Financial Review

Take 63

Sinclair Noe — April 4, 2017

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DOW + 39 = 20,689
SPX + 1 = 2360
NAS + 3 = 5898
RUT – 1 = 1368
10 Y + .01 = 2.36%
OIL + .94 = 51.18
GOLD + 2.70 = 1256.70

The U.S. trade deficit fell in February as exports increased to a two-year high and slowing domestic demand weighed on imports. The Commerce Department reports the trade deficit declined 9.6 percent to $43.6 billion. Some of the decline in imports in February likely reflects slower consumer spending.

Trade will probably be either neutral or impose a small drag on gross domestic product in the first quarter after subtracting 1.8 percentage points from fourth-quarter growth. In addition to trade, weak consumer spending also likely constrained the economy in the first three months of the year. The Atlanta Federal Reserve is forecasting GDP rising at a 1.2 percent rate in the first quarter, a deceleration from the 2.1 percent pace logged in the fourth quarter.

In a separate report, Factory orders rose 1% in February for the seventh increase in eight months, a sign of the rebounding fortunes of the manufacturing industry.

The U.S.-China trade deficit dropped 26.6 percent to $23.0 billion in February. The decline in the U.S.-China trade deficit comes ahead of Chinese President Xi Jinping’s visit later this week. President Trump has declared China the “grand champions” of currency manipulation. Trade relations with China are further complicated by growing tensions with North Korea.

The outcome of their talks could have longstanding ramifications for two of the world’s most important currencies. The valuation of a given currency can make stocks and bonds denominated in that currency attractive to foreign investors. Cheaper currencies can help to boost stocks by making companies’ goods more competitive on the global market.

President Trump vowed  today to cut red tape to speed up approval of infrastructure projects and said his overhaul could top $1 trillion on roads, tunnels and bridges, one of his 2016 election campaign promises. Trump did not provide further details on the amount or where the money would come from when he spoke to a White House meeting of 50 chief executives and other business leaders.

U.S. Transportation Secretary Elaine Chao said at the forum that the administration plans to release a legislative package in May. The administration wants to improve the electrical grid and water systems, rebuild airports, bridges, roads and potentially hospitals for military veterans and broadband. National Economic Council director Gary Cohn told executives that privatizing air traffic control, which the administration proposed in its budget outline in March, “is probably the single most exciting thing we can do.”

The Washington Post reported this morning that the White House is looking at the possibilities of creating a carbon tax and a value-added tax as part of tax reform. The Post’s report cites administration officials and “one other person briefed on the process.” Administration officials told the Post that no final decisions have been made about whether a value-added tax or a carbon tax would be included in a tax-reform plan.

Trump will need to come up with ways to raise revenue if he wants to lower tax rates without adding to the deficit. House Republicans have proposed raising revenue through a tax on imports known as border adjustment, but that proposal is opposed by several GOP senators.

Value-added taxes are a type of consumption tax, while carbon taxes would be imposed on the manufacturing of some types of fuel. Later in the day, the White House issued a statement saying, “As of now, neither a carbon tax nor a VAT are under consideration.” One thing is certain though, tax reform will not be easy.

Take 63. There is a new plan to repeal and replace Obamacare. Vice President Mike Pence and two top White House officials made an offer in a closed-door meeting with members of the House Freedom Caucus.

The proposal under discussion  would allow states to opt out of two key Affordable Care Act provisions: essential health benefits, which require insurers to cover certain services, and community rating, which bars carriers from charging consumers based on their medical history or gender. Eliminating these federal requirements could wipe out the safeguards requiring insurance companies to offer insurance to people with pre-existing conditions – one of the most popular provisions of the Affordable Care Act.

The benchmark 10-year Treasury yield fell Tuesday to as low as 2.31 percent, within a basis point of its 2017 low. The level to watch now is the Feb. 24th low at 2.308%. Anything below this pivot, even on an intraday basis, signals that a meaningful top was put in at the March high. And if support falters, the next support is 2.13%.

For all the talk of consumer confidence, it isn’t translating to sales at brick and mortar stores. Retail is the worst performing sector so far, this year. Today, Ralph Lauren said it was shutting its flagship Fifth Avenue store in New York and cutting jobs; Urban Outfitters announced a decline in same store sales; Citigroup downgraded L Brands; First Data Corp., the payments processor, said point-of-sales data for department stores slumped 10.9 percent in March.

Payless ShoeSource is the latest retailer to file for Chapter 11 bankruptcy protection. Payless will close nearly 400 stores as it attempts to boost its balance sheet and restructure its debt load. Payless has 4,400 stores in 30 countries and employs nearly 22,000 people. It was bought in 2012 by private equity firms Golden Gate Capital and Blum Capital partners.

Federal Reserve Bank of Richmond President Jeffrey Lacker said he’s resigning immediately and he regrets his role in disclosing confidential information related to the U.S. central bank’s deliberations in 2012 in an interview with an analyst from Medley. That info, dealing with the Fed’s planned purchase of mortgage securities, was published by the analyst; followed by various investigations over the years, leading to today’s resignation. In a statement emailed by his lawyer, Lacker wrote: “In 2012, my conduct was inconsistent with those important confidentiality policies.”

JPMorgan Chase CEO Jamie Dimon is out with his annual letter to shareholders, in which he discusses not only the bank’s business outlook but also various current economic and political issues. Dimon said he has high hopes for the U.S. but believes there is “something wrong” with the country as well, writing: “Our problems are significant, and they are not the singular purview of either political party. We need coherent, consistent, comprehensive and coordinated policies that help fix these problems.”

Dimon added: “The solutions are not binary — they are not either/or, and they are not about Democrats or Republicans. They are about facts, analysis, ideas and best practices (including what we can learn from others around the world).”

Dimon noted that the U.S. is “an exceptional country,” but there are numerous areas where the country needs to improve. Among them are low wage growth, high health-care costs and overcrowded prisons. Businesses are overburdened with regulations, the nation’s infrastructure needs help, and the education system “is leaving too many behind,” he added.

Among the other ills: Taxes are making U.S. companies less competitive globally, income disparity is widening, and social mobility is decreasing. “The lack of economic growth and opportunity has led to deep and understandable frustration among so many Americans,” Dimon said. “It is understandable why so many are angry at the leaders of America’s institutions, including businesses, schools and governments — they are right to expect us to do a better job.”

Dimon listed 11self-inflicted problems for the economy: excessive regulation, high spending on wars, student loan growth, high health care costs, high-skilled immigrants leaving the US, felony convictions leaving millions with criminal records, a tight mortgage market, the labor force participation rate is too low, education leaves too many behind, the need to invest in infrastructure, and a flawed corporate tax system.

On other issues; Dimon said he’s concerned the U.K.’s departure from the European Union might trigger political unrest throughout the region that could split the currency union, resulting in “devastating economic and political effects.” Dimon devoted more than a third of his letter to deregulation.

Dimon asserted that the Dodd-Frank Act effectively ended the possibility of government bailouts for “too big to fail” banks. He also called for modifying the Financial Stability Oversight Council — the panel of regulators created by the Dodd-Frank Act, however he did not call for repeal of Dodd-Frank.

Separately, JPMorgan said in its annual report that it expects $49 billion of net interest income this year, up from about $46 billion in 2016, assuming additional loan growth and no changes in interest rates. Average core loan growth will be about 10 percent, and loan write-offs will remain close to historically low levels.

In what appears to be a reference to Warren Buffett, Dimon talked about the “secret sauce” that powers the American economy: trust. In the past, Buffett has also talked about the “secret sauce”. Dimon wrote: “A strong and vibrant private sector (including big companies) is good for the average American. Entrepreneurship and free enterprise, with strong ethics and high standards, are worth rooting for, not attacking.”

Dimon is right, trust is important, but it can’t be cajoled or demanded. It must be earned.

Wells Fargo has been ordered to reinstate a former bank manager who was fired after reporting suspected illegal behavior to his superiors and a company hotline. The manager, who wasn’t identified, was dismissed in 2010 after reporting on incidents of suspected bank, mail and wire fraud by two bankers in the Los Angeles area.

Wells Fargo was also ordered to give the whistle-blower about $5.4 million in back pay, compensatory damages and legal fees after OSHA determined his warnings were at least a contributing factor in the termination.

Wells Fargo said they would immediately issue a check along with thanks to the whistle-blower for alerting them to the problems. No, just kidding about that last part – Wells Fargo said they would appeal the order.

Caution Still Hampering Markets

Charles Schwab: On the Market

Posted: 4/4/2017 4:15 PM ET

Caution Still Hampering Markets

The U.S. equity markets finished with only slight gains in choppy trading, with industrials doing the heavy-lifting for the Dow following comments from President Trump on infrastructure overhaul. Meanwhile, a rebound in crude oil prices gave energy issues a boost, but caution and renewed trade anxiety ahead of the US/China talks later this week kept sentiment in check, while late-day news of Fed member Jeffrey Lacker's immediate departure after disclosing improper disclosure of confidential information had little effect. Treasury yields and gold gained modest ground, while the U.S. dollar was little changed.

The Dow Jones Industrial Average (DJIA) rose 39 points (0.2%) to 20,689, the S&P 500 Index inched 1 point (0.1%) higher to 2,360, and the Nasdaq Composite added 4 points (0.1%) to 5,899. In moderate volume, 801 million shares were traded on the NYSE and 1.8 billion shares changed hands on the Nasdaq. WTI crude oil rose $0.79 to $51.03 per barrel and wholesale gasoline gained $0.03 to $1.72 per gallon. Elsewhere, the Bloomberg gold spot price increased $2.65 to $1,256.15 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was flat at 100.55.

Urban Outfitters Inc. (URBN $22) reported that thus far during the first quarter, same-store retail segment net sales are mid-single-digit negative, wider than the FactSet estimate of a 1.2% decline. Shares were solidly lower. 

Shares of Staples Inc. (SPLS $10) jumped following a report from the Wall Street Journal that the company is exploring a possible sale and is in early talks with buyout firms. SPLS did not commented on the report.

Acuity Brands Inc. (AYI $174) reported fiscal 2Q earnings-per-share (EPS) of $1.53, or $1.77 ex-items, compared to the FactSet estimate of $1.83, as revenues rose 3.5% year-over-year (y/y) to $805 million, below the projected $828 million. The company noted that the growth rate of lighting solutions in the North American market in the first half of its fiscal year was lower than anticipated. Shares finished solidly lower.

Factory orders match forecasts, trade deficit narrows more than expected

Factory orders (chart) rose 1.0% month-over-month (m/m) in February, matching the Bloomberg expectation, while January's figure was upwardly revised to a 1.5% gain. February durable goods orders—preliminarily reported two weeks ago—were adjusted slightly higher to a 1.8% increase, from the preliminary reading of a 1.7% gain, and versus expectations of no revision. Orders of nondefense capital goods excluding aircraft—a proxy for business spending—were unrevised at a 0.1% dip.

The trade balance (chart) showed that the deficit came in at $43.6 billion in February, compared to the Bloomberg estimate of $44.6 billion. January's deficit was revised lower to $48.2 billion. Exports ticked 0.2% higher m/m to $192.8 billion, while imports fell 1.8% to $236.4 billion.

Treasuries were lower, as the yield on the 2-year note rose 2 basis points (bps) to 1.25%, the yield on the 10-year note gained 3 bps to 2.35%, and the 30-year bond rate advanced 4 bps to 2.99%.

Bond yields and the U.S. dollar have been diverging, with the former dropping to pressure financials, which have led the last two sessions of losses for the stock markets, while the latter has rebounded from a multi-month low set in late-March. The markets continue to grapple with upbeat economic data, exacerbated political uncertainty here and abroad, and the Fed's March rate hike and outlook for future increases. Amid this backdrop, see Schwab's Director of Market and Sector Analysis, Brad Sorensen's, CFA, latest Schwab Sector Views: Financials—Opportunity or End of the Run?, at www.schwab.com/marketinsight, and follow Schwab on Twitter: @schwabresearch. Also, check out our videos by Schwab's Vice President of Trading and Derivatives, Randy Frederick and Senior Fixed Income Research Analyst, Collin Martin, CFA, titled, Fed Hiked Interest Rates, So Why Are Bond Yields Still So Low?, and Randy's and Schwab's Chief Fixed Income Strategist, Kathy Jones' discussion, Three Fed Hikes Seen in 2017: How Should Bond Investors Respond, at www.schwab.com/insights. Follow Randy and Kathy on Twitter: @randyafrederick and @kathyjones.

This sets the stage for tomorrow's economic calendar, which will bring MBA mortgage applications and ADP's employment change report, projected to show job growth of 190,000 for March ahead of Friday's key nonfarm payroll report. However, data that will likely garner the most attention is two key reads on March services sector activity in the form of the ISM non-Manufacturing Index and Markit's Services PMI Index. ISM's report is expected to show a slight deceleration to 57.0 from February's 57.6 level and Markit's index is projected to show a revised figure of 53.1 from 52.9, and down from the prior month's 53.8 level. Readings above 50 for both indexes denote expansion. Moreover, the minutes from the Fed's March monetary policy meeting are poised to foster a reaction given the uncertainty and recent moves in the stock, bond and currency markets.

As noted in the latest Schwab Market Perspective: Working off the Froth, the modest downward pressure on stocks recently appears to be working off some overly optimistic sentiment. We view this as a healthy pause in an ongoing bull market. Investors are facing the realization that "soft" data—such as confidence readings and business surveys—doesn't necessarily translate immediately into "hard" data—like retail sales, capital expenditures, and industrial production. It's this hard data that translates into economic growth and increasing profitability. Looking at some of the parabolic moves in recent confidence surveys, it would be difficult for hard data to keep up. Historically, wide spreads between soft and hard data tend to narrow in both directions—soft data tends to retreat, but hard data tends to play some catchup. We expect that pattern in this cycle, too. Read more about this in Schwab’s Chief Investment Strategist Liz Ann Sonders' latest article, Hard Times: Time for the Hard Data to Catch Up to the Soft Data, as well as the rest of our perspective at www.schwab.com/marketinsight. Follow Liz Ann on Twitter: @lizannsonders.

Europe shows resiliency supported by energy, Asia lower in light action

European equities finished mostly higher, showing some late-session resiliency as financials paused from some recent weakness, while oil & gas led to the upside as crude oil prices rebounded. Stocks appeared to shrug off continued festering political uncertainty on both sides of the pond , with the U.S. and China set to meet later this week and skepticism lingering regarding U.S. President Trump's business-friendly agenda. Also, Brexit negotiations remained in focus and France heads toward a key Presidential election later this month. For analysis of the European political front, see Schwab's Chief Global Investment Strategist Jeffrey Kleintop's, CFA, and Randy Frederick's videos, "Brexit" Underway: How Can Investors Prep Now That Article 50 Has Been Triggered? and Why Should the French Presidential Election Be Important to Investors? at www.schwab.com/insights. Follow Jeff on Twitter: @jeffreykleintop. Also, Director of International Research, Michelle Gibley CFA, offers her article, Europe Votes: Could More Countries Reject the EU? at www.schwab.com/oninternational. A stronger-than-expected read on eurozone retail sales may have had a limited positive impact on the markets, along with weakness in the euro and British pound versus the U.S. dollar. Bond yields in the region finished mostly lower.

Stocks in Asia finished lower amid heightened political uncertainty in the U.S. and Europe being met with a flare-up in concerns toward North Korea and the looming meeting between the U.S. and China later this week. For commentary on global trade and China, check out Schwab's Jeffrey Kleintop's, CFA, articles, Top Five Trade Issues Investors Should Be Watching, and The Fed has China in a Tough Spot . Also, the yen showed some strength, U.S. auto sales figures came in softer than expected yesterday, and the Reserve Bank of Australia (RBA) held its monetary policy stance unchanged but appeared to be slightly more dovish, noting concerns about the labor market. Volume was lighter than usual with markets in China and India closed for holidays. Stocks in Japan fell, pressured by the yen's strength, while financials contributed to a decline for Australia's markets. South Korean equities also traded to the downside. Emerging markets have enjoyed strong returns in 2017, led by Indian stocks, which have rebounded sharply after a brief post U.S. election slide. For more on emerging markets read Schwab's Michelle Gibley's, CFA, article, Emerging Markets: Why They Deserve a Place in Your Portfolio. Read all these commentaries at www.schwab.com/oninternational.

Service sector PMI reads will dominate tomorrow's international economic calendar, while the Reserve Bank of India will meet to discuss monetary policy, with economists expecting no change to its stance.

Financial Review

Lie or Be Lehman

Sinclair Noe — May 27, 2015

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DOW + 121 = 18,162
SPX + 19 = 2123
NAS + 73 = 5106
10 YR YLD – .01 = 2.13%
OIL – .38 = 57.65
GOLD + .20 = 1189.00
SILV – .07 = 16.75

Yesterday the Dow posted a triple digit loss, today a triple digit gain; not enough to cover yesterday’s losses. The Nasdaq was higher on strength in semiconductor stocks; the Nasdaq posted a new record high close, taking out the high from April 24. The dollar was slightly stronger, oil was down again.

Severe storms and devastating floods over the weekend in Texas and Oklahoma have killed at least 19 people. Another 14 people are missing in Texas, including eight members of two families whose vacation home was swept away. The flooding has also resulted in complications for business travelers. About 11 inches of rain fell in Houston on Monday while parts of Austin have been hit by as much as 7 inches. Helicopter crews in both cities rescued people who had been stranded in cars and on top of buildings. The National Weather Service issued a new flash flood warning today.

The IRS says tax return information for about 100,000 U.S. taxpayers was illegally accessed by cyber criminals over the past four months. The stolen information included tax returns and other tax information on file with the IRS. The IRS said the thieves accessed a system called “Get Transcript.” In order to access the information, the thieves cleared a security screen that required knowledge about the taxpayer, including Social Security number, date of birth, tax filing status and street address. The IRS is notifying those affected. The IRS said the breach does not involve its main computer system that handles tax filing submission, and that system remains secure…, for now.

A red card for FIFA, the Federacion Internationale de Football Association, plus 14 arrests for illegal activities that make the governing body for soccer look more like a mafia crime family. The Department of Justice indictment names 14 people on charges including racketeering, wire fraud and money laundering conspiracy. In addition to senior soccer officials, the indictment also named sports-marketing executives from the United States and South America who are accused of paying more than $150 million in bribes and kickbacks in exchange for media deals associated with major soccer tournaments. Law enforcement officials say their investigation has just begun and there will be more action taken to clean up the sport.

As leaders of FIFA gathered in Zurich for their annual meeting, more than a dozen plainclothes Swiss law enforcement officials arrived unannounced at the Baur au Lac hotel, an elegant five-star property with views of the Alps and Lake Zurich. They went to the front desk to get room numbers and then proceeded upstairs. The concierge called the guest and informed them they should open their hotel door rather than having police break it down.

Swiss police arrested seven FIFA officials who are now awaiting extradition to the United States. Swiss prosecutors said they had opened their own criminal proceedings against unidentified people on suspicion of mismanagement and money laundering related to the awarding of rights to host the 2018 World Cup in Russia and the 2022 World Cup in Qatar. The president of FIFA, Sepp Blatter, was not arrested but he might be questioned in coming weeks.

Meanwhile, the US Department of Justice alleges a “24-year scheme” for FIFA officials “to enrich themselves through the corruption of international soccer.” Why is the US leading this investigation? Well, it involves some US sports marketing people and apparently many of the bribes were paid in US dollars and funneled through US banks. Beyond that, we just really don’t like soccer.

G-7 finance ministers and central bankers are meeting in Dresden, Germany. The host country set the agenda and it did not include discussion of Greece. They might not stick to plans. US Treasury Secretary Jack Lew spoke with Greek Prime Minister Alexis Tsipras today for the second time in less than a week and told a London audience that “everyone has to double down” on reaching an accord. While the G-7 doesn’t have a mandate to decide how to deal with Greece, it brings together officials from the Eurozone’s three biggest economies, as well as the European Central Bank, The International Monetary Fund, and the European Union – the institutions backing the $262 billion aid package that expires next week.  The Greeks are reportedly drafting an accord.  Maybe they could borrow some money from FIFA.

Richmond Fed boss Jeffrey Lacker says policymakers must ensure that financial industry creditors do not expect government bailouts and must be willing to let firms fail in order to restore market discipline. Lacker also continued his assault on Dodd-Frank’s Title II and repeated his call to repeal the Fed’s emergency lending authority, arguing that less regulation, not more, is needed to make the system safer. British monarchy may appear to be nothing more than a vestigial ceremonial version of leadership, yet in that role, Queen Elizabeth delivered a speech today to mark the State Opening of Parliament and she promised an in-or-out popular vote on membership in the European Union. That has been a matter of debate and now the path towards a vote looks potentially shorter than anticipated, with some now talking of a referendum in 2016 rather than 2017.

Fed Chair Janet Yellen plans to skip the annual gathering of economists and policy makers in Jackson Hole this year, marking the second time in three years the Fed’s top official won’t be traveling to Wyoming. Yellen’s predecessor, Ben Bernanke, skipped the 2013 gathering. The topic of this year’s conference is inflation dynamics and monetary policy.

Former Federal Reserve Chairman Ben Bernanke said he does not see signs of extreme movements in the US real estate and financial markets. Bernanke also said that if the Fed lifts interest rates, it would be good news because it means the U.S. economy is strong enough.

Royal Bank of Scotland, Britain’s largest taxpayer-owned lender, could pay as much as $4.5 billion to resolve claims of misconduct in its handling of US mortgage securities. The legal action relates to $32 billion in residential mortgage-backed securities sold to Fannie and Freddie from 2005 to 2007.

Back in 2005 Deutsche Bank was selling derivatives that were supposed to be a form of insurance against a huge financial disaster. And after they had sold billions of dollars of these derivatives, they started writing guarantees to the pool, or conduit, that was writing the guarantees. Deutsche was getting its derivative based version of insurance from Deutsche Bank’s own money; essentially selling derivatives on the derivatives it was selling to itself; while taking a commission off the top, of course. And by the way, these derivatives were super-senior, so they were highly rated – that’s an important point. When things went bad in 2008, they charged more for the derivative form of insurance because it was highly rated, but they also still treated it as if it was very highly rated, even though the world of finance was melting down. Deutsche figured that there was not a reliable method to measure the risk in light of the market conditions, and so they just figured there was zero risk.

Ultimately, the realities of 2008 showed that risk was quite a bit higher than zero. The SEC thought the whole thing was a bit fishy, but Deutsche maintained that it did not suffer any losses. Which was true because the insurance/derivatives never paid off. And the reason it never paid off was because it was highly leveraged, and it might have destroyed the bank, and they were clever enough to write into the derivative contract that they might not pay if they didn’t want to, so they did not pay. And in Deutsche’s twisted logic that meant the derivatives were very high quality; so good that they sold them to clients and even bought some themselves and then held it on their books as high credit quality capital.

In 2010, three whistle blowers stepped up to say that Deutsche had mismarked billions in exposures in 2008 and 2009 to make it look healthier than it really was. And this is important because banks are required to keep a certain amount of very safe capital available in the event of a problem; this is called tier one capital; and if a bank does not have enough tier one capital on hand, then they are basically considered insolvent. For example, in 2008, Lehman Brothers did not have enough tier one capital and they collapsed. As it turns out, Deutsche Bank did not have enough tier one capital on its books in 2008, but they did have highly leveraged derivatives, which were kind of, sort of like insurance created out of thin air, and backed by other derivatives, which were backed by their own capital, which was protected by nothing more than imagination and bogus credit ratings.

If Lehman Brothers had been smart enough to create derivatives out of thin air and call them insurance, they might never have collapsed. And If Deutsche Bank had not lied about the credit quality of their derivatives, they could have ended up like Lehman. But that didn’t happen, because Deutsche Bank lied. Yesterday, the Securities and Exchange Commission said that Deutsche Bank made material misstatements about a giant derivatives portfolio, inflating its value at the height of the financial crisis; and the bank failed to account for a “material risk for potential losses estimated to be in the billions of dollars”. The bank agreed to pay a $55 million penalty, without admitting or denying wrongdoing. Nobody goes to jail. The bank is not sanctioned. Deutsche said it had cooperated with regulators throughout the investigation and said the settlement “will have no impact on previous financial reports.” Hey it was a long time ago, in the ancient past. And the moral of this story is that when a bank gets in trouble, they should lie or be Lehman.

Tuesday, July 08, 2014 - Everything Except Productive Purpose

Financial Review with Sinclair Noe

DOW – 117 = 16,906
SPX – 13 = 1963
NAS – 60 = 4391
10 YR YLD - .05 = 2.56%
OIL - .13 = 103.40
GOLD - .40 = 1320.60
SILV - .03 = 21.12

 

Down 2 days and already I’m seeing the financial talking heads asking if this is the start of a correction. Just a reminder that markets go up and down and sometimes sideways. The markets don’t need a big reason to move. Right now, we’re heading into earnings reporting season, and a few things happen; first, some investors might look at a position and determine that prospects for earnings are not so great, or some investors are taking the opportunity to put some cash in their pockets, just in case they see a bargain basement opportunity.

A trend in place is more likely to continue than it is to reverse, and it reverses when we can see clear evidence of a reversal. Yes, the market looks overvalued by many metrics, yes there seems to be irrational exuberance; but the markets can remain irrational longer than you can remain solvent; yes, we’ve seen a couple of down days but we’ve gone 33 months without a correction, but we’ve had a bunch of down days during that same time. Right now, we’re seeing a minor pullback into a trading range as we await earnings season.
 

 Should you stay or should you go? The markets have hit recent highs, and so you have to wonder if you get out when the getting is good. After hitting record highs, the past 2 days have seen declines; let me be very clear, 2 down days do not constitute a trend; not unless you trade the minute bars. Still, it can be sickening to see profits melt away. Conversely, cutting exposure with the aim of putting cash back to work when valuations drop can be soothing at first, but maddening if stocks continue climbing. There is a fine line between adjusting exposure based on valuations and timing the market; and either way it’s a real trick heading into earnings reporting season.

With interest rates at historic lows and stocks climbing, holding cash in a portfolio has been costly, but on the flip side, cash can serve as a buffer against market pullbacks and corrections, and it provides flexibility to buy again if prices drop; in other words, you keep your powder dry. The real return on cash has to consider the idea that you can use it to make even more money down the road. Of course, for that strategy to work, you have to reinvest the cash; you have to look for bargains or look for other opportunities. If you aren’t willing or able to do that analysis then the risk is that you build up cash and don’t know when to get more invested.

This is where the idea of rebalancing comes in; it doesn’t require sophisticated analysis; you just sell high and buy low. If your risk tolerance points you toward a 60% allocation in stocks, and the stocks go up in price and now you hold 70% in stocks, cash out, to bring the equity allocation back to 60%; turn around and put that cash into a part of the portfolio that has dropped. The idea is that you are buying low; the unfortunate side effect is that you might be dumping your winnings into a losing position. A variation on the theme is sell high and buy something you don’t already hold.

But then the question is where do you go to find value? An article in the New York Times suggests that everything is in bubble territory. The chief investment strategist at BlackRock, one of the world’s biggest asset managers, spends his days searching for potential opportunities for investors to get a better return relative to the risks they are taking on, and he says there are very few cheap assets these days. At the current level of the Standard & Poor’s 500 index, every dollar invested in stocks buys you about 5.5 cents of corporate earnings, down from 7.4 cents two years ago, and lower than just before the global financial crisis in 2007-2008.

Bonds offer next to nothing in the way of returns, and if you want to chase yield in the debt markets, you’ll find some of the riskiest issues can’t even breach 5%. Real estate has spiked in many locations, even farmland has rocketed. It’s not that any one area is outrageously overvalued. Most people would agree that stock valuations are lower than 2000, and real estate peaked in 2006, and we haven’t really recovered to those levels. It’s just that everything that could be considered a financial asset has gone up. And of course, as prices go up, the potential future returns drop.

Maybe that’s a reflection of a slowing global economy. Maybe it’s a result of the central bankers printing lots of money, but not directing where the money would go; and so the money was parked on the sidelines, and not put to productive use, not being invested in things like factories or infrastructure. And then the risk is that folks chasing yield take on more and more risk until something pops.

Taking a look at economic data today, the Federal Reserve report on consumer debt for May showed debt increased $19.6 billion, not including mortgage or real estate related lending; that’s down from a $26.1 billion increase in April. Revolving debt, including credit-card balances, rose $1.79 billion in May following an $8.85 billion April advance that was the biggest since November 2007. Non-revolving debt, which includes car and education loans, gained $17.8 billion in May, the biggest increase since February 2013, after climbing $17.3 billion in the previous month. Car sales continue be show strength, reaching a 16.9 million annual rate last month, the fastest pace since July 2006.

The JOLT survey, or Job Openings and Labor Turnover survey shows that as of the end of May, companies increased the number of job openings almost back to pre-recession levels. Despite greater demand for workers, pay scales have not budged much.  Wages for all private-sector employees increased 2% in the year ended in June, according to the Labor Department, exactly where wage growth has trended through all of this recovery.

News from the small-business sector, however, suggests pay growth is ready to break out of the 2% range. According to the June survey of small firm owners by the National Federation of Independent Business, a net 21% of small businesses report lifting compensation in the last few months. That is the highest reading since the end of 2007. So, it looks like we are getting closer to seeing wage growth in the near future, but we’re not quite there yet. And since we aren’t seeing actual proof of wage inflation, it could be argued that the Fed should wait a bit longer before tapping the brakes. And for that matter, even if we start to see signs of wage inflation, that might be a good thing.

Federal Reserve Bank of Richmond President Jeffrey Lacker said in a speech today that “subdued productivity gains” along with “moderate” increases in consumer spending and “more tempered” growth in housing construction, will lead to economic growth in the range of 2% to 2.5%, well below the Fed consensus of 3% growth. Lacker says “broad-based advances in technology are far less likely than in the past, and that we should prepare for relatively stagnant productivity growth trends going forward.”

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said today that inflation will likely stay quite low for about 4 or 5 years. Kocherlakota says the Fed is “undershooting its price stability goal” of 2% inflation and will likely continue to do so for some time to come; he sees the probability of inflation averaging more than 2% over the next four years as being “considerably lower” than the probability of inflation coming in less than 2% over the same time period. Kocherlakota is skeptical of improvements in the jobs market, saying “much of the decline in the unemployment rate since October 2009 has occurred because the fraction of people who are looking for work has fallen.” That means the Fed is also failing to meet its job creation goal, which is damaging for the economy.

When you look at last week’s jobs numbers something doesn’t seem to add up, at least it gives pause to consider the numbers. GDP growth equals productivity growth plus job growth, or at least growth in hours worked. We’ve been adding jobs at a good pace, but the economy contracted 2.9% in the first quarter. That leaves productivity, and it turns out that there is a long term trend in decelerating productivity growth. And the problem with productivity is not that workers aren’t working hard; the problem is that we haven’t been investing in the right tools for the job.

Earnings season kicked off with a report from Alcoa. It was better than expected. Including all charges, the company earned $138 million or 12 cents a share during the quarter. That reverses the company’s $148 million loss in the same period a year ago. Revenue also came in ahead of expectations. Alcoa reported revenue of $5.8 billion, which is 2.6% higher than expected. Revenue is flat from the year-ago period.

Earlier Samsung issued an earnings warnings, claiming profits could fall as much as 26% from a year earlier. Smartphone and tablet sales took a pretty big beating. Samsung put out a statement that says tablet sales are slow because consumers are slower to upgrade tablets compared to upgrading smart phones. They also blamed the rising Korean won, which is up 9% against the dollar in the past 3 months; they blamed excess inventory in Europe, and competition in the mid and low-end of the market, and a few other excuses as well.