Financial Review

Focus on Earnings

Sinclair Noe — July 21, 2017

Podcast: Play in new window | Download (Duration: 13:15 — 7.6MB)

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DOW – 31 = 21,580
SPX – 0.91 = 2472
NAS – 2 = 6387
RUT – 6 = 1435
10 Y – .03 2.23%
OIL – 1.25 = 45.67
GOLD + 10.50 = 1255.50
BITCOIN + 1.33% = 2703.19 USD
ETHEREUM + 3.41% = 221.94

Stocks pulled back from record highs earlier this week.  For the week, the Dow fell 0.3% but the S&P 500 is up 0.5% and the Nasdaq added 1.2%. The Nasdaq is coming off a 10-day string of gains, matching its longest streak since Feb. 24, 2015 – so a pullback today was overdue.

At long last, tech stocks have finally recovered all the losses they suffered during the bursting of the dotcom bubble in 2000. It only took 17 years. The S&P 500 Information Technology Index closed Wednesday at an all-time high of 992.3. In doing so, it broke the previous record of 988.5, which was set back in March 2000.

In the intervening years, tech shares had lost as much as 80% of their value before beginning the slow ascent back to the top of the market. That ultra-slow recovery highlights how long it can take stocks to come back from bubbles. Tech stocks in the S&P 500 index now trade at a price/earnings ratio of 18.4, according to FactSet, based on projected sector profits in the coming 12 months.

That means tech is now trading at a 28% premium to tech companies’ valuations over the past decade. To be sure, that’s nothing compared to the triple digit P/Es seen in the late 1990s.

The FANG stocks, (Facebook Apple, Amazon, Netflix, and Alphabet-Google) have rocketed up this year, rising nearly 40 percent, four times the gain of the S&P 500. And the trend doesn’t seem to be ending. The technology heavy Nasdaq Composite Index raced ahead of the broader S&P 500 again this week.

And yet as investors pile into the FANG stocks, one measure of the return investors can expect from those stocks has shrunk to a new low. As of the end of the second quarter, the average free cash-flow yield of the FANG stocks, based on the past 12 months, slid to just 1.4 percent. That’s less than half of what that measure was just two years ago and now nearly a full percentage point below the yield on a 10-year Treasury.

Tech is back to being the biggest sector in the market, representing about a quarter of the S&P 500. That’s still well below the one-third share of the market that tech stocks occupied in the late 1990s. But remember that this figure does not include several big stocks that the public regards as “tech” but that S&P classifies as “consumer discretionary” stocks — a list that includes Amazon, Priceline, and Netflix. Moreover, Tesla isn’t even in the S&P 500, despite being valued at more than $53 billion.

If you want to make money in the stock market, you’d better nail earnings season. The reason is simple: Quarterly results are exerting unprecedented influence over stock returns and, by extension, portfolio performance. In recent quarters, reporting companies have seen their shares move four times the normal daily average, the most in the past 18 years, according to data compiled by Goldman Sachs.

The punishment for missing earnings is also the harshest in almost two years. In the first quarter of this year, companies that fell short dropped more than 2.5% in a single day, on average, according to Wells Fargo data.

One possible explanation is the rise of passive investment vehicles such as exchange-traded funds and quant funds. By trading large swaths of the equity market, rather than individual stocks, participating investors are diluting the effects of specific company fundamentals during non-earnings periods. Then, once earnings season rolls around, stock prices are spring-loaded to react more sharply to any new information.

This ETF effect is compounded by how price-insensitive the traders who use them can be — buying and selling based on what their models tell them and ignoring valuations that might otherwise raise red flags. Goldman finds that the FAAMG group that has led the stock market’s latest rally to new highs — consisting of Facebook, Amazon, Apple, Microsoft, and Google — has been realizing more than 50% of its quarterly return during earnings week.

In addition, the tech, materials, and consumer discretionary sectors are also seeing more than 30% of their quarterly returns generated in the five days surrounding releases.

General Electric reported quarterly profits fell 57% to $1.2 billion, as sales in its oil and gas, transportation and lighting divisions fell. Outgoing GE boss Jeffrey Immelt said the company was working in a “slow-growth, volatile environment”. He said a cost-cutting plan and other measures should put the firm on track to hit profit targets for the year. GE is down about 19% year to date.

Honeywell reported a better-than-expected quarterly profit. Net income attributable to Honeywell increased 5.5 percent to $1.3 billion, or $1.80 per share, above expectations of $1.78 per share. Revenue rose about 1 percent to $10 billion, topping expectations of $9.8 billion.

Honeywell also raised the low end of its 2017 earnings per share forecast by 10 cents. Sales in Honeywell’s aerospace business, which activist investor Daniel Loeb wants to be spun off, fell about 3 percent to $3.67 billion in the quarter, but the drop was much smaller than forecast.

The Department of Labor ordered Wells Fargo to pay $575,000 and to rehire a whistleblower the bank had dismissed in September 2011 after the former employee raised concerns over the opening of customer accounts without their knowledge. Despite news reports and lawsuits claiming the bank had retaliated against whistle-blowers, an investigative report by the bank’s board of directors released in April found no pattern of retaliation.

The U.K. cabinet will accept the free movement of EU citizens for up to four years after Brexit as part of a transitional deal. The news comes after a meeting between Prime Minister Theresa May and British businesses, in which companies stepped up pressure to avoid a so-called hard Brexit.

Bank of America has chosen Dublin as its future European Union hub, the latest major financial services firm to outline its plans to deal with Brexit, Britain’s departure from the 28-nation bloc.

Many banks and financial firms have concentrated their European operations in London, taking advantage of deep and liquid markets as well as the wide variety of support industries that have built up in the British capital, including accountants and lawyers. But those companies now face the distinct possibility that they may no longer be able to serve European clients from London after Britain leaves the Euro Union.

With Britain as a member of the EU, companies based in the country have been able to sell financial products across the Continent under “passporting” rules, which allow a lender licensed in one member state to work throughout the European Union. That is no longer guaranteed when Britain leaves in 2019, so financial companies have been moving forward with contingency strategies, and Bank of America is the latest lender to announce its plans.

American and European authorities have shut down two of the largest online black markets, AlphaBay and Hansa Market, and arrested their operators. AlphaBay, the largest so-called dark net market, was taken down in early July at the same time the authorities arrested the reported founder of the site, Alexandre Cazes, a Canadian man who was living in Bangkok.

Cazes committed suicide in his jail cell shortly after he was arrested. After AlphaBay went down, users streamed to one of its largest competitors, Hansa Market. But on Thursday, the Dutch national police announced that they had taken control of Hansa Market in June and had been operating the site since then, monitoring the vendors and customers and gathering identifying details on those involved in the 50,000 transactions that took place.

AlphaBay and Hansa Market were successors to the first and most famous market operating on the so-called dark net, Silk Road, which the authorities took down in October 2013.

You’ve undoubtedly heard that, in reaction to the hiring of Anthony Scaramucci as communications director, Sean Spicer has resigned as White House Spokesperson (leaving the White House to find someone else to not give press briefings).

Sarah Huckabee Sanders will replace Spicer. Given the nature of Trump coverage—and Spicer’s outsized role in it—you probably heard about the resignation within ten seconds of it happening. Scaramucci said he hopes that press secretary Sean Spicer will go on “to make a tremendous amount of money.”

Financial Review

Fed Talk & Earnings

Sinclair Noe — October 17, 2016

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

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DOW – 51 = 18,086
SPX – 6 = 2126
NAS – 14 = 5199
10 Y – .03 = 1.76%
OIL – .31 = 50.04
GOLD + 3.90 = 1,260.50

Kurdish forces advanced on villages near Mosul, the start of a campaign to reclaim Iraq’s second-largest city from Islamic State militants who seized it more than two years ago. U.S. warplanes are providing air support for the operation, which involves nearly 30,000 Iraqi and Kurdish troops.

Government bond yields climbed around the world after Friday’s comments by Federal Reserve Chair Janet Yellen fueled bets that U.S. policymakers may be prepared to tolerate faster inflation in the interests of a more emphatic economic recovery.

By the middle of next year, Federal Reserve Bank of Boston President Eric Rosengren says he expects unemployment to fall to 4.7 percent and inflation to beat the Fed’s 2 percent target, leaving policymakers at risk of having to squelch the recovery with faster-than-expected rate increases. Rosengren said: “If you wait too long … the more likely you are going to have to do it more quickly … The less likely you are to calibrate it just right.”

The result: a jobless rate that might dip to an ultra-low level, but then force the Fed to risk a recession with faster increases. Rosengren argues the Fed might instead engineer a soft landing that brings the economy to full employment and “we would basically stay there.”

Fed Vice-Chair Stanley Fischer spoke this afternoon at the Economic Club of New York; Fischer suggested that low rates can lead to longer and deeper recessions, making the economy more vulnerable. He added they can also threaten financial stability, although the evidence so far doesn’t show a heightened threat of instability.

His remarks contrasts with those of Fed Chair Janet Yellen on Friday, when she suggested that the Fed may want to run a “high-pressure economy” with low interest rates. Fischer said technology and demographics are contributing to low rates, but are out of the Fed’s control. Fischer said other reasons contributing to weak growth include productivity and labor force growth, an aging population, weak investment and weak foreign growth.

It is probably worth noting that the Fed does not have a great track record of preventing recessions or bear markets. The Fed seems to be pretty good at creating bubbles, not so much at preventing the aftermath. Booms lead to busts and the Fed has not been able to repeal the business cycle.

Wall Street investors now place a 67% chance of a Fed rate hike in December. Today, Treasuries rebounded from a four-month low and the dollar fell after mixed economic data bolstered the case for accommodative monetary policy. Oil declined.

Output at U.S. manufacturers rose for the third time in four months on production of consumer goods and construction materials, a sign the industry is recovering from a prolonged spell of weakness. The 0.2 percent gain at factories, which make up 75 percent of production, followed a 0.5 percent decrease the prior month.

A rebound in manufacturing and mining output was offset by surprisingly weak demand for utilities. In September, mining production rose 0.4 percent as gains in oil and gas well drilling offset a drop in crude oil extraction. That left mining output rising at a 3.7 percent rate in the third quarter following six consecutive quarterly declines.

Energy services firm Baker Hughes reported on Friday oil firms increased drilling rigs last week for the 16th straight week. So, in case you were wondering, oil prices around $45 to $50 a barrel is the level where US drillers pump up their production. That doesn’t mean companies in the oil patch will turned profitable in the third quarter; Oilfield service providers Halliburton and Schlumberger are expected to reported significantly lower earnings (or even losses) later this week.

More than 80 companies in the S&P 500 are set to report earnings this week, according to Thomson Reuters. So far, 34 companies have reported third-quarter results and 62% have topped forecasts, just above the long-term “beat” average of 59%. Earnings of S&P 500 companies are expected to have dipped 0.4 percent in the third quarter, according to Thomson Reuters data.

Bank of America’s third-quarter profits rose nearly 6 percent from a year earlier, helped by strong results in investment banking and trading, as well as lower expenses. BofA earned $4.4 billion in the three months ending in September, up from $4.1 billion in the same period a year earlier. The per-share figure rose to 41 cents versus 38 cents a year ago, easily beating the 34 cents per share analysts were expecting. While revenue was relatively flat year over year, the bank managed to cut expenses.

Management at Deutsche Bank has discussed cutting back investment-banking operations in the US to save money. Reducing US operations could be part of a deal with the US Department of Justice over mis-selling of mortgage-backed securities in the run-up to the 2007 US housing crisis. This is devastating news for the 3 or 4 people who actually wanted to apply for a job with Deutsche Bank.

Financial shares have been a decent performer in the past month, up about 1%, but year-to-date the financial ETFs have been the second worst performers.

At the closing bell, Netflix reported earnings, more specifically Netflix crushed earnings. Third quarter earnings per share came in at .12 cents compared to estimates of .06 cents. Revenue jumped 36% to $2.29 billion. US subscriber growth grew to 370,000, beating estimates of 300,000. International subscriber growth came in at 3.2 million, beating estimates of 2 million. Shares popped about 20%.

IBM reported its smallest drop in quarterly revenue in more than four years, helped by continued growth in the company’s cloud and analytics businesses. Revenue fell to $19.23 billion from $19.28 billion a year ago. Net income fell to $2.85 billion, or $2.98 per share, from $2.95 billion, or $3.01 per share.

IBM is betting on Watson, its artificial intelligence technology, to help it expand, employing about 10,000 workers on the project and investing billions of dollars. The company does not report separate financial results for Watson, but UBS estimates that it may generate $500 million in revenue this year and grow rapidly, nearing $17 billion by 2022.

Intel, Yahoo, and Goldman Sachs release earnings results tomorrow, and Morgan Stanley on Wednesday.

Minneapolis-based grocery chain Supervalu has reached a deal to sell grocery discount chain Save-A-Lot to a private equity investor. Onex Corp. agreed to pay $1.4 billion in cash for Save-A-Lot, which owns 472 stores and licenses naming rights and supplies another 896 locations. Supervalu, which has 3,342 stores, including the Save-A-Lot locations, said it would use the cash from the transaction to pay down debt.

Apple has drastically scaled back its automotive ambitions, leading to hundreds of job cuts and a new direction that, for now, no longer includes building its own car. Hundreds of members of the car team, which comprises about 1,000 people, have been reassigned, let go, or have left of their own volition in recent months. Apple executives have given the car team a deadline of late next year to prove the feasibility of the self-driving system and decide on a final direction.

Tesla Motors said it would collaborate with Panasonic to manufacture solar cells and modules in New York. Under the agreement, which is a non-binding letter of intent, Tesla said it will use the cells and modules in a solar energy system that will work seamlessly with its energy storage products Powerwall and Powerpack. Panasonic is already working with the U.S. automaker to supply batteries for the Model 3, its first mass-market car. Panasonic is expected to begin production at the Buffalo facility in 2017.

Samsung Electronics said its system chips business has started mass production of semiconductors using 10 nanometer technology, adding it was the first company in the industry to do so. Samsung said in a statement a tech product launching early next year will use chips made with its 10-nanometre production technology without specifying the device.

Chemical companies including Honeywell and Chemours are ramping up efforts to produce alternative coolants used in air-conditioners and refrigerators, following a global pact to reduce planet-warming greenhouse house gas emissions.

On Saturday, some 150 nations struck a global agreement in Kigali, Rwanda, on ways to phase down hydrofluorocarbon (HFC) gases, which are currently used in air-cooling systems and refrigerators, and help curb the release of climate-warming emissions. As per the agreement, developed countries such as the United States have to move first to reduce HFCs. Equipment manufacturers will switch to making systems with alternative coolants as chemical makers produce new HFC substitutes.

Honeywell began developing HFC alternatives as far back as 2000 and has invested $500 million to date. The company has committed $900 million in total. Chemours, which was spun off from DuPont Co in 2015, said in May it will invest “millions of dollars” to set up a new plant to produce an auto refrigerant substitute in Texas.

Twitter has lost another potential buyer after Salesforce chief executive Marc Benioff said the company does not intend to bid for the social firm, marking yet another potential high-profile buyer turning its back on the site. Salesforce follows Google and Disney in walking away from Twitter, which at one point appeared to be in the middle of a potentially lucrative bidding war.

However, investors will now wonder whether any company will buy Twitter, which has struggled to grow or generate much revenue, especially when compared with rival Facebook, despite its sizeable and loyal user base.

Financial Review

No Sense in Wasting Our Time

Sinclair Noe — February 23, 2016

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

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DOW – 188 = 16,431
SPX – 24 = 1921
NAS – 67 = 4503
10 Y – .02 = 1.75
OIL – 2.09 = 31.30
GOLD + 17.10 = 1226.40

The G20 is meeting this weekend in Shanghai. The US will call on G20 countries later to use fiscal policy in order to boost global demand.  American officials will also urge all members to refrain from manipulating exchange rates for competitive purposes, in line with existing G20 commitments.

The world’s oil giants were meeting today. At a conference in Houston, Saudi oil minister Ali Al-Naimi, considered the world’s most powerful energy policymaker, said production cuts will not happen. Last week, Saudi Arabia, Russia, Qatar and Venezuela proposed a freeze that would cap production at January levels.

But Naimi said: “Freeze is the beginning of a process, and that means if we can get all the major producers to agree not to add additional balance, then this high inventory we have now will probably decline in due time. It’s going to take time. It is not like cutting production. That is not going to happen because not many countries are going to deliver even if they say they will cut production, they will not deliver. So there is no sense in wasting our time seeking production cuts.”

Global production is projected to be 95 million barrels a day in the first quarter of 2016, and consumption around 94 million, according to the EIA.

JP Morgan will set aside an additional half a billion dollars to cover potential bad loans to oil and gas companies in the first quarter. According to a study by Deloitte, thousands of jobs have been cut in the U.S. energy sector and roughly a third of oil producers, or 175 companies, are at high risk of slipping into bankruptcy this year, increasing the risk that bank loans will not be repaid.

JP Morgan expects to set aside an additional $500 million for oil and gas loans in the first quarter, on top of the $815 million it had at the end of 2015; they will also increase reserves for metals and mining loan exposure by $100 million to $350 million.

What worries Wall Street types? A hedge fund called Two Sigma surveyed Wall Street analysts, and here’s what has them losing sleep: a market liquidity event, or a rapid draw-down with losses of more than 20% in one or more assets as market participants try to liquidate positions simultaneously; a hard landing for China, with GDP growth dipping below 3%; sustained global deflation, which would be the big 3 economies experiencing consecutive CPI readings below zero; emerging market sovereign debt crisis with one or more emerging markets defaulting on public debt leading to the risk of contagion; and US corporate credit liquidity crisis, which you probably remember from 2008.

BHP Biliton posted a $5.6 billion first half loss, due in part to a massive write-down of US energy assets. The world’s largest mining company by market value cut its midyear dividend by 74% to 16 cents a share.

Other leading miners and energy giants, including Rio Tinto, Glencore and ConocoPhillips, have cut shareholder payouts in recent months. BHP’s first half loss included an $858 million charge against the Samarco iron-ore mine in Brazil, where a wastewater dam collapsed in November, killing 19 people and polluting 400 miles of rivers.

Home Depot reported a profit of $1.4 billion, up from $1.3 billion a year earlier. Revenue grew to $20.9 billion from $19.1 billion. And Home Depot raised guidance for 2016.

Toll Brothers reported first-quarter net income of $73 million. That was down from its year-ago result of $81 million. The results matched analyst estimates. Revenue increased about 10% and came in better than estimates.

European earnings roundup: Standard Chartered shares plunged after full-year underlying operating income fell 15% to $15.4 billion. Swiss Re posted a 31% rise in 2015 net income, announced the retirement of CEO Michel Lies, and declared a dividend hike and €1-billion-euro buyback. Danone reported a rise in sales for the fourth quarter, boosted by a resurgent performance in its fresh dairy unit in the U.S.

Puerto Rico’s much-delayed audited financial statements for 2014 are expected to be finished and issued by April, Governor Alejandro Garcia Padilla said in a letter to House Speaker Paul Ryan, attributing the tardy submission to “complexities posed by our current financial crisis.”

The S&P Case-Shiller 20-city composite was steady in December, with 10 of 20 cities showing increases in prices for existing homes. After seasonal adjustment, prices rose 0.8%. Over the last 12 months, home prices increased 5.7%, with Portland, San Francisco and Denver each posting double-digit gains. Home prices in Phoenix were up 0.5% in December and up 6.3% for the past 12 months.

In a separate report, the National Association of Realtors reported home resales rose 0.4% to an annual 5.47 million rate in January; that topped expectations of 5.3 million. It was higher than year-ago levels by 11%. Tight supplies pushed prices higher. The median price was up 8.2% from a year earlier in January, the fourth straight month of accelerating yearly price gains.

According to the New York Fed’s quarterly report on household debt, mortgage debt outstanding nearly doubled in the period from 2000 and 2006, but has risen only about 1% since 2012. In 2008 Americans had $12.6 trillion in debt outstanding, of which housing debt made up $10 trillion, or 79% of the total. In the fourth quarter of 2015, there was $12.1 trillion in total debt, and housing’s share had dwindled to 72%, or $8.7 trillion.

One reason is that cash-out refinancing has dropped from around $300 billion a year down to around $30 billion a year, and the small amount of cash-out refi going on is almost completely offset by people repaying second mortgages and HELOCs. Also, the pace of home buying has slowed even as Americans are paying down their home loans.

Another reason is that homeowners are paying down mortgage debt much faster than in previous years, and the reason is that more people are holding their mortgages for longer; people aren’t moving as much as in the past and that means that mortgages are getting older; so payments are further along in their amortization process and principal, rather than interest, is being paid down.

Consumers' confidence fell in February to the lowest level in seven months, as American became a bit more pessimistic about job prospects and business conditions. Stock market losses also added to the anxiety. The Conference Board’s consumer confidence index dropped to 92.2 from a revised 97.8 in January. Consumers’ short-term outlook grew more pessimistic, with consumers expressing greater apprehension about business conditions, their personal financial situation, and to a lesser degree, labor market prospects.

Western Digital will buy SanDisk for $15.8 billion, sticking with plans to combine the makers of memory chips after a potential Chinese investor backed out of another deal amid a national security probe. Western Digital will pay $78.50 a share in cash and stock for SanDisk, 16 percent more than Monday’s closing price.

United Technologies has rejected another merger offer from Honeywell International on concerns it will not be approved by antitrust regulators. Honeywell is said to have offered $108 per share for United Technologies last week, a more than 20% premium to the share price at the time.

United Technologies said the two firms only held “preliminary” conversations. A tie up would have created one of the aerospace industry’s largest companies worth more than $160 billion. However, United Technologies broke off talks because a deal “would face insurmountable regulatory obstacles and strong customer opposition”.

Boeing has won an order from United Continental for 25 current-generation 737 aircraft in a transaction that could be worth over $2 billion at list prices. The follow-on deal comes just weeks after United agreed to buy 40 737-700 jets.

Alphabet is shuttering Google Compare, its U.S. comparison-shopping site for auto insurance, credit cards and mortgages after one year. The quick reversal is a setback to the company’s efforts to provide consumers with niche shopping and financial-services tools, and follows the demise of a similar website called Google Advisor that was shuttered in 2011.

Bill Gates weighs in on Apple’s battle with US government. The world’s richest person shared his thoughts on Apple versus the FBI, and says there should be a debate about whether or not the phone of one of the San Bernardino shooters should be unlocked.

Meanwhile, in the latest edition of their annual letter published today, Bill and Melinda Gates argue that the world needs “an energy miracle,” and are willing to bet that such a breakthrough will arrive within 15 years. In the letter, Gates outlines the environmental and economic quandary that the world faces: a growing population, growing demand for services, and increased energy use.

Each of these factors contributes to rising carbon dioxide emissions, a major driver behind climate change, and there’s no sign that their upward trends will reverse. But Gates argues that we could still avert environmental disaster by focusing on the carbon dioxide produced by energy – specifically, by reducing it to zero.

And even though the energy represents a multi-trillion-dollar market, Gates says the normal venture capitalist model that has worked for biotech and worked for software is not quite right here.” He cited the Breakthrough Energy Coalition – a fund he launched late last year with Facebook CEO Mark Zuckerberg – as a promising new model.

Financial Review

Spotting Highs and Lows

Sinclair Noe — February 22, 2016

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Financial Review

Just Around the Corner

Sinclair Noe — April 17, 2015      

 

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DOW – 279 = 17,826
SPX – 23 = 2081
NAS – 75 = 4931
10 YR YLD – .03 = 1.85%
OIL – .52 = 56.19 Oil posted a 12% gain for the past week.
GOLD + 5.30 = 1,203.30
SILV – .06 – 16.23
 
The economy continues to expand and consumers are feeling better. The University of Michigan Consumer Sentiment Index rose to 95.9 in April, up from 93 in March. Separately, The Conference Board said leading indicators rose 0.2% in March; the leading economic index has been slowing over recent months but it still points to moderate expansion in economic activity.

Consumer prices rose 0.2% in March. Gasoline prices rose 3.9%, which was the biggest jump since February 2013; still, gas prices are about 33% below year-ago levels.  The core-CPI, which excludes energy and food prices, also rose 0.2% due to higher cost of housing and used cars. The cost of clothes, housing, cars, and medical care increased, while food and airfare decreased. Core prices have risen 1.8% in the past year. While the “all-items index” (which includes things like food and energy) declined 0.1% over the last 12 months. Higher inflation would indicate a stronger dollar because it could reinforce the view that the Fed might hike interest rates sooner rather than later.

The Labor Department reports real average hourly earnings for all employees increased 0.1 percent from February to March, seasonally adjusted. This result stems from a 0.3-percent increase in average hourly earnings being partially offset by a 0.2-percent increase in the Consumer Price Index. Real average hourly earnings increased by 2.2 percent, seasonally adjusted, over the past 12 months.

Another tidbit from the Labor Department shows that long-term, wages have not just been flat but slightly down over the past 40 years. Adjusted for inflation, average weekly earnings for production and nonsupervisory employees, the bulk of the workforce, topped out in October 1972. In today’s dollars, the weekly paycheck in 1972 was the equivalent of $811, compared with current paychecks at $703 a week. A recent jump in real average earnings is largely due to low inflation, rather than surging paychecks. Cheaper gasoline and a strong dollar have pushed down overall prices, leaving many Americans with more money, even though they aren’t spending it.

After a string of soft U.S. economic data, the dollar hovered near a one-week low against a basket of major currencies on Friday and was on track for its biggest weekly drop in a month. The dollar index set a fresh one-week low this morning; but moved higher following the economic data on inflation.

An interesting article in the Murdoch Street Journal today argued the idea that the Fed has already tightened monetary policy just by talking about tightening monetary policy. The talk about hiking rates has made itself felt in stock, bond, and most important foreign exchange markets; a version of the taper tantrum, if you will. The dollar’s sharp rise in the last six months is due not just to the European Central Bank’s dramatic easing of monetary policy through quantitative easing (QE, the purchase of bonds with newly created money), but to the juxtaposition of the ECB’s action against anticipation that the Fed will soon tighten. Anticipation of tighter U.S. monetary policy also shows up in various measures of risk such as the spread between yields on corporate bonds and safe Treasuries, which have widened, or the stock market, which has stopped climbing.

This might explain why the economy didn’t seem to take off with the benefits of lower oil prices. It’s also a reminder of something investors and Fed officials routinely forget: Markets discount the Fed’s actions long before they actually occur, in ways that are not obvious at the time.

Bloomberg’s trading terminal experienced a global outage this morning, with traders complaining all over Twitter they had been hit by the issue. And yes, this does affect worldwide trading, especially in the bond markets. There are more than 300,000 subscribers to the Bloomberg terminals and they pay about $20,000 per year for the subscription, so it is for serious business. A lot of traders stepped out for coffee this morning. Service was restored after a couple of hours.

China’s securities regulator tightened rules on margin lending while the country’s two stock exchanges said they would make it easier to short stocks, or bet that stocks will fall in price in an effort to temper the country’s soaring stock markets. Asian markets were generally lower today.

German government bonds continued to break records this morning, lifted by the ECB’s commitment to stimulus, coupled with investors’ appetite for low-risk assets amid growing concerns over Greece. European stocks are down 2.1 percent this week, poised for the worst drop in four months and trimming 2015 gains to 18 percent. In early trade, the yield on Germany’s 10-year bond slipped to 0.049%, breaking through Thursday’s all-time low. The yield on the country’s 30-year debt was just below half a percentage point.

“Liquidity is drying up in Greece,” Greek Finance Minister Yanis Varoufakis said yesterday in Washington. Athens will continue to “compromise for a speedy agreement, but will not be compromised.” International Monetary Fund Managing Director Christine Lagarde warned that she wouldn’t let Greece miss a debt payment. Greece is struggling to win more aid to avoid a default, while resisting more austerity measures. And the Greeks seem to be dragging their feet when it comes to spelling out specific reforms; the reason is simple; the reforms the EU is requesting won’t work and would not be accepted by Greek voters. So, slowly the EU is starting to realize that a Greek exit from the Eurozone would be a big mistake; they don’t know how big a problem it would create but the thinking is that it would be major. Today, there appeared to be a shift in thinking.

In the event of a missed payment, there is no specific plan B to keep Greece in the monetary union. Which is a frightening proposition that now has the big banks scared of other countries exiting the euro, and even bigger concerns that it could breakdown into bank runs. So now, international creditors are starting to show more flexibility in negotiations over Greek finances to prevent a euro exit. The red-line is that the Syriza led government in Athens needs to commit to at least some economic reforms.

If you have been following the Greek situation, it sometimes sounds like it flips then flops between a possible resolution and what seems to be an inevitable train wreck; either Greece bows down to it paymasters or it defaults and exits the Euro Union. But the longer the Greeks delay, the more they are likely to see flexibility from creditors. A Greek exit would be.., well nobody knows but it would probably be bad. And yet, default seems inevitable because they are just too far in the hole. More and more it looks like a best case scenario is a partial default, a few concessions, Greece stays in the Eurozone. That doesn’t mean it will happen that way, but that looks like a possibility. And if, in this whole process, Greece can wean itself off of dependence from the banksters, they could even pull out of the economic depression they are in.

We have a few earnings reports to cover today:
American Express reported quarterly revenue that fell short of analysts’ estimates, dropping 2.7% to $7.9 billion. AmEx was hurt by a stronger dollar and the loss of several co-branded tie-ups; AmEx recently ended its co-branded relationship with JetBlue, while its agreement with Costco is due to expire next March.

Schlumberger shares rose slightly after the oil equipment provider topped first-quarter earnings projections, although revenue missed. Excluding charges, the company booked a per-share profit of $1.06, beating estimates of $0.91, but down from $1.21 a year earlier. Blaming a decline in drilling activity, Schlumberger said it now plans to cut 11,000 more jobs in addition to the 9,000 job cuts announced in January. You might think a big earnings miss would result in a nasty day of trading, but the Wall Street crowd like to see job cuts.

General Electric reports its revenue fell a worse-than-expected 12% in its first quarter. Overall for the quarter ended March 31, GE reported a loss of $13.5 billion, or $1.35 a share, compared with a profit of $3 billion, or 30 cents a share, a year earlier.

Honeywell reported a 5% drop in quarterly revenue, in part due to a stronger dollar, even as net income rose. Honeywell raised the lower end of its full-year profit forecast, even as they cut their full year revenue forecast.

Fifty years ago April 19th, Gordon Moore, he one-time CEO of Intel, predicted that the number of components on semiconductors or “chips” would continue to double every twelve to eighteen months even as the cost per chip would hold constant. The idea came to be known as Moore’s Law. And it really was a radical idea. Most commodities do not behave like that. Think about meat, grains, coffee, or oil, which get worse and more expensive over time. Computing power and related components of the digital revolution including memory, displays, sensors, digital cameras, software and communications bandwidth, continue to get faster, cheaper, and smaller roughly at the pace Moore anticipated. And through economies of scale, low prices encourage more uses, which raises production and lowers costs in a virtuous cycle. With each cycle of Moore’s Law, computing power doubles, even as price holds constant. If you want to have any understanding of the digital revolution, you have to be able to grasp Moore’s Law.

Thanks to Moore’s Law, tomorrow’s digital products are certain to be better and cheaper. Think of it as the granddaddy of disruption, and the life blood of innovation. Fifty years ago, Moore thought the exponential growth cycle might last for 10 years, but 50 year later it still applies. Every time it seems like innovation has hit a wall, we just break through. And that means there is something new and wonderful just around every corner.

FINANCIAL REVIEW

Floors and Ceilings

Sinclair Noe — October 17, 2014

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Financial Review

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DOW + 263 = 16,380
SPX + 24 = 1886
NAS + 41 = 4258
10 YR YLD + .05 = 2.20%
OIL + .27 = 82.97
GOLD – .70 = 1239.20
SILV – .10 = 17.37

The markets were down for the week, even with the bounce today. For the week, the Dow and the S&P each dropped about 1%; the Dow was down 164 points on the week, and the S&P was down 20 points. The S&P is now down for 4 consecutive weeks.

Let’s take a look at the charts. Earlier in the week I talked about support and resistance. Someone mentioned to me that they weren’t quite clear on the concept. So, here is a good way to look at these topics. Support is the floor and resistance is the ceiling. Think of a chart as a staircase under construction. The stairs are being built, hopefully higher and higher, and to prop up the stairs, you have to have a structure, or floors and ceilings. When you break through the ceiling to a new higher level, that ceiling then becomes the floor for the next level up. In other words, resistance becomes support. If the staircase of price falls, the last floor will catch you, or provide support. Then to go higher yet again, you will have to punch through that ceiling, or resistance, again.

So, let’s look at support and resistance for the major indices. The Dow Industrials dropped below support last Friday, when the price dropped below the 200 day moving average at 16,592. On Monday, the Dow dropped below another level of support at 16,310, slightly below the old low of 16,333 on August 7. Tuesday, the Dow was just slightly lower, trying to cling to that level of support. Wednesday, was another big down day. Thursday was an inside day, just slightly down; an inside day means the high and the low were within the range of the highs and lows for Wednesday. Then today we got a bounce.

So, as of today, we have a new floor, which is the low for the day of 16,118. The next ceiling, or level of resistance is 16,310, and then the next level of resistance is the 200 day moving average at 16,586, and then the next level of resistance is the old high on September 19th at 17,350. That means the Dow would have to break through three ceilings to get back to new highs. Keep in mind the idea of the staircase, and as we go through each ceiling we have to have something to prop up the staircase. We would need very strong earnings, or accommodative monetary policy, or something that could justify those prices going higher.

Now, the really important short-term level of resistance and support is around 16,310. If we look back over the past few months we find that that level served as support in April, May (twice in May), and August. That’s important because the more times that floor supports the market it indicates that that is a level where the floor is very strong. If the Dow cannot hold above the 16,300 to 16350 level, then the next support level is around 15,350 from back in February. So, if next Monday or Tuesday, we take out today’s low of 16,118, the next level of support is all the way down to 15,350.

For the S&P 500 index the 200 day moving average is at 1906, which is also the low from August. Of course that level was breached at the start of the week. And so now the old level of support at 1906 becomes the new level of resistance. Then, the next level of resistance would be the old high from September 19, at 2019. If the S&P 500 can’t hold above today’s low of 1864, we might expect to drop down to the next level of support. The next levels off support are at 1815, the old low from April; then at 1737, the old low from February.

Today’s price action would indicate that the indices are trying to reverse the slide. If you use candlestick charts, the pattern today could be described as a morning star. The morning star is a three candle pattern. The first candle was Wednesday, which was a big down day; yesterday was a neutral day (slightly positive on the S&P 500 and only slightly negative on the Dow), or what is known as a doji; and today we had a strong positive day that closed above the high from Wednesday.

When found in a downtrend, this pattern can be an indication that a reversal in the price trend is going to take place. What the pattern represents from a supply and demand point of view is a lot of selling in the period which forms the first black candle; then, a period of lower trading but with a reduced range, which indicates indecision in the market; this forms the second candle. This is followed by a large white candle, representing buyers taking control of the market. Today, you have to think that some of the hedge funds and big money players were stepping in to buy the dip, or pick up bargains, or to cover short positions. And if you want to increase your probabilities, you would wait for confirmation in the fourth candle, however today’s move was big enough that more aggressive traders might not wait. With the usual caveat that I don’t know what the markets will do on Monday, you don’t know; nobody knows. None of this is a guarantee, it is just looking at probabilities.

Another consideration is that we are still in a very long and strong bull market; the past couple of weeks have not changed that overall trend. We’ve had a few whiffs of panic, lots of indecision, and reasons for concern, but we haven’t seen a full-fledged freak out. The possible exception to that, at least in equities, would be the Russell 2000 index of small cap stocks, which saw a 10% drop, or what is considered a correction; and there we saw a nice bounce back this week. The Russell was down about 3 points today, but for the week it is up about 30 points at 1082.

There are several possible reasons why small caps have found support, including: bargain hunting and short covering, but also small caps have less international exposure; and with global weakness, especially in Europe, the small caps are a way to focus on US growth. And even though the economic news in the US has not been great, it has been reasonably good and it has been better than most other global markets.

Today, the Thomson Reuters/University of Michigan preliminary October reading on the overall index on consumer sentiment came in at 86.4, up from 84.6 in September, and the highest since July 2007.

And separate data showed groundbreaking for new homes rose more than expected last month. Housing starts rose 6.3% to an annual 1.02 million-unit pace. Newly issued permits also rose. You’ve got to think the recent reduction in rates will have a somewhat positive effect for the housing market in the next couple of months.

Toss in a few good earnings reports today: GE’s third-quarter net income rose 10% to $3.5 billion, or 35 cents per share; that was better than expected. Revenue, at $36.1 billion was a bit under guesstimates, but then GE raised guidance on revenue.

Morgan Stanley reported an 87% increase in third quarter earnings, as they got back to their investment banking roots, and focused on bond trading and wealth management; and working on the Alibaba IPO also helped.

Honeywell reported net income rose to $1.17 billion in the quarter, or $1.47 per share, from $990 million, or $1.24 per share, a year earlier. Honeywell also raised the low end of its full-year forecast range for both profit and revenue, and said it is looking for acquisitions. Not a big surprise as Honeywell is very involved in aerospace, which has been very strong this year.

Schlumberger reported better than expected earnings and revenue. Schlumberger is in the oilfield services business, and they provide drilling technology and equipment, and construction services and such. Of course, the drilling activity in the US has carried over to that sector. Of course, it will be interesting to see how the oil sector fares moving forward as oil prices are down more than 25% from the June highs.

Earlier this week, Russian President Vlad Putin warned that Russia might reduce gas supplies to Europe if Ukraine steals from the transit pipeline to cover its own needs. In June, Russia cut off supply to Ukraine over what gas exporter Gazprom said were billions of euros in unpaid bills. Without Russian flows, there is concern Ukraine might have to siphon off gas from flows transiting the country en route to Europe this winter. Today, after talks with leaders from Europe and Ukraine in Milan, Italy, Putin said a deal had been reached that would ensure gas supplies to European buyers “at least for the winter.” More talks continue in Brussels next week.

Also, earlier this week, Credit Suisse published a report saying rising inequality in the US is at levels that have been associated with recessions in the past, and that the ratio of income to wealth is at the highest level since the Great Depression. Today, Federal Reserve Chairwoman Janet Yellen delivered a speech in Boston at a conference on inequality, and she said the increase in inequality is a concern for her. Though Yellen didn’t go so far as to echo Credit Suisse’s recession alarm, she did warn that rising inequality risked doing serious harm to the overall strength of the US economy. Yellen noted that living standards have been “stagnant” for most Americans for the past few decades, and that is an unhealthy development for an economy that relies mainly on consumer spending to drive growth.

Yellen also stepped just a little outside the boundaries of monetary policy to hint at the idea of more federal funding for education. The Boston Fed named education as one of the four “building blocks of opportunity” that could help reduce inequality, with the other three being parents’ financial resources, starting a business, and inheritance.