Financial Review

Pick a Lane

Sinclair Noe — November 17, 2015

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

Subscribe: iTunes | Android | RSS

DOW + 6 = 17,489
SPX – 2 = 2050
NAS + 1 = 4986
10 YR YLD – .01 = 2.26%
OIL – .95 = 40.79
GOLD – 12.30 = 1070.80
SILV – .06 = 14.29

Global equity markets moved higher today, following the rally yesterday on Wall Street and brushed off concerns related to Friday’s terror attacks in Paris. In their final communique from a summit in Turkey, the leaders of the world’s largest economies stuck to a goal of lifting their collective output by an extra 2% by 2018, even though growth remains uneven and weaker than expected globally. G20 leaders also endorsed plans to address Syria’s refugee crisis, taxation, climate change, cyber security and inequality.

France launched another set of airstrikes on the ISIS stronghold of Raqqa in Syria early Tuesday as the country steps up its response to last week’s deadly attacks. The bombings follow a second night of home searches in France and Belgium to catch those responsible and linked to the killings. President Francois Hollande is now looking to expand his powers under France’s state-of-emergency statute and has called on the U.S. and Russia to form a “big unified coalition” to destroy ISIS.

Meanwhile, Russian officials said they had found evidence that the passenger jet that crashed in Egypt last month was downed by a bomb, the first time those investigating the crash have cited proof of a terrorist attack. Russia’s military doubled its attacks in Syria on Tuesday. President Putin ordered Russian naval forces in the Mediterranean to work as allies with French warships in attacking ISIS targets in Syria; not necessarily a France-Russia alliance, but certainly greater military coordination.

The consumer price index increased by a seasonally adjusted 0.2% in October. The CPI measures prices at the retail level and is used to determine cost of living adjustments. The cost of housing and medical care, two of the biggest expenses for most families, climbed again and are running above a 3% annual rate. Rents rose 0.3% in October and medical care jumped 0.7%, the biggest increase in five months. Food prices, meanwhile, rose just 0.1%, marking the smallest gain in five months. Energy prices advanced 0.3%, even though the price of gasoline was down last month. The discrepancy comes from seasonal adjustments. Overall inflation is up 0.2% in the past year. Core prices, excluding food and energy, are up 1.9% in the past 12 months.

Separately, a new report from Aon Hewitt shows health insurance costs for employees of midsize and large companies averaged $4,700 in 2015; that’s up 130% from $2,001 in 2005. The report shows 38% of employers have increased their participants’ deductibles and/or copays in the last year, and another 46% may do so in the future. Employers are making cutbacks in health coverage in other ways, too. Some 18% of companies are reducing subsidies for covered dependents, and 17% are adding a surcharge for adult dependents who have access to other health coverage. Plus, 43% of companies are considering using unitized pricing, in which employees pay per person instead of individual versus family.

So there are some signs of inflation in some areas but no indication that inflation is overheating, at least according to the headline inflation numbers. Still, for most of us, it seems like there is inflation; housing and rents have increased, health care, education, and food prices seem to be on the rise. Even wages are starting to show gains. The economy has added jobs at a rapid pace over the past few years, putting some upward pressure on wages and reducing the unemployment rate to 5%. The government said real, or inflation-adjusted, hourly wages advanced 0.2% in October. Real wages have climbed 2.4% in the past 12 months.

You’re not just imagining it. Prices are going up, except for commodities. And the price of energy has an oversized influence on the annual inflation rate. The Federal Reserve’s preferred measure of inflation is the Personal Consumption Expenditures index, or PCE, which is running at a 1.3% annualized pace; still below the Fed’s target of 2% inflation but likely to rise quickly with expected increases to health care premiums over the next few months.

Now add fiscal policy to the mix. After years of gridlock the government has finally approved a 2 year budget, and it actually includes some spending; it will likely add 0.3% to gross domestic product, rather than subtracting 2% from growth; it might even result in a few government jobs, rather than cutting government jobs. And those government workers will go out and spend their paychecks on Main Street, adding to demand and circulating money through the economy. Next year will be the first since 2010 that fiscal policy adds to growth. For years, Fed Chair Bernanke (and more recently Chair Yellen) complained about headwinds from fiscal policy, or the lack thereof. Now we are about to see a shift from monetary policy alone to fiscal policy – a passing of the baton, which is always the most perilous part of a relay; too early or too late, and the race comes to a grinding halt.

The next concern is whether fiscal policy is capable of running with the baton (to extend the analogy), and staying in the correct lane. If government spending goes to projects that improve productivity – things like infrastructure and education – then it will likely improve growth. French President Francois Hollande said he will step up spending on security in the wake of the terrorist attacks in Paris, but this type of spending is not likely to result in economic growth. So, it’s not just a matter of changing from monetary policy to fiscal policy, it is important that something is actually accomplished with the stimulus. This has been the big drawback of monetary policy; the Fed dropped money on Wall Street but it never made it to Main Street.

A new Reuters analysis shows that corporate spending on buybacks and dividends has surged relative to investment in long-term growth through R&D and other forms of capital spending, in a troubling sign that corporate America may be undermining itself. Almost 60% of the 3,297 publicly traded non-financial U.S. companies examined bought back their shares since 2010. In fiscal 2014 alone, the total amount returned to shareholders (including share repurchases and dividends) reached $885 billion, way more than the companies’ combined net income of $847 billion. And the spending on buybacks, or financial engineering squeezes out investments in R&D, which has dropped.

Industrial production fell 0.2% in October but manufacturing output advanced 0.4% in October. Overall production was held down by a drop in mining and utility output. In addition, the Fed revised August production higher to a 0.1% gain from previous estimate of a 0.1% drop. As a result, industrial production was up at a 2.6% annual rate in the third quarter.

The National Association of Home Builders/Wells Fargo housing market index pulled back 3 points to 62, slightly below expectations but up from 58 a year ago. A reading over 50 signals improvement. Builders have reported strong results in the most recent earnings season. D.R. Horton, the largest US homebuilder, reported a 44% jump in profit in the most recent quarter, with orders up 19%. Lennar, the number-two builder by volume, also reported profit and revenue that were better than expected. Orders rose more than 10%.

Greece has reached a preliminary deal with its international lenders on home foreclosures reform, removing a major obstacle holding up fresh bailout loans for the debt-laden country. The changes will see Athens qualify for a €2-billion-euro sub-tranche of new financial aid to pay off state arrears and €10-billion-euro in funds to help recapitalize the country’s four main banks.

Walmart beats. Walmart earned $1.03 per share from continuing operations in the third quarter, but $0.99 excluding adjustments to its leases. Still, that was marginally higher than the $0.98 expected by analysts. Comparable-store sales, or sales at stores open at least a year, at Walmart’s US stores were up 1.5%. E-commerce sales were up by 10%.

Home Depot beats. The do-it-yourself home-improvement chain earned $1.36 per share in third quarter, beating expectations for $1.32. This was driven by a healthy 5.1% gain in comparable-store sales, which was better than the 4.6% expected by analysts.

Urban Outfitters missed. Urban Outfitters reported record third quarter sales that missed estimates, and earnings per share matched estimates, but comparable-store sales climbed by just 1% during the period, missing expectations for 3.4% growth. The news came after shares dropped 7.4% following the company’s announcement that it acquired a group of restaurants including the fast-casual chain Pizzeria Vetri. Apparently I’m not the only one who fails to see the synergy between retail clothing and pizza.

Shares of Dick’s Sporting Goods are getting clobbered. Dick’s reported third quarter adjusted earnings of $0.45 per share, missing expectations by a penny. Same-store sales, or sales at stores open at least a year, were up 0.4% in the quarter across the company, less than the 1.9% increase that was expected. And then the salt on the wound: the company lowered fourth quarter guidance.

A New York state judge denied a temporary restraining order sought by daily fantasy sports companies DraftKings and FanDuel in an effort to keep operating in the state after NY Attorney General Eric Schneiderman deemed the games to be illegal gambling. The government will now move for an injunction against the companies which will be heard in court on Nov. 25. DraftKings continues to operate as usual in New York despite the pressure from Schneiderman’s office, but FanDuel stopped taking new deposits from state players on Friday.

A US House of Representatives investigative panel plans to hold a 2016 hearing on skyrocketing drug costs. Earlier this month, the U.S. Senate Special Committee on Aging launched a probe into drug pricing at Valeant and Turing, signaling growing bipartisan agreement over the need to review prescription medicine costs across the nation.

Financial Review

Goodnight and Good Luck

Sinclair Noe — February 11, 2015  

 

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

DOW – 6 = 17,862
SPX – .06 = 2068
NAS + 13 = 4801
10 YR YLD un = 1.98%
OIL – .75 = 49.27

President Obama has asked Congress for formal authorization to fight the Islamic State that would prohibit the use of “enduring offensive ground forces” and limit engagement to three years. The proposed resolution says Islamic State “has committed despicable acts of violence and mass execution.” Its militants have killed thousands of civilians while seizing territory in Iraq and Syria in an attempt to establish a hub of jihadism in the heart of the Arab world. Don’t expect a quick vote by Congress, maybe something in March, maybe just more talk.

We keep hearing that ISIS is growing, and one way they recruit jihadists to their cause is through slick websites and social media. So, you might be wondering why the government doesn’t just close down those sites. I don’t know, but today, the hacktivist group Anonymous has launched a massive cyber-attack against ISIS. A list of more than hundred Twitter and Facebook accounts suspected to belong to Islamic militants has been released by Anonymous. Twitter has already suspended more than 1500 ISIS accounts since the group released the first list in June, 2014 and dozens of militant recruiting websites were knocked offline using collective DDoS Attack. Thousands of Twitter accounts associated with ISIS are still active and spreading jihadist propaganda, but Anonymous says this is just the beginning.

The federal government ran a bigger deficit in January, pushing the imbalance so far this budget year up 6.2% from the same period a year ago.  The Treasury Department said the deficit for January stood at $17 billion compared to $10 billion a year ago.

Home prices moved higher across most of the country. According to the National Association of Realtors, the median price of an existing single-family home rose in the 4^th quarter from a year earlier in 86% of the 175 metropolitan areas measured. Twenty-four areas had price gains of 10% or more, up from 16 regions in the third quarter. Prices declined in 24 areas. The median was $208,700, up 6% from the fourth quarter of 2013. NAR reports Phoenix home prices increased 3.9% over the past year to a median price just over $200,000.

Finance ministers from across the Eurozone have gathered in Brussels today to try to figure out what to do about Greece. The newly elected Greek government is looking for relief from austerity measures. Those restrictions were a condition of Greece’s being granted a total of 240 billion euros, or about $272 billion, in loans from its European neighbors and the International Monetary Fund since 2010. Greece still needs to receive its next loan installment, €7.2 billion, or otherwise bridge the financial gap, to keep from defaulting on its international debt payments in coming months.

Reckless lending and reckless borrowing went hand in hand in the years leading up to the euro crisis. Greek officials did indeed use financial tricks developed by Wall Street to mask the size of budget deficits. Still, even before Greece joined the eurozone, it was clearly living far beyond its means. International lenders knew or should have known this; they were not defrauded so much as willfully blind.  The bailout of Greece was not a rescue of the country, but rather a rescue of the creditors; it was a bank bailout. The Greek government only received 11% of the bailout money to date; the rest went to creditors, or who knows where.

Greece now has more debt than it can ever repay, and lenders share some of the blame for this.  Spending cuts have only resulted in destroying the economy. The Greeks understand; that’s why they voted for Syriza; that’s why there are tens of thousands of Greeks protesting in the streets of Athens today. Unlike many countries, the protestors are not protesting against their government, they are protesting for their government to fight against the creditors. At some point the Euro Union will have to let Greece out of debtors’ prison. At a certain point you have to stop squeezing countries that are in the depths of a depression. And ultimately, some form of forgiveness benefits creditors as much as it helps debtors. Greece is well past the point where debt forgiveness could be considered reward for bad behavior.

By the way, the finance minister for Greece, Yannis Varoufakis, considered by some to be a bit radical, but also well known for research in game theory. So, how about a little game of chicken? Good luck.

Ten U.S. states have sent a letter to Anthem complaining that the company has been too slow in alerting clients that they were victims of a massive data breach disclosed last week and claiming the health insurer should commit to reimbursing customers for losses during the lag time.

The FBI is examining how fraudulent tax returns were filed in 19 states through Intuit’s tax-preparation software TurboTax and whether a computer data breach allowed access to personal information. Intuit halted e-filings of state returns last Friday after spotting criminal attempts to get refunds through its systems, but resumed filing after steps were taken to combat the activity.

A federal judge has approved the IRS issuing summonses requiring certain companies to hand over information about US taxpayers who used Sovereign Management and Legal for offshore accounts. The companies include FedEx, DHL, UPS, Western Union, The Federal Reserve Bank of New York, and HSBC. This could get interesting.

Apple has plenty of cash on the books, but they want more; so, they’re issuing Swiss bonds. For Apple, the lure of issuing in Swiss francs is clear: Swiss government yields are negative as far out as 2027, with its 10-year government bond yielding negative 0.09%. Apple’s strong brand and high credit ratings—Aa1 from Moody’s Investors Service and AA+ from Standard & Poor’s—should make it an attractive proposition for yield-starved investors who have Swiss currency to put to work. That will make any funding ultracheap.

What will Apple do with the extra cash? Activist investor Carl Icahn has a suggestion: more dividend dollars and a few less Apple shares. This is a common theme on Wall Street; according to the Academic-Industry Research Network. Over the past decade, the companies that make up the S&P 500 have spent an astounding 54% of profits on stock buybacks. Last year alone, U.S. corporations spent about $700 billion, or roughly 4% of GDP, to prop up their share prices by repurchasing their own stock. Last year’s buybacks were about 3.3% of market capitalization. Since 2004, stock buybacks totaled $6.9 trillion, and that must surely skew our understanding of earnings.

Apple, which began playing with a record valuation of $700B during midday trading in November, ended the day yesterday at $710 billion. The landmark comes just two weeks after Apple posted the largest quarterly net income of any public company in history. Apple will also be launching a new energy project, partnering with First Solar on an $850M solar farm in California.
The deal will supply enough electricity to power all of Apple’s California stores, offices, headquarters and a data center. Apple will get 130 megawatts, enough to power 60,000 California homes. It’s the biggest-ever solar procurement deal for a company that isn’t a utility, and it nearly triples Apple’s stake in solar.

But it’s not the biggest solar project in California, not by a long shot.

Nearly 4,000 acres of desert near Desert Center California have been converted into a massive solar farm. The Desert Sunlight Solar Farm has been running since December and it was officially dedicated on Monday. The 550-megawatt farm is the largest on public lands managed by the federal Bureau of Land Management. It will provide enough energy to power more than 160,000 average California homes annually. Desert Sunlight was developed by First Solar of Tempe.

First Solar received $1.46 billion from the U.S. Department of Energy, a partial loan guarantee funded by a group of private investors, to finance the project. Pacific Gas & Electric Company and Southern California Edison already have agreed to purchase power from Desert Sunlight for the next two decades.
Before 2009 no solar projects had been permitted on public land. Today, there are 29 permitted commercial-scale solar projects throughout the Southwest. Desert Sunlight is the sixth solar project to come online, and eight more are under construction.

Desert Sunlight is the world’s largest solar power plant, but just slightly. The Topaz solar project in San Luis Obispo County, Calif. — which, like Desert Sunlight, was built by Arizona-based First Solar — also has a capacity of 550 megawatts. But the desert has more abundant sunlight than San Luis Obispo County, so Desert Sunlight will actually generate more electricity than Topaz.

It’s an open question, though, whether future solar projects will be anywhere near as big as Desert Sunlight. Developers have been gravitating toward smaller solar farms, which are easier to build and usually have a smaller environmental impact.

One major obstacle for solar development has been the looming expiration of a 30% federal investment tax credit, which is scheduled to fall to 10% at the end of 2016. Another challenge for solar energy developers is that California and other states are already on track to meet increased requirements for renewable energy generation. But the outlook may be more positive after Gov. Jerry Brown in his inaugural speech last month called for half of the state’s power to come from renewable sources by 2030, up from the previous goal of 33% by 2020.

And finally, the Powerball lottery is up to almost $500 million, making it one of the top payouts ever. Actually, the cash payout would be about $370 million, and then you would have to cut taxes out of that. Still, you would be left with a healthy sum. Playing the lottery is a long shot, and it really doesn’t make much sense. But if you are going to play, might as well play when the payout is big. And for a couple of bucks, you can enjoy your own personal fantasy of how you might spend those millions; that’s got to be worth something. Your odds are 175-million to one. If you buy 2 tickets, each ticket will still be 175-million to one odds. It’s a bad bet. Good Luck.

FINANCIAL REVIEW

Finally, Holograms

Sinclair Noe — January 21, 2015

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

DOW + 39 = 17,554
SPX + 9 = 2032
NAS + 12 = 4667
10 YR YLD + .05 = 1.85%
OIL + .93 = 47.40
GOLD – 1.30 = 1293.90
SILV + .14 = 18.21

Gold moved above $1300 an ounce today. When was the last time you saw that? Last August. For the past 3 years, gold has been shellacked, but it is now testing an important level of resistance, and it coincides with the European Central Bank’s anticipated Quantitative Easing plan, which should be revealed on Thursday. Today we learned that an ECB executive board has called for bond purchases of roughly €50 billion per month over the next 12 months. The final number and details could change after the full board weighs in on the plan on Thursday. And the devil will be in details, and one of the most important is whether the ECB will let Greece play in their QE games.

The Bank of Japan held off expanding its stimulus program today, even as they cut their core inflation forecast to 1% from 1.7%. Two Bank of England policy makers dropped calls for higher interest rates. Elsewhere, the battle against inflation intensified as the Bank of Canada unexpectedly cut interest rates for the first time since 2009, saying the oil price shock will drag down inflation. The Bank of Canada is lowering its target for the overnight rate by one-quarter of one percentage point to 0.75%. The Canadian dollar, also known as the loonie, weakened sharply against the dollar, from around 1.20 down to 1.23.

The International Monetary Fund cut its forecast for inflation in advanced nations almost in half. And it looks unlikely the US will achieve its target of 2% inflation. The Federal Reserve FOMC meets next week, and there is growing consensus that Fed policy makers need to reassess their outlook for the economy as global weakness and disappointing data on consumer spending test their resolve to raise interest rates this year. Federal funds futures markets now show only a 15% chance the benchmark interest rate will be 0.5% or higher in June. And more than resisting inflation, the pressing issue seems to be how to create demand and economic energy.

President Obama delivered his State of the Union address last night. He called for new taxes on high-income earners and large financial institutions to pay for free community colleges. Other topics included foreign policy, healthcare, the Internet, Keystone XL, infrastructure, trade agreements, cyberattacks, climate change, and immigration reform.

Yea, that’s not going to happen. There are some things that will actually get done. Obama proposed reducing mortgage insurance premiums on government-backed loans in order to make it easier for low-income Americans to buy homes. This falls under Housing and Urban Development, which is under Obama’s control. Also, reducing methane emissions in the oil and gas industry by fixing leaky equipment and reducing “flaring” of natural gas; this one is the EPA, again under Obama’s control.

I think we might see congressional authorization of the military action against ISIS in Syria. The bombing of ISIS is already underway and congress is real bad at undoing something that has already started. Congress might not act and just leave the military action in a sort of limbo; don’t be surprised if congress tacks on a resolution indicating that the president acted illegally when he failed to get authorization in advance, because there is nothing like a unified front when you go to war. But there seems to be consensus that ISIS needs to be bombed to hell.

Treasury Secretary Jacob Lew said today he is confident that the Obama administration and Congressional Republicans can agree on a plan to reform a “dysfunctional” business tax code. He put the odds of a deal at “greater than 50-50.” Lew is probably a bit overly optimistic. Apple pie can’t even get 50-50 odds in Washington.

The White House wants to lower the corporate tax rate by closing loopholes. Lew said the top corporate tax rate should be reduced to 28% from 35%, and a new minimum tax on foreign earnings should be created to help make it simpler for businesses to repatriate income. Other proposals include a 25% tax rate for domestic manufacturing and allowing more small businesses to use cash accounting.

If I had to bet on one thing not happening even though it sounds plausible, I might say legislation to prevent cyberattacks. Nobody likes the thought of having credit card information stolen, or malware infecting their computer, so you might think lawmakers could come together on legislation but I doubt congress is up to the challenge. It is a serious security issue; the Pentagon says that nearly every US weapons program tested last year showed “significant vulnerabilities” to cyber-attacks. You have to imagine that utilities, and airports, and almost everything is vulnerable to cyber-attacks. And nobody likes getting hacked, but figuring out what to do might not be easy.

First, there are a lot of legitimate companies that gather information on you and then sell that info and there is fierce industry opposition to new security or privacy rules. Meanwhile, civil liberties and privacy activists think that panic about cyber breaches will lead to surveillance and filtering that would destroy the open Internet in the name of saving it. Accommodating these concerns should not be an impossible task, but in today’s Washington, it has been.

But the fundamental flaw is that nobody is held responsible for insecure systems and bad code. Data breaches cause companies headaches but usually it is little more than bad PR; there are no massive verdicts that have prompted reforms of other defective products. The companies that write bad code have effectively protected themselves through software license agreements, and many companies would still rather hope for the best than spend money to fix their systems.

Here was another strange example in yesterday’s earnings report from Netflix; they report solid earnings growth, not so great on the revenue numbers, but good news on new subscribers. The interesting part was where they talked about competition in the Netherlands. By analyzing Google search terms, Netflix has learned that their biggest competition in the Netherlands is Popcorn Time, which has an unusually strong fan base. Popcorn Time is one of the most popular services for watching pirated movies and television shows. Netflix Chief Executive Officer Reed Hastings wrote a letter to shareholders saying, “Piracy continues to be one of our biggest competitors.”

Twelve years ago, Steve Jobs convinced music labels to sell their songs for 99 cents on iTunes by arguing that was a better solution than losing the sale to music pirates. Popcorn Time shows that as the legal options improve, so do the illicit ones.

Microsoft Windows runs on 91% of the world’s computers, so there is a good chance you use Windows. There is also a good chance that you hate your Windows system because it is old or you hate it because it is the newer Windows 8. Good news. Today Microsoft unveiled the new Windows 10, skipping right past Windows 9 without explanation.

Here’s what you need to know; if you have Windows 7 or 8, you can upgrade to Windows 10 for free in the first year (it won’t be released until later this year, so you have time). The Start Menu returns, it can be viewed as a full-screen Windows 8-like display of tiles or a more familiar Windows 7-like drawer of apps. Windows 10 sticks to desktop mode when it recognizes a mouse and keyboard and tablet mode when there is no keyboard and mouse. The new “Snap” feature will allow Windows 10 users to work on up to four apps at once on the same screen. And there will be a new browser called Spartan.

Now for the cool stuff. Microsoft’s version of Siri will be part of Windows 10. By using voice commands, Cortana can show your notifications, stock information, sports news, and other functions typical of smartphone voice assistants. But you can also say “show me the spreadsheet on January sales” or “show me photos from last month,” and it will quickly run the search query.

And the coolest part: it can make holograms. Windows 10 Hologram will let you play games, watch videos and create virtual elements that will appear in your view. This should be a good way to train people to do surgery or repair plumbing, or learn on-the-go, or play immersive games, or to create 3D toys or devices in a 3D space, which will behave like 3D objects when you interact with them wearing new Microsoft headgear called a HoloLens. HoloLens comes with a holographic processing chip that understands your gestures, voice and where you’re looking. It can map the world around you and display holograms that appear to be in thin air or on objects that surround you. And then of course, you can print them on a 3D printer.

The Commerce Department said single-family housing starts, the largest part of the market, jumped 7.2% to a seasonally adjusted annual pace of 728,000-units – the highest level since March 2008. That offset a 0.8% fall in groundbreaking for the volatile multi-family homes segment, lifting overall housing starts 4.4% to a 1.09 million-unit rate last month.

Time for another edition of “Banks Behaving Badly”. We start with Standard and Poors, the credit rating agency; S&P will be suspended for a year from rating securities in the largest piece of the CMBS market. The Commercial Mortgage Backed Securities probe is separate from a lawsuit by the Justice Department tied to subprime home loans that S&P rigged, or rather rated before the credit crisis. The ratings agency is expected to settle that matter as soon as this quarter for about $1 billion.

In a speech yesterday, Federal Reserve governor Jerome Powell said widespread manipulation of key benchmark interest rates such as the London Interbank Offered Rate, or Libor, threatens public confidence in the financial system, and must be prevented through fines and criminal prosecution. Seriously, I think the man has been asleep for the past five 6 years, and he just woke up.

In 2008, JPMorgan authorized legal counsel to file papers making a loan to GM unsecured instead of secured. While secured creditors were repaid in full during GM’s bankruptcy, unsecured creditors took losses. During bankruptcy proceedings, JPMorgan initially won its argument that the security interest was still in effect, but the appeals court today reversed that decision, and JPMorgan will lose about $1.5 billion. $6.5 billion for the London Whale, about $35 billion in legal expenses since 2009, and now $1.5 billion to GM. This is no way to run a bank.

FINANCIAL REVIEW

Strange Days Indeed

Sinclair Noe — October 2, 2014

0 0 

   

Financial Review

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

DOW – 3 = 16,801
SPX + 0.01 = 1946
NAS + 8 = 4430
10 YR YLD + .03 = 2.43%
OIL + .59 = 91.32
GOLD + 1.30 = 1215.30
SILV – .08 = 17.20

The Dow Industrial dropped about 130 points in early trading, but then recovered, mainly

In economic news:
The number of Americans filing new claims for unemployment benefits fell last week by 8,000 to a seasonally adjusted 287,000. Separate data showed small businesses hiring workers at the fastest pace in 8 months. The National Federation of Independent Business said its monthly survey of its members found they added an average of 0.24 workers per firm last month, on a seasonally adjusted basis. Tomorrow the government will report on non-farm payrolls for September; we’re looking for about 220,000 net new jobs and the unemployment rate to hold near 6.1%.

A report from the Commerce Department showed new orders for factory goods posted their biggest decline on record in August. Factory orders dropped 10.1%, following a 10.5% increase in July; the wild swings are attributed to orders for airplanes. Stripping out transportation orders, new orders were down a more modest 0.1%.

Since June, the European Central Bank has lowered the interest rate on bank deposits parked at the ECB to negative territory, a first for this central bank, and added new lending and private-asset purchase programs. Today, the ECB wrapped up a policy session and announced nothing new. They will wait and see if some of the stuff they’ve done in the past few months, will actually start to impact the Eurozone economy. They really can’t cut rates much lower, and there is only tepid demand for any kind of a lending program. They’ve already announced a plan to purchase collateralized bank bonds and bundles of loans known as asset backed securities, but that won’t start for about 2 weeks. So, for now, they sit back and wait and watch. Today’s ECB meeting was held in Naples; about 1,000 protesters were arrested.

You’ve already heard about the Liberian man who took a flight to the US and then came down with Ebola. He is in a Dallas Texas hospital fighting for his life. At first CDC officials thought there were just a handful of people possibly exposed, then they upped the number to 18, then about 40 people who would need to be monitored for possible Ebola infection. Now they say up to 100 people may have had direct or indirect contact with the patient. Dallas County officials said 12 to 18 people had direct contact with the Texas patient, and they in turn had contact with scores of others. If it sounds like a contagion, well it is. But the good news is that the health care system in the US should be more effective than the health care system in Western Africa. With the right care, people can survive an infection. Keep calm and carry on.

The New York Times reports a cyber-attack this summer on JPMorgan Chase compromised more than 76 million household accounts and seven million small-business accounts, making it among the largest corporate hacks ever discovered. In a regulatory filing, the bank said that the information leaked included names, email addresses, phone numbers and addresses. The bank said that there’s no evidence account information was taken. By the time JPMorgan first suspected the breach in late July, hackers had already gained the highest level of administrative privilege to more than 90 of the bank’s computer servers. And it appears the hackers made off with a list of the applications and programs that run on every standard JPMorgan computer, a hacker’s roadmap of sorts, which hackers could cross check with known vulnerabilities in each program and web application, in search of an entry point back into the bank’s systems.

Hong Kong has the sixth largest stock market in the world, which is second in Asia after Tokyo, and is the sixth largest hub for foreign exchange trading. It maintains open borders to investors and does not impose any capital controls.

Beijing’s man in Hong Kong, CY Leung has told pro-democracy protesters to step down, and repeated warnings that the consequences would be serious if they sought to surround or occupy government buildings, but he says he will not resign. Tens of thousands of people have taken to the streets in the last week to demand full democracy, including a free voting system when they come to choose a new leader in 2017. Now the protestors have surrounded at least 2 government buildings, including the building housing the Chief Executive CY Leung. It looks like the standoff is coming to a head. It will be an interesting weekend.

An International Red Cross building in eastern Ukraine was bombed and one worker was killed. Seven Ukrainian soldiers were killed in a single strike by tank fire on their armored personnel transporter on Monday. On Wednesday at least 10 people were killed when shelling hit a school playground in Donetsk. The Russian and Ukrainian governments say the ceasefire is holding; if so, it is just by a thread.

Turkey will join in the fight against ISIS; they also want to see Syrian President Assad removed from power. Turkey is already struggling with 1.5 million refugees from the Syrian war alone. It has now deployed tanks and armored vehicles on the border with Syria as fighting intensified and the parliament approved the measure to go to war. It is not clear whether Turkey will take immediate action, however the approval of the MPs could enable the US to use its large airbase in southern Turkey for air strikes against ISIS.

Of course ISIS has grown quickly, in part because they have taken over oil wells, but that raises the question of who has been buying oil from ISIS. The answer is smugglers, and they buy on the cheap. A barrel of oil that would ordinarily sell for over $90 can be discounted as much as 75 percent. But it’s still a profitable sale for ISIS, as the money it loses from such a discount is more than made up for by the readiness of customers to buy its oil and the plethora of routes through which it can export it.

Global oil prices have fallen to their lowest level in more than two years after Saudi Arabia cut its official selling price. Concerns of oversupply after higher output in the US, together with forecasts of lower global demand by the International Energy Agency, are driving prices down. But that just seems to highlight a most peculiar marketplace, especially in light of the geopolitical risks. Oil prices drop and stock markets are floating merrily along near record highs in the face of the Russia-Ukraine conflict, the emergence of ISIS and a new round of fighting in Iraq and Syria, mass protests in Hong Kong and China’s ongoing territorial disputes. And the cherry on top: credit markets show low spreads, while long-term bond yields have fallen in most advanced economies.

Strange days indeed. What gives?

Markets have taken the view that the Russia-Ukraine conflict will remain contained, rather than escalating into a full-scale war. The sanctions and counter-sanctions between the West and Russia have increased, but so far they are not causing significant economic and financial damage to the European Union or the US. Russia is feeling the pain of the sanctions, but that means they are likely to continue to supply natural-gas supplies to Western Europe.

The turmoil in the Middle East has not triggered a massive shock to oil supplies and prices like those that occurred in 70s. On the contrary, there is excess capacity in global oil markets. Iraq may be in trouble, but about 90% of its oil is produced in the south, near Basra, which is fully under Shia control, or in the north, under the control of the Kurds. Only about 10% is produced near Mosul, now under the control of ISIS. Yesterday, Saudi Arabia signaled to the markets that it was more interested in maintaining market share than in defending prices. Saudi Aramco, the national oil company, stunned markets by announcing that it was cutting prices by about $1 a barrel to Asia, the crucial growth market for the Persian Gulf producers, as well as by 40 cents a barrel to the United States.

The main source of supply growth continues to be the United States, which, as a result of the shale oil boom, now rivals Russia and Saudi Arabia in oil output. While the United States remains a modest oil exporter, its surging output pushes other oil, particularly from West Africa, out of the American market, helping to lower prices. Net oil imports to the United States have fallen since 2007 by 8.7 million barrels a day, roughly equivalent to total Saudi and Nigerian exports.

What could go wrong?

Well, the situation in Hong Kong could turn violent. Russia may break the ceasefire in Ukraine, or they might turn off the natural gas supplies with the first winter storm. The Eurozone could relapse. An ISIS jihadist could decide to leave the desert and try to wreak havoc on a major city. Toss in a sidebar story of turbulence in Thailand, or Argentina, or Turkey, or Egypt, or hackers doing great damage in the cyber-world, and you’ve got the makings of a brouhaha. You can’t rule out financial contagion, or any other kind of contagion.

One hundred years ago, the financial markets were complacent, just like today; they ignored the risks that led to World War I until late in the summer of 1914. Of course, back then the markets were poor at correctly pricing low probability, high impact tail risks. Today, with the interconnected, high technology the markets are still poor at correctly pricing risk, they can just misprice it much faster.

FINANCIAL REVIEW

The Failure of the Holder Doctrine

Sinclair Noe — September 25, 2014

0 0 

   

Financial Review

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

DOW – 264 = 16,945
SPX – 32 = 1965
NAS – 88 = 4466
10 YR YLD – .06 = 2.51%
OIL – .32 = 91.21
GOLD + 5.30 = 1222.90
SILV – .18 = 17.60

In economic news:
For the week ending Sept. 20, seasonally adjusted initial claims for unemployment compensation were 293,000, up 12,000 from the previous week’s revised level of 281,000. For the comparable week of 2013, the figure was 316,000.

Orders for durable goods dropped 18.2% in August; which sounds absolutely horrible until you put in in perspective; durable goods orders were up 22.5% in July. It sounds like the economists behind this report need to step away from the crack pipe, but the real reason for the volatility is airplane orders, which are for big expensive durable goods, and usually in big, expensive contracts. For example, Boeing took orders for 107 new planes in August, but that’s down from 324 orders in July. Stripping out the transportation sector, order rose 0.7%. Orders for core capital goods – a broader measure of business investment – climbed by 0.6% in August.

Tomorrow the government will reveal the third of three regular estimates of growth in the period of April to June. The gain in GDP is likely to be raised to 4.7% from a prior estimate of 4.2%, mainly because fresh data show that consumers spent much more on health care than initially estimated. If so, that would mark the fastest spurt of growth since the recession ended in mid-2009. The third quarter ends in just a few days, and it is estimated that 3Q GDP expanded at about a 3.2% pace.

The war continues. French fighter jets struck ISIS targets in Iraq and US fighter jets struck ISIS targets in Syria. A third night of air raids by the United States and Arab allies targeted ISIS controlled oil refineries in eastern Syria that have been a major source of revenue for the terrorist group. Britain announced today that it too would join air strikes against ISIS in Iraq, after weeks of weighing its options. Prime Minister David Cameron recalled parliament, which is expected to give its approval tomorrow.

Iraq’s Prime Minister Haidar al-Abadi, in New York to attend a UN meeting, said he had credible intelligence that ISIS networks in Iraq were plotting to attack US subways and French metro trains. US intelligence officials say they have no evidence of specific threats.

The Russian parliament is considering a proposal that would allow the Kremlin to seize foreign assets on Russian soil, and there are a lot of foreign assets in Russia, many of them oil related.

Attorney General Eric Holder is resigning. He will step down when a successor is confirmed for the post. Holder has been Attorney General for nearly six years, making him one of the longest serving AGs in our history. He was also the first African American AG. White House officials are already pushing out narratives about Holder’s “historic legacy of civil rights enforcement and restoring fairness to the criminal justice system,” but there is one area where Holder was an absolute failure: going after the banksters on Wall Street.

As of today, there has been no significant surge in criminal cases stemming from the financial crisis, to the profound annoyance everyone who sees aggressive prosecution as the only deterrent for future fraud. Instead, Holder has preferred blockbuster civil settlements, including a recent $13 billion deal with JPMorgan Chase CEO Jamie Dimon and an impending agreement with Bank of America that could top $12 billion. That sounds like a lot of money, but the actual amounts are…, well nobody really knows what the actual amounts are; we do know that it is significantly less than the headline numbers after factoring in tax accounting and credits for actions already being undertaken by the banks; what has come to be known as “soft” consumer relief; things like banks getting credited for the amount of a short sale that was going to happen anyway. And there has been lack of transparency around how these penalties are being paid to aggrieved consumers. One federal judge, rejected a settlement with Citibank in 2011, called the fine “pocket change”. Holder’s Justice Department appealed; making certain the fine was not too harsh for the banking giant.

Under Holder, the Justice Department greatly expanded the use of deferred prosecution agreements with large corporations, from financial firms to agricultural giants. These are arrangements that take the place of criminal prosecutions; instead, the offending corporation supposedly admits wrongdoing, pays a fine, which is typically a small fraction of yearly profits, and agrees to remedy internal problems that lead to the crime. In return, the government agrees not to prosecute.

There are a couple of problems with the deferred prosecution agreements, or DPAs. First the banksters never really got around to admitting wrongdoing. The admissions of wrongdoing have been incredibly vague, at best. In at least one case, involving Libor rate rigging, the CEO of Barclays gave a written admission as part of the DPA, and then went out and made public claims that he had done nothing wrong. Another problem with DPAs is that they do not act as a deterrent. The idea is supposed to be something similar to a probationary period for the bank; stay out of trouble and the prosecutors will not go after harsher punishment. The reality is that DPAs are repeatedly violated without consequence.

Perhaps the most egregious example came when Justice allowed HSBC to enter deferred prosecution for wide-ranging multibillion-dollar money laundering at the bank on behalf of large illegal drug operations and also terrorist groups. There was ample evidence that HSBC had set up separate teller windows at its Mexican bank branches to accept the large trays of cash coming from the Mexican drug cartels. And there was solid evidence that HSBC had conducted business with Iran, and Cuba and other entities on a sanctions blacklist. The punishment amounted to about 2 months’ profits. If you’re going to put people in jail for having a joint in their pocket or for slinging dime bags on the corner in a city street, you cannot let people who laundered $850 million for the worst drug offenders in the world walk. But that’s exactly what Holder did, time after time after time.

In March, the Justice Department’s own inspector general released a report that found that the criminal division’s efforts to hold Wall Street executive accountable were a low priority, and in some cases the lowest possible priority, despite Holder’s claims that it was at the top of his to-do list.

Holder has tried to explain his lack of prosecutions relating to the 2008 collapse by claiming the cases were too hard to prove, but that is a weak argument. The Sarbanes Oxley Act, for example, would provide a straightforward template: it makes it a crime for executives to sign inaccurate financial statements, and there is ample evidence that Wall Street CEOs were aware of the toxicity of the sub-prime mortgages sold by their firms.

Late last year, Judge Jed Rakoff of the Federal District Court of Manhattan published an essay titled, “The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?” Rakoff cited the Financial Crisis Inquiry Commission report that found multiple examples of fraud. He suggested a doctrine of “willful blindness” at Holder’s Justice Department and said “the department’s claim that proving intent in the financial crisis is particularly difficult may strike some as doubtful.” Needless to say, it is rare that a sitting judge publicly calls out the nation’s top cop for what amounts to cowardice. Advocates for financial accountability often point to the Savings and Loan crisis as a counter-example of Holder’s failure to prosecute: despite much smaller-scale fraud, 1,000 bankers were convicted in federal prosecutions and many went to prison.

Holder’s failure to prosecute had a name: the Holder Doctrine; and its origins go back to the days of Enron and the prosecution and conviction of Arthur Andersen, the former “Big Five” accounting firm convicted of obstruction of justice for destroying documents relating to the Enron scandal. The prosecution and collapse of Arthur Andersen cost many otherwise decent accountants their livelihood. Holder admitted as much in Senate testimony last year. He said:
“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if we do prosecute — if we do bring a criminal charge — it will have a negative impact on the national economy, perhaps even the world economy,”… “I think that is a function of the fact that some of these institutions have become too large.”

Holder continued, acknowledging that the size of banks “has an inhibiting influence.” He said that it affects “our ability to bring resolutions that I think would be more appropriate.”

According to the Holder Doctrine and Justice Department guidelines, before bringing a criminal case, prosecutors must consider “the nature and seriousness of the offense, including the risk of harm to the public, and applicable policies and priorities, if any, governing the prosecution of corporations for particular categories of crime.” The conventional wisdom is that simply charging a company with a crime raises the possibility of putting the firm out of business because customers, suppliers, counterparties and others will stop doing business with it. In other words, the banksters were just too big to jail.

The Holder Doctrine raises all sorts of interesting questions. Should we prosecute corporations ever? Or should we only prosecute small businesses? Should the size of an institution or its systemic importance influence the decisions of prosecutors? Wasn’t Dodd-Frank legislation supposed to fix the too big to fail problem. If the banks are still too big to jail does it also mean they are still too big to fail? If shutting down a huge bank would impose too many costs on society, then why don’t prosecutors insist that the banks be split up as a condition of not dropping the entire C-suite into the deepest hole in the gray bar hotel?

We don’t yet know Holder’s successor at Justice, but there should be a litmus test for the new AG. Keep it simple. Just ask if they believe in justice for all?

FINANCIAL REVIEW

War, Pay Phones, Small Business and Big Banks

Sinclair Noe — September 24, 2014

0 0 

   

Financial Review

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

DOW + 154 = 17,210
SPX + 15 = 1998
NAS + 46 = 4555
10 YR YLD + .03 = 2.57%
OIL + 1.18 = 92.80
GOLD – 6.30 = 1217.60
SILV – .11 = 17.78

President Obama addressed the United Nations General Assembly today. He condemned ISIS, and said there was no reasoning and no negotiation with their brand of evil. He said the US “will work with a broad coalition to dismantle this network of death”; that coalition is now up to 40 countries. He urged Muslims to reject the ideology of ISIS and al-Qaeda. He also announced a US warplanes hit ISIS vehicles and arms dumps in new air strikes in Iraq and Syria. ISIS continues to advance in Syria and aid agencies report some 130,000 Kurdish refugees have crossed into Turkey in the past few days. An Algerian jihadist group linked to ISIS has released a video which it says shows militants beheading a French tourist.

The president’s speech also criticized Russia for the recent invasion of Ukraine. Today, NATO reports Russia has withdrawn a sizable number of its troops from eastern Ukraine, although some remain. Russian backed rebels in the region said they had begun pulling back their heavy artillery after Ukrainian troops did the same. For now, the cease fire appears to be holding.

The stock market recovered after three days of losses; for the Dow Industrials it was two days of triple digit declines. Not much in the way of economic news today. New home sales were up 18% in August. In a separate report, the Mortgage Bankers Association said applications for loans to purchase homes fell last week as mortgage rates crept up. New loan applications are well off peaks seen early last year. Yesterday, the NAR reported existing home sales had flat lined, with both “cash sales” and “sales to investors” dropping, or rather plunging since late 2013. Every month since late last year, existing home sales have been below their year-ago levels. Bad news for flippers. Looking at the bigger picture it might give some hints to family formation, or lack thereof. For economists, it might serve as a lesson that rising home prices are a symptom of economic strength, not a cause; and you can’t sustain rising home prices without rising wages.

European Central Bank President Mario Draghi renewed a pledge to keep monetary policy loose for an extended period. The euro dropped below $1.28. The dollar has now posted gains for 10 straight weeks, pushing the dollar index above 85 for the first time since July 2010. A stronger dollar likely means lower prices on basic commodities; it also serves as stimulus for the Eurozone and Japan, making their exports cheaper; and a strong dollar might even fuel another round of M&A activity; also, this might be a great time to take a European vacation.

You’ve heard the stories of data breaches at Target, and then the big one at Home Depot, potentially affecting some 56 million customers; now add Jimmy John’s to the list; 216 stores of the restaurant chain were involved in a security breach on July 30. There has to be a more secure way to buy a sandwich. The security breach at Home Depot is now resulting in fraudulent transactions that may be draining cash from some customer bank accounts as criminals use stolen card information to buy prepaid cards, electronics, groceries, or whatever. Financial institutions are also stepping up efforts to block the transactions by rejecting them if they appear unusual. Best advice is to keep a close eye on your own accounts.

Some people think the next big thing is Apple Pay; it doesn’t store credit card data and Apple fingerprint reading technology could provide an extra layer of security, but it’s a long way from being ubiquitous. It is estimated Apple could end up taking in around $90 million in transaction fees from Apple Pay next year, climbing to more than $300 million by 2016. That should make payments absolutely, super-duper safe and secure.

Meanwhile, Apple announced it is pulling its latest update of the new iOS 8 operating system, which they sent out to fix the glitches in its new HealthKit app. The problem with the update is that people who installed it lost the fingerprinting ID capability and phone calls kept getting dropped. Other than that, how did you enjoy the play Mrs. Lincoln?

Remember Blackberry. Once upon a time Blackberry was the cool mobile phone, and then Apple became the cool mobile phone and Blackberry was so square. Well, they’ve embraced that. Blackberry introduced a new phone today, it’s called the Passport, and the screen is square, not rectangular, so it won’t fit in any pocket.

Wal-Mart thinks the next big thing is a Wal-Mart checking account; they will partner with Green Dot to offer checking accounts accessible by mobile phones, and it comes with a debit card, and monthly fees are waived if you use direct deposit, and it doesn’t rely on credit scores or credit bureau ratings. Wal-Mart is trying to tap into the vast “unbanked” market, which now gets raked over the coals at check cashing stores.

Earlier today, it was reported that the Securities and Exchange Commission has been investigating whether bond fund manager Pimco inflated the returns of its Total Return Exchange Traded Fund run by founder Bill Gross. The probe is said to have sped up in recent weeks but has been going on for “at least a year.” Which means that it was happening when Mohamed El-Erian announced he was leaving the firm.

Investigators from the SEC’s enforcement division are examining whether the $3.6 billion Pimco Total Return ETF bought investments at discounted prices but relied on higher valuations for the investments when the fund calculated the value of its holdings shortly thereafter. Such a maneuver could make it seem as though the ETF had scored quick gains when it was in fact taking advantage of variations in the way some investments are valued in the bond market; which is another way of saying Pimco may have provided inaccurate information about the fund’s performance.

Do you remember where you were in 1988? Do you remember where you worked? Do you remember what you were paid? If you can’t remember what you were paid 26 years ago, don’t worry, there’s a good chance it is the same as today. The economic recovery has yet to translate into higher incomes for the typical American family. After adjusting for inflation, US median household income is still 8% lower than it was before the recession, 9% lower than at its peak in 1999, and essentially unchanged since the end of the Reagan administration. And the income of the median US household is just under $52,000; the same as it was in 1988. Now granted, that number, reported last week in the latest income and poverty data, is based on median income; also, it refers to households, and the typical household has changed over the years. Still…

Six years ago the financial crisis hit Wall Street, turning a housing crisis that was already hammering Main Street into the worst recession since the Great Depression. Job losses averaged nearly 800,000 per month between November 2008 and April 2009 as the unemployment rate climbed. The economy contracted at a rate of 8.3% between the fourth quarter of 2008 and the first quarter of 2009. The crisis hit businesses big and small, but it hit small business harder.

Jobs at small businesses fell 60% from the pre-crisis peak in December 2007 until the private sector started adding jobs again in February 2010. That represents a decline that is 40% larger than the fall in jobs among larger businesses. This is especially problematic because small businesses employ half of the private sector workforce, and since 1995 small businesses have created about two out of every three net new jobs, or 65% of total net job creation. Small businesses have created jobs in every quarter since 2010, and are back to creating two out of every three net new jobs, but still remain well below the job creation levels that we need to see to fill the “jobs gap” left in the wake the recession.

Part of the decline in job creation has also been due to anemic new business formation. Over the past 20 years, businesses less than two years-old accounted for one-quarter of gross job creation even though they employed less than 10% of workers. But, during the crisis new business formation fell sharply. In the decade prior to the crisis, more than 620,000 firms were started every year. But, starts have averaged just about 550,000 annually since 2009, a decline of about 11%. And small business just keeps getting smaller; in 2000, the average new firm had 7.7 employees; by 2010, that number had declined to 5.5.

The formation and growth of small businesses depends on well-functioning credit markets, but throughout the recession and even during the recovery today critical parts of our credit markets are shut for small firms. Small business loans on the balance sheets of banks are down about 20% since the financial crisis; meanwhile, loans to larger businesses have risen by about 4% over the same period. The Federal Reserve Bank of New York reports that 37% of all small businesses applied for credit in the fall of 2013. About 45% did not apply, presumably because they did not need credit, but about 20% did not apply because they were discouraged from doing so. Of businesses that did apply, over 40% either received no capital at all or received less than the amount that they requested.

Part of the problem is that many small community banks closed in the crisis, and they haven’t been replaced; just one new community bank charter was granted in 2010, just 3 new charters in 2011. There were 6,840 banks and 1,173 thrifts last year, down from 14,507 banks and 3,566 thrifts in 1984. And of course the big banks just consolidated and got even bigger, and the Federal Reserve Bank of Atlanta reports that big banks are less likely to extend credit to a small business than a small regional bank.