Financial Review

Times Are Changing

Sinclair Noe — October 13, 2016

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

Subscribe: iTunes | Android | RSS

DOW – 45 = 18.098
SPX – 6 = 2132
NAS – 25 = 5213
10 Y – .04 = 1.74%
OIL + .37 = 50.55
GOLD + 2.90 = 1258.80

Today’s trading started with a sharp dive, followed by a slow drift higher (still finishing in negative territory). At one point, the Dow dropped to 17,959, or a 185-point decline. The S&P 500 index dropped as low as 2114, taking out the lows set in early September. And that is where some support came in. The question is whether support can hold.

With the holidays coming up, bears would need to strike during the next couple of weeks. Otherwise, we’ll go into the low-volume year-end mode and the window for a correction would close until the New Year.

Minutes from the September FOMC meeting… Many members thought raising rates would be warranted “relatively soon” if the U.S. economy continued to strengthen, but internal divisions remained over the timing of the next move. Relatively soon probably means a December rate hike. Some Fed hawks thought that waiting too long to hike could lead to a recession, I guess maybe they think more people with more jobs is problematic?

China’s exports tumbled 10% in September, causing China’s trade surplus to narrow to $42 billion, the smallest since March; imports also declined. The disappointing trade figures pointed to weaker demand both at home and aboard, and deepened concerns over the latest depreciation in China’s yuan currency, which hit a fresh six-year low against a firming US dollar. Asian stocks tumbled to three-week lows.

The number of people who applied for unemployment benefits was flat at 246,000 in the first week of October. Initial jobless claims have been under 270,000 for 15 straight weeks. The last time claims were that low for that long was in 1973.

Yesterday we reported on the JOLT survey, the Job Opening and Labor Turnover report which offers extra detail about the labor market. One interesting stat emerged from breaking down the quits rate. Quits are linked with a tight labor market and the thinking being that if someone quits their job it means they feel confident about finding another one.

The rate of workers quitting government jobs is near an all-time high. As wage pressures build up in the private sector and lead to pay raises, many government workers may be feeling more secure about leaving a job in the public sector and going after higher wages and a greater possibility of raises in the future.

The US Energy Information Administration reported that domestic crude supplies rose by 4.9 million barrels in the week ended Oct. 7. This was the first weekly rise in crude supplies in 6 weeks. The American Petroleum Institute late Wednesday reported a rise of 2.7 million barrels.

And while that was happening…The U.S. military launched cruise missile strikes overnight on three coastal radar sites in rebel-controlled areas of Yemen, retaliating after failed missile attacks this week on a U.S. Navy destroyer. The strikes represent a potentially significant step for the U.S. in Yemen, where a bloody civil war has pitted Iranian-backed Houthi rebels against a Saudi-led coalition supported by the US.

There is a strong bond between Iran and the Houthi uprising working to overthrow the government in Yemen. Houthi leaders go to Iran for ideological and religious education, and Iranian and Hezbollah leaders have been spotted on the ground advising the Houthi troops. It is fairly likely that Iranian advisers are responsible for training the Houthis to use the type of sophisticated guided missiles fired at the US Navy.

For Iran, supporting the revolt in Yemen is a good way to bleed the Saudis, Iran’s regional and ideological rival. For the most part, the US has avoided direct involvement in the fight, until last night; and even then, the US limited its response; as much as cruise missile strikes can be considered limited.

Insured property losses for both residential and commercial properties from Hurricane Matthew are estimated to be between $4 billion and $6 billion from wind and storm surge damage according to analysis from Corelogic; 90% of the insurance claims are expected to be related to wind and 10% is expected to be related to storm surge – this does not include insured losses related to flooding. And it does not include uninsured losses and economic disruption.

With all of that considered, Moody’s analytics reportedly predicts the total economic cost could rival the $70 billion worth of damage caused by Superstorm Sandy. And the worst is yet to come, at least in North Carolina.

Flooding after a hurricane can be a slow-moving, if predictable, affair. Rainwater collects into streams that feed into tributaries that feed into rivers, and several days later, all the rainfall over hundreds of square miles is flowing down one swollen river. Post-Matthew, rivers in North Carolina are not expected to crest until as late as Friday or Saturday. And to make it even worse, North Carolina is the second largest pork producer in the country, with lots of industrial scale pig farms that dispose of waste in open-pit lagoons.

Wells Fargo CEO John Stumpf has resigned, effective immediately; Stumpf does not leave empty-handed, his retirement comes with a golden parachute totaling $137 million. COO Tim Sloan has been named the new CEO and he has an immediate test – Wells Fargo reports third-quarter results tomorrow. Sloan will surely try to sell the idea that Wells has put the problems of the past behind it.

However, one of the themes of the recent Congressional hearings was that Wells was systemically flawed, its corporate culture was rotten through and through. And Stumpf’s failure to recognize and act on problems was confirmation of the disease. After all, opening fake accounts to meet unrealistic sales quotas was not the first wrongdoing at the bank. And Stumpf’s replacement, Tim Sloan was in the chain of command that could have dealt with the problem – but didn’t.

Other big banks reporting tomorrow include JPMorgan Chase and Citigroup.

Deutsche Bank is implementing a company-wide hiring freeze as CEO John Cryan seeks to lower costs and shore up investor confidence. The bank is struggling to reverse a slide in shares that eroded almost half of its market value this year, amid concerns about mounting legal costs after the DOJ requested $14 billion to settle a probe into faulty securities.

HP Inc. expects 3,000 to 4,000 employees to exit between fiscal 2017 and fiscal 2019. The company’s board said the restructuring plan is expected to save $200 million to $300 million beginning in fiscal 2020.

Delta Air Lines reported adjusted quarterly profit of $1.70 per share, beating estimates by 5 cents. However, revenue was below forecasts. Delta also said an August outage cost the airline $100 million.

CSX reported quarterly profit of 48 cents per share, 3 cents above estimates. Revenue also beat. The railroad operator’s results were hurt by a drop in freight volumes, which were still able to exceed estimates.

Pfizer lost its appeal in a patent case over its pain drug Lyrica in a U.K. court, but said it would seek a further appeal.

Although sales of high-end virtual reality headsets have been slow, Sony released a virtual reality “add-on” for its Playstation 4, priced at $399. Best Buy and GameStop opened doors early to meet the high demand. Amazon was already selling out.

Facebook and Alphabet are working with a Chinese company, Pacific Light Cable, to lay an ultrafast internet cable between Los Angeles and Hong Kong. The 12,800-kilometer cable will use new fiber-optic technology.  Facebook, Microsoft, and Alphabet have invested hundreds of millions of dollars in the underwater cables that carry most of the world’s internet traffic, an effort by the technology companies to ensure they have enough network capacity to cheaply shuttle information between their data centers. The investments have pushed aside the telephone companies that have dominated the capital-intensive market for more than a century.

Amazon is hiring more than 120,000 seasonal employees across its fulfillment centers, sortation centers and customer service sites in the United States for the upcoming holiday season. More than 14,000 seasonal positions were transitioned to regular, full-time roles after the holidays last year, and Amazon expects to increase that number in 2016.

The bankruptcy court handling Hanjin Shipping’s insolvency proceedings plans to put the firm’s Asia-U.S. operations up for sale as early as tomorrow, in an effort to raise funds and help rehabilitate the indebted company. The sale would reportedly involve the employees, customers and some of the assets, including vessels, in Hanjin’s trans-Pacific network. Hanjin shares closed up 30% on the news.

Uber’s business model of classifying workers as independent contractors may have received a blow from New York State regulators, who ruled that two former drivers are eligible for unemployment payments. Unlike contractors, employees are entitled to a variety of rights and protections, including a minimum wage and workers’ compensation insurance, and are typically costlier for companies to rely on.

The decision could make it more difficult for Uber, its rival Lyft and other new businesses operating in what is known as the gig economy by raising their costs and challenging their business model. The rulings by the New York State Department of Labor were sent to the two Uber drivers (one also worked for Lyft) in August and September but have not previously been reported.

Bob Dylan has won the Nobel Prize for Literature in a surprise decision that made him the only singer-songwriter to win the award. (Clearly, the times are a changing.) The Swedish Academy recognized Dylan for “having created new poetic expressions within the great American song tradition.” More than 50 years on, Dylan is still writing songs and is often on tour.

Financial Review

Table Scraps

Sinclair Noe — October 5, 2016

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

Subscribe: iTunes | Android | RSS

DOW + 112 = 18,281
SPX + 9 = 2159
NAS + 26 = 5316
10 Y + .03 = 1.72%
OIL + 1.02 = 49.71
GOLD – 1.90 = 1267.50

The Institute for Supply Management said its services index shot up to a reading of 57.1% in September from 51.4% in August, on a scale where any reading over 50% indicates improving conditions. Sub-indexes on business activity, new orders, and employment – all posted big gains.

Private-sector employment slowed a bit in September. According to data from Automatic Data Processing employers added 154,000 private-sector jobs last month, down from 175,000 in August. This is the smallest increase since April.

Analysts use ADP’s data to get a feeling for the Labor Department’s employment report, which will be released Friday and covers government jobs in addition to the private sector. ADP’s report showed that small private-sector businesses added 34,000 jobs in September, medium businesses added 56,000 and large businesses added 64,000.

The US trade deficit rose 3% in August to just over $40 billion as imports climbed to the highest level in almost a year. Exports edged up to about $188 billion to mark the highest level since July 2015. The drop-off likely stems from weak global demand and a strong dollar that makes American goods more expensive for foreign customers to buy.

US imports, meanwhile, increased 1.2% in August to $228 billion and hit the highest level in 11 months. The deficit is on track to be smaller in the third quarter than in the spring. That’s likely to boost third quarter Gross Domestic Product.

The National Retail Federation is looking forward to a very happy holiday season; they expect sales for November and December excluding autos, gas and restaurant sales, to increase 3.6% to $655.8 billion. This is higher than the 10-year average growth of 2.5%. Non-store sales, which includes e-commerce, are expected to increase 7% to 10%. The organization believes consumers are in a stronger position from previous years, with steady gains in jobs and incomes.

The International Monetary Fund has issued a warning about the global banking system; a third of biggest banks in the world’s richest countries are so weak their problems could not be solved even by a recovery and rising interest rates. About a third of European banks, with $8.5 trillion in assets, and a quarter of U.S. banks, with $3.2 trillion in assets, are in this too-weak-to-recover category.

The IMF says, “This suggests the need for fundamental changes in both bank business models and system structure to ensure a vibrant and healthy banking system.” Earlier this year, the IMF said in a report on the German financial sector that Deutsche Bank appeared to be the riskiest bank in terms of threats posed to global financial system, an insight that prompted a sharp fall in the bank’s stock. Today, fund officials did not backtrack from this view.

Gross debt in the non-financial sector has more than doubled in nominal terms since the turn of the century, reaching $152 trillion last year, and it’s still rising. The figure includes debt held by governments, non-financial firms and households. The IMF says current debt levels now sit at a record 225 percent of world gross domestic product; about two-thirds of the liabilities reside in the private sector.

The rest of it is public debt, which has increased to 85 percent of GDP last year from below 70 percent. Finance chiefs and central bankers from the IMF’s 189 member nations meet this week in Washington for the annual meeting of the fund, which was conceived during the Second World War to oversee the world monetary system.

Fitch has cut the outlook on Wells Fargo’s credit ratings to Negative, but affirmed the bank’s existing rating of AA-, which is investment-grade. In an announcement, Fitch cited “potential reputational damage from the recent regulatory actions and fines,” as well as a belief that the lender could face “earnings pressure.”

Hurricane Matthew battered Haiti and is now hitting the Bahamas. At least 11 deaths were blamed on the powerful storm during its weeklong march across the Caribbean, five of them in Haiti (and possibly many more). The Category 4 hurricane could hit Florida – or come dangerously close – late tomorrow or early Friday and then scrape the East Coast all the way up to the Carolinas over the weekend. Hundreds of thousands of people along the lower East Coast have been urged to evacuate their homes.

A global agreement to combat climate change by shifting the world economy away from fossil fuels will take force next month after passing a threshold for ratification with support from European nations. In total, 72 countries out of 195 have ratified the agreement. The deal will formally start in 30 days. It took eight years for the previous U.N. climate deal, the 1997 Kyoto Protocol that obliged only rich nations to cut emissions, to gain enough backing to take effect.

Chicago Fed President Charles Evans would be “fine” with raising U.S. interest rates by year end if U.S. economic data continued to come in firm, though any further moves would need to see inflation moving higher. Speaking to reporters after a speech in New Zealand, Evans said any hike would likely come at the Fed’s December policy meeting, though he would not rule out a move in November.

The European Central Bank will probably gradually wind down bond purchases before the conclusion of quantitative easing, and may do so in steps of 10 billion euros ($11.2 billion) a month. The talk of tightening and tapering has spurred a reversal in government bond prices across the world, with U.S. Treasuries dropping while German 10-year bond yields are at -0.03 percent this morning, up from -0.15 percent last Friday.

After returning to the bench earlier this week, the Supreme Court will hear a case today that will clarify an issue at the heart of the federal crackdown on insider trading over the past eight years. Justices will decide whether to make it harder to prove illegal activity when company insiders receive no cash or other tangible benefits for their tips.

Fidelity Investments is a huge mutual fund company, founded seven decades ago and run ever since by the Johnson family. A private venture capital arm run on behalf of the Johnsons, F-Prime Capital Partners, competes directly with the stable of Fidelity mutual funds in which the public invests.

That conflict can be seen in the case of Ultragenyx Pharmaceutical, a biotech start-up. In 2011 and 2012, the Johnsons’ F-Prime Capital invested a total of $11 million on Ultragenyx before the start-up made an initial public offering of its stock. The pre-IPO investment effectively prevented Fidelity mutual funds from making the same play.

If both the private fund and Fidelity’s ordinary funds had invested, they would have violated US securities laws, which prohibit affiliated entities from buying substantial stakes in the same companies at the same time.

The managers of Fidelity’s public funds eventually did purchase Ultragenyx shares, but not until after the stock price skyrocketed in the firm’s January 2014 initial public offering. The Fidelity funds bought about 1.1 million Ultragenyx shares in the second quarter of 2014. The average price for the stock was $41.17 during that three-month period – 12 times higher than the $3.55 a share paid by F-Prime Capital.

The Johnson family’s VC fund pulled down about $128 million on the deal, representing a gain of more than 1,000%. Investors in Fidelity’s public funds – not so much. Over the past three years, U.S. regulatory filings show, the Johnson-led venture arm has beaten Fidelity mutual funds to some of the hottest prospects in tech and bioscience – including the best performing IPO of 2015.

And after the big initial price surge, they sell it to Fidelity’s public funds. Over this same time frame, there are no examples of Fidelity’s public funds getting into a hot IPO, and then later selling it at a higher price to the Johnson family’s private VC fund.

In a written statement to Reuters, Fidelity said it follows the law relating to potential conflicts of interest between its mutual funds and the venture capital arm. If this sounds like a conflict of interest, well it is, but that doesn’t mean it is illegal. As long as certain rules are followed, the Johnson family gets to eat steak and public investors get the table scraps. I’m guessing they won’t say that in their marketing brochures.

One of the big movers today was Sears Holding, up about 19% on news it was looking to sell its Craftsman tool brand. Final bids may value the brand at about $2 billion, and are reportedly due at the end of the month. Sears put its three best-known brands – Craftsman, Diehard and Kenmore – up for sale in late May in an effort to raise cash. Sears has been burning through cash for at least 8 years and even adding $2 billion to the coffers will likely keep the once iconic retailer afloat for just another year.

Google has officially staked its claim as a bona fide hardware brand, unveiling a raft of new products it hopes will win market share in the smart-phone, smart-home and virtual reality space. Among them: Pixel and Pixel XL smartphones, the Daydream View VR headset, Google Wifi, Chromecast Ultra and Google Home. The common theme in all the new hardware is new Artificial intelligence-powered Google Assistant, which is designed to pull together all of Google’s services into a single, easy-to-use voice-based interface.