Financial Review

A Perfect Gift

Sinclair Noe — June 3, 2015

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DOW + 64 = 18,076
SPX + 4 = 2114
NAS + 22 = 5099
10 YR YLD + .10 = 2.37%
OIL – 1.68 = 59.58
GOLD – 7.70 = 1186.00
SILV – .27 = 16.58

The U.S. trade deficit narrowed in April on a drop in imports. The Commerce Department said the trade gap narrowed to $40 billion from March’s revised deficit of $50 billion. The 26 percent drop in the April trade deficit was the largest decrease since early 2009 and reflects a surge in imports in March following the end of a West Coast ports labor dispute.

Service industries expanded in May at the slowest pace in 13 months. The Institute for Supply Management’s non-manufacturing index, which includes an array of industries from real estate to dining, declined to 55.7 from April’s 57.8. Readings above 50 signal expansion. Limited growth in orders reflects an American consumer who has been saving the extra cash from low gasoline prices and rising employment rather than spending it. Arts and entertainment, real-estate firms and rental companies led the list of the 15 non-manufacturing industries that reported growth in May. Mining, which includes oil extraction, contracted. An index of employment in service industries dropped to 55.3 in May from 56.7.

Payrolls processor ADP reports private employers added 201,000 jobs in May, the most since January. The ADP data came ahead of the U.S. Labor Department’s more comprehensive non-farm payrolls report on Friday, which includes both public and private-sector employment. It is estimated that the Friday Jobs Report will show 225,000 new jobs in May and the unemployment rate steady at 5.4%.

Meanwhile, the Labor Department has released details on the April jobs report. Payrolls grew in 50 U.S. metro areas with a population of 1 million or more in April compared with a year earlier. The biggest increase occurred in Silicon Valley’s San Jose metro area, where payrolls grew 6%. That was followed by the areas surrounding Orlando, Fla., where payrolls grew 4.3%, and Riverside, Calif., which saw 4.1% payroll growth. Employment in New Orleans was the only metro area without an increase; holding steady in April from a year ago. Austin, Texas had the lowest unemployment rate in April, at 3%, followed by Salt Lake City, Utah, at 3.1%. The Las Vegas area had the highest jobless rate at 7.1%. Metro Phoenix came in at 4.9%.

Two weeks before a FOMC policy meeting, the Fed publishes the Beige Book, an anecdotal assessment of the economy, named for its unassuming beige binding and page turning eloquence. Reports from the Federal Reserve’s 12 major regional district banks show a “generally optimistic” outlook for U.S. economic growth, which is “expected to continue at a modest to moderate pace in several districts.”

“Modest growth” was seen since the April 15 Beige Book publication in four Fed districts, while “moderate growth” was seen in three others. Dallas was the only district to report that its economic pace “slowed slightly.” Richmond and New York were the only districts in which consumer spending hadn’t picked up since April 15. And auto sales picked up everywhere except in New York and Cleveland. The Fed highlighted the effect of low gas prices in some of its districts, saying they had provided “a tailwind for consumer spending”; however that assessment has not yet been backed up by hard data. Employment levels were up slightly, with some districts reporting labor shortages.

The European Central Bank left interest rates unchanged at record lows. ECB president Mario Draghi said monetary policy stimulus is filtering through to the economy as planned, and he insisted the European Central Bank needs to see its bond buying through to the finish. Since the ECB started its $1.2 trillion quantitative easing program three months ago, inflation in the 19-nation euro area may have bottomed out. The inflation rate in the Eurozone was positive for the first time in six months in May, rising to 0.3 percent from zero. Draghi said:  “The recovery is on track exactly according to our projections.”

The fly in the European soup bowl could be Greece. The Greeks presented their proposal for a bailout; creditors presented a take-it-or-leave-it ultimatum in reponse; Greece threatened to miss a loan repayment to the IMF due on Friday if they can’t get a proposal they can live with. German Chancellor Angela Merkel stepped in to unblock the stalemate. Greek Prime Minister Alexis Tsipras is meeting today with European Commission President Jean-Claude Juncker.

OPEC is set to carry on pumping oil nearly flat-out for at least the next several months. OPEC is scheduled to meet Friday to determine production quotas and with oil prices having stabilized at around $65 a barrel there’s little appetite within OPEC to modify production limits or address Iran’s request to give it more room in the market as sanctions ease. OPEC officials will be meeting with executives from several major oil companies. Today, BP CEO Bob Dudley said he believes global oil supplies will continue to grow, putting downward pressure on prices.

And in an interesting twist, the leaders of six of Europe’s largest oil producers are calling for a plan to price greenhouse gas emissions, citing climate change as “a critical challenge for our world.” In a letter to the executive secretary of the United Nations Framework Convention on Climate Change and the president of the upcoming 2015 Paris Climate Conference, the CEOs of BP, Royal Dutch Shell, Statoil, Total, Eni, and BG Group focus on creating a framework for carbon pricing in countries that currently lack one, and then connecting that framework internationally.

The OECD, which has a history of cutting its growth outlooks, has done it again, reducing its global forecast due to lagging investment and risks, including a possible Greek default. Chief Economist Catherine Mann said that despite “monetary accommodation, less fiscal drag and a reduction in oil prices,” we’re not getting growth that is “matching the average of the past two decades.”  The OECD now expects the world economy to expand 3.1% in 2015, down from 3.7% predicted in October. Last year, the world economy grew 3.3%.

Several of FIFA’s big corporate sponsors including Coca-Cola, Visa, and Adidas said they welcomed the resignation of the soccer governing body’s president, Sepp Blatter, amid a wide-ranging corruption scandal, and urged the organization to enact swift reforms to restore its credibility. Of all the individuals and firms tied up in the scandal over bribery and corruption at FIFA, so far scrutiny has largely escaped KPMG. KPMG was the auditor for FIFA for the entire time under investigation, and it served as advisor for the Russia and Qatar official organizing committees when they prepared the winning bids that are now the target of corruption investigations in the U.S. and Switzerland.

Looking to expand its user base and rev up its revenue engine, Pinterest is planning to launch “buyable pins,” enabling users to buy items they see directly via Pinterest. Although Pinterest won’t take a cut of each transaction, merchants will have the option to pay for “promoted pins” – giving the company an important revenue source following its $11 billion valuation. Instagram has also announced a similar feature, permitting advertisers to add a button to encourage viewers to click through to their website.

The internet is the future of course, but online advertising has always been a fraction of the huge budgets spent on TV ads. That’s expected to change by 2019. PriceWaterhouseCoopers estimates that online advertising, which in 2014 brought in $49.45 billion in revenue in the US, will climb to $83.89 billion by 2019. That year will prove to be a major tipping point in advertising, with online ads overtaking television for the first time. Over this same period, TV advertising in the US will grow from $69.2 billion to $81.05 billion.

Wendy’s unveiled a new $1.4 billion share buyback, announced the closing of the sale of its bakery operations, reiterated guidance for 2015 and provided a longer-term outlook.

Avian flu has been the bane of American poultry farmers for months. Three deadly strains have forced them to kill off entire flocks of chickens, turkeys, and other birds to stop infection spreading, and to shut down facilities for costly disinfection procedures. Now consumers are going to start feeling the effects too. The price of wholesale consumer-grade eggs in the US reached an all-time high of $2.62 per dozen yesterday.

The nation’s population of egg-laying hens has been decimated. More than 30 million hens have been killed in Iowa alone, and it will be more than a year before egg production returns to normal across the country. On June 1, the fast-food chain Whataburger announced it will be limiting the hours that customers can order breakfast at its 800 restaurants in 14 states. Instead of serving breakfast taquitos and biscuit sandwiches with scrambled eggs 12 hours a day, Whataburger will offer them for four hours on weekday mornings and six hours on weekend mornings.

Takata will “rapidly” reduce its use of ammonium nitrate as an air bag propellant after it appeared “to be one of the factors” contributing to inflator ruptures; that was part of the testimony of Takata executive Kevin Kennedy before  a congressional subcommittee yesterday. However, Representative Michael Burgess, the Texas Republican who chaired the hearing, said he “couldn’t believe” what he was being told. “They are still making an air bag with ammonium nitrate as a propellant without a desiccant and they’re putting that in replacement and new vehicles.” Burgess said, “It almost seems like there should be a warning label stamped on the car.”

Hedge-fund manager John Paulson is donating $400 million to Harvard University, the biggest gift in the school’s history. Harvard’s School of Financial Engineering and Applied Sciences will be renamed after Paulson. Paulson rose to fame and fortune in 2007 by using credit default swaps to bet against the subprime mortgage lending market, essentially a bet that mortgages would fail. That gamble paid off big. And while $400 million sounds like a large amount; it won’t make a big difference, not like donating the money where there is actual need. Harvard already has a $36.4 billion endowment, so really it was a perfect choice… for someone like Paulson.

FINANCIAL REVIEW

Greek Drama

Sinclair Noe — January 6, 2015

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

DOW – 130 = 17,371
SPX – 17 = 2002
NAS – 59 = 4592
10 YR YLD – .08 = 1.96%
OIL – 2.23 = 47.81
GOLD + 14.20 = 1220.30
SILV + .36 = 16.65

The 114th Congress convened today for the first time. Mitch McConnell was selected as Senate Majority Leader. John Boehner was elected to a third term as Speaker of the House. The good news is that it won’t take much effort to outperform the 113th Congress; that bar was set pretty low.

Let’s quickly cover the economic data. Commerce Department report factory orders dropped 0.7% in November. Orders for durable goods fell 0.9%, while orders for non-durable goods fell 0.5%. The setback was paced by declining demand for business equipment such as electronics and industrial machinery.

The Institute for Supply Management said its nonmanufacturing index fell to 56.2% from 59.3% in November. Yet readings over 50% signal that more businesses are expanding instead of contracting and the index is coming off a nine-year high, so some cool down might be inevitable. Retailers, hotels and restaurants topped the list of the 12 non-manufacturing industries that reported growth in December, another sign that gains in employment and cheaper gasoline are giving American households a boost. Cheaper fuel helped drive down the index of prices paid at service providers to 49.5, the first time since September 2009 that more companies reported costs were falling than rising.

Cheaper fuel doesn’t really describe what is happening with oil prices; it’s more like a collapse, or a meltdown, at least for the past few days. Yesterday WTI crude dropped about 5%, and today almost 5%.

Today, Saudi King Abdullah said his country would deal with lower prices with a “firm will”, meaning they have no plans to cut production to prop up prices. Other oil producing countries such as Russia, Venezuela, and Libya can’t afford to unilaterally cut production; same deal for frackers and oil shale players in the US.

Lower fuel prices are deflationary, as confirmed today by the prices paid index, and that was reflected in the bond market, as the 10-year treasury yield dropped below 2% for the first time since May of 2013. Lower bond yields translate into higher bond prices and carry some benefits for the economy. Lower bond yields mean lower mortgage rates, a boon for homeowners looking to refinance their home loans at lower rates, and lower rates on other loans to consumers and businesses. Lower yields are not so great for banks, which face a tighter margin on their loans, and today the shares of major bank stocks moved lower. Also, lower rates are a challenge for savers and people on fixed incomes.

And don’t forget, the lower yields are set against a backdrop of the Federal Reserve’s continued warnings that they plan to start tightening monetary policy to force rates higher. Maybe the Fed will move forward with tightening because lower oil prices are acting as a $1.6 trillion quantitative easing program for the world economy. But the bond market is also telling us the global economy is weak.

And it’s not just the US; the yield on the German 10-year government bonds fell to a record low of 0.44% while Japan hit a new nadir of 0.28% and the UK reached 1.58%. Now, you might be wondering why Germany pays about 150 basis points less on their 10-year bonds than US 10-year bonds. Are US treasuries riskier than German bunds? No. US Treasury bonds are about as safe as you can get. The United States is not at risk of default, and in the doom and gloom scenario where the US might default on its debt you wouldn’t find German or Japanese or French debt to be a safe harbor. German bonds are denominated in euros, while US bonds are denominated in dollars. So, higher US rates don’t reflect fear of default; they reflect the expectation that the dollar will fall against the euro over the decade ahead. And the reasoning behind that is because right now the Eurozone is dealing with very low inflation, right on the edge of deflation; while the US is dealing with inflation at almost 2%. If you look at the expected inflation implied by yields on inflation-protected bonds relative to ordinary bonds, they seem to imply roughly 1.8% inflation in the US over the next decade versus half that in the euro area, which means that the inflation differential explains about 60% of the interest rate differential.

Also, right now the US economy is strong; certainly stronger than the Eurozone, but the bond market is forward looking, and the expectation is that over the long term, say 10 years, the 2 major economies will revert to a more normal, more level playing field, which means the dollar would fall and the euro would rise relative to each other. Or another way of looking at it; the US economy is sprinting and will eventually need to pause and catch its breath, while the Eurozone will eventually manage to dig itself out of the hole it is in.

Of course that notion is based on the idea that the Eurozone will not splinter on the periphery and that they will actually stop digging a deeper hole. This has been the topic of heated debate ahead of the January 25 elections in Greece. Euro Union officials have been meeting in Brussels and they say Greece will stay in the Union; the matter is settled. Still, the democratic process in Greece is a threat for Germany and its allies. We’ve seen this before. In 2011, Greece announced a referendum to determine if the Greek people wished to adopt the Euro Union imposed austerity program. The Greek Prime Minister Papandreou was forced from office and replaced by a Euro Union selected bureaucrat, a former vice president of the European Central Bank. Democracy failed and the Euro bankers and German austerity prevailed.

How did that work out? Well, 3 years later more than one million Greeks have lost their jobs; unemployment is at 25%; youth unemployment is over 50%; one-third of businesses have failed; the economy has contracted by about 25%; pensions have been cut in half; the health care system has collapsed and infant mortality has shot up by more than 40%; the Greek economy is caught in deflation; and austerity has managed to increase public debt from 130% of GDP to 175% of GDP. The election later this month is not so much about the Greeks wanting to leave the Euro Union, as it is about the Greeks wanting to put an end to austerity programs that have not worked.

Austerity has been tried elsewhere. Two years ago France was labeled the problem child of the Eurozone. The Austrians were certain that France would explode in hyperinflation unless they were forced to tighten their belts and cut their debt. Some pundits called France worse than Greece. The big difference is that France was much bigger than Greece and they refused to take their marching orders from the Troika or the Germans; and the result is that today the French economy has better economic growth than Britain since 2007, and the French government can borrow with an interest rate of 0.8%, just a smidge more than Germany, and less than the US. France still has economic weakness, but it did not implode and the Eurozone did not disintegrate.

Der Spiegel reports that Angela Merkel thinks Greece can be ejected safely from the euro, if the anti-austerity Syriza party wins the elections on January 25 and carries out its pledge to tear up Greece’s hated “memorandum” with the EU-IMF “Troika”. It was revealed last week that Germany offered Greece a “friendly” return to the drachma in 2011. The leaked minutes of an IMF board meeting in May 2010 admitted that what took place was not a “rescue”: Greece should have been given debt relief, but was instead sacrificed to save the euro – and the banks. It is the failure of Brussels and Berlin to acknowledge this that makes Greeks so bitter, and this crisis so politically explosive. This time, Berlin seems almost eager to finish the job and push Greece out of the Union. Syriza says it doesn’t want to exit the EU, but it will exit the bailout and demand a 50% cut in outstanding debt.

Meanwhile, European Central Bank President Mario Draghi has been saying that he wants to stimulate the Eurozone with a trillion-euro of quantitative easing to head off deflationary forces that threaten to bog down the Eurozone. And if Draghi’s stimulus plan is big enough to make any difference it would involve the purchase of sovereign debt. The next ECB meeting is scheduled for January 22. The Greek snap election is scheduled for January 25. The question is whether Draghi will agree to buy Greek bonds 3 days before the possible election of an anti-austerity, anti-bailout party that has vowed to not pay that same debt. Any bond buying announcement could be seen as interfering in the election. And Draghi can’t just announce a huge bond buying program that excludes Greece’s bonds from the purchases; not unless he wants to throw the democratic process under the bus; and it would likely lead to the very Greek bond sell-off that the ECB wishes to avoid.

And the battle is not just Greece versus Germany. Italy’s debt ratio has spiked from 116 per cent of GDP to 133 per cent, despite austerity and meeting EU deficit rules. The Bank of Italy warns that any further drift towards deflation could have “extremely grave consequences”. Italy, Spain, Portugal, and even France could side with the Greeks. The southern European nations have gone through crisis only to see their debt burden increase while GDP has been flat or even contracting; the more they cut spending to balance the books, the more the economy contracts.

Draghi might just delay any decision, but meanwhile the Eurozone is tipping into outright deflation, and delays would be seen as a sign of weakness, and exacerbating that problem you have low energy prices, which have a deflationary impact. In the past few weeks, the ECB has been trying to downplay the deflation problem.

So, even if Greece votes against austerity, there is hope that cooler heads will prevail and the Union will remain intact, and over time the Eurozone will dig out of its current hole. That is the likely plot, but there will be a big Greek drama played out over the next 3 weeks and nobody is quite certain how the story ends.

FINANCIAL REVIEW

Taking on Water

Sinclair Noe — November 6, 2014

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

Financial Review
DOW + 69 = 17,554
SPX + 7 = 2031
NAS + 17 = 4638
10 YR YLD + .03 = 2.38%
OIL – .70 = 77.98
GOLD + 1.30 = 1142.30
SILV + .11 = 15.53

Record highs for the Dow Industrial Average and the S&P 500 index. Milk and cookies time.

Outplacement consultant Challenger, Gray & Christmas says layoffs increased by 51,000 last month. Layoffs are down 4% from a year ago, and the increase in October follows a 14 year low in September. Meanwhile, the Labor Department reports the number of Americans applying for new jobless benefits fell by 10,000 last week, to 278,000; the eighth straight week under 300,000. This is all part of the setup for tomorrow morning’s monthly jobs report.

The big news today comes from the European Central Bank; ECB president Mario Draghi announced the central bank will increase its balance sheet by €1 trillion, or about $1.2 trillion, over the next 2 years. Interest rates are already at record lows, and Draghi has said they can go no lower. The ECB has issued long-term loans to banks and started buying covered bonds in the hope of flooding the economy with enough liquidity to ease credit constraints. Purchases of asset-backed securities are due to start this month.

Exactly what the ECB will purchase remains uncertain, but they are likely to move into the €1.4 trillion market for investment grade non-financial corporate bonds next month. Corporate bonds still won’t be enough and the ECB will have start buying government debt early next year.

There was a minor brouhaha about Draghi’s announcement; Reuters reported that some ECB policymakers were upset that Draghi was being overly aggressive with monetary policy. Draghi squashed that when he gave the statement, he said the asset purchases had “been approved and underwritten unanimously.”

Meanwhile the Bank of England also met today, and said it would keep its benchmark interest rate at 0.5%, where it has been since March 2009. The bank also left unchanged a stimulus program of holding 375 billion pounds, or about $600 billion.

Meanwhile, an ignominious revelation as Irish newspapers printed a letter from former ECB president Jean-Claude Trichet to former Irish finance Minister Brian Lenihan back in November 2010 where the ECB explicitly threatened to cut off emergency funding from the Irish banking system, unless Ireland immediately applied for a bailout and agreed to a program of austerity and bank recapitalization.

So, it appears the ECB really did take notes from the Federal Reserve.

Let me take you back to 2008 to refresh your memory. The major financial institutions were looking into the furnace of a global financial meltdown; the Bush administration had cobbled together a 3 page plan to bail out the banksters; most politician, both Republicans and Democrats weren’t buying in. Then-senator Obama told reluctant Democrats that as president, he would pursue major foreclosure relief efforts, but it was important to keep the banks out of the furnace. With candidate Obama on board, the bailout passed with minimal Republican support. And then after the election of 2008, the new administration decided that changing bankruptcy laws would be too difficult. Obama and Geithner let the banksters run the administration’s mortgage modification program; truly putting the foxes in charge of the hen house; and as we all know now, the mortgage mod plan was an epic failure.

On Tuesday, voters voted with their middle finger. Republicans say the 2014 midterms were a referendum on Obama’s failed policies, and they are right; but these were also failed policies of the GOP. Following the financial crisis of 2008 the politicians saved Wall Street and spit on Main Street. As the voters left the polls they were surveyed; two-thirds said the US economic system “favors the wealthy”; about 80% said they were worried about the direction of the economy; about half said things will be worse for the next generation. The economy, as in every election, remained the top issue on voters’ minds.

There has been economic recovery from the near meltdown in 2008, but it has been uneven and insufficient for most people; a few drops of tepid water on a hot summer day in Phoenix; enough to keep you alive but not enough to quench your thirst; meanwhile, a cool waterfall for the lucky few who have it made in the shade. Both Republicans and Democrats share blame for the economic shortcomings, but the buck stops in the Oval Office; rightly so. Voters may or may not be aware of all the details, but they know the game is rigged.

Everything is rigged. The Libor is rigged. The foreign exchange markets are rigged. The metals markets are rigged. The stock market is rigged. The tax system is rigged. The justice system is rigged. And of course, Washington DC is rigged.

If you steal a soda from the corner grocer, you would probably go to jail, and rightly so; but a bankster can steal billions, forge signatures on documents (remember robo-signing), perjure, money launder, inside trade, cheat on taxes, lie on official documents and the worst that happens is a slap on the fine that is ultimately paid by shareholders and consumers, and the whole thing is tax deductible. And the regulator and prosecutor then shuffle through the revolving door to get paid off by corporate America.

There has been some economic recovery but the economy is still headed in the wrong direction. Consider that in 2005, for every $1 of financial wealth there was 66 cents of non-financial wealth, things like homes and family businesses. Ten years later, for every $1 of financial wealth there was just 43 cents of non-financial wealth. What happens to all this financial wealth? Over 90% of the assets owned by millionaires are held in low-risk investments (bonds and cash), the stock market, and real estate. Business startup costs made up less than 1% of the investments of high net worth individuals in North America in 2011. Small business is the backbone of America, the economic engine for new jobs, but that engine has run out of fuel.

On the corporate side, stock buybacks are employed to enrich executives and hedge fund activists rather than to invest in new technologies. In 1981, major corporations were spending less than 3 percent of their combined net income on buybacks, but in recent years they’ve been spending up to 95 percent of their profits on buybacks and dividends. Now you might say that corporations are just sitting on a hoard of cash anyway, so why not employ that cash somewhere; but what it really says is that we have run out of productive ideas and good old Yankee ingenuity is dead. I don’t believe that, I just think we need the right soil to grow small businesses again.

The Upper Middle Class of America Owns a Smaller Percentage of Wealth Than the Corresponding Groups in All Major Nations Except Russia and Indonesia. The upper middle class in the US, defined as everyone in the top half below the richest 20%, owns 11.9 percent of the wealth – that’s 11.9% for the upper middle class in the US. Indonesia at 10.5 percent and Russia at 7.5 percent are worse off, but in all other nations the corresponding upper middle classes own 12 to 27 percent of the wealth. The American Dream is dead.

America’s bottom half compares even less favorably to the world: dead last, with just 1.3 percent of national wealth. Only Russia comes close to that dismal share, at 1.9 percent. The bottom half in all other nations own 2.6 to 10.2 percent of the wealth; just 1.3% in America. A rising tide lifts all boats. And we keep hearing that the tide is coming in, but only a few yachts are rising, and the other boats are taking on water. Don’t get me wrong, I’m not talking about a handout. I’m talking about a hand up, in an economy that’s not rigged against you. It’s the idea of equality of opportunity, make of it what you will.