's knows this all too well, the damage wrought on the US by the hurricanes Katrina, Rita and Wilma in 2005 and Superstorm Sandy in 2012 to name but a few all brought significant claims to the insurance market.”

And so, Lloyd’s is changing models to account for climate change, by building in forward projections, not just historical data. This will likely lead to changes in insurance pricing, and in this way, we will all be affected, but it doesn’t stop there. This means changes in environmental policy of course, and also housing and land use policy. And this is not just about insurance companies trying to jack your rates. “Ultimately, insurance exists to pick up the pieces and pay the claims” when extreme weather hits, but there may also come a time when insurance companies stop paying claims, and deem certain areas uninsurable, which is the equivalent of a financial death sentence. And that’s just the start; wait until the Environmental Protection Agency announces rules intended to slow the pace of climate change.

And what happens when the EPA moves on to regulation of greenhouse gas emissions? And it won’t be long before you start hearing more about cap and trade; and I predict that in the not so distant future we’ll all be familiar with the R.E.C. market, which is almost non-existent today. You don’t know about REC now, but you will.

Flood insurance will disappear for some areas, drought and crop insurance will vanish in other areas. And even if you live on a hill, it doesn’t mean you escape consequences, because this will also require massive investment in infrastructure; above and beyond updating outdated bridges. And this will eventually result in a complete revamp of our power structure. The days of coal fired power plants and flaring off natural gas in the oil fields are coming to an end just as surely as the days of whale oil lanterns passed into the darkness of history. And because necessity is the mother of invention, these are when we need, and I believe we will find imaginative and innovative solutions.

Wednesday, April 02, 2014 - Speak Your Mind by Blowing Your Wad

Financial Review with Sinclair Noe

DOW + 40 = 16,573
SPX + 5 = 1890
NAS + 8 = 4276
10 YR YLD + .04 = 2.80%
OIL – 33 = 99.29
GOLD + 10.10 = 1290.90
SILV + .22 = 20.08

The S&P 500 closed at another record high.

The Commerce Department reported that orders to US factories rose 1.6% in February, the most in five months. January's durable goods orders were revised to show a larger drop of 1.0% instead of the previously reported decline of 0.7%. Yesterday, the Institute for Supply Management said its manufacturing index rose in March.

A private survey showed that US companies stepped up their hiring in March. Payroll processer ADP said private employers added 191,000 jobs. ADP also revised February's job creation up to 153,000 from the 139,000 figure reported earlier. The report comes ahead of the government's monthly jobs report, scheduled to be released on Friday; the over-under number for Friday is 200,000 net new jobs.

We know the Federal Reserve will be watching the jobs report. St. Louis Fed President James Bullard speaking to reporters at his branch of the central bank, said a formal rate rise is "still a considerable distance away." Federal Reserve Bank of Atlanta President Dennis Lockhart said today: “Based on my working medium-term outlook, I see the latter half of 2015 as the likely time frame for the first move to higher rates,” but if the economy doesn’t grow as he current expects, Lockhart thinks, “a later liftoff date… will likely be appropriate.”

Lately bad weather was cited as the reason that Walmart and FedEx and Delta’s earnings were disappointing.  If it isn't one-time charges that happen every quarter being removed from reported results, it's the weather being blamed. Of course, even if the weather truly was awful enough to prevent people from shopping, or buying a house, that demand should simply show up in a later month. A certain amount of productive capacity is lost, but pent up demand should rev things right back up again. The March jobs report won’t be the final word on the weather and the economy, but if we don’t see some sort of significant improvement, then we are running out of bad weather excuses.

Russian, American, and European diplomats continue to talk about settlement talks that might halt further Russian military action in Ukraine; Crimea is a done deal, but Ukraine is another matter. NATO will suspend "all practical civilian and military cooperation" with Russia because of its annexation of Crimea, saying it has seen no sign that Moscow was withdrawing troops from the Ukrainian border.

Meanwhile, Gazprom, the Russian energy company has fired a shot across the bow, raising the price it charges Ukraine for natural gas. The price jumped from $268 per 1,000 cubic meters of gas to $385, or about a 44% increase. Gazprom execs attributed the price increase to an unpaid debt for gas. This is not the first time energy has been used as an economic weapon, nor will it be the last.

The US has been undergoing an oil and gas renaissance; the White House has promoted exploration and drilling, and output has jumped. When it comes to natural gas, the US is being compared to Saudi Arabia, or Saudi America. Of course, that provided no advantage to thwart Putin’s aggression in Crimea. One reason Saudi America has failed to instill fear in Russia is that we lack the capacity to export LNG to Europe, and probably won’t be able to export in any significant quantities for a few more years; and then it would probably be a few more years before Ukraine could build facilities to receive such exports.

Meanwhile, we ran into a rash of reports in the past week or so, all telling us that our reliance on fossil fuels is killing us. The American Association for the Advancement of Society, the Intergovernmental Panel on Climate Change, and the World Meteorological Organization all confirmed that the planet is getting hotter; 13 of the past 14 years have been the hottest ever recorded. The Antarctic ice shelf is melting, Greenland too; the rain forests are dying and the Gulf Stream is collapsing. It’s not just the melting ice and the poor polar bears; the reports warn of very human problems of hunger, disease, drought, flooding, refugees, violence, and war.

Necessity is the Mother of Invention, and the time is now for innovation; and the good news is that there are inventors who have been working on these problems and have created solutions; the bad news is that the status quo and the powers that be are entrenched. This is a defining moment, and energy is being used as an economic weapon, and that weapon is pointed directly at our own foot.

And the entrenched powers just became more entrenched. The Supreme Court has struck down the aggregate campaign contribution limits, opening the gates for even more money to flood into the political system. The good news is we have the best politicians money can buy. The bad news is we have the best politicians money can buy. The 5-4 ruling in McCutcheon v. Federal Election Commission was penned by Chief Justice John Roberts and joined by justices Anthony Kennedy, Samuel Alito and Antonin Scalia; Justice Thomas went a step further and called for a complete end to campaign finance reform.

The decision relies heavily on the assertion in the 2010 Citizens United ruling that influence and access are not a corruption concern. This means that a single donor will soon be able to contribute millions of hard dollars in limited contributions, to political parties, candidates and political action committees.

Federal law sets certain limits, so you can't just go write a candidate a check for a million dollars and call it a day. That means you can't give more than $2,600 to any one candidate per election. Even if you were to donate once in the primary election and again in the general, the absolute most you could give to an individual candidate's campaign is $5,200. And you can’t, or couldn’t just spread money across the board. For the 2013-2014 election cycle, Federal Election Commission rules state that a donor can give no more than $123,200 to all political committees, with two sub-limits of $48,600 to candidates and $74,600 to political parties and political action committees. In other words, there was a limit, a cap on aggregate spending. Those limits are no more.

 Now, a single donor can now give more than $5 million in individually limited contributions to every House candidate, every Senate candidate, every state party committee, every national party committee and every leadership PAC connected to one political party. The McCutcheon ruling also did away with the aggregate limit on donations to political action committees, or PACs, which can give money directly to candidates. While there's a limit on how much PACs can give to each candidate, there's no limit on the number of PACs that can exist. Without the aggregate limit, one donor can now give $5,000 each to 1,000 different PACs. And those 1,000 PACs can turn around and funnel that money straight to one candidate. Which means that one candidate could haul in $5 million in direct contributions from one donor, funneled through a network of PACs.

So, if you have a big wad of money that you would like to waste on buying politicians, the Supreme Court has just ruled that you can blow your wad just a freely as you can speak your mind.

The new Michael Lewis book, “Flash Boys” looks at High Frequency Traders front running trades, using technology to jump in front of a trade and skim some profits. The uproar from Wall Street has been hilarious. There are claims that front running isn’t really bad; it doesn’t hurt ordinary investors; it may actually add to liquidity, blah, blah, blah. This is kind of like saying a mafia hit man is good for the neighborhood because he spends his money at the local grocery store and he hasn’t killed anybody on my street.

As we said the other day, High Frequency traders front running the market is not new; it has been going on for years, but the book and the 60 Minutes interview and the publicity finally caught the attention of otherwise somnambulant sleuths at the FBI who are investigating front running, which is a criminal offense. Where this could get interesting is that the High Frequency Trading firms set up shop in close proximity to the stock markets in New York, and they pay for high speed access to the exchanges’ computer systems and data.

The New York Stock Exchange calls it “fully managed co-location space next to the NYSE Euronext’s US trading engines in a new state of the art data center”. The NYSE is the landlord. And they can set up the “super high density” fiber optic connections for an initial fee of $7,000, or a onetime upgrade fee of $9,200. In other words, the New York Stock Exchange and the Nasdaq are complicit in the skimming operation. I didn’t hear Lewis or 60 Minutes talk about that, but that is the ugly truth.

The other funny thing about the Michael Lewis book and interview is the notion that some clever fellows, backed by hedge fund guru David Einhorn and a few other Wall Street big dogs, had come up with a clever technical fix in a new and better exchange called IEX.  Protected by a spool of fiber to ward off the high frequency traders like garlic against vampires. Free market triumphs, mission accomplished. Don't even think about a minimum transaction tax, a speed bump rule such as a minimum order duration, or anything more comprehensive than that.