Financial Review

Remain Buckled Up

Sinclair Noe — August 24, 2015

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DOW – 588 = 15,871
SPX – 77 = 1893
NAS – 179 = 4526
10 YR YLD – .06 = 2.00%
OIL – 2.30 = 38.06
GOLD – 5.50 = 1155.90
SILV – .56 = 14.89

The “Fasten Your Seat-belt” sign stayed on for the entire trip.

The Dow Jones Industrial Average dropped 1089 points, or 6%, to 15,441 to start the session; that was the largest intraday drop in Dow history. The S&P 500 opened 100 points, or 4.9%, lower at 1,874. The Nasdaq Composite began the day down 360 points, or 7.6%, to 4,349. All three major US market indexes are now in correction territory, a 10% drop from a recent high. The latest round of selling comes on the heels of the worst week for the broad S&P 500 since 2011 that stripped more than $1 trillion in market value from US equities.

Before the market opened, Dow futures, S&P 500 futures and Nasdaq 100 futures triggered circuit breakers after falling at least 5%. The New York Stock Exchange operator NYSE Group invoked the rarely used “Rule 48,” which relaxes some trading rules in a bid to ensure a smooth opening to trading. The rule is instituted when trading before the start of the regular session is especially volatile. At the market open, a slew of single stocks and exchange-traded products triggered single-stock circuit breakers, which are initiated when there is a price drop of 10% or more in a five-minute period.

Over the past 5 days the Dow Industrials dropped 2,198 from peak to trough; the Dow lost 1,697 from peak to today’s close; and the Dow was down 1,666 from the open 5 days ago to today’s close. All major trend lines have been violated.

You know things are bad when we start talking about circuit breakers; just to refresh your memory, the New York Stock Exchange said it will halt trading for 15 minutes if the Standard & Poor’s 500 Index drops 7 percent. And just when it looked like the circuit breakers might trip, the market recovered; almost. The Dow bounced back to a loss of only about 100 points; maybe short sellers covered; maybe the Plunge Protection team stepped in; maybe bargain hunters nibbled. Who knows? And then the major indices resumed their slide in the final hour of trade.

A downturn in the stock markets is fairly common; a weekly drop of more than 5 percent has happened 28 other times since 1980. On average, the market is relatively flat the next week, up 1.65 percent over the next four weeks, and up close to 5 percent over the next 12 weeks. Also important to note is that 60 percent of the time, the index moves higher the following week.

Some of the standout years include huge drawdowns of more than 20 percent over the next 12 weeks in 1987 and 2008. On the opposite side of the spectrum, there were massive turnarounds in 1998 and 2009. So, just because the markets drop 10%, it doesn’t mean the markets will go into a 20% bear market. Of course, if you are going to a 20% loss, you have to pass by 10% first.

U.S. markets average one 10 percent correction every 20 months. On average, we should expect these declines to take 71 trading days to play out (about three months). These 10% corrections are more common in a secular bear market. We are not in a secular bear market.

World stock markets fell sharply again as panic selling in China picked right back up to start the week. China’s stock markets have now wiped out the gains built up during the year. The Shanghai Composite Index closed down 8.5%. Fresh signs of a slowdown in China, the world’s second largest economy, have jolted stocks, bonds, currencies and commodities in recent days. Investors were further rattled today by the lack of fresh steps to stem the selloff over the weekend from Chinese authorities. Taking the cues from Asia, the European markets closed lower across the board.

The Chinese central bank is reportedly ready to flood the banking system with liquidity to increase lending, the latest in a series of measures designed to give the flagging economy a boost. China gave approval for pension funds run by local governments to invest in the stock market. The measure was approved over the weekend by the State Council. State media in China estimate close to $97 billion will be eligible to be invested under the new rule. Analysts also expect the People’s Bank of China to lower the reserve requirement ratio by 50 basis points to 100 basis points in reaction to massive capital outflows.

Of course, the People’s Bank of China has already intervened in markets; by devaluing its currency, freezing the markets, banning short-selling, arresting short-sellers, and pumping tens of billions of Dollars into the market; one day it appears to provide relief, the next day (like today) it hits the sidewalk with a thump. This has reportedly set up a power struggle in China. The whole world is waiting for massive action from the Chinese government, an economic bazooka that can blast through all this market madness. The problem is that China doesn’t have one. That’s because China’s growth model is broken, and it can’t be fixed by cash injections or other emergency policy measures. The old fixes won’t work anymore.

The Federal Reserve has been intervening in the US markets for the past 7 years (OK, the past 100 years, but the past 7 for today’s example). And after years of Zero Interest Rate Policy and $4.2 trillion in QE securities added to their balance sheet, we are left to wonder what other tools they have in their toolbox. The Fed has been talking about raising interest rates, and that now appears dead for the September FOMC meeting. Or to put it another way, they wouldn’t raise rates if the meeting were held tomorrow. Who knows where we’ll be in 3 weeks. What the Fed and the PBOC are learning is that the global economies are now inextricably linked. The strong dollar and a slowdown in China hits emerging markets. The US is not an island in the global economy. And maybe monetary policy intervention in the markets just can’t get the job done anymore.

Ten-year Treasury yields dropped below 2 percent for the first time since April. Futures traders cut the probability to 24 percent that the Fed will raise interest rates at its September meeting, from 48 percent on Aug. 14. The chance of a December increase fell to 47 percent from 74 percent.

Oil prices plunged to 6.5-year lows as concerns over demand from China rippled across energy markets. Brent crude is below the $45 per barrel level for the first time since 2009, while WTI crude is back into the $30s. Commodities sank to the lowest in 16 years.

Gas prices in the US remained level over the last two weeks, according to the bi-weekly Lundberg survey. Prices were 22% lower than they were for the two-week period a year ago. Significant cuts in retail prices are expected across the US due to the latest developments in the oil markets.

The euro strengthened to $1.15 and the Japanese yen is also higher with traders discounting a move by the Federal Reserve to raise interest rates next month. The euro is now at its lowest level since last February.

Now, that is all backdrop for today’s market movement. Why did stocks fall? More sellers than buyers; actually the numbers matched but selling was the more compelling storyline for the day. Why did markets fall? Who knows? Still, I have seen the steady parade of economists who predicted 9 of the last 5 recessions, and market pundits who predicted 20 of the past 2 corrections, explaining why we are all going to hell in a handbasket.

We’ve also had the Alfred E. Neuman pundits, saying they’re not worried and the markets will rebound tomorrow and everything is beautiful. Whenever you get involved in stocks, you should know your exit plan, even before you buy. If your exit plan called for you to be out, then you should be out. If your plan called for you to remain at these levels, then you sit and wait it out. If you get emotional about market moves, you should not be in the market.

As global markets convulsed this morning, Apple chief executive Tim Cook dashed off an email to Jim Cramer at CNBC. Cramer read the email live on air. Cook wrote: “I can tell you that we have continued to experience strong growth for our business in China through July and August… Growth in iPhone activations has actually accelerated over the past few weeks, and we have had the best performance of the year for the App Store in China during the last two weeks.”

Well, as you might imagine, that calmed the frayed nerves of Apple investors, at least a little. Apple shares started the session down more than 15 then managed to rally into positive territory, finishing down 2.5% for the day. The difference was about $75 billion in market cap. Which raises the questions:  Where is the public filing that accompanies this letter which constitutes nothing short of a private business update with an outside, and unregulated by Apple, market cheerleader? And, just how is this not a Regulation Fair Disclosure violation?

Wednesday, July 16, 2014 - The Color of the Day is Beige

Financial Review with Sinclair Noe

DOW + 77 = 17,138
SPX + 8 = 1981
NAS + 9 = 4425
10 YR YLD - .01 = 2.53%
OIL + 1.38 = 101.34
GOLD + 6.20 = 1300.80
SILV + .07 = 20.89

A record high close for the Dow; the 15^th record high close of the year for the Dow. The S&P 500 did not take out the old high from July 3^rd. We have a few economic reports to cover, plus Fed Chair Yellen continued testimony on Capitol Hill, and lots more.

Industrial production increased 0.2% in June to 103.9. This is 24.1% above the recession low, and 3.1% above the pre-recession peak. For the second quarter, industrial production advanced at an annual rate of 5.5%; so the quarter was good but the month of June was less than expected.

The Commerce Department reports producer prices increased by a seasonally adjusted 0.4% last month, above forecasts for a 0.2% gain, after falling 0.2% in May. Year-over-year, the producer price index rose at an annualized rate of 1.9% in June. The core rate, stripping out food and energy prices, was up 0.2%.

This afternoon, the Federal Reserve released its Beige Book, a collection of reports from the 12 Fed districts. The general consensus is that economic growth was moderate to modest. Most Districts were optimistic about the outlook for growth. Consumer spending increased in every district. Retail sales grew modestly in most districts. Auto sales, which have been on the upswing for more than a year, continued to stand out as particularly brisk support for the economy, but broader retail sales were more subdued. Labor market conditions continue to improve with all districts reporting slight to moderate employment growth. Several districts reported "some difficulty" finding staff for skilled positions, however there doesn’t seem to be any pressure on wages. Here’s a hint, if you can’t find skilled workers, try offering higher wages. The report gave a mixed appraisal of the US housing market. Conditions "varied" across the country, with some regions suffering from weak demand.

Fed Chair Janet Yellen returned to Capitol Hill to deliver her second day of Humphrey Hawkins testimony. The prepared remarks were the same as yesterday, then they open up for a Q&A. Some of the key points from today’s hearing:

Yellen said she is optimistic about the economy, “We had a very surprising negative growth in the first quarter, which is a number that in a way doesn't seem consistent with the underlining momentum in the economy and many indicators of spending and production. And I do think the economy is recovering and that growth is picking up and that we have sufficient growth to support continued improvement in the labor market."

Yellen said threats to financial stability are moderate “and not a very high level.” She again weighed in on valuations, saying: "Some things may be on the high side and there may be some pockets where we see valuations becoming very stretched but not generally. The use of leverage is not broad-based, it hasn't increased, and credit growth is not at alarming levels by any means."

Yellen did not single out specific sectors today. Yesterday she said biotech and social media looked a bit over-valued. That had some talking heads complaining; the funniest rant came from Jim Cramer, who said: “Next time, Fed Chief Yellen, it might pay to point out that there are plenty of cheap stocks out there, too. At least that way you can help us make money, not just lose it.” Maybe someone can tell Cramer the Fed is not in business to help him make stock picks, no matter how much help he needs. The Fed has been incredibly accommodative to Wall Street, and Cramer still complains. The Fed doesn’t issue a price target on Twitter. But if you read between the lines, Yellen was likely saying that there are no plans to raise the margin requirements on brokers.

There were some questions about a bill in the House that would require the Fed to follow a mathematical rule for when to raise or lower interest rates. Yellen didn’t like that idea; she said there is no magic formula for raising rates. Yellen again expressed confidence the Fed can exit when the time comes. The Fed has a variety of tools it can use to raise interest rates. In the distant future, the Fed’s balance sheet will shrink in size.

The best line from the Fed did not come from Yellen; Dallas Fed President Richard Fisher was speaking today at the University of Southern California. Fisher said ending asset purchases this fall isn’t enough; the Fed should start to taper the reinvestment of maturing securities in October. Fisher said: "Monetary policy is a bit like duck hunting. If you want to bag a mallard, you don't aim where the bird is at present, you aim ahead of its flight pattern. To me, the flight pattern of the economy is clearly toward increasing employment and inflation that will sooner than expected pierce through the tolerance level of 2%."

Meanwhile, it’s earnings reporting season. Bank of America said profit declined 43% as it spent $4 billion to cover litigation costs, including a mortgage settlement with AIG. There seems to be a trend developing in banks’ earnings reports; they are making money on investment banking and some other areas, but results are weak for mortgage originations, and they are setting aside big chunks of earnings to pay for legal settlements.

Bank of America and the Department of Justice are reportedly negotiating a mortgage securities settlement, which could cost the bank around $13 billion.

Intel was up more than 9% after a very strong earnings report after the close yesterday. Yahoo fell today following weaker than expected earnings. EBay posted lower than expected 2Q results and even though sales were up this month, EBay cut its outlook for the third quarter.

Merger and acquisition activity has been wild lately. Today’s M&A stories revolved around Rupert Murdoch’s plan to buy Time Warner for $85 a share, or about $75 billion. Time Warner says it isn’t interested in exploring a sale, but if they sell, there are other potential suitors. General Electric is in talks to sell its household appliances business; that’s a part of the company that’s been around since 1905, when they invented the electric toaster. Yesterday, the number 2 tobacco company, Reynolds American agreed to buy the number 3 tobacco company, Lorillard for $25 billion.

One of the motivating factors behind mergers lately has been something called inversion, basically merging with an overseas company to avoid corporate taxes in the US. Members of the House and Senate have made proposals to curb the inversion trend in recent months, and the president included a provision in the budget he presented to Congress this year that would have effectively banned the move. But none of these efforts have yet gained traction. Today, Treasury Secretary Jack Lew called on Congress to enact legislation to halt inversion, effective immediately and retroactive to May.  Making any new legislation retroactive through May could disrupt several megadeals that have already been struck, such as the Medtronics deal.

Global M&A volume in the first half was the highest since 2007. One of the side effects of the M&A frenzy back in 2007-2008 was the frenzy of pink slips that followed. Deals are sold to investors on the basis of “creating value” with terms like “efficiencies” and “synergies”; code words for cost cutting and mass-layoffs. Acquisitions, layoffs, and cost-cutting are the simplest things to do for a CEO, as opposed to inventing things and boosting sales organically, which is hard. Analysts love M&A, investors too, and of course the investment bankers promote it as the best thing since sliced bread, or maybe electric toasters.

Last year, Microsoft acquired Nokia’s mobile phone business and promised $600 million in cost saving and efficiencies and synergies. Now, Microsoft employees are bracing for up to 12,000 layoffs, the biggest ever for Microsoft. The layoff news will come before the company holds its post-earnings conference call after the market closes July 22.

Leaders of the five BRICS nations agreed on the structure of a $50 billion development bank by granting China its headquarters and India its first rotating presidency. The leaders also formalized the creation of a $100 billion currency exchange reserve, which member states can tap in case of balance of payment crises. Both initiatives, which require legislative approval, are designed to provide an alternative to financing from the International Monetary Fund and the World Bank, where BRICS countries have been seeking more say.