Financial Review

Like It Never Happened

Sinclair Noe — June 29, 2016

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DOW + 284 = 17,694
SPX + 34 = 2070
NAS + 87 = 4779
10 Y + .04 = 1.51%
OIL – .30 = 49.58
GOLD + 6.80 = 1319.30

Stocks rallied for a second day, and it was a global rally. The dollar weakened. The yield on 10-year Treasuries rose four basis points to 1.51 percent after falling Monday to the lowest in almost four years. The MSCI All-Country World Index had its biggest two-day gain since August. The S&P 500 moved from negative year to date to slightly positive. The Dow Jones Industrial Average stretched its rebound to 553 points since Monday’s close.

Britain’s FTSE 100 Index erased its post-Brexit losses with a 6.3 percent surge over two days. The Stoxx Europe 600 Index climbed 3.1 percent. The gauge has recovered 4.7 percent after tumbling 11 percent over two days. It is still heading for a second consecutive quarterly decline. Emerging-market shares climbed. Maybe cooler heads prevailed; maybe it is a short squeeze. Goldman’s basket of the most shorted shares in the Russell 3000 Index rose the most since 2009. Doesn’t matter. Prices moved higher.

And so this raises the question of whether all the fear over Brexit was justified, or if this is just the calm before the storm. The fall in the pound sterling is a blessing for the British economy, and a headache for the Eurozone. The exchange rate is acting as a shock-absorber. The FTSE 100 index of equities in London is back to where it was on the eve of the vote, compared to falls of roughly 6% in Germany and France, 10% in Spain, 11% in Italy, 13% in Ireland, and 14% in Greece.

The UK was stripped of its AAA credit rating but there has been no sign of systemic meltdown. Britain’s Brexiteers must come up with a coherent policy on trade very fast, and the EU must come off their ideological high-horse and face the reality that they have absolutely no margin for economic error.

US Secretary of State John Kerry warned in stark terms on his post-Brexit swoop into Europe that nobody should lose their head, or go off half-cocked, or “start ginning up scatter-brained or revengeful premises.” Nobody seemed to heed his words at the EU’s summit in Brussels, but the situation still carries the potential for significant economic damage, even if it plays out in slower motion.

European Union leaders wrapped up a two-day conference in Brussels and called for an orderly British withdrawal from the bloc to minimize instability. They also spelled out conditions for a new relationship with a departing Britain, warning that if British business wants to continue to enjoy the seamless single market after its departure, it would also have to accept that EU citizens can continue to enter Britain.

Francois Hollande, the French President, has warned London that it will no longer be the center of euro-denominated clearing following the Brexit vote, dealing a blow to one of the City’s biggest markets and casting further doubt on the London Stock Exchange’s merger plans. Mr. Hollande, speaking after a tense meeting of European Union leaders last night, said: “The UK has said it doesn’t want any more freedom of movement. Now it won’t have access to the single market anymore.”

Scottish minister Nicola Sturgeon, spoke before the European Commission in Brussels, trying to make the case for Scotland to stay in the EU. In last week’s referendum, Scottish voters backed staying in the EU by a nearly 2-1 majority. Mrs. Sturgeon argued that Scotland must not be dragged out of the EU against its will. She wants to negotiate directly with Brussels to protect membership rights of Scots and is open to a new independence referendum, splitting from the UK, if that is the only way to keep Scotland in the bloc. Sturgeon drew a mixed response from EU leaders. Spanish Prime Minister Rajoy said flatly, “If the United Kingdom leaves, Scotland leaves.”

Moody’s has cut its outlook on the British banking system from stable to negative following last week’s referendum, saying: “We expect lower economic growth and heightened uncertainty over the U.K.’s future trade relationship with the EU to lead to reduced demand for credit, higher credit losses and more volatile wholesale funding conditions.”

The Federal Reserve delivered a report card on the largest banks in their annual stress tests. US units of Deutsche Bank and Banco Santander were the only firms to fail the tests in 2015, and they failed the tests again this year. The Fed gave Morgan Stanley only a conditional pass, saying that the bank also had to resolve weaknesses in its processes. Morgan Stanley has until Dec. 29 to resubmit its capital plan for approval. The stress test results, known as CCAR (or Comprehensive Capital Analysis and Review), are particularly important because they determine how much capital big U.S. banks can put toward dividends, stock buybacks, acquisitions or investments.

General Electric has won approval to drop its designation as a too-big-to-fail financial institution, capping a transformation that has included the sale of almost all of its lending business. The Financial Stability Oversight Council determined that GE no longer poses a threat to U.S. financial stability. The decision marks the first time a company has been granted formal release by the council.

The Commerce Department reports consumer spending increased 0.4 percent last month, on increased demand for automobiles and other goods. Consumer spending in April was revised up to show it advancing 1.1 percent instead of the previously reported 1.0 percent jump. Consumer spending rose at a 1.5 percent annual rate in the first quarter, holding down gross domestic product growth to a 1.1 percent pace. Personal income rose 0.2 percent after advancing 0.5 percent in April. Wages and salaries gained 0.2 percent. Savings slipped to $730.6 billion last month from $753.7 billion in April.

A gauge of pending home sales slid 3.7% in May, a step back following several months of strong sales. The National Association of Realtors’ index fell to 110.8 in May from a downwardly-revised 115.0 in April. Even with that revision, April figures were the highest since February 2006 – but May marked the first year-over-year decline since August 2014.

The index forecasts future sales by tracking real estate transactions in which a contract has been signed, but the deal has not yet closed. Last week the NAR reported sales of previously-owned homes rose to the highest level in more than nine years in May. So, it appears demand is still strong but there is a shortage of inventory.

Congress has been thinking about doing something about the debt problem in Puerto Rico. Of course, Congress hasn’t actually done anything yet. They did table further debate on a bill, which means a vote could come later this evening or tomorrow on a measure to allow Puerto Rico to restructure its total debt and establish an oversight board to impose big cuts in spending. And it probably doesn’t matter.

Puerto Rico will default on more than $1 billion in general obligation bonds on Friday. The default will mark the first time the U.S. territory has failed to pay what it owes on general-obligation debt, a $13 billion swath that its constitution says has the top claim to the government’s funds. Puerto Rico had already defaulted on debt issued by three agencies, but creditors were left with little recourse because the securities were backed by weaker legal safeguards.

Governor Garcia Padilla previously said the commonwealth couldn’t raise enough to cover what’s owed to bondholders even if he shut down the government. The island has about $2 billion in principal and interest payments due Friday, and total debt of around $70 billion. Without the ability to file for bankruptcy protection as cities including Detroit have done, Puerto Rico pushed Congress to give it legal tools to force creditors to the bargaining table and prevent an onslaught of lawsuits. Instead, it looks like they will be headed to court.

Energy Transfer Equity has terminated its merger agreement with Williams Cos. after a court ruled that it can walk away from the deal since it was unable to deliver a required tax opinion by June 28. Williams published a statement saying it is committed to completing the merger and will “enforce its rights” under the terms of its agreement. The deal had been valued at nearly $33 billion when it was signed last year.

Toyota announced another massive recall. The Japanese carmaker said it needed to recall 2.8 million cars over a possible fault in emissions control units, after it announced on Tuesday that 1.4 million Prius and Lexus models had to be brought in to have their air bag inflators fixed.

Coca-Cola expects to pull some of its beverages from Vermont stores this week as the state imposes a new law requiring all products made with genetically modified organisms to include warning labels. Although its top beverages will stay on shelves, including Coca-Cola, Diet Coke and Coke Zero, some smaller brands or configurations may temporarily disappear. Kellogg, Campbell Soup and Mars previously announced they would comply with the Vermont law and begin labeling their products for GMOs.

Nike’s futures sales disappointed. Nike reported adjusted earnings per share of $0.49, beating the consensus by a penny. Revenue rose 6% to $8.2 billion but was a bit shy of estimates. The closely followed worldwide futures orders jumped 11%, missing the 13% increase that analysts were anticipating.

Thursday, April 17, 2014 - The Growth Industry for the Next 20 Years

Financial Review with Sinclair Noe

DOW – 16 = 16,408
SPX + 2 = 1864
NAS + 9 = 4095
10 YR YLD + .08 = 2.72%
OIL + .83 = 104.59
GOLD – 7.60 = 1295.60
SILV + .02 = 19.75

Stocks ended a holiday-shortened week with mixed results. Stock markets will be closed tomorrow in observance of Good Friday. The S&P 500 had its best week since last July. For the week, the Dow rose 2.4%, the S&P 500 added 2.7% and the Nasdaq advanced 2.4%.

With less than one-fifth of S&P 500 companies having reported results so far, about 63% have topped earnings expectations and 52% have topped revenue expectations. Of course that’s part of the dance between corporations and analysts, but it does move stock prices. For example, Goldman Sachs reported an 11% drop in quarterly profit and revenue fell 8%, but the results were better than estimates and share price was higher on the day.  Among the other earnings related movers today, Google, IBM, Mattel, and United Health were down on poor earnings news, while Morgan Stanley, GE and Pepsi moved higher.

The number of Americans filing new claims for unemployment benefits rose less than expected in the latest week and came near pre-recession levels. The Labor Department also reports weekly earnings of the typical full-time worker rose 3% in the first quarter compared to a year earlier, the fastest pace since 2008. Median earnings came in at $796, that’s the point where half of all workers made more and half made less. This means that earnings growth is now outpacing inflation in consumer prices, which increased at 1.4%. Earnings that rise faster than costs mean workers will have more money to spend on discretionary purchases, or maybe to shore up their personal finances.

This might indicate that the labor market is getting tighter, or at least working through some of the slack, as companies have to pay a bit more to retain or attract workers. Consumers that spend more, boost business profits, which means companies respond by producing more, which means more hiring and an even tighter labor market, which leads to higher worker earnings. Of course, this is just one report, and one report does not make a trend.

One of the reasons it might not be a trend is that the income is not evenly distributed. Recent Labor Department research shows that the top 20% of earners accounted for more than 80% of the rise in household income from 2008-2012. Income fell for the bottom 20%. That had a direct impact on spending. The top households increased spending by about $2,300 from 2008-2012, notably on health care, transportation and education. The 20% of households with the lowest incomes cut spending by about $150.

Top diplomats from Ukraine, Russia, the European Union and the United States have agreed on a set of measures to ease mounting tensions in eastern Ukraine. In Geneva today, Secretary of State John Kerry said the measures include disarming pro-Russian militants occupying buildings in eastern Ukraine and the return of the buildings to their legitimate owners. A joint statement from the four powers says amnesty will be granted to protesters who surrender weapons and leave the buildings, except for those found guilty of capital crimes.

Speaking at the White House, President Obama said he hopes Russia will honor the agreement but he also said that given past practices, there are no assurances of cooperation from Moscow. He said the administration is holding talks with European allies about possible new sanctions if Russia reneges on the deal.  The agreement does not specifically require Moscow to withdraw 40,000 troops massed on its border with Ukraine, and does not reference Russia's annexation of Ukraine's Crimean peninsula last month. It also does not obligate Moscow to hold direct talks with the interim government in Kiev. Peace monitors will be put in place and dialogue will continue, but this is a very real diplomatic move toward de-escalation. That’s good.

This has been a most unusual geopolitical act of aggression in Ukraine; it has revealed the use of sanctions as an economic weapon going up against the threat of cutting off natural gas supplies as an energy weapon.

In Russia, the economic costs have been masked by recent patriotic fervor but could soon haunt the Kremlin, as prices rise, wages stall and consumer confidence erodes; the major Russian stock market index dropped 10% in March; by some accounts, more than $70 billion in capital has fled the country so far this year; key interest rates jumped to 7% from 5.5% to combat inflation and support the ruble, a step that could slow growth; and unemployment has spiked. Beyond the whipped up patriotic fervor there isn’t much reason for Russians to feel good about their situation. The only thing positive for the Russian economy is its energy supplies.

And when Russia intervened in Crimea, they threatened to turn off the energy supply to Ukraine and Europe. The clock is ticking. Europe has about 6 months before the cold weather returns, to wean themselves from dependence on Russian nat gas.

One way to replace Russian gas is through home-grown renewable energy production. Today, the Ukrainian embassy in Washington DC hosted officials from the renewable energy industry to try and lure investment in green energy such as solar, wind, and biofuels. It will be interesting to see where this goes.

The oil industry would like to take the crisis in Ukraine and use it as an opportunity to flood the European market with fracked-in-the-USA natural gas. For this ploy to work, it's important not to look too closely at details. Like the fact that much of the gas probably won't make it to Europe because any gas fracked in the US would actually be sold on the world market to any country belonging to the World Trade Organization.

Plus, it would require massive infrastructure bailout in Ukraine and Europe; a single LNG terminal can cost $7 billion and it still requires massive infrastructure beyond the terminal. There could be a couple of very cold winters in Europe before those massive industrial projects are up and running.

Plus, there is the environmental problem of even more fracking in the US; Americans might put up with fracking in their own back yard if it results in energy independence and more jobs, but when you switch the argument to energy security for Ukraine and Europe, it becomes a tougher sell.

Plus, there is the concern about expanding fracking in light of the recent studies coming out in very plain and blunt language stating the climate is changing and fracking and burning carbon based fuels is a huge culprit. The gas industry itself, in 1981, came up with the clever pitch that natural gas was a "bridge" to a clean energy future. That was 33 years ago. That’s a long bridge.., to nowhere.

The answer is in renewable energy sources. If Russia wasn’t threatening to take away the nat gas, nobody would pay any attention to Putin. Real energy independence is also energy security, and it will be impossible to achieve as long as we rely on the oil and gas industry. So, how long would it take to become energy independent? Less than you might imagine.

It would take a big change in thinking and in political will, but we’ve done it before. During World War II, the US retooled automobile factories to produce 300,000 aircraft, and other countries produced 485,000 more. In 1956 the US began building the Interstate Highway System which eventually extended more than 47,000 miles and changed commerce and society. Clean technology is the answer, and not just because fossil fuels are cooking the planet but because the clean tech is more efficient.

Today the maximum power consumed worldwide at any given moment is about 12.5 trillion watts, according to the US Energy Information Administration. The agency projects that in 2030 the world will need almost 17 trillion watts of power as the global population and living standards rise, with almost 3 trillion watts being consumed by the US. That forecast is based on the idea that we continue with the current mix of energy sources we use today, which is heavily dependent on fossil fuels.

If, however, the planet were powered by clean technology, with no fossil fuel or biomass combustion, an intriguing savings would occur. Global power demand would only be about 11.5 trillion watts and the US demand would drop to only about 1.8 trillion watts. That means that in 2030, we would need less wattage than we need today; and that decline occurs because, in most cases, electrification is a more efficient use of energy. For example, less than 20% of the energy in gasoline is used to move a vehicle and the rest is wasted as heat, whereas 85% of electricity delivered to an electric vehicle is used to provide motion.

Of course clean technology would require massive infrastructure investment as well. The good news is that it is not money handed out by government or consumers but rather an investment that is paid back through the sale of electricity and energy, and because of the efficiencies and the advances in the technologies, it is cheaper than fossil fuel based energy. Energy will be the growth industry of the next 20 years; it is essential for a growing population and a standard of living; and as Putin’s intervention in Crimea has reminded us, it is essential for geopolitical stability.