Financial Review

Another Record

Sinclair Noe — May 19, 2015

 

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DOW + 13 = 18,312.39 (record)
SPX – 1 = 2127
NAS – 8 = 5070
10 YR YLD + .03 = 2.26%
OIL – 2.17 = 57.26
GOLD – 17.80 = 1209.00
SILV – .61 = 17.17

Record high for the Dow Industrials.

Construction starts on new U.S. homes was up 20% in April to a seasonally adjusted annual rate of 1.14 million. That’s the biggest monthly percentage gain in over 24 years and the highest level since November 2007.  Total housing starts remain far below an average pace of about 1.5 million over the 20 years leading up to the housing bubble’s 2006 peak.

A board member of the European Central Bank says the ECB will “frontload” its asset purchases in May and June – that is, step up buying in those months – to maintain its monthly average of $67 billion, given an expected drop in liquidity in the summer vacation period. The policymaker also said the recent selloff in German bunds and other sovereign bonds is not a cause for concern but the rapidity of the move is worrying.

Greek Finance Minister Yanis Varoufakis told a Greek TV channel last night that Greece is “very close” to a deal, other officials are less enthusiastic. European Commission President Jean-Claude Junker said this morning that there will be no agreement for Greece at this week’s summit. At some point, Greece will run out of cash; exactly when is a matter of conjecture but even optimistic forecasts are under 60 days.

Members of the ECB’s Governing Council are scheduled to meet in Frankfurt tomorrow to discuss the fate of the Greek economy. Greece is in such a precarious position that any change in central bank policy could alarm markets and have serious consequences. But the council is reportedly running out of patience and could impose stricter controls on Greek banks to maintain emergency lending protocols. Traders and investors are clearly nervous about the state of the Eurozone, and the euro was down about 2% against the dollar today.

Deutsche Bank is studying whether to move large chunks of its British operations to Germany if the U.K. leaves the EU, underlining the potential fallout in the City of London in the event of a “Brexit”. The German lender, which employs 9,000 people in the U.K., is the first major bank to start formally examining the consequences of a British referendum on EU membership.

The UK slipped into deflation for the first time in at least 55 years. Consumer prices slipped 0.1% year-over-year in the UK, marking an unexpected return to deflation. The UK has not experienced falling prices since the 1950s and 1960s, but its most recent extended bout with deflation was in the 1930s, during the Great Depression.

Taking advantage of the lower borrowing costs in the Eurozone, McDonald’s and United Technologies are now the latest big U.S. companies to issue debt in euros (called “reverse Yankee” bonds), selling €2 billion-euro and €750 million-euro, respectively. The total raised by U.S. companies issuing euro-denominated debt so far this year is just over €37 billion-euro, more than double the previous record of €17 billion-euro in 2007.

Oil prices were down again today. There are several factors at play with oil prices. First, the dollar index has bounced from 93.1 on Friday, up to an intraday high of 95.5 today. The old idea is dollar up, oil down, or vice versa. Next, the Saudis have been pumping out quite a bit; 7.5% more in March than February, or about 7.9 million barrels a day.

Over the weekend, Goldman Sachs issued a research report showing strong inventories combined with weak economies pushing weak demand; the rally in oil prices from $47 mid-March to $63 in early May was described as premature and prices could drop down to around $45 by October. When you look at the recent rally it seems largely supported by sentiment. We still have massive stockpiles. Still, your guess is as good as theirs.

Meanwhile, get ready for a boom in solar. Solar panel makers globally are preparing for their best year since 2011 as China and Japan take advantage of falling prices to shift more of their energy production to clean power. Panel production is forecast to grow by almost a third this year.

China, signed a pact with the US in November to get 20 percent of its energy from renewable sources by 2030, with its total carbon emissions peaking the same year. To reach that goal, the Chinese government earlier this year boosted its target for 2015 solar installations to 17.8 gigawatts from about 12 gigawatts. Japan may install as much as 12.7 gigawatts of solar power this year, the most after China. The country has promoted wider use of renewable energy, especially rooftop panels, after the 2011 Fukushima nuclear plant meltdown.

Cheaper solar has also made the technology more economically viable for emerging economies such as India and South Africa. In India developers are installing panels to replace more expensive diesel generators. The Bloomberg Global Solar Energy Index is up 65% year to date and the TAN Solar ETF is up 39% year to date.

Founding members of the China-backed Asian Infrastructure Investment Bank will hold a three-day meeting in Singapore this week to discuss the draft articles of agreement and operational policies for the establishment of the institution. Although 57 countries have joined the AIIB as founding members, the U.S., Japan and Canada have remained notable absentees.

In a new financial industry survey, more than a third of the respondents said they witnessed or knew of wrongdoing in the workplace. And nearly half said regulators were ineffective in stopping it.

The numbers are in on 2014 CEO compensation, and it does not look like the controversial income gap in America is narrowing. The average S&P 500 company CEO made 373 times the salary of the average production and non-supervisory worker in 2014, up from 331 times in 2013. This translates into an average CEO pay package of $22.6M, up from $20.7M last year.

The Los Angeles City council voted today to increase its minimum wage to $15 an hour by 2020 from the current $9 an hour, in what is perhaps the most significant victory so far in the national push to raise the minimum wage. Several other cities, including San Francisco, Seattle, and Oakland have already approved increases, and dozens more are considering doing the same. The impact is likely to be particularly strong in Los Angeles, where, according to some estimates, more than 40 percent of the city’s work force earns less than $15 an hour. The vote could set off a wave of minimum wage increases across Southern California and there might be national implications.

Japanese air bag manufacturer Takata has agreed to the largest automotive recall in American history, declaring nearly 34 million vehicles defective due to problems with air bag inflators. The case involves air-bag inflators that may deploy with too much force, breaking apart and shooting shrapnel inside the cars. Six deaths have been linked to the defective air bags. Takata faces multiple class actions in the United States and Canada as well as a criminal investigation. With vehicles from 11 different automakers and a severe shortage of repair parts, it could take years for all the cars to be made safe.

It has been a busy day for earnings from retailers. Wal-Mart drew more shoppers to its stores in the last quarter, but international sales were hurt by the stronger dollar, causing overall sales to fall. Wal-Mart said its profit fell 7% to $3.34 billion, as revenue fell 0.4% to $114.8 billion.  U.S. same-store sales edged up 1.1%.

Home Depot reported quarterly profit and revenue that topped expectations, and they also lifted its profit and sales targets for the year. TJX Cos. posted first-quarter earnings of 69 cents a shares, above forecasts for 66 cents a share, on revenue of $6.9 billion. Urban Outfitters reported first-quarter earnings and sales that came in below expectations. Dick’s Sporting Goods reported first quarter profit topped expectations but issued second quarter guidance in the low range of projections.

Wednesday, August 06, 2014 - Where Water Flows

Financial Review with Sinclair Noe

DOW + 13 = 16,443
SPX +.03 = 1920
NAS + 2 = 4355
10 YR YLD - .01 = 2.47%
OIL - .54 = 96.84
GOLD + 17.30 = 1306.30
SILV + .27 = 20.11

Let’s start with the economic news of the day:

The Commerce Department says the trade gap for June shrank 7% to $41.5 billion, the lowest reading since January. That was smaller than the roughly $44.8 billion shortfall the government had assumed in its first snapshot of second-quarter gross domestic product published last week; so that would indicate the 2Q GDP number could be revised higher by 0.3%.

Exports edged up 0.1% to a record high of $195.9 billion in June, supported by a surge in automobiles, parts and engines, which rose to an all-time high. Consumer goods exports also hit a record high. There was also a jump in crude oil exports. Imports fell 1.2% in June, the largest drop in a year; petroleum imports declined to $27.4 billion, the lowest level since November 2010, from $28.3 billion in May.

Elsewhere, the Gaza-Israel ceasefire is holding for a second day. The Iraqi government carried out an airstrike on ISIS, killing 60 in the city of Mosul. Russia is massing troops near the Ukrainian border. Renewed fighting in eastern Ukraine has forced the suspension of a search for the remains of the victims of crashed flight MH17. Russian President Putin has banned agricultural imports from countries imposing sanctions on Russia. So, it might be difficult to buy California avocados in Moscow, although the Kremlin hasn’t yet created a list of food and ag products that will be banned.

Of course it might be difficult to buy California avocados anywhere, unless California gets some rain. The entire state is experiencing drought, and 82% of California is in “extreme” drought; of that, 58% of the state is in an “exceptional drought”, the driest conditions possible, an increase of more than 20% in a single week. Record-low rainfall has sent rivers, lakes and water reservoirs to their lowest levels in decades; threatening the water supply of many cities. The unusually dry conditions have increased the risk of wildfires, which have already ravaged parts of the state; most recently an area near Yosemite National Park.

The long-term drought cutting off California's water supply continues to parch the state, and even NASA can see it now. With the entire state now in severe drought, NASA's Aqua satellite took a picture of California to compare the terrain with a similar image taken from 2011. California is turning brown and parched. In 119 years of record keeping, 2013 was the driest calendar year for California, and it’s even worse this year. Even with a possible El Niño lurking in the tropical Pacific, there is no quick fix to this drought. It will take years of above-average rainfall to recover.

In the major cities like Los Angeles, residents are getting mixed messages: don’t water your lawns or hose off the sidewalk or you could face a fine of $500; at the same time they could be fined if they don’t keep their lawns and neighborhoods looking nice. That has spawned a new side business for landscapers: lawn painting. Prices vary but typically range from 25 cents to 35 cents per square foot of grass. On average, a 500-square-foot lawn is likely to cost $175 for a fresh coat of green paint. The dye is marketed as safe and nontoxic.

The drought’s biggest victim could be California’s Central Valley, the source of fully half the nation’s fruits and vegetables, where panicked farmers are taking extraordinary steps to survive a drought that could drive them out of business. Some farmers are drilling water wells thousands of feet, others are paying more than $2,500 for an acre foot of water; that’s at least 6 times the price of what water was going for last year. Desperate farmers have scrambled to save valuable citrus orchards; others have already lost the battle and been forced to bulldoze dead trees. It’s estimated that 10% of California’s farmland went unplanted this season. And the environmental damage might not be repaired in our lifetimes.

A recent University of California, Davis, study found the state’s agriculture industry stands to lose at least $1.5 billion this year alone due to the drought; losses that threaten to devastate a region where virtually everything is tied to farming. Already, small towns where the population is made up primarily of farm laborers, are warning unemployment rates could hit 50% in coming months because there will be no crops to harvest. That’s terrible news for an area already stricken by some of the highest poverty rates in the nation and where many cities still haven’t fully recovered from the Great Recession. And that’s just the start of a vicious cycle. No crops means people can’t work. Prices for produce go up, and people can’t afford to eat.

And as the state dries up, we are seeing the commoditization of water. Actually, that’s nothing new. For at least the last 10 years, the big banks and wealthy investors have been buying up water, or water rights. In 2008, during its annual “Top Five Risks” conference, Goldman Sachs called water “the petroleum for the next century” and those investors who know how to play the infrastructure boom will reap huge rewards. A 2008 New York Times article mentioned Goldman Sachs, Morgan Stanley, Credit Suisse, Kohlberg Kravis Roberts, and the Carlyle Group, had “amassed an estimated an estimated $250 billion war chest to finance a tidal wave of infrastructure projects in the United States and overseas.” In a 2012 JP Morgan equity research document, it states clearly that “Wall Street appears well aware of the investment opportunities in water supply infrastructure, wastewater treatment, and demand management technologies.” Billionaire T. Boone Pickens owned more water rights than any other individuals in America, with rights over enough of the Ogallala Aquifer to drain approximately 200,000 acre-feet (or 65 billion gallons of water) a year.

This summer, various business forces are combining to remind us that fresh water isn’t necessarily or automatically a free resource. It could all too easily end up becoming just another economic commodity. At the forefront of this debate is Peter Brabeck, chairman and former CEO of Nestle. In his view, citizens don’t have an automatic right to more than the water they require for mere “survival”, unless they can afford to pay for it. For context, the World Health Organization sets such “survival” consumption levels at a minimum of 20 liters a day for basic hygiene and food hygiene – higher, if you add laundry and bathing. In the United States, the odds are that flushing your toilet consumes 50 liters of water a day, and your average daily consumption of water probably tops 125 gallons.

If you’re curious to know what a society existing on “survival” water supplies might look like, just take a glance at Detroit. When the city became the largest US municipality ever to file for bankruptcy protection, they began to look at the payments residents owed to city hall, including delinquent water bills. Instead of letting it slide, the city cut off water; leaving more than 100,000 of the city’s 700,000 citizens without running water in their homes.

Just this past week, we saw the city of Toledo, Ohio tell a half million residents the water wasn’t safe to drink. Flooded by tides of phosphorus washed from fertilized farms, cattle feedlots and leaky septic systems, the most intensely developed of the Great Lakes is increasingly being choked each summer by thick mats of algae, much of it poisonous. Toledo was unlucky: A small bloom of toxic algae happened to form directly over the city’s water-intake pipe in Lake Erie, miles offshore. Beyond the dangers to people and animals, the algae wreaks tens of billions of dollars of damage on commercial fishing and on the recreational and vacation trades. Ohio has stopped well short of actually ordering the sources of phosphorus runoff to cap their production.

Nestle Waters North America division is the largest bottled water company in the country; they have to pay for water, at least some of it. Nestle pumps some of its bottled water from an aquifer near Palm Springs, thanks to a partnership with the Morongo Indian nation. Their joint venture, bottling water from a spring on land owned by the Morongo in Millard Canyon, has another advantage: since the Morongo are considered a sovereign nation, no one needs to report exactly how much water is being drawn from the aquifer.

And there is some validity to the argument that we risk depleting the supply of fresh water through careless and irresponsible consumption of what many think of as a free or nearly free resource. But what, exactly is that role? Is it to allow large corporations to buy up water rights, and possible corner the market for water? One role for the markets might well be in developing water related technologies to treat waste water or desalinate water, or even to extract water from the air; or to develop ways to use less water than we use now to grow crops and make products such as paper, or electronics, or the billions of gallons used to dye clothes.

So far, private equity hasn’t been able to figure out the technology or the potential for startups in this relatively nascent field. There is hard science, and a fair amount of infrastructure investment required. Venture capital favors the get rich quick schemes, even if the latest phone app might fade in 18 months, they can make a quick strike. Venture capital tends to gravitate to areas it knows, and areas it knows will not require heavy upfront costs, even if it could provide a steady flow of income and water for decades to come.