Financial Review

Hat Trick

Sinclair Noe — July 14, 2016

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DOW + 134 = 18,506
SPX + 11 = 2163
NAS + 28 = 5034
10 Y + .07 = 1.54%
OIL + .75 = 45.50
GOLD – 7.70 = 1335.60

The S&P and Dow closed at record highs. The S&P hit 2,168.99, its fourth straight intraday record peak, while the Dow hit 18,537.57 to mark its third straight intraday record high.

The Bank of England took markets by surprise, making no change to interest rates. The call to leave rates unchanged at 0.5% was largely unexpected by investors, as traders had priced in a more than 80% chance of a rate cut to a record low of 0.25%. The BOE said in a statement that most of the policymakers expect to loosen monetary policy by August; apparently they just need a little more time to put together a package of measures to stimulate growth. Maybe they are just trying to keep their powder dry.

U.S. producer prices jumped 0.5% in June — the biggest increase in more than a year — largely owing to higher oil prices and margins for financial services. Yet inflation overall remains muted. In the past 12 months, the producer price index has advanced 0.3%, the first year-over-year increase since the end of 2014. Core prices – stripping out food, energy, and trade margin categories – core prices rose a smaller 0.3% in June.

The number of applications for U.S. unemployment benefits last week held at the lowest level since mid-April. Jobless claims were unchanged at 254,000 in the week ended July 9. Companies having trouble finding qualified and skilled workers are hesitant to dismiss employees. Weekly claims have been below 300,000 for 71 straight weeks, the longest period since 1973 and consistent with robust employment conditions.

Sales of new single-family homes likely grew at a seasonally adjusted annualized rate of 530,000 units in June, up 8.6 percent from a 488,000 annualized pace in May. The Mortgage Bankers Association said June’s estimated pace of sales was up 7 percent from a year earlier. Without adjusting for seasonal factors, there were likely 47,000 new homes sold last month, unchanged from May.

JPMorgan Chase reports second quarter profit slipped 1% versus the same period a year earlier, but that beat estimates. JPMorgan’s second-quarter net income slipped to $6.2 billion in the second quarter ended June 30 from $6.3 billion a year earlier. Net revenue rose 3 percent to $25.2 billion from $24.5 billion. Six major banks report earnings on Friday.

BlackRock, the world’s largest money manager, said second-quarter profit fell 3.7 percent as performance fees declined and clients shifted money from stocks to lower-fee fixed income and cash investments. Net income in the three months through June declined to $789 million, or $4.73 a share, from $819 million, or $4.84 a share, a year earlier.

BlackRock is the first big U.S. money manager to report second-quarter earnings, giving a glimpse of how firms navigated financial markets that were rattled by Britain’s vote to leave the European Union.  Larry Fink, chairman and CEO of BlackRock, weighed in on the recent stock market rally, saying the data on fund flows don’t support the moves. He said the recent rally has been supported by institutional investors covering shorts.

That is probably an oversimplification of what we are seeing. Institutions bet big before the Brexit vote that the markets would skyrocket and that the UK would not leave the EU and unfortunately the exact opposite result happened, forcing these same institutional players to then scramble and go short the market. Well everyone went short at the same time and thus whenever markets move in a herd mentality, one way or the other, it creates opportunities for others to take advantage of the situation.

Certainly short covering is part of the story, but I think we are also seeing a long term bull that went through 13 months of sideways action, or consolidation, and now is breaking out on a bit of decent news. Consider that Brexit did not result in a Lehman moment; central bankers around the globe are pumping money into the system; the Federal Reserve is not hiking rates; the June jobs report showed a strong rebound; earnings season will beat expectations even if it is slightly negative for a fifth consecutive quarter.

The market has been running, a full-fledged sprint to record highs. And even though overbought indicators are flashing a warning sign, remember that the market climbs a Wall of Worry. In situations like this, the market can surprise and just keep running.  Eventually and inevitably, there will be a pause, maybe even a pullback, but I don’t know when; maybe tomorrow, maybe two weeks, maybe longer. Sure, there is plenty that could go wrong but they aren’t going wrong right now.

KFC owner Yum Brands rose 3 percent to $88.27 a day after its key China business showed signs of strength.

Delta’s higher-than-expected quarterly profit sent its shares 3.6 percent higher. An airline industry index has risen almost 12 percent over the past six sessions.

Line Corp. rose in its U.S. trading debut after the Japanese messaging company raised more than $1 billion in the biggest technology initial public offering of the year. Shares opened at $42, after pricing at $32.84 apiece. The company, which is listing shares in Japan and the U.S., will start trading in Tokyo on Friday. Shares closed up 26.6 percent at $41.58.

Monsanto is considering a deal with BASF. The seed giant is considering the acquisition of BASF’s agriculture-solutions unit. While the price tag of the potential deal is unknown, Monsanto would probably pay in newly issued shares. The talks come after Monsanto rejected a $62 billion takeover bid by Bayer in May, and today Bayer sweetened the offer to $64 billion. Global agrochemicals companies are racing to consolidate, partly in response to a drop in commodity prices that has hit farm incomes.

The Federal Communications Commission voted unanimously today to open nearly 11 gigahertz of high-frequency spectrum for mobile, flexible and fixed-use wireless broadband; that made the United States the first country to set aside an ample amount of airwaves for so-called 5G wireless applications and networks. New 5G networks are expected to provide speeds at least 10 times and maybe 100 times faster than today’s 4G networks.

5G technology could have a broad impact beyond things like speeding up movie downloads. It could also improve road traffic by monitoring sensors in streetlights, roadside architecture and cars. It could even help detect air pollution using sensors in trees. In other words, this is the platform for the Internet of Things. Verizon and AT&T have said they will begin deploying 5G trials in 2017, and the first commercial deployments at scale are expected in 2020.

California regulators have again rejected Volkswagen’s plan to fix diesel vehicles that were programmed to cheat on air pollution tests, saying the idea was “incomplete” and “substantially deficient.” The proposal would have covered about 16,000 3.0-liter diesel cars for model years 2009 to 2016. About 85,000 VW 3-liter diesel vehicles that cheat on emissions are on roadways nationwide.

Google faces a new antitrust attack from European Union regulators who allege the search engine skews results in its own favor and unfairly restricts rival online advertising platforms. The European Commission announced a new round of charges against Google, claiming that some of the company’s advertising products restricted consumer choice. The new charges relate to some of Google’s online advertising tools — the main engine for $75 billion in annual revenues — and parts of the company’s search business linked to online shopping.

Financial Review

Earnings Reporting Season

Sinclair Noe — July 11, 2016

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DOW + 80 = 18,226
SPX + 7 = 2137
NAS + 31 = 4988
10 Y + .07 = 1.43%
OIL – .65 = 44.76
GOLD – 10.80 = 1355.60

The S&P 500 Index traded at a new intra-day high this morning, topping 2143, and closing at a record high 2137, taking out the old high of 2130 from May of last year.

And just because we hit a new high, doesn’t mean we’ve reached the top.  Typically, a breakout results in a bullish rally. The market has broken its multiyear record 17 times, and each of those instances has been followed by prolonged growth. After these 17 multiyear highs, the average return for the S&P 500 has been 8.5% over the next six months and a whopping 15.5% over the next year. Not a guarantee, just an indication of past performance. If you are a bit cautious, wait for confirmation, such as a weekly close above the old high.

So it may come as a surprise that the S&P 500 is also poised to match its longest earnings recession since 1936. At 25 times reported profit, the S&P 500 is trading at a higher multiple than it has for 90 percent of the time in the past eight decades. Earnings have been declining for four consecutive quarters, and if the second quarter numbers do not improve we will have a fifth consecutive quarter of declining earnings. Earnings are not expected to improve; they will probably be down about 5.6% from a year earlier, according to FactSet. And yet, a majority of stocks will probably report better than expected earnings. The average “beat rate” – the percent of the time a company beats the consensus earnings estimate – is 61% for the broad market.

Wall Street analysts lower the bar for earnings and then cheer when a company steps or stumbles over the bar. The “typical” quarter sees companies in aggregate report better-than-expected numbers, with the average margin of upside running around four percentage points. If the pattern persists, companies have an outside shot of ending about even with the 2015 period. The current forecasts for the third quarter are for a slight dip of less than 1 percent in profits, followed by a more notable bounce-back in the fourth quarter.

As far as deciphering the actual earnings reports, well I’ve been reading and analyzing reports for a couple of decades and it just keeps getting tougher and tougher to make sense of the numbers. An analysis of results from 500 major companies by The Associated Press, based on data provided by S&P Capital IQ, a research firm, found that the gap between the “adjusted” profits that analysts cite and bottom-line earnings figures that companies are legally obliged to report, or net income, has widened dramatically over the past five years. At one of every five companies, these “adjusted” profits were higher than net income by 50 percent or more. Many more companies are in that category now than there were five years ago. And some companies that seem profitable on an adjusted basis are actually losing money.

Lynn Turner, chief accountant at the Securities and Exchange Commission, said companies are still touting “made-up, phony numbers” as much as they did 15 years ago, perhaps more, and few experts are calling them out on it. Turner said, “The analysts aren’t doing enough to get behind the numbers that management gives them to find out what’s really going on.” And this of course, begs the question, what is the job of Securities and Exchange Commission?

Alcoa used to be one of the Dow 30 stocks, and with the ticker symbol AA, it kicks off the earnings reporting season. Not only is Alcoa first in line, it is the poster child for what we might expect. Alcoa reported quarterly earnings and revenue that beat analysts’ expectations. The company posted adjusted second-quarter earnings per share of 15 cents on revenue of $5.3 billion. Analysts expected the company to report earnings of about 9 cents per share on $5.2 billion in revenue.

Despite beating expectations, Alcoa’s second-quarter adjusted earnings per share declined from 19 cents in the comparable year-ago period. Revenue also fell — from $5.9 billion — compared to the same quarter last year. After the announcement, Alcoa shares jumped more than 4 percent in after-hours trading.

Earlier in the year, oil and stocks were trading in concert. Oil prices fell more than 1 percent today, hitting two-month lows on extended selling after the market’s break below a key technical support level last week due to oversupply fears. Last week, oil slumped nearly 8 percent in its biggest weekly losses in six months and already hit a two-month low on Thursday after disappointing drawdowns in U.S. crude and gasoline inventories pointed toward weak demand.

Interior minister Theresa May will become Britain’s next prime minister on Wednesday, after her only rival abruptly quit the race today, removing the need for a drawn-out leadership contest. May was left as the only candidate to succeed David Cameron, who announced he was stepping down after Britons voted last month to leave the European Union. May favored a vote to Remain in last month’s referendum.

The Bank of England is weighing a raft of emergency measures to stem the flood of money out of Britain’s biggest property funds that caused fresh market panic last week. These could include “enforced notice periods before redemptions, slashing the price for investors who rush to the door, or additional liquidity requirements for funds.”

Australia’s Malcolm Turnbull declared victory on Sunday in a marathon national election, with his coalition government retaining power and the opposition Labor Party conceding defeat. It’s still unclear whether the prime minister will lead a majority government or one that needs the support of smaller parties and independents. The coalition has so far won 74 of 150 House of Representative seats and is projected to take 76, or the slimmest majority possible.

Prime Minister Shinzo Abe’s Liberal Democratic Party and its allies won a stronger majority in Japan’s Upper House election on Sunday, in a development that will make it far easier to push through his economic agenda. Abe later confirmed a new round of stimulus, nearly $100 billion worth of measures, including loans. To fund a supplementary budget, they said the cabinet will consider the first additional issuance of new government bonds in four years. The announcement on new stimulus measures helped send the yen down 2% against the dollar and pushed the Nikkei up 4%. Other Asian markets also moved higher this morning.

Japanese messaging service Line Corp., set for a dual New York and Tokyo listing this week, has priced its initial public offering at the top of its marketed range, and is expected to raise as much as $1.3 billion and value the company at $6.9 billion. Line’s offering will be the biggest tech IPO of the year and it will mark the first Japanese company to list new shares in the U.S. since 2000.

The hacking outfit OurMine has already been responsible for a few high-profile Twitter account takeovers, but the latest may be particularly embarrassing for the company. Twitter CEO Jack Dorsey had his account briefly hacked Saturday morning, as OurMine tweeted out a link to its website and a message that it was “testing your security,” along with a Vine clip that has since been deleted.

UFC was sold. The mixed martial arts promoter was sold for $4 billion to a consortium of investors, led by the talent agency WME-IMG. Backing the transaction are private equity firms Silver Lake, Kohlberg Kravis Roberts and Michael Dell. Ultimate Fighting Championship fights are now shown in more than 156 countries and claim millennials as some 45% of its audience.

Thomson Reuters agreed to sell its intellectual property and science business to private equity firms Onex Corp and Baring Private Equity Asia for $3.55 billion in cash. The business, which has 3,200 employees, provides intellectual property and scientific information and associated tools and services to governments, universities and companies.

All Starbucks store employees and managers in the U.S. are in for at least a 5% raise starting in October. Employees with at least two years of service will also now be eligible for double the amount of stock award in the company, which is doled out each November as an equity reward that turns into shares of Starbucks stock after a specific time period. The wage increase combined with the new stock award policy means compensation will increase between 5% and 15%.

Black Friday is coming four months early for some retailers. Stores including Target, Sears, Banana Republic, Express, the Gap and Old Navy are offering deals around the same time as Amazon’s big Prime Day sale, which starts tomorrow. Wal-Mart has even eliminated the $50 minimum spending requirement for shoppers to receive free shipping on their online orders. Amazon shares hit a record on Friday, and gained another 1% today.

That all comes ahead of Tuesday’s second annual Prime Day, when subscribers will get access to over 100,000 deals. It will be Amazon’s biggest day ever. Countdown deals rolled out last week, and on Friday Amazon started offering specials. Starting at midnight Pacific time, members of the $99 a year Prime service will see deals as frequently as every five minutes throughout the day.

Today is July 11, or 7-11. Free Slurpees for everyone! At least at participating 7-Eleven convenience stores. Between 11 a.m. and 7 p.m. at participating stores, visitors can receive a free small Slurpee drink available in various flavors.  This is the 14th year the retailer has offered free Slurpee drinks on its birthday.

Maybe Slurpees aren’t your thing. I understand. Just wait until tomorrow July 12, Cow Appreciation Day at Chik-fil-A. The chicken chain will offer a free entrée to anyone dressed in cow attire, whether “head-to-hoof” or sporting a cow-spotted accessory, like a purse or hat.