Financial Review

Rotate This

Sinclair Noe — June 10, 2015

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DOW + 236 = 18,000
SPX + 25 = 2105
NAS + 62 = 5076
10 YR YLD + .06 = 2.48%
OIL + 1.29 = 61.43
GOLD + 9.20 = 1186.60
SILV + .07 = 16.11

The yield on 10-year German government bunds broke above 1% overnight for the first time since September 2014; part of a broader global bond sell-off that’s been deepening since late April. Last week, ECB President Mario Draghi said investors should get used to periods of higher bond market volatility and stated the central bank wouldn’t do anything about it. US government bonds are selling off – which is sending yields higher as they move inversely to price – as part of the global bond rout that was started back in April. The size of the US corporate-bond market has ballooned by $3.7 trillion during the past decade, further siphoning demand from US Treasuries. And some of that money is just getting out of bonds, which might explain the rotation into stocks today.

Of course, I have no idea why the stock market moved higher today. I don’t know, you don’t know, and the talking heads on TV don’t know. It is nearly impossible to know what might spur or spook the herd of millions of investors to suddenly move in any given direction at any given time. Is it a new trend or just a bounce on pent-up demand? We don’t know. What we do know is that markets fluctuate, and they also rotate.

And while US equity markets have been trading in a tight range, there’s still plenty of action under the surface. A closer look at the 10 main sectors in the S&P 500 index reveals that investors have continued to move out of one sector into another, rotating in an anticipation of an interest-rate hike this year and subsequent rise in borrowing costs. The process of dumping interest-rate sensitive stocks such as utilities and consumer staples have accelerated over the past few weeks thanks to gyrations in government bond markets. The utilities sector is already in correction territory, having dropped more than 10% from its late-January peak, and down 4.6% since the start of the month.

Internal rotation isn’t the only problem with the current market. Deterioration in market breadth – markets rising on the back of fewer and fewer stocks – is something a lot of investors are watching. Less than 60% of S&P 500 components are trading above their 200-day moving average. Trading above the average implies an upward trend while trading below it implies that the stock may be losing support and is likely to fall further. Today, the 10 main sectors in the S&P 500 were all higher. Yesterday, the Dow Industrial Average went negative year to date, bouncing back into positive territory today with all 30 Dow stocks posting gains. Pfizer, Apple, United Health, and Disney have posted double digit returns this year. Wal-Mart, Intel, and American Express have posted double digit losses for the year.

Anyway, the selloff in bonds has pushed people into real estate.  While that may seem counter-intuitive, there’s a reason: fear that rates will move even higher. Total mortgage application volume jumped 8.4 percent last week. Refinance volume increased 7 percent on the week, and applications to purchase a home jumped 10 percent, both seasonally adjusted. Purchase volume is now 15 percent higher than the same week one year ago.

The selloff in bonds gets people all worked up, even though it has not been particularly dramatic. There was more volatility in the bond market in 2013 with the “taper tantrum”; you may remember a brief spell where just the hint of exiting QE saw the 10 year note spike above 3%. Still, the yield on the 10-year Treasury note has climbed from 1.65% in January to 2.49% today as the markets anticipate the Fed raising the Fed funds target rate; but if or when the Fed hikes rates, it will likely be small, incremental, well-communicated increases; and it might not be anytime soon. Today, the World Bank joined the IMF in asking the Fed to wait until 2016 before it raises rates, citing an uneven US recovery and the risks to emerging markets of tightening policy any sooner.

I read today that higher yields were a sell signal. No. The sell signal was when the yield on the 10-year bund dropped to 0.05% back in April, or when US Treasuries were floating around 1.65%. There is certainly a chance that yields could breakout, and prices could breakdown when yields hit 2.5%, and if that results in redemptions at bond funds and bond ETFs, we could see a domino effect, or what trader’s call “spontaneous combustion” that could push yields much higher with added volatility. But that’s the exception, not the norm. Usually, the bond market has a built-in self- correcting mechanism. A deep selloff will have economic consequences. Rates typically rise when the economy is improving; higher rates tend to cool economic growth before it can get overheated, and as the economy slows, rates drift lower. Of course markets can and do overshoot.

And all this speculation is based on the assumption that there is a certain efficiency and the markets are not rigged. You know what they say about assumptions. The Justice Department has begun an examination of trading in the US Treasury market. The government is also continuing to look into possible collusion in gold and silver markets and in trading around certain oil benchmarks. The investigation into Treasury trading is in the very early stages, but this follows guilty pleas from some of the biggest banks on charges of rigging the Forex markets, and the Libor markets, and the ISDA Fix; which means banks are in no position to be anything other than cooperative with investigators.

I also read today that the stock market rallied on positive news regarding Greece. German Chancellor Angela Merkel’s government may be satisfied with Greece committing to at least one economic reform sought by creditors to open the door to bailout funds. While the Germans still insist on a package of steps that includes higher taxes, state asset sales and less generous retirement benefits, they may settle for a clear commitment by the Greek government to a measure up front to unlock aid.

Merkel sounded a positive tone, saying:  “Where there’s a will, there’s a way. The goal is to keep Greece in the euro area.” Of course, we’ve heard many times that we are nearing a settlement on the Greek problem, usually followed by Teutonic demands for discipline and austerity. I’ve been saying that the only intelligent solution involves giving some sort of break to the Greeks. It might happen, but don’t hold your breath. And I doubt the hint of resolution will lift global markets, even though a breakdown in negotiations could cause serious damage.

Index provider MSCI will not add Chinese A-shares to its widely tracked emerging markets index. The Shanghai Composite ended almost flat after falling as much as 2.2%. MSCI said it aims to add the yuan-denominated equities at “some point”, just not today.

Spending on health care in the US fell at a 0.4% annual rate in the first quarter, suggesting gross domestic product will be revised even lower. Health care is the second biggest service sector by spending after finance. The U.S. economy contracted by 0.7% in the first three months of the year, but the government will revise the data for a second time at the end of the month. And even though spending was down in the first quarter, over the past year health-care spending has risen at an unadjusted 7.2% pace.

Workers’ wages and benefits may be picking up faster than previously thought. The Labor Department reports employer costs for employee compensation jumped 4.9% from a year earlier in March, the second consecutive increase at that relatively robust level. Average cost per hour worked rose to $33.49 in March, versus $31.93 a year earlier. Wages and salaries climbed 4.2% to $22.88 while benefits rose 6.4% to $10.61. Health insurance, one component of benefits, was up 2.5%. That’s well above a 1.2% gain as recently as the third quarter of 2013 and a sign the labor market is getting tighter.

US crude oil inventories continue to fall. The latest data from the Energy Information Administration showed that inventories fell by 6.81 million barrels in the week ending June 5. Last week’s decline brought the total to 470.6 million barrels, keeping inventories at the highest levels for this time of year in at least 80 years.

The US is now the top oil and gas producer in the world. US oil production rose to a record last year, gaining 1.6 million barrels a day, according to BP’s Statistical Review of World Energy. The US now passes Russia in total oil and gas production; and the US has passed Saudi Arabia as the top crude producer. The BP report also shows China’s energy demand growing at the slowest pace since the Asian financial crisis of the late 1990s, as the economy slows. And while there has been a boom in US oil production, we’ve seen an even bigger boom in non-fossil fuels and renewables. Last year non-fossil fuels, including nuclear, accounted for more of the increase in global energy consumption than oil, gas and coal combined. Particularly notable are record installations of solar panels.

The EIA released its latest short-term monthly outlook report on Monday, which forecasts that US crude production will fall from 9.6 million barrels per day in May until early 2016. Meanwhile, US oil production is on the rise for now. And at the same time, we are seeing demand destruction. Just this week, we saw the G7 agree to cut carbon emissions a record amount in the next three-and-a-half decades and end fossil fuel use altogether this century. In the past few years, we have already seen an extended flat period in oil demand, due to the financial crisis, that has only recently shown modest gains as prices dipped. The age of oil has now begun to end; that may seem like an exaggeration and it doesn’t mean the age of oil is dead today; it will take time and at the very least it means more volatility, so be aware and beware, because the world is changing in a massive way.

Financial Review

Generally Quite High

Sinclair Noe — May 6, 2015

 

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DOW – 86 = 17,841
SPX – 9 = 2080
NAS – 19 = 4919
10 YR YLD + .07 = 2.24%
OIL + .30 = 60.70
GOLD – 1.80 = 1192.20
SILV – .02 = 16.59

A worldwide sell-off in government bonds deepened today. Benchmark 10-year Bunds now trade at 0.53%, having hit a record low of 0.05% last month, when many expected them to turn negative. For German bund investors that represents a 12% loss over the past 2 weeks, or roughly 25 years of yield just went down the drain. In the past month, the yield on French 10 year debt is up 42 basis points, on 10-year Italian bonds the yield is up 62 basis points, Australia up 62 basis points, Hong Kong up 29 basis points. And here in the US, the 10 year Treasury yield has jumped from 1.9% a month ago, to 2.24% today. Around the world yields have been rising and bond prices have been falling.

Meanwhile, oil prices have been rising. Crude prices hit fresh 2015 highs; earlier in the session prices topped $62 a barrel before sliding back. This follow a 22% gain in April. A couple of reports show oil supplies dropping for the first time this year. U.S. oil inventories fell 3.9 million barrels last week, the first weekly decline since Dec. 26, according to data provided by the U.S. Department of Energy. Late yesterday, the American Petroleum Institute reported stockpiles fell by 1.5 million barrels. The data showed a sharp drop in imports for the week, likely just a blip in the reporting. Meanwhile, domestic oil production remains strong at more than 9.3 million barrels a day, declining by just 4,000 in the weekly data, and crude inventories remain near record highs, at 487 million barrels. So, the price of oil rallied well before any recovery in supply-demand balances.

Still, the price of oil is what it is, and compared to 2 months ago, it has now recovered enough to provide inflationary pressure. Fuel prices are a key ingredient to a basket of goods that are measured to determine inflation. And the price of oil affects much more than just the price at the pump; it affects manufactured goods or anything that requires energy or transportation. We don’t know if the recovery in oil prices will continue or not, but the recovery has been strong enough to have an inflationary impact. When oil prices rise because of increased demand that indicates the economy is strong and we need more oil to transport all the products being made and services being sold; however, when oil prices rise due to a reduction in supply that indicates the economy is shrinking not growing; when we have a recovery in inflation without a recovery in growth, the result is stagflation, which is still a form of inflation, even if it turns out to be temporary.

And the bond market hates inflation because it erodes the real, inflation adjusted return on bonds. An uptick in inflation could also give the Fed leeway to raise short-term interest rates in order to reduce the demand for credit and help prevent the economy from overheating. So this might go a long way to explaining the meltdown in bonds in the past few weeks.

There are other explanations to consider as well. The increase in oil prices might be due, in large part to speculative traders, first betting on lower oil prices, and as prices moved a little higher, they were caught in a short squeeze. Tens of millions of barrels are struggling to find buyers in Europe with traders of West African and North Sea crude blaming poor demand. The deep disconnect between the oil futures and physical markets looks similar to the events of June 2014 when the physical market weakness became a precursor for a futures price crash. Traders said around 80 million barrels of Nigerian and Angolan crude oil are on the market with at least a dozen May-loading cargoes still available. Futures prices do not match the physical market.

Still, higher oil prices have an inflationary impact that is being felt in the bond market, kind of, sort of. The bond market is not oblivious to higher oil prices, but there might be another reason for falling bond prices. Maybe central banks have decided to ease up on bond purchases. The Federal Reserve stopped large scale asset purchases a few months ago, but the European Central Bank stepped in with their own quantitative easing program, buying about $66 billion worth of bonds a month, which would push bond prices higher, unless there was a pause in their purchase plan. Maybe that has something to do with the bond meltdown, maybe not. These are complex markets, and they can be moved for any number of reasons, but we do know that whatever is happening is reflected in price, and the price has been moving lower. And as bond prices move lower, stock prices have also been moving lower.

This morning, Federal Reserve Chairwoman Janet Yellen warned of the risks in the stock and bond markets in the environment of low interest rates. Yellen said that equity market valuations are “generally quite high” and “there are potential dangers there.” Yellen was speaking at a forum on finance in Washington, and she added: “Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

Using a valuation technique sometimes referred to as the Fed model, U.S. equities remain cheap compared with government bonds. The S&P 500’s earnings yield, or profit as a percentage of price, stands at about 5.5 percent, more than twice the 2.2 percent rate on 10-year Treasuries. Still, Yellen said the Fed is aware of the possibility that there could be a sharp jump in long-term rates when the Fed raises interest rates. The announcement from Yellen sounded like so much jawboning; the Fed may have some concerns about inflation but right now the economy is not showing signs of strength, not enough to warrant a rate hike.

Productivity in the U.S. fell in the first quarter; the largest back-to-back decline in more than two decades. The measure of employee output per hour decreased at a 1.9% annualized rate, following a 2.1% drop in the fourth quarter. Part of the blame may be attributed to the harsh weather, port-related delays, the stronger dollar and a drop in oil costs that brought the economy to a near-halt in the first quarter and hurt efficiency and profits. The lack of business investment in new technology may also mean productivity will continue to stall. As worker costs are pushed up, it also means corporate profits will be challenged.

ADP, the payroll processing firm, reports the economy added just 169,000 private sector jobs last month; the first time in two years that new jobs created has dipped below 200,000 for two months straight. ADP says job creation has slowed for five months in a row. Mark Zandi, chief economist of Moody’s Analytics issued a report saying: “Fallout from the collapse of oil prices and the surging value of the dollar are weighing on job creation. However, this should prove temporary and job growth will reaccelerate this summer.” The ADP report is sometimes considered an indicator, or maybe an omen, of the Labor Department’s monthly jobs report, which will be reported Friday.

Greece has made a €200 million-euro interest payment to the IMF, although concerns over its future continued to rattle European markets. Athens faces another €750 million-euro debt repayment due on May 12 and it isn’t clear where the money is going to come from. The cash-strapped country still remains in a deadlock with creditors over its next tranche of bailout funding. Meanwhile, the possibility of a Greek default is another factor weighing heavily on the European bond market. It is estimated that past week’s losses on German bonds erased $410 billion in valuation – more than enough to pay for the Greek debt. I’m just saying.

The 2010 “flash crash” that sent the Dow plunging almost 1,000 points was five years ago today. But since then, there have been changes made in the hope of reducing the chances that it could happen again. The British trader fighting extradition to the U.S. on charges of having contributed to the 2010 “flash crash” told a London court today that he’d done nothing wrong.

In today’s edition of “Banks Behaving Badly”: According to its latest quarterly filing, JPMorgan is in “advanced stages” of settlement talks with the DOJ and Federal Reserve over previously disclosed foreign exchange investigations. The bank said the amount it may need to pay – in excess of legal reserves – could be as much as $5.5 billion. Meanwhile, JPMorgan has been placed under formal investigation in France as part of a probe into alleged tax evasion by senior managers at investment firm Wendel, part of a wider investigation in which as many as 14 Wendel executives face charges including tax evasion and insider trading over transactions conducted in 2004-2007. The bank is suspected of acting as an accessory to tax evasion.

The City of Los Angeles has filed a civil lawsuit against Wells Fargo alleging the bank has been looking the other way as its sales people opened up accounts and issued credit cards to customers without their knowledge or permission. Wells Fargo has pushed to get every customer to carry at least 8 different Wells Fargo accounts. Wells Fargo employees said that the company had a systematic, high-pressure quota system for employees that ultimately left them with the choice of engaging in fraud, or being disciplined or fired. Employees were expected to constantly get customers to open new accounts and purchase new banking products, or else. To reach the quota, sales people just started inventing accounts. Some employees went so far as to raid client accounts for money to open additional accounts.

In addition to charging fees on unwanted accounts, San Francisco-based Wells Fargo harmed customers by placing them into collections based on unauthorized withdrawals and reported damaging information on their credit reports when unwarranted fees went unpaid. The lawsuit seeks a court order shutting down the alleged wrongdoing, along with penalties of up to $2,500 for every violation and restitution for customers who were harmed. Wells Fargo denies the allegations.

FINANCIAL REVIEW

King Dollar and the Eurozone

Sinclair Noe — October 10, 2014

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Financial Review

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DOW – 115 = 16,544
SPX – 22 = 1906
NAS – 102 = 4276
10 YR YLD – .02 = 2.30%
OIL – .25 = 85.52
GOLD – .60 = 1224.00
SILV + .05 = 17.50

The 10 year German bund has a yield that is 141 basis points lower than the US 10 year Treasury note. The yield on German debt will get you 0.89%. Standard & Poor’s lowered France’s credit outlook today, and you can still get a 10 year French note with a yield of 1.25%. A 10 year note from Spain will only get you 2.06%. Is this because the US debt is riskier than the Spanish debt? No, just the opposite.

The problem in the Eurozone is deflation, and it threatens to bring the economy to a grinding halt, and send the EU into a triple dip recession. The president of the European Central Bank, Mario Draghi, gave no indication of any further monetary stimulus beyond what was announced this summer, suggesting in a speech in Washington that governments needed to do more on the fiscal side. Draghi said in effect that Eurozone countries that have enough money should spend it, a clear reference to Germany. His comments echoed remarks this week from Christine Lagarde, the head of the International Monetary Fund.

Today, German Chancellor Angela Merkel said her government was examining how to encourage investment, particularly in the “digital sphere” and the energy sector. Merkel did not elaborate, but the hint was that Germany might use government spending to stimulate growth, a possible shift in position that could ripple across the entire Eurozone. Merkel’s remarks may have been less a declaration of policy change than a signal that her thinking on stimulus was evolving.

On Wednesday, the Federal Reserve released minutes from the September FOMC meeting, and they expressed concern about the global economy and the dollar. In the past 4 months the dollar has jumped about 8% versus the euro; that kind of swing can prove a threat to trade and to financial markets. The Fed normally focuses on the US economy, unless there are global developments that are important enough that they could intrude. Fed officials pointed with concern to the slowdown in China, Europe and Japan. They also worried that the concurrent strengthening of the dollar would add to the risk of price deflation.

We know that a strong dollar could weaken US export performance and hold back growth, but the recent global slowdown represents a more ominous problem. Global economic weakness would undermine the ability of the Fed to maintain financial asset prices well above the levels strictly warranted by the fundamentals. Of course this has been how the Fed has addressed the crisis and the recovery for the past 6 years, they pumped up Wall Street with easy money. A global slowdown threatens that tactic.

The events of the past week indicate the Eurozone and especially Germany might be closer to a move away from the single minded focus on budget austerity that has, to date been an absolute failure. The bigger question is whether the Eurozone countries and the ECB will take action, and if they can actually do anything before the continent slips into full-fledged deflation; and further, what role that might mean for the Federal Reserve.

Finance ministers and central bankers gathered in Washington for the annual meetings of the World Bank and International Monetary Fund and today, Treasury Secretary Jack Lew urged the Group of 20 major economies to refrain from competitive currency devaluations. Federal Reserve officials are hunting for new tactics to raise price increases to their target as slowing global growth, cheaper commodities and flat wages sound warnings that inflation is descending toward the danger zone.

With inflation at 1.5% according to the Fed’s preferred index, low-flation is getting to be a real issue again. We know a stronger dollar makes US exports overseas less affordable, but a strong dollar makes it cheaper for Americans to pay for imported goods. A 10% increase in the dollar versus currencies of major trading partners could trim inflation by a quarter percentage point, and the Fed has not yet communicated a plan for how they will lift inflation to their desired target of 2%.

An inflation rate approaching zero is bad for the economy because of its impact on behavior by businesses and consumers. Companies’ inability to raise prices hurts profits, and they rarely compensate by cutting wages, so they fire workers instead. Consumers anticipating falling prices may postpone discretionary purchases. This can combine to create a vicious circle of less spending and further downward pressure on prices. Think about your own situation; in the past couple of weeks you’ve seen prices at the pump drop. Were you tempted to drive another day or two before you fill up the tank in the hope that you might save a few pennies per gallon?

And what we are seeing in the Eurozone is that once low-flation becomes deflation, the central bankers don’t really have the tools to deal with the problem. It is known as pushing on a string. They can flood the markets with easy money, but they can’t create demand, because, you know, prices will be lower next week. As we are seeing in the Eurozone, and as we saw in Japan, if you let it go on for too long it becomes a lock-in, it reinforces a bad outcome.

Substantial rallies in the dollar have the power to slam the brakes on GDP growth in a way that Fed tightening even doesn’t. GDP growth could decline by a percentage point if the rapid move in the dollar continues through early 2015. That fall in GDP is even larger than what would occur as a result of a 50-basis-point rise in long-term interest rates, and it works with a lag, too. Even when the dollar rally tapers off, it would be expected to constrain GDP through early 2016.

And for now at least, you might reasonably expect the dollar rally to continue; there is a trend in place. The long dollar bets mean money is being parked in the US, and that means continued downward pressure on long-term interest rates, at least for now. And another thing, when there are very rapid and pronounced changes in the exchange rate there is a tendency for investors to lock in gains from previously accumulated US assets. In other words, there is a tendency to sell stocks, and companies with overseas exposure are more likely to experience a greater decline. And the selloff in stocks is yet another hit to US GDP. It’s a nasty cycle.

On Wall Street, stocks closed out a volatile week with another triple digit loss for the Dow, giving the market the worst week since May 2012. The Dow industrials have now turned negative year to date. Yes, that was fast. The Dow lost 2.7% for the week. The S&P 500 dropped 3.1% on the week. The VIX, the volatility index jumped 45% for the week. The Stoxx Europe 600, Europe’s benchmark stock index posted its biggest slide in 2 years, down 4.1% for the week. The S&P 500 is sitting right at its 200 day moving average. The Dow Industrial dropped below the 200 day moving average, about 40 points lower.

A moving average is simply an average of a certain number of data points. The 200-day moving average is calculated by summing the past 200 days and dividing the result by 200. The 200-day moving average represents the average price over the past 40 weeks. This helps to smooth out day to day volatility and give a longer-term look at the overall trend. The 200 day moving average is considered a very important level of resistance or support; in this case, support. When a stock or an index breaks down below this key level of support you sometimes see a bounce, because there will be some investors who think they are now able to buy stocks cheap. But the bounce can sometimes be misleading; that’s known as a dead cat bounce. If dropped from high enough, even a dead cat will bounce. So the next few days will be critical to see if the markets can bounce, and if they can bounce, will they rally, or will prices just keep falling from here. If we don’t see a turnaround, it would confirm a downward trend.

This week the Nobel Committee handed out prizes for a better lightbulb, the LED; a better microscope, that sees nanoparticles; and a French author that I had never heard of. Today, Malala Yousafzai and Kailash Satyarthi have won the Nobel Peace prize. If you have not heard the story of Malala or heard her speak, you should; she will inspire you. She is the daughter of a teacher, and she grew up in and around schools, at least until 2008, when the Taliban took control of the Swat region of Pakistan, where she lived. The Taliban tried to close down schools for girls. That year, her father took her to Peshawar where she made a speech in front of national press titled “How Dare the Taliban Take Away My Basic Right to Education?” She was only 11 years old. In early 2009, Malala started blogging anonymously for the BBC about what it was like to live under the Taliban.

Two years ago, armed men boarded the converted truck that Malala and her classmates used as a makeshift school bus and they shot Malala in the head. She survived. Nine months after she was shot, Malala gave a now famous speech at the UN, where she said: “They thought that bullets would silence us. But they failed.” She’s continued her high-profile campaign for girls’ education with The Malala Fund, which raises money to promote girls’ education.

At 17, Malala is the youngest winner of the Nobel Peace prize, which she will share with 60 year old Kailash Sayarthi. In 1980 Satyarthi founded the Save the Childhood Movement, and he has helped rescue more than 80,000 children from bondage, trafficking and exploitative labor in the past three decades; he also spearheaded a movement to make free and compulsory education a constitutional right for children in India in 2009.

The Nobel committee said it “regards it as an important point for a Hindu and a Muslim, an Indian and a Pakistani, to join in a common struggle for education and against extremism”.