Fence-Sitting Persists

Charles Schwab: On the Market

Posted: 8/22/2016 4:15 PM ET

Fence-Sitting Persists

Last week's uncertainty has carried over to this week, as U.S. equities finished mixed and near the unchanged mark, amid evident caution ahead of the start to the Federal Reserve's annual symposium in Jackson Hole, Wyoming this week, which culminates with Friday's speech by Fed Chairwoman Janet Yellen. A pullback in crude oil prices from last week's rally also fostered some negative sentiment, while some M&A news gave the healthcare sector a boost. Treasuries finished higher and the U.S. dollar was flat, while gold was lower.

The Dow Jones Industrial Average (DJIA) decreased 23 points (0.1%) to 18,529, the S&P 500 Index shed 1 point (0.1%) to close at 2,183, while the Nasdaq Composite gained 6 points (0.1%) to 5,245. In lighter volume, 693 million shares were traded on the NYSE and 1.5 billion shares changed hands on the Nasdaq. WTI crude oil fell $1.70 to $47.41 per barrel, wholesale gasoline lost $0.03 to $1.48 per gallon and the Bloomberg gold spot price declined $3.03 to $1,338.44 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was nearly unchanged at 94.55.

Dow member Pfizer Inc. (PFE $35) announced an agreement to acquire oncology bio-pharmaceutical company Medivation Inc. (MDVN $80) for $81.50 per share in cash for a total enterprise value of about $14.0 billion. PFE said the deal is expected to be immnew ediately accretive to its earnings upon closing and it does not expect it to impact its current 2016 guidance. PFE was modestly lower, while shares of MDVN rallied nearly 20%.

Domestic economic docket dormant but Fed gathering set to command attention

Treasuries were higher amid a dormant economic calendar, as the yield on the 2-year note dipped 1 basis point (bp) to 0.74%, the yield on the 10-year note declined 4 basis points (bps) to 1.54%, and the 30-year bond rate fell 5 bps to 2.24%.For analysis on the fixed income markets see the video from Schwab's Managing Director of Trading and Derivatives, Randy Frederick and Fixed Income Director Collin Martin, CFA, titled Tempered Expectations for Bond Returns: Why Hold Bonds? Also, for commentary on the record high stock market, see the video from Schwab's Chief Investment Strategist, Liz Ann Sonders and Randy Frederick, titled Long-Running Bull Finally Attracting Believers? See both at www.schwab.com/insights and follow us on Twitter: @randyafrederick, @lizannsonders and @schwabresearch.

Fed policy focus and accompanying volatility is likely to begin to ramp back up this week, with the U.S. economic calendar yielding key data on the housing sector in the form of tomorrow's new homes sales, with economists expecting a 2.0% month-over-month decline during July to an annual rate of 580,000 units, as well as Wednesday's release of existing home sales. As well, some manufacturing data may also likely garner some attention, with Thursday's durable goods orders report in focus, as well as two reports tomorrow—Markit's Manufacturing PMI Index, forecasted to tick lower to 52.7 during July from the 52.9 posted in June, with a reading above 50 denoting expansion in activity, as well as the Richmond Fed Manufacturing Index. For a look at the housing market, see Schwab's Director of Market and Sector Analysis, Brad Sorensen's, CFA, latest Schwab Sector Views: There's a New Sector Coming. However, the highlight of the week will likely be the Fed's highly-anticipated annual monetary policy symposium in Jackson Hole, Wyoming, which will culminate with Friday's speech by Federal Reserve Chairwoman Janet Yellen.

As noted in the Schwab Market Perspective: The Calm Before the…., a period of peace has reigned in the market over the past month, but the lull in volatility likely won’t last. However, we do believe the secular bull market has further to run. The third quarter is shaping up to improve on lackluster first half U.S. economic results but weak corporate confidence remains an impediment to stronger growth. Fed uncertainty is likely to heat up heading toward the September Federal Open Market Committee (FOMC) meeting. Read the whole perspective and our sector views at www.schwab.com/marketinsight.

Europe and Asia mixed on commodity weakness and Fed focus

European equities finished mixed, with basic materials and oil & gas issues seeing pressure as commodity prices fell, led by crude oil prices amid lingering supply speculation. The U.S. dollar gained modest ground as Fed rate hike expectations continued to resurface following comments over the weekend from Fed Vice Chair Stanley Fischer that the Central Bank was close to reaching its targets for full employment and 2.0% inflation. The euro dipped compared to the greenback, while bond yields in the region moved to the downside. However, the British pound was higher versus the dollar, continuing its recent rebound from a sell-off that followed the Bank of England's (BoE) decision earlier this month to cut its benchmark interest rate further and boost its asset purchases. The BoE's decision was aimed at bolstering the economy on the heels the late-June vote by the U.K. to leave the European Union, known as a Brexit. The pound has also found support from last week's July economic data that showed retail sales easily topped forecasts, jobless claims unexpectedly declined and consumer price inflation surprisingly rose. For more on the potential impact of the Brexit vote, see the Schwab Center for Financial Research's article, Brexit: What Investors Should Know, at www.schwab.com/marketinsight.

Stocks in Asia finished mixed, with the global markets continuing to focus on the divergent monetary policy landscape following comments over the weekend by U.S. Fed Vice Chair Fischer and ahead of this week's annual Fed policy gathering. Also, Bank of Japan (BoJ) Governor Kuroda hinted at further stimulus measures, while uncertainty regarding more policy action in China persisted. The yen weakened versus the U.S. dollar, though crude oil prices gave back some of a recent run. For more on Japan's potential increased stimulus measures see Schwab's Chief Global Investment Strategist Jeffrey Kleintop's, CFA, article, What investors need to know about helicopter money, and amid the heightened uncertainty, Jeff offers Three Reasons Why Now is Not the Time to Retreat from Global Diversification. Read both articles at www.schwab.com/oninternational and be sure to follow Jeff on Twitter: @jeffreykleintop. Japanese equities, as well as those traded in Hong Kong, advanced, while mainland Chinese fell. Meanwhile, securities traded in Australia, South Korea and India all saw declines for the session.

Tomorrow's international economic calendar will be dominated by the Markit Manufacturing PMI from around the globe, as well as trade data from the U.K.

Schwab Center for Financial Research - Market Analysis Group

Financial Review

Waiting for the Jobs Report

Sinclair Noe — March 3, 2016

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

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DOW + 44 = 16,943
SPX + 6 = 1993
NAS + 4 = 4707
10 Y – .02 = 1.83%
OIL + .05 = 34.71
GOLD + 24.40 = 1264.90

We have a batch of economic reports, so we’ll run through the data and then break down the implications.

The Institute for Supply Management’s non-manufacturing index dropped 0.1 point to 53.4%. Any reading over 50 signals expansion. ISM’s production gauge rose 3.9 points to 57.8%. Growth in the services sector has been expanding at a slower pace for the past four months, and that is now showing up as contraction in service sector employment. Details from the services survey showed the employment index declined to 49.7 from 52.1 in January, indicating companies last month started cutting staff.

The number of Americans who applied for unemployment benefits rose by 6,000 to 278,000 in the last week of February, but the overall pace of layoffs still hovered near post recession lows. The average of new claims over the past four weeks, meanwhile, fell by 1,750 to 270,250 and hit a three-month low. In a separate report, global out placement consultancy Challenger, Gray & Christmas said U.S.-based companies announced 61,599 job cuts last month, down from 75,114 in January. Layoffs remained concentrated in the energy sector. Tomorrow the Labor Department will publish the monthly non-farm payroll report; look for a net gain of 190,000 to 200,000 jobs.

The productivity of U.S. businesses fell at a 2.2% annual pace in the fourth quarter, a smaller decline than previously estimated 3% decline. For all of 2015, productivity rose a meager 0.7%, just one-third as fast as the post-World War II average. In the fourth quarter, output rose a seasonally adjusted 1% in the final three months of 2015 instead of a 0.1% advance. Hourly compensation for all workers, adjusted for inflation, rose 1.1% in the fourth quarter and 2.8% for the full year. It wasn’t so much an increase in wages as lower oil prices kept a lid on inflation.

Orders to U.S. factories increased in January by the most in seven months, while a key category that tracks business investment plans rose by the largest amount in 19 months. Factory orders rose 1.6 percent in January after two months of declines. It was the biggest jump since June, though it was driven by demand in the volatile category of commercial aircraft. At the same time, orders in a core sector that serves as a proxy for business investment rose 3.4 percent, the sharpest one-month gain since June 2014. Orders for durable goods, products meant to last at least three years, rose a revised 4.7% in January, down from prior estimate of a 4.9% gain. Orders for nondurable goods fell 1.4%.

Stocks spent most of the session today in negative territory, before a bit of buying in the final hour. The economic data was mixed; nothing bad, nothing great; the economy appears to be chugging along; we need to wait for the jobs report tomorrow morning because that is always the big report each month, and one of the few reports that can sway the Federal Reserve. A big gain in tomorrow’s jobs report would definitely put a near-term hike back on the table. The S&P 500 has jumped almost 9% from a 22-month low reached in February, though the gains have come with weak volume, signaling a lack of conviction in the rally.

The flippers are back. RealtyTrac reports the total number of investors completing a flip, 110,008, was the highest since 2007. Even so, the average number of flips per investor, 1.63, was at the lowest since 2008. The average gross profit from flipping homes hit a 10-year high of $55,000 in 2015. That represented a return on investment of 45.8%. RealtyTrac defines flipping as selling a property more than once within a 12-month time period to a buyer other than a family member. Flips made up 5.5% of all sales nationwide. In Arizona, flips made up 7.1% of all sales.

More deflationary pressures in the Eurozone are surfacing, raising the chances ECB President Mario Draghi will increase stimulus at a central bank meeting next week. Markit’s composite Purchasing Managers Index fell to 53 from 53.6 in January – its lowest level in 13 months – while the firm’s measure of output prices across manufacturing and services fell further below the key 50 level. Markit says the slowdown in business activity, slower hiring and price declines “suggest that the region’s recovery is losing momentum.”

Latin America’s largest economy shrank the most in a quarter century last year and no recovery is in sight as shriveling demand and political crisis pummel activity. Brazil’s gross domestic product contracted 1.4 percent in the three months ended in December, after a 1.7 percent drop the previous quarter; for 2015 Brazil’s GDP dropped 3.8 percent. Brazilian courts granted more than 5,500 bankruptcy filings in 2015, the most since 2008.

The prolonged recession has made it tougher for the government to shore up its finances. Consumer and investor confidence levels have rebounded this year from record lows, which would normally suggest that the economy is bottoming but there are no real signs of recovery. The Organization for Economic Cooperation and Development forecasts the Brazilian economy to contract 4 percent this year, while the International Monetary Fund sees a 3.5 percent recession. Both forecast stagnation next year, which would mean no growth until 2018.

Oil prices have bottomed, according to the International Energy Agency. The price rally, however, will be capped in the medium term by a potential increase in the U.S. shale oil production once a rise in oil prices makes it profitable again. But prices are expected to grow throughout 2016 and into 2017, unless US shale producers have stronger than expected survivor skills. But other than that, the IEA says oil has bottomed and the price will probably hit $60 a barrel within the next 12 months.

Count hedge funds as among those licking their chops and loading up on energy companies, on a bet that happy days will be here soon for oil. Meanwhile, Blackwell Global says the recent rally above $30 is “largely a dead-cat bounce. Subsequently, expect crude to challenge the downside in the coming weeks, as the screaming hordes of market pundits stop declaring that crude oil’s bullishness is here to stay.” Which all sounds reasonable enough, or you could submit your own guess.

Former Chesapeake Energy CEO Aubrey McClendon died in a car crash yesterday after being indicted for conspiring to rig bids for leases in the oil and natural gas industry. McClendon slammed into an embankment while traveling at a “high rate of speed,” according to the Oklahoma City Police Department, which also said “he pretty much drove straight into the wall.” Chesapeake shares soared 24% on Wednesday and 25% today – not related to the fatal accident – after the company said it did not expect to face criminal prosecution or fines related to the indictment.

Costco posted an 8.7% decline in second-quarter profit, though the warehouse chain’s comparable-store sales increased. Kroger said its earnings rose 7.9% in the latest quarter, though revenue missed expectations and same-store sales growth slowed.

M&A roundup: Cisco has announced a $320 million deal to buy Leaba Semiconductor, an Israeli company that designs networking chips. Samsonite is close to buying luggage maker Tumi Holdings, in a deal that could be valued at $2 billion. MGM Resorts has reached an agreement to sell its Shops at Crystals mall in Las Vegas to a Simon Property Group partnership for $1.1 billion.

There are also vague rumors that PayPal is considering a $47/share offer from American Express. Yahoo is exploring the sale of $1 billion to $3 billion of patents, property and other “non-core assets.” General Electric’s proposed deal to sell its appliance business to China’s Haier Group for $5.4 billion has received approval from U.S. anti-trust authorities.

IBM has filed a lawsuit against Groupon, alleging that the daily deals website operator builds its business model using patents without authorization. “Groupon has refused to engage in any meaningful discussions about reaching a license agreement to end its infringement of IBM’s patents,” the firm’s complaint said. Big Blue filed a similar lawsuit against Priceline last year, accusing it of patent infringement in running its travel and dining websites.

U.S. carriers are set for a dogfight over newly opened flight rights to Havana, but their interest in other Cuban destinations appears to be lukewarm. Airlines had until the close of business on Wednesday to submit applications to the Department of Transportation that outlined the routes they would like to fly. That came after a February agreement paved the way towards restoring commercial air service between the two countries for the first time in decades.

What did they know and when did they know it? Volkswagen disclosed that former executives Martin Winterkorn and Herbert Diess were briefed internally about diesel emissions issues on U.S. vehicles, months before the firm publicly acknowledged its defeat devices. At issue is whether VW management waited too long to inform investors of potential liabilities that would later cause a massive erosion of the company’s share price and market value.

When a company’s stock price falls off a cliff, it’s hard to rally the troops, but it can be done. Case in point: LinkedIn Chief Executive Jeff Weiner is declining his 2016 annual stock compensation (a reported $14 million) in order to pass it on to workers at the professional social network. LinkedIn’s stock had dropped nearly 38% since its disappointing Q4 results on Feb. 4. Weiner isn’t the only one employing the strategy. Back in October, Twitter CEO Jack Dorsey paid out $200 million in stock to employees.

Financial Review

Another Strong Jobs Report

Sinclair Noe — December 4, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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DOW + 369 = 17,847
SPX + 42 = 2091
NAS + 104 = 5142
10 YR YLD – .05 = 2.28%
OIL – 1.01 = 40.07
GOLD + 25.30 = 1087.90

The economy added 211,000 jobs last month, beating estimates of about 200,000. The unemployment rate held steady at 5% as more workers entered the labor pool. The Labor Force Participation Rate increased in November to 62.5%, from 62.4% in October. The last two months’ jobs numbers were revised higher. The government said 298,000 new jobs were created in October instead of 271,000. September’s gain was raised to 145,000 from 137,000. Over the past 12 months, the economy has added 2.64 million jobs.

Let’s break down jobs by sector: Employment in construction rose by 46,000 in November, with much of the increase occurring in residential specialty trade contractors (+26,000). Over the past year, construction employment has grown by 259,000.

Professional and technical services added 28,000 jobs. Over the year, professional and technical services have added 298,000 jobs.

Health care employment increased by 24,000 over the month, following a large gain in October (+51,000). In November, hospitals added 13,000 jobs. Health care employment has grown by 470,000 over the year.

Employment in food services and drinking places continued to trend up in November (+32,000) and has risen by 374,000 over the year.

Retail trades added 31,000 and has increased by 284,000 over the year.

Mining lost 11,000 jobs; this area includes jobs in oil drilling and support services. Since a recent peak in December 2014, employment in mining has declined by 123,000.

Information lost 12,000 jobs over the month. Within the industry, employment in motion pictures and sound recording decreased by 13,000 in November but has shown little net change over the year.

State and local governments added 8,000 jobs in November, while the federal government added 6,000 jobs.

The past five years of job growth have been in the private sector. Government jobs are still 561,000 below the peak.

The number of persons working part time for economic reasons increased in November. These workers are included in an alternate measure of unemployment known as the U6, which increased to 9.9% from 9.8%.

In November, average hourly earnings for all employees on private non-farm payrolls rose by $.04 cents to $25.25, following a $.09 cent gain in October. Over the year, average hourly earnings have risen by 2.3 percent, falling from a 2.5% pace in October that raised hopes of rising wages in the months ahead. The average workweek for all employees on private non-farm payrolls edged down by 0.1 hour to 34.5 hours in November.

Prepare for liftoff. Unless there is some catastrophe in the next 12 days, the jobs report was strong enough to lock in a Federal Reserve rate increase at the upcoming December 16^th FOMC meeting. This was the last major economic report before the Fed policy meeting, and recent speeches from Fed Chair Janet Yellen and other policymakers leaves little doubt about their intentions.

In yesterday’s testimony to Congress’s Joint Economic Committee, Yellen stated her view that given existing demographics the United States needs to create about 100,000 jobs per month to absorb the natural growth of the labor force. Any job creation above that would be consistent with continued improvement in the labor market, either further cutting the unemployment rate or else drawing new people into the labor force out of the ranks of the discouraged; and that is exactly what we saw in this month’s jobs report – more people entered the work force.

Yellen has not quite come out and said explicitly that 100,000 new jobs is the green light for a December rate hike, but she’s dropped about as many hints as the Fed ever does about the future course of economic policy. When the Fed hikes rates on December 16^th, it will be one of the best communicated rate hikes ever.

There is no question that the labor market has shown improvement. The economy has added jobs for 69 consecutive months, gaining more than 13.7 million jobs. The unemployment rate dropped down to 5% in October and even as more people moved into the labor force in November, the unemployment rate held steady.

This is quite simply a historic time for job growth. And don’t give me the garbage about how you don’t’ believe the numbers. The statistics are imperfect, I grant, but they are the most accurate information available and there is no evidence they have been doctored – none. And this slow, steady, and strong job growth doesn’t fit into many political narratives but you should look at the numbers rather than narratives.

We are now at what the Fed would like to call full employment; that point where everybody who has some job skills and wants a job, can find a job; the point where there are just enough jobs to stimulate growth without pushing inflation above target. The problem is – we’re not there yet. Millions of working age people left the workforce in the downturn and they have not returned. The percentage of the population working was unchanged at 59.3, which is only a tenth of a percentage point higher than it was a year earlier.

The uptick in the participation rate, though small and based on historically low levels, is an encouraging indication of progress for those who had dropped out of the labor force. It suggests that labor-market slack still is greater than the 5% unemployment rate would strictly indicate.

And wages just have not been growing, which means no wage push inflation. For many people, a pay increase only comes with a second, or third job. So, we’re not yet at the point where demand pushes economic growth. The economy can probably add millions more jobs and the unemployment rate could drop to about 4% before we really see full employment.

Yesterday, Yellen said, “I think we’ve seen some welcome hints” of wage increases, but she cautioned, “it’s tentative evidence; we don’t know if it will last.”

Meanwhile the European Central Bank cut interest rates yesterday and extended their quantitative easing program. The Bank of Japan recently added more stimulus to prop up their economy. The divergence has resulted in a stronger dollar which hurts US exports, as seen in a separate report today showing the U.S. trade deficit widened in October as exports fell to a three-year low, suggesting that trade could again weigh on economic growth in the fourth quarter. The Commerce Department said the trade gap rose 3.4 percent to $43.9 billion, a sign that the worst of the drag from a stronger dollar was far from over. September’s trade deficit was revised up to $42.5 billion from the previously reported $40.8 billion.

The blowout year for mergers and acquisitions just keeps getting bigger. According to Dealogic, global M&A volume just soared to $4.3 trillion, pushing 2015 to date ahead of 2007’s total, when the previous record of $4.29 trillion of mergers was struck. U.S. targeted M&A volume hit a record high in September and currently stands above $2 trillion for the first time ever. What’s driving the deal making? Cheap debt, which might change if the Fed hikes rates.

Uber is raising more money, and the new valuation will make it larger than 80% of the S&P 500 stocks, including old, established names like Dow Chemical, BlackRock, and Netflix. Bloomberg reports the car-booking startup is looking to raise as much as $2.1 billion in a financing round that would give it a valuation of $62.5 billion. Uber has increased actual U.S. gross revenue about 200 percent this year and is profitable in more than 80 cities around the world, and the number of U.S. trips completed this year has increased 250 percent compared with the same period last year.

So, why is the Fed on a near-certain track to raise interest rates? Normally Wall Street reacts badly to the prospect of rate hikes, but today’s triple digit rally in the Dow Industrials and the NASDAQ Comp, are just an indication that a Fed rate hike has been baked into the cake and the strong jobs numbers really are an indication of a stronger economy, which should be reflected with higher valuations.

The Fed’s easy money policies have driven Wall Street for the past 7 years, and there has to be some concern that if the Fed takes the punchbowl away, the party might be over. But that might be part of the reason why the Fed is no longer willing to keep monetary policy at the emergency levels of 2008. The Fed has to be concerned that an overabundance of free money is spoiling corporate America, resulting in unicorn valuations. We know how that story ends and it is ugly. The thinking is that it is better to tap on the brakes now, even though the economy is growing slowly, rather than waiting for the economy to go much faster and slam on the brakes, only to swerve into the ditch, again.

Also, remember the exhortations of Former Fed chair Bernanke, repeated by current Fed chair Yellen, that there is only so much we should expect from monetary policy. Economic growth must be supported by fiscal policy. The House and Senate have taken a concrete step toward reviving the Export-Import Bank, by voting to renew the bank’s funding as part of a five-year highway and transportation construction measure. Obama signed the bill into law today, hours before current funding was scheduled to run out. The highway bill is a good example of fiscal policy adding to economic growth; spending on infrastructure is an investment that pays dividends in jobs and increased productivity, and taking on infrastructure projects while rates are still low just makes sense.

But today’s jobs report signals that rates won’t stay low for long. And that means higher mortgage rates, higher credit for auto loans and credit cards, and all manner of debt. And it is coming sooner rather than later.

Financial Review

While the Getting is Good

Sinclair Noe — April 9, 2015

 

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DOW + 56 = 17958
SPX + 9 = 2091
NAS + 23 = 4974
10 YR YLD + .06 = 1.96%
OIL + .37 = 50.79
GOLD – 8.70 = 1194.50
SILV – .36 = 16.25

Initial claims for unemployment benefits increased 14,000 to 281,000 in the week ending April 4^th.  Over the past 4 weeks, jobless claims have averaged 282,500 a week; the lowest level in 15 years. While companies are maintaining headcounts, job listings also have climbed. Openings rose to 5.1 million in February, the most since January 2001, according to the JOLTS report on Tuesday.

Wholesale inventories rose 0.3% in February as wholesale sales fell 0.2%, perhaps a sign that companies experienced less demand in late winter that could cause them to temporarily scale back production.

In a televised speech today, Iran’s  supreme leader, the Ayatollah Ali Khamenei said Tehran would agree to a final nuclear accord with the US and five other nations only if all sanctions over its disputed nuclear work were lifted.  In remarks apparently meant to keep hardline loyalists on side, he warned about the “devilish” intentions of the United States. Meanwhile, Iran’s oil minister, speaking today in China said that OPEC would “coordinate” to accommodate Iran’s return to oil markets without causing a price crash.

Samsung Electronics expects to ship record numbers of its new Galaxy S6 smartphone after it goes on sale tomorrow, but will have problems fulfilling demand for the curved-edged version due to difficulties in manufacturing the screens. The hope is that the launch of the flagship device will help spark a turnaround at Samsung following a slump in earnings over the past year or so.

American Airlines and US Airways received their single operating certificate from the Federal Aviation Administration on Wednesday, an important step in the integration of the two airlines. The merger between the airlines closed in December 2013, but the carrier still operated separate American and US Airways flights. Passengers will not see much change. Flights will still be operated under the American and US Airways brands until the carriers merge their reservation and passenger ticketing systems this year. Once that is done, the US Airways brand, ticket counters and website will change to American.

Walgreens will close 200 of its 8,232 US drugstores. The company will also reorganize corporate and field operations and revamp its technology, which along with the store closings will help cut an additional $500 million in costs by the end of fiscal 2017. That would extend a $1 billion cost-cutting initiative announced in August.

Yesterday we talked about the idea that the prospect of higher rates has been pushing consumers away from revolving debt, like credit cards, even as they take on more non-revolving debt, such as car loans; it might also be leading to more borrowers locking in low rates of floating rate mortgages. And mergers and acquisitions are back in a big way. Yesterday was a $100 billion dollar day for M&A.  It started with a big deal in the energy sector; Royal Dutch Shell’s $70 billion acquisition of BG Group of Britain signals that the kinds of mega-energy-mergers that reshaped the industry in the late 1990s may be due for a revival. Mylan’s $29 billion approach to Perrigo, meanwhile, underscores just how red-hot consolidation in health care continues to be. Both of the generic drug makers had done their own deals in just the last two years.

This afternoon, news that Blackstone Group and Wells Fargo are nearing a deal to buy a real estate portfolio from General Electric worth as much as $30 billion. It could be one of the largest real estate deals since Blackstone acquired Equity Office Properties Trust for $39 billion in 2007 at the height of the last property boom. Commercial values in the US have since reached records as investors from around the globe seek places to put money at a time of near-zero interest rates. Unloading the assets would further Chief Executive Officer Jeffrey Immelt’s goal of shrinking GE Capital, whose lack of access to credit during the 2008 financial crisis put the parent company at risk. GE Capital has been disposing billions of dollars in holdings, including foreign bank stakes, while Immelt works to bulk up the industrial side of GE’s business.

Bankers and hedge fund managers are licking their chops as a spree of M&A, fueled by the expectation that a multi-year run of cheap money may be coming to an end is expected to push transactions that could top record value amounts.  Deal value has already surged to $1 trillion for 2015. A projected $3.7 trillion worth of deals this year would be second only to 2007, when all M&A surpassed the $4 trillion mark. Part of that comes on growing sentiment that, whenever the Federal Reserve finally decides to increase rates, this won’t be coming until after summer; so get the deals done while the getting is good. Data housed by S&P Capital IQ says seven of the 10 biggest M&A transactions in the wake of the financial crisis have all been announced within the last 16 months. What’s more, S&P Capital data shows, the year-to-date announced deal value is, right now, as high as it has ever been, including the bellwether year 2007. That also means that deals are attracting a premium.

It does not mean that every deal will work out. Altera stock dropped after reports that talks to be bought by chipmaker Intel Corp. have fallen apart. Intel has been on the hunt for growth as it faces a slowdown in the market for PCs that forced a $1 billion cut in its first-quarter sales forecast last month. Altera shares had jumped 28 percent on March 27 after reports of the talks.

In his annual letter to shareholders, Jamie Dimon, the chief of JPMorgan Chase, warns “there will be another crisis” – and the market reaction could be even more volatile, because regulations are now tougher; but the next crisis won’t be caused by the banks because there are so many regulations in place that they would not be the likely cause of a meltdown.  He argued the crackdown on the financial sector, added to more-stringent requirements for capital and liquidity, will hamper banks’ capacity to act as a buffer against shocks in financial markets. Of course, not having enough funds set aside for an emergency didn’t work out so well in 2008. Then he goes on to say the bank is in a better position than before and is much more prepared to handle a downturn. If it all sounds a bit confused; not really; Dimon doesn’t like regulations; JPMorgan share price has not been great and Dimon blames regulations.

Remember that this was an annual letter to shareholders, which means it is basically a 39 page sales brochure. There were plenty of nice charts and graphs, and everything seemed to move from the bottom left side of the page to the upper right side of the page. There is some revisionist history when it came to the acquisitions of Bear Stearns and WaMu, see page 19 of the letter.

Dimon also blamed legal and regulatory costs for weighing on the firm’s share price, writing: “While we acknowledge that our P/E ratio is lower than many of our competitors’ ratio, one must ask why. I believe our stock price has been hurt by higher legal and regulatory costs and continues to be depressed due to future uncertainty regarding both.” The letter mentions continuing foreign-exchange settlement negotiations as an area of uncertainty. Dimon calls for some serious policy discussion about the way regulators regulate, and he thinks the legal costs will “diminish” over time; and they would probably diminish faster if he can change the regulatory policies. He didn’t provide a chart on legal costs, but if he did, the numbers for the past five years would have been about $32 billion; which is bigger than all the credit they extended to small business in 2014, and bigger than the bank’s net income last year. Dimon said he expects the firm’s legal costs to “normalize” in 2016. Deep in the footnotes you can find that the bank is still looking at nearly $6 billion in legal expenses. Which is actually about the average paid for legal expenses in the past few years, but I don’t know if that means it is normal.

The European Central Bank bolstered its emergency funding for Greece’s stricken banks, as Athens made good on its promise to pay back the International Monetary Fund, averting an unprecedented default. Having threatened to deliberately miss a €448m loan repayment to the Fund without a guarantee of fresh bail-out cash, Athens sent its latest payment this morning. Christine Lagarde, the director of the IMF confirmed the payment while speaking in Washington, saying: “Yes, I got my money back.”

The Greek government has warned its paymasters it would run out of funds to make its loan obligations and continue to pay out a €1.7bn monthly social security bill without a release of bail-out cash. A two-month stalemate in Greece’s bail-out negotiations has seen capital flee the country’s banks, which have repeatedly hit the limit on the emergency cash. The ECB’s latest move will just cover the €1.1bn that was withdrawn from banks from March 30 to April 8.

Greece is currently negotiating a short-term bailout extension that it doesn’t really want, offered by European institutions which don’t trust the Greek government and approved by other governments that are running out of patience. That’s the bottom line. Athens currently has until about April 15 to present a completed reform list to its creditors.

But even if Greece gets the bailout deal when European finance ministers meet on April 24 (which isn’t assured), we’ll be back in the same place in about two months. Then, the government isn’t going to want another extension. It’s going to want the major debt deal it promised to deliver when it won the election. A deal to reduce debt is actually a good idea, even if Germany doesn’t want it. Greece’s far-left government is correct about the country’s debt burden; it’s completely unsustainable under the current plans. Greece is about to get some relief for a few months. After that, Athens, Frankfurt and Brussels go back to the brutal negotiations.

Tuesday, August 19, 2014 - It’s Just a Matter of Time

Financial Review with Sinclair Noe

DOW + 80 = 16,919
SPX + 9 = 1981
NAS + 19 = 4527
10 YR YLD+ .02 = 2.40%
OIL (sept) = 94.48
GOLD – 2.00 = 1296.20
SILV - .18 = 19.50

The consumer price index rose a seasonally adjusted 0.1% in July. Food prices rose 0.4%, but energy costs declined 0.3%; the first drop in energy prices since March. Consumer prices have risen an unadjusted 2% over the past 12 months, down slightly from June. Prices surged in the early spring but have since tapered off. Excluding volatile food and energy prices, the core rate has risen 1.9% in the same span, unchanged from the prior month. Almost all of the increase in consumer prices can be traced back to housing costs, or shelter prices; over the past year, shelter prices are up 2.9%.

Hourly wages have risen about 10% overall since June 2009, to $24.45 an hour. But over the same span they’ve slipped 0.3% in “real” or inflation-adjusted terms. Since the Great Recession ended five years ago, the amount of money Americans earn each hour after adjusting for  inflation has actually fallen. And that largely explains why the economy is growing so slowly.

The Federal Reserve should be in no hurry to raise interest rates because there is no serious threat from inflation, at least not now.

According to the US Travel Association and GfK, a market research firm, you might not take a vacation this year. About 40% don't plan on using all of our paid time off. The share of American workers taking vacation is at historic lows. In the 1970s, about 80 percent of workers took a weeklong vacation every year. Now, that share has dropped to a little bit more than half. The declining popularity of vacation has wide-ranging effects not just on workers, but also on their employers and indeed the overall economy. Studies have found that taking fewer vacations is correlated with increased risk of heart disease; other research has shown that workers who take vacations, or even a small break during the workday, are more productive when they return. This vacation aversion is a North American phenomenon; the US is the only “advanced” economy that doesn’t require companies to give paid vacation days.

Housing starts rose to an eight-month high in July. Groundbreaking for new housing jumped 15.7% last month to a seasonally adjusted 1.09-million unit annual pace; this follows 2 straight months of declines. Groundbreaking for single-family homes, the largest part of the market, increased 8.3% in July to a seven-month high. Starts for the multi-family homes segment, such as apartments, jumped 33%.

Home Depot reported quarterly profit today. Profit rose 14% to $2.05 billion. Sales rose 5.7% to $23.8 billion. The number of transactions rose 4.2%. Home Depot said it expects same store sales to grow faster in the second half of the year, as more people take on remodeling projects. However, Home Depot maintained its full-year sales growth forecast of about 4.8%. Lowe's, the world's second-largest home improvement company, is scheduled to report results tomorrow.

Back in 2006 bust, when the housing market went bust, Phoenix was one of the first cities to get hammered with lower prices; in 2011, Phoenix was one of the first cities to snap back; prices, off by nearly 60% from peak, then rebounded sharply; home prices are up nearly 46% from the 2011 low. The number of homes in some stage of foreclosure has fallen to about 4,300 homes today from more than 50,000 four years ago.

Now, prices and sales are cooling off. Inventories of homes listed for sale have climbed to their highest level in three years while the number of houses sold in June fell 12% from a year earlier. Investors accounted for nearly 15% of homes bought in June, down from about one-quarter last year and one-third of sales in June 2012. The market is moving away from from bargain-hunting investors, who typically pay cash for distressed properties, to traditional buyers with mortgages. The Phoenix market is slowly moving back to normal, but there is still a long way to go.

Employment in Phoenix, after expanding at an average annual pace of 2.6% and 2.8% in each of the last two years, is up just 1.5% so far this year. When people don’t have a job or are not secure in their jobs, they don’t buy houses. The sluggish local economy is compounded by consumers still too battered from the bust to think about getting a loan. Some don't have sufficient equity to turn a house sale into an adequate down payment on their next purchase. Others suffered credit blemishes or income hits that make banks reluctant to lend.

Reuters reports Phoenix based PetSmart is exploring a potential sale of the company. Jana Partners, which has reported a 9.8% stake in PetSmart, has been calling on the company to pursue a sale after what it calls years of financial underperformance. There is no guarantee the review will lead to a deal and PetSmart could still determine that it would be better off on its own.

Today marks the ten year anniversary of Google. The company went public August 19, 2004 at a price of $85 a share; and it’s gone up 1,304% since then. A few stocks have done better over that time, but only a few, and of those, only Apple was in the S&P 500 10 years ago when Google went public. Today, Google’s revenue tops $65 billion, more than all but 40 US companies. Net profit margins exceed 20%, higher than all but three. Ten years ago, Google had a forward PE of 52; today, the forward PE is 20. So as share prices have constantly moved higher, valuation has constantly moved lower; which is a neat trick.

Over the past 10 years, or you could say over the past 25 years, a great deal of wealth has flowed to the tech giants of Silicon Valley; which means that the wealth has flowed away from Wall Street. And the techies have finally figured out they don’t need Wall Street bankers to make a deal. According to data from Dealogic, approximately 70% of the tech deals completed in early August have been sealed without a Wall Street bank consultant helping the buyer identify the transaction. And over the past two years, the trend has been growing, with more than half the tech deals in 2012 occurring without a banker working on behalf of the buyer. This M&A consulting shift highlights a subtle but growing divide between fee-eager bankers and the tech giants of today.

Maybe the problem is that the banks just have a hard time remembering who their clients are. Case in point: you may remember the story of Standard Chartered, the British bank, which back in 2012 paid about $667 million to settle charges that it had engaged in money laundering by making transfers for clients in Iran and other countries that were covered by American sanctions. They had to add compliance monitors. A few months later the bank’s chairman denied any wrongdoing, which was a direct violation of the settlement; and he was forced to quickly recant. Today, it seems that all of those new legal staffers and crime-fighting committees also didn’t get the memo about what they are meant to be doing. New York’s financial regulator slapped another $300 million fine on Standard Chartered for “failures to remediate anti-money laundering compliance problems as required” in its previous settlement.

Part of the bank’s 2012 agreement included hosting an independent monitor permanently installed by regulators on-site to vet anti-money laundering procedures. This monitor was back-testing the bank’s processes and found them lacking, particularly when it came to flagging suspicious dollar transfers from its Hong Kong and United Arab Emirates affiliates.

In a statement, Standard Chartered said that it “has already begun extensive remediation efforts and is committed to completing these with utmost urgency.” And this time they really, really mean it; not like last time. So, this raises the question of how many times a bank can break the law, and get away with a slap on the wrist. What does a bank have to do before they forfeit their charter?

The New York State regulator, Benjamin Lawsky, said: “If a bank fails to live up to its commitments, there should be consequences. That is particularly true in an area as serious as anti-money-laundering compliance, which is vital to helping prevent terrorism and vile human rights abuses.”

So, the penalty is nearly $1 billion in fines over the past couple of years, but actually works out to about 12% of bank profits over the same time.

You might also remember last month when Attorney General Eric Holder announced the $7 billion settlement with Citigroup for its role in packaging troubled mortgages into securities and selling them as investments in the years before the crisis, even though a bunch of Citigroup bankers knew better and did it anyway. And last November, there was a settlement with JPMorgan. And there is a chance that later this week we will see a settlement announced with Bank of America.

It all falls in line with the “too big to fail” idea known as the Holder Doctrine, which stems from a 1999 memo, when then Deputy AG Holder included the thought that big financial settlements may be preferable to criminal convictions because a criminal conviction often carries severe unintended consequences, like loss of jobs and the inability to continue as a going concern. Holder was thinking of the collapse of Arthur Anderson after the collapse of Enron. So, now Holder holds to the idea of settlement over prosecutions.  Instead of the truth, we get from the Justice Department a heavily negotiated and sanitized “statement of facts” about what supposedly went wrong.

The problem is, of course, that these settlements allow for the Wall Street bankers to get away with their bad behavior without being held the slightest bit accountable. And with no real deterrent, as Standard Chartered has just confirmed, it’s just a matter of time until they do it all over again.

Thursday, August 14, 2014 - The Circular Capex Spending Problem

Financial Review with Sinclair Noe

DOW + 61 = 16,713
SPX + 8 = 1955
NAS + 18 = 4453
10 YR YLD - .01 = 2.40%
OIL - .39 = 97.20
GOLD + .70 = 1313.90
SILV + .05 = 19.95

Iraqi Prime Minister Nouri al-Maliki stepped down today, a surprising reversal for a prime minister who a day earlier had assured his supporters that he wouldn’t step down unless forced out by Iraq’s high court.

President Obama says the US operations have broken the ISIS siege of Mount Sinjar. Thousands of Yazidi refugees were stranded on the mountain. Many of those displaced had now left the mountain and further rescue operations are not planned, however US airstrikes against ISIS will continue for now. And Iraqi and Kurdish forces fighting ISIS will continue to receive US military assistance.

Russian President Vladimir Putin said Russia would stand up for itself but not at the cost of confrontation with the outside world, which sounded like a softer, gentler Putin. Trust him about as far as you can throw him. Intense fighting continues as the Ukrainian military kept up its offensive to retake separatist strongholds in Eastern Ukraine.

A new, five-day truce between Israel and Hamas appeared to be holding despite a shaky start, after both sides agreed to give Egyptian-brokered peace negotiations more time. The second extension of the ceasefire, this time for five days rather than three, has raised hopes that a longer-term resolution to the conflict can be found; maybe.

The Missouri State Highway Patrol will take over the supervision of security in the St. Louis suburb that's been the scene of violent protests since a police officer fatally shot an unarmed black teenager.

Earnings season continued to wind down. WalMart reported earnings and revenue that met expectations, but the company cut its forecast for coming quarters. Last night, Cisco Systems offered a weak outlook for its current quarter and announced massive job cuts despite reporting revenue that beat expectations.

We’ve all heard of jobs offshoring; US jobs that once built the world’s biggest middle class, have been sent overseas, and it’s been going on for quite some time. The idea was heralded as free trade globalism and the argument was that it was merely mutually beneficial free trade; but American jobs have been lost and continue to be lost, not to competition from foreign companies, but to multinational corporations that are cutting costs by shifting operations to low-wage countries.

One result of offshoring is lower labor costs, but that also means lower wages. University graduates in the US are just as likely to be employed as bartenders or baristas as they are to get a job as a software engineer of plant manager. And there’s a good chance that recent grads are still living at home with their parents. More than half with student loans are having a hard time paying down student loan debt; 18% are either in collection or delinquent; another 34% have student loans in deferment or forbearance. And if they do find jobs, they find those jobs don’t pay well. Wages have stagnated.

Even though the economy has been adding jobs, it has not been enough to push a recovery in wages. In July, average hourly wages rose a penny to $24.45, a disappointing result after strong gains in June and May. In 23 of the past 24 months, the yearly increase in hourly pay has ranged from 1.9% to 2.2%, or about one-third less than usual during an economic recovery. The 12-month increase in wages as of July was just 2%; and inflation wiped out about three-fourths of that gain. There’s been no change since the start of 2014. While it might seem counterintuitive that wages are flat while jobs are being added, the likely reason is that there are a lot of poor paying jobs plus a few very good paying jobs. According to revised data from the Commerce Department, employee compensation, including wages and benefits, was lower for each year from 2011 to 2013 than previously calculated.

Jobs off-shoring, by lowering labor costs and increasing corporate profits, has enriched corporate executives and large shareholders, but the loss of millions of well-paying jobs has made millions of Americans downwardly mobile. Between October 2008 and July 2014 the working age population grew by 13.4 million persons, but the US labor force grew by only 1.1 million. In other words, the unemployment rate among the increase in the working age population during the past six years is 91%. Since the year 2000, the lack of jobs has caused the labor force participation rate to fall, and since quantitative easing began in 2008, the decline in the labor force participation rate has accelerated. Clearly there is no economic recovery when participation in the labor force collapses. In addition, jobs off-shoring has destroyed the growth in consumer demand on which the US economy depends with the result that the economy cannot create enough jobs to keep up with the growth of the labor force.

Some people argue that the problem with economic growth doesn’t start with wages and jobs, but rather with credit, and they point to graphs of the recent rise in auto loans; just as mortgages once fueled a housing boom, now, subprime lending is fueling a boom in auto sales. Credit tightened in the wake of the housing collapse and the housing market remains weak, while auto lenders have become aggressively permissive and US auto sales have made a huge recovery, leading some to argue that consumption depends on access to credit. This is wrong. Access to credit is the lubricant for the engine of economic commerce; it is not the engine. The real driver of the economy is good paying jobs.

There have been magnificent innovations in transportation, medicine, communication, and technology as commerce has spread globally. Credit did not create technological advances, people did. Money and credit could always be used to purchase the tools to make money in business, but money could never produce anything by itself; food, clothing, shelter, cars, and thousands of other worthwhile things were always made by the labor of people, not the sweat and intelligence of a coin or a plastic credit card.

The Federal Reserve just released a report showing that two-thirds of American households have no savings set aside for an emergency, and 40% are unable to raise $400 cash without selling possessions or borrowing from family and friends. Offshoring, by lowering labor costs and increasing corporate profits, has enriched corporate executives and large shareholders, but the loss of millions of well-paying jobs has made millions of Americans downwardly mobile. In addition, jobs off-shoring has destroyed the growth in consumer demand on which the US economy depends for expansion. Corporations are borrowing money not to invest for the future but to buy back their own stocks, thus pushing up share prices.

A new report from Morgan Stanley shows the average age of industrial equipment in the US is now almost 10.5 year old. That’s the oldest since 1938, at the height of the Great Depression. Nonresidential capital expenditure; in other words, spending on equipment, nonresidential buildings like factories, and intellectual property, has fallen short of the long-term trend by 15% per year. That means businesses have pumped into the economy $400 billion less than they normally would have every year. That's $1.6 trillion over the past four years, and it's affecting every sector. Spending has been down 14% on buildings, 16% on equipment, and 6% on intellectual property.

Instead of investing that money, corporations have been hoarding cash; by some estimates, corporations are sitting on a pile of almost $2 trillion. Occasionally they dip in for share buybacks. S&P 500 companies bought back an estimated $160 billion in stock in the first quarter; that would lag only the $172 billion in the third quarter of 2007, shortly before the worst bear market since the Great Depression. Repurchases are all the rage, but are all too often made for an unstated and ignoble reason: to pump or support the stock price. Another corporate incentive for buybacks is that a pumped-up share prices make the stock grants and options held by senior executives more valuable. Occasionally they dip into the cash pile for mergers and acquisitions. North American M&A activity stands at $1.2 trillion year to date, up 83% from last year. This year is almost certain to be the best year for M&A since the crisis. Boosting growth and returns through long-term investment in their business hasn't registered nearly as highly.

The problem then becomes circular: weak demand holds back capital expenditures, which drags on growth, which depresses demand. Productivity growth in the United States, the rate of growth in the level of output per worker, is near a 30 year low. Spending on research, development and technology, would surely improve this trend. Productivity alone does not spur capex spending. Rather, spending increases when demand increases. You don’t buy a new factory or new equipment unless your customers are spending. However if your customers are spending, you will happily invest in the facilities to fill their orders. But real median household income fell 10% between 2007 and 2012. And since the financial crisis, demand across the US economy as a whole has been far below trend.

Several of America’s great cities, such as Detroit, Cleveland, St. Louis have lost between one-fifth and one-half of their populations. Real median family income has been declining for years, an indication that the ladders of upward mobility that made America the “opportunity society” have been dismantled. So, now we face a tipping point, where we either start to reinvest in industrial production or watch the infrastructure turn to rust, and the US becomes a third world country.

The good news is that we are making progress in some areas. We add jobs every month, more than 200,000 jobs per month for the past six months. Capacity utilization is now up to 79%. US exports now top $2 trillion, the highest level in history. Despite the numerous false dawns since the Great Recession, analysts still expect capex to pick up. If it does, then the broader economy should benefit. Factories and equipment will have to be replaced, eventually. It might represent an opportunity; if we’re lucky.