Financial Review

Falling Knives

Sinclair Noe — March 8, 2016

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

Subscribe: iTunes | Android | RSS

DOW – 109 = 16,964
SPX – 22 = 1979
NAS -59 = 4648
10 Y – .07 = 1.83%
OIL – 1.67 = 36.23
GOLD – 6.50 = 1261.50

Small business confidence declined further in February as lingering concerns about sales growth and profits hurt capital spending and hiring plans. The National Federation of Independent Business (NFIB) said its small business optimism index dropped one point to a reading of 92.9 last month, with none of the index’s components showing an increase. The index decreased 1.3 percentage points in January.

Spending and hiring plans weakened a bit as expectations for growth in real sales volumes fell. Earnings trends worsened a bit as owners continued to report widespread gains in worker compensation while holding the line on price increases.

China’s February trade performance was far worse than economists had expected, days after top leaders at the National People’s Congress sought to reassure investors. Exports fell 25% from a year earlier, the biggest drop since May 2009, while imports slumped 13%, leaving a trade surplus of $32 billion. It’s easy to blame Chinese New Year distortions, but the numbers point to bigger economic problems.

Japan’s 10-year yield extended its push into negative territory, dropping to an all-time low of minus 0.12 percent, meaning almost three-quarters of Japanese government bonds currently offer yields at or below, zero percent. By far the biggest move in trading overnight was the Japanese 30-year, which saw its yield plunge 22 basis points to a record low 0.468 percent. Japan’s 40-year yield is now lower than the U.S. 12-month yield.

After a long wait for inflation to accelerate, Fed officials face a complex and possibly divisive debate over whether recent evidence of rising prices is strong enough to move ahead with planned rate hikes.

In separate statements on Monday, policymakers at the core of that debate staked out starkly different views, with Fed Vice Chairman Stanley Fischer saying economic data now points to the “first stirrings” of inflation, while Fed Governor Lael Brainard countered that the evidence was not yet clear, and it would be much safer to wait. The Fed is not expected to raise interest rates next week, but they might signal they are looking at a rate increase in April or June.

Mario Draghi, the President of the European Central Bank, who is widely expected to tinker with the Eurozone’s financial plumbing this week in the face of weaker-than-expected inflation and six weeks of volatility weighing on business sentiment. Once again, with the market already pricing aggressive action, there’s a risk of disappointment when the ECB meets Thursday. If the ECB takes action, it sets up a divergence in monetary policy between the Eurozone and the US.

Yesterday we told you that the big jump in iron ore prices was short covering and not based on fundamentals. We have also said that trading in the energy markets has been driven by speculation more than fundamentals. Goldman Sachs tells investors the current commodity rally will fade as higher prices prompt more supply to enter the market. Yesterday, iron ore prices jumped 19%; despite the move, Citigroup says it is still bearish as supply and demand fundamentals remain firmly in place; while Axiom Capital Management said the price jump was probably just a “blip.”

Now normally, when Goldman makes a recommendation, we need to consider the possibility that it is a contrarian indicator, but in this case, they might be right. The commodity markets, especially energy, is a supply driven market, and when prices go higher, supply floods back into the market. But the current oil market is still oversupplied and prices have to remain lower for supplies to meaningfully shrink and re-balancing to take place.

The oil market has been especially volatile. Oil’s 2016 roundtrip is nearly complete. WTI crude started the year at about $40 per barrel, and bottomed around $28.75 a barrel – a double bottom actually in late January and early February. That represents more than a 34% swing.  After a 5.5% gain on Monday, the price returned to just a few pennies shy of $38. Brent crude touched $40 per barrel yesterday for the first time in 2016, and moved up to a three month high today before sliding. Now that is nothing but speculative trading.

When prices move higher it is likely a short squeeze because the fundamentals have not changed; there is still an oil glut; OPEC can’t be trusted to freeze production; and it will take time to winnow the producers and eliminate the weak players.

 Meanwhile, China is looking at extra stimulus, Japan has gone to negative interest rates, and the ECB meets Thursday to consider adding even more monetary stimulus. The net effect should be that all these countries weaken their own currency, and the dollar should strengthen. And commodities are priced in dollars, which should lead to lower prices. Just a reminder, stocks have been trading close to commodities for at least the past few months.

Oil and natural gas producer Chevron will cut its budget by at least 17 percent for the next two years as it finishes construction on major expansion projects and works to save cash. The company said it plans to spend between $17 billion to $22 billion annually in 2017 and 2018. For 2016, the company has already announced it would spend $26 billion. Executives reiterated the company’s commitment to pay its $1.07 quarterly dividend.

Goodrich Petroleum, an oil & gas exploration company said it will not make interest payments due March 15 and April 1 on some of its bonds, and will instead opt to use the 30-day grace period it is allowed before being officially in default. Goodrich said it has already launched an offer to exchange all of its outstanding unsecured notes and preferred stock for its common stock. If the exchange offers are not taken up, the company said it would likely file for Chapter 11 bankruptcy protection.

It can be tempting to look for bargains in the oil patch but some folks think it is tempting to catch a falling knife. I wonder how long it will take before Houston turns into Detroit.

Rooftop solar panel installer Vivint Solar terminated an agreement under which it would have been taken over by solar energy company SunEdison after SunEdison failed to “consummate” the $2.2 billion deal. Vivint said it intended to “seek all legal remedies available” as a result of the “willful breach” of the merger agreement by SunEdison.

SolarCity’s shares popped today after announcing a deal to install solar panel systems in Whole Foods Market stores across the U.S. The plan aims to increase the production of solar power and offset the need for a traditional grid power while helping the organic food store save money. In total, the energy firm will retrofit up to 100 Whole Foods stores with rooftop solar panels.

The U.S. Air Force has selected Pratt & Whitney to build the engines for Northrop Grumman’s new $80 billion long-range strike bomber program. Analysts had expected Pratt to be chosen as the supplier since the company already builds engines for Lockheed Martin’s F-35 combat jet. Other key suppliers for “airframe or mission systems” include BAE Systems, GKN, Spirit AeroSystems, Orbital ATK, Rockwell Collins and Janicki Industries.

Cyprus has become the fourth Eurozone nation to exit an EU-IMF bailout, as finance ministers gave the green light to leave its program without a follow-up fund. Cyprus was forced into a €10-billion-euro bailout in March 2013, due to a toxic combination of broken banks, a soaring deficit and an inability to access market financing. By contrast with Cyprus, Greece (the only Eurozone country left in a rescue program) was caught yesterday in a new disagreement between the EU and IMF regarding the strength of its bailout reform commitments.

In the latest volley in its high-profile fight with Apple, the Justice Department has appealed a decision that protects the company from unlocking an iPhone in a New York drug case. Prosecutors, who say Apple has unlocked at least 70 iPhones in the past, are relying on the same “All Writs Act” in a California court, where a judge ordered the company to unlock a device belonging to one of the San Bernardino shooters. The clash has intensified a long-running debate over how much law enforcement and intelligence officials should be able to monitor digital communications.

The Arizona Regional Multiple Listing Service reports overall sales in February were down 2.6% year-over-year. Cash Sales (frequently investors) were down to 29.0% of total sales. Active inventory is now down 0.7% year-over-year, and inventory is down for the fifteenth consecutive month.

Sportswear giant Nike, Swiss watch brand Tag Heuer and German luxury car company Porsche will end their endorsement deals with tennis star Maria Sharapova after she tested positive for an illegal heart drug at the Australian Open. Sharapova brings in, or brought in, a reported $30 million per year in endorsements.

Sharapova said she’s taken the drug, meldonium for over a decade, long before a 2016 ban by the World Anti-Doping Agency, which outlawed the substance as a performance-enhancer. So you might be wondering why there is a problem with a heart drug. Meldonium delivers oxygen through the blood. This can save lives when poor circulation reduces blood supply and oxygen to tissues. For the same reason, reducing the need for oxygen can enhance athletic performance.

Over the course of a workout, as our bodies use oxygen, our blood becomes oxygen deficient—because we’re using up oxygen at a faster rate than our lungs can replace it. Not so if you’re Maria Sharapova on meldonium. Her blood stays oxygen-rich longer, allowing her to perform longer in practice and in matches. And because the drug changes the actual substance that is metabolized in the body, it changes the way Sharapova feels after a workout, too.

This winter was the warmest on record for the contiguous U.S., according to the National Oceanic and Atmospheric Administration. The average temperature across the lower 48 states was 36.8 degrees Fahrenheit, breaking the mark set in 1999-2000. It was 4 degrees higher than the 20th-century average.

FINANCIAL REVIEW

One Thing Is One Thing

Sinclair Noe — January 13, 2015

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

DOW – 27 = 17,613
SPX – 5 = 2023
NAS – 3 = 4661
10 YR YLD – .02 = 1.89%
OIL – .03 = 46.04
GOLD – 2.30 = 1232.10
SILV + .43 = 17.14

The stock market went south so fast. We started the day with a triple digit gain, up more than 250 points, then down by more than 100; there was a 425 point swing from high to low.

It is earnings reporting season. Shares of home builder KB Homes fell 16% after reporting softer demand in the fourth quarter hit gross margins, which will continue to lag prior-year results for some time.

CSX, the railroad company, today announced record fourth-quarter 2014 net earnings of $491 million, a 15 percent increase from $426 million for the same period last year. The company also generated record fourth-quarter earnings per share of $0.49, up 17 percent from $0.42 per share in 2013.
Tomorrow, JPMorgan and Wells Fargo will report earnings; Bank of America reports on Thursday, and Goldman Sachs on Friday.

MetLife wants the government off its back. The US’s biggest life insurer is going to sue to challenge its designation as “systemically important”. The institutions that receive the designation are expected to bolster their capital and liquidity and to submit to heightened monitoring by the Federal Reserve under the 2010 Dodd-Frank Act to prevent another financial crisis. MetLife is the first to sue.

The Justice Department and more than a dozen states attorneys general have accused Standard and Poor’s Credit Rating Agency of handing out, for a fee, highly inflated credit ratings to mortgage investments that then collapsed and helped to spur the financial crisis. The government is looking for a settlement of $1 billion. Still, S&P mounted a two-year campaign to defeat civil fraud charges, portraying them as retaliation for cutting the credit rating of the United States. But it turns out that one thing is one thing and the other thing is the other thing. S&P never really had a defense; there are hundreds of emails and memos and phone recordings clearly indicating that S&P was creating bogus ratings, for a fee. So, now S&P is looking to settle for $1 billion, which represents about one year’s profit.

Let’s take a look at today’s economic data. The federal government ran a budget surplus of $2 billion in December. The December figure brings the government’s budget deficit for the first three months of fiscal 2015 to $177 billion, which is 2% higher than the first quarter of fiscal 2014. The government spent $333 billion in December, up 44% from December 2013. Total receipts were $335 billion, an increase of 18%.

The World Bank cut its outlook for global growth, saying a strengthening US economy and falling oil prices won’t be enough to offset deepening trouble in the Eurozone and emerging markets. The drop in oil has bolstered the US recovery by giving consumers more money to spend, leading the bank to revise up its growth projection for the world’s largest economy by 0.2 percentage point to 3.2%. And the World Bank says the global economy is being pulled by a single engine, the US economy.

The copper market is saying that won’t be enough to eliminate a supply glut that’s lasted at least two years. Because of the drop in oil, there is just a general avoidance of raw materials. Falling oil prices also reduce mining companies’ energy costs, giving the producers an incentive to continue mining the metal, even as demand drops. Copper also may have been hit by technical selling when the price reached $2.72 a pound, which equals $6,000 a metric ton on the London Metal Exchange. The bottom fell out when we broke $6,000, and it’s been down ever since. Today, March copper dropped .12 to $2.60.

The Labor Department reports there were 4.97 million job openings in November, the highest level since early 2001, and up from 4.83 million in October. With 9.07 million unemployed people in November, there were about 1.8 potential job seekers per opening. The Job Openings and Labor Turnover Survey, or JOLT survey, shows the number of separations, such as quits and layoffs, fell to 4.62 million in November from 4.86 million in October. Meanwhile, the total number of hires declined to 4.99 million from 5.1 million. Now, let’s break it down; when workers are confident they can switch jobs, they are more likely to quit. Get a new job with more pay. We are starting to see that a little more than in the past 4 or 5 years, but workers generally lack the confidence to make that transition. Workers’ reluctance to quit means that employers don’t have to quickly ramp up pay for employees.

The Friday jobs report showed unemployment dropping to 5.6% but the problem is that wages also dropped. People aren’t quitting their jobs for better paying jobs, but there may be hope for better wages. ADP reports that people who stayed in their jobs in the third quarter scored an average 2.8% raise during the prior year, and that’s adjusted for inflation. The Labor Department’s employment cost index says much the same thing. The wage and salary part of the index, which excludes benefits, rose 1.6% for private-sector workers in the six months ending in September. And we are seeing some industry sectors paying more wages: restaurant workers got 3.3%, hotel workers 3.5%, construction workers 2.9%. Those numbers are not inflation adjusted and they are not big increases but they are increases. The next employment cost index, or ECI, which won’t be published until the end of the month, but the ECI has been rising throughout 2014. The third quarter ECI wage numbers were much stronger than the hourly earnings data. And that’s how it starts.

Meanwhile, the NFIB small-business-optimism survey rose to 100.4 in December, the highest reading since October 2006; and the report showed that 25% of firms reported compensation increases over the past three months, while 17% expected to increase compensation over the next six months. And the ECI tends to track with the NFIB’s optimism survey.

Of course, as the unemployment rate drops, it is not a guarantee that wages will go up. The thinking is that once we do get closer to full employment the picture for wages will change and the long awaited acceleration in labor compensation will finally materialize. The truth is that wages have been stagnant for more than 30 years, and we’ve had extended periods of low unemployment during that time. Inequality has been increasing for over three decades, and during that time we have been at or near full employment many times. Yet, wages over this time period have been flat. As noted by the Economic Policy Institute, “Since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline, even though decades of consistent gains in economy-wide productivity have provided ample room for wage growth.” The idea that market forces alone will increase wages sufficiently to offset increasing inequality is not supported by the evidence from these years.

Yields on Japanese government bonds hit record lows today. The yield on the five-year government bond hit zero for the first time, while the benchmark 10-year yield fell to a record low 0.25%. The Bank of Japan remains the dominant force in the domestic bond market, buying ¥8 trillion to ¥12 trillion a month of Japanese government bonds and driving yields lower as it seeks to flood the economy with cash to defeat more than a decade of deflation. Few investors are willing to bet against Japanese government bonds with the Bank of Japan buying at that volume. Also, last year the Swiss National Bank introduced negative interest rates on bank deposits; that followed a similar move by the European Central Bank. So, the central bank has been joined by foreign investors, who plowed a net ¥8.7 trillion last year into medium- and long-term Japanese debt, mostly government bonds.

It’s no secret that Europe is slowing down and that more stimulus is necessary. Euro zone government bond yields fell on the prospect of looser ECB policy and many Eurozone countries sold debt to lock in ultra-low borrowing costs. The euro dropped to a 9 year low against the dollar. The euro has fallen in seven of the last eight sessions and is on pace for a sixth straight week of losses. The ECB is expected to launch its own quantitative easing at next week’s meeting, as data out of the euro zone has become bleaker and bleaker by the day. Data from Greece showed its economy was mired in deflation while engineering orders in Germany fell 10 percent year-on-year in November.

Yes, oil was falling again today. Prices are down nearly 60% since peaking in June 2014—US crude futures for February touched $44.20 per barrel at one point today. Today’s drop was thanks to the UAE’s oil minister reiterating that OPEC has no plans to cut production, though all OPEC countries are losing money.

Remember the manufacturing renaissance? The idea was that China’s rising labor costs would make it more economical to keep manufacturing operations in the US, and maybe even some companies that had sent jobs offshore would send them back; they call it reshoring. Makes sense. Especially when you add in the idea of increased energy production in the US adding to lower production costs. And some of that has happened. Labor costs did rise in China, or at least some of the large, urban, coastal cities, such as Shenzhen. Some companies have already shifted facilities further inland in China, or even left China for Vietnam, Cambodia or (in the case of textiles) Bangladesh – just not back to the US. Energy costs have dropped, as we are all well aware. Both energy costs and shipping costs are volatile, and shipping costs only have a small impact on most manufacturers.

And there are examples of a renaissance. Dow Chemical does plan to invest $4 billion to expand its chemicals production on the Gulf coast; in the past two years, the aluminum industry has announced $2.3 billion of new manufacturing investments in the US. The US auto industry is alive and well. In 2014, 16.5 million vehicles were sold nationwide, making it the industry’s best year since the Great Recession, when sales plunged to hit a low of 10.4 million vehicles in 2010. And manufacturing has seen four straight years of growth, and we’ve added 520,000 new manufacturing jobs in the last 3 years. But we have to remember that we lost 2.5 million manufacturing jobs between 2007 and 2009. And we might never again employ the same numbers of people in manufacturing, in part because manufacturing is changing, and automating.