Financial Review

Slipping from Highs

Sinclair Noe — May 30, 2017

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DOW – 50 = 21,029
SPX – 2 = 2412
NAS – 7 = 6203
RUT – 11 = 1371
10 Y – .03 = 2.22%
OIL – .04 = 49.62
GOLD – 4.00 = 1263.80
BITCOIN + .89% = 2261.89
ETHEREUM + 18.73% = 232.85

Stocks inched lower, with the S&P 500 retreating slightly from a record, as weakness in the energy and financial sectors outweighed gains in technology shares.

Aided by rising incomes and tax refunds, Americans boosted spending in April at the fastest clip since the end of 2016 and monthly inflation rebounded but remained fairly low due to lower oil prices. Personal income rose 0.4 percent in April, in line with expectations, and consumer spending increased by 0.4 percent.

Americans spent far less in the first three months of 2017, inducing the economy to slow to a paltry 1.2% rate of growth. Although spending in March was revised up to show a 0.3% increase instead of no change, outlays barely rose in the first two months of the year.

The personal consumption expenditures price index, the Federal Reserve’s preferred measure of inflation, rose 0.2 percent. The rate of inflation over the past 12 months slowed to 1.7% in April from a multiyear high of 2.1% in February. The core rate of inflation dipped to a 1.5% pace from 1.6% in March.

The average credit score nationwide hit 700 in April – the highest level since 2005 – according to Fair Isaac, the creator of FICO credit scores. Meanwhile, the share of consumers deemed to be riskiest, with a score below 600, hit a new low of roughly 40M, or 20% of U.S. adults who have FICO scores.

Meanwhile, U.S. home prices rose 5.8 percent in March, according to the S&P/Case-Shiller U.S. National Home Price Index. The gains were enough to reach a 33-month high, climbing at the strongest rate in nearly three years. The inventory of homes for sale remains “unusually low.”

Prices are rising across the country. Half of the 20 cities tracked by the S&P Corelogic Case-Shiller rose more than 6% from March 2016 to March 2017. The smallest gain of 4.1%, in New York, was roughly double the rate of inflation. The index is based on a three-month average. For March, Phoenix posted a 0.6% gain, with a 5.6% gain for the past 12 months.

And the consumer confidence reading for May, came in at 117.9, slightly below a consensus estimate of 119. Just three months earlier, consumer confidence hit its highest level in more than 16 years, but heading into summer, the bloom is off the rose.

An index that measures current economic conditions edged up to 140.7 from 140.3, but a gauge that looks out six months dipped to 102.6 from 105.4.

The economic data, while not overwhelming, still points to firming domestic demand that could allow the Federal Reserve to raise interest rates next month. Fed Governor Lael Brainard said a hike is probably coming soon, though the central bank may want to delay if inflation remains soft.

The Fed has also signaled it plans later this year to begin shedding some of its $4.5 trillion in bond holdings, most of which it amassed in the wake of the financial crisis and recession. It would initially set a low cap on the securities allowed to run off, and raise that every three months, under the plan.

Brainard largely agreed, saying the process should be set on “autopilot” and be “calibrated” to the differences between maturing Treasury- and mortgage-backed assets. She also suggested it would likely begin this year, noting the process could be halted and even reversed if the U.S. economy faced an “adverse shock.”

Dallas Fed head Robert Kaplan told CNBC that while he was concerned about the recent economic data, he expected two more rate hikes in 2017 and a start to the process of unwinding the Fed’s $4.5 trillion bond portfolio, most of which was accumulated after the financial crisis.

However, he doesn’t think that’s because the economy is about to take off. Instead, Kaplan sees growth likely continuing the path of about 2 percent and not the 3 percent or more boom in gross domestic product that the administration has been forecasting.

Fed Bank of St. Louis President James Bullard said the path of inflation in the U.S. is “worrisome”, speaking in Tokyo on Friday. The Fed’s plan for raising interest rates in the coming years is also too aggressive. Bullard suggested the financial markets’ view of the upcoming rate hike trajectory is currently out of lockstep with that of the Fed. Fed futures are currently pricing in around a 65 percent chance of a rate hike in June.

Amazon.com became the second of the current S&P 500 components to hit the $1,000 price mark. Priceline was the first S&P 500 stock to hit $1,000, doing so in September 2013. Alphabet’s Class A shares were close behind, hitting a record of $997.62 before ending the session up 0.3 percent at $996.17.

Shares of Amazon have risen 33 percent so far in 2017 alone, adding roughly $120 billion to its market value. Among the other four largest U.S. companies by market cap, Apple and Facebook share prices have also risen nearly 33 percent this year while Alphabet has gained 26 percent and Microsoft has added 13 percent.

The combined market cap of the top five is near $3 trillion, or more than 13 percent of the S&P 500 index stocks’ capitalization. Amazon, the only one of the top five not in the technology sector, accounts for 17 percent of the market cap of the S&P 500 consumer discretionary sector.

British Airways’ flights are back to their normal schedule, following an IT glitch over the long weekend that saw thousands of people stranded around the world. Explaining the disaster over the weekend, CEO Alex Cruz told the BBC: “There was a power surge and there was a back-up system, which did not work at that particular point in time.”

Customers are entitled to compensation under EU law if their flights are delayed by at least 3 hours for reasons within an airline’s control. So, this glitch will likely cost British Airways about $130 million just in customer compensation.

Payless ShoeSource is preparing to launch a second round of store closings, seeking court approval to trim its retail business by closing up to 408 stores if negotiations with landlords fail to result in rent concessions. The latest closings would bring the total number of recently closed Payless stores to nearly 800.

Payless is already in the process of closing nearly 400 of its locations. The Kansas-based retailer had more than 4,000 stores, employing some 22,000 people, when it sought chapter 11 protection last month.

As traditional retail stores close and vacancies mount, landlords across the country appear newly receptive to leases as short as a week. The upswing in pop-up stores, as the short-term placements are called, is playing out in all sorts of ways, and in all sorts of places — including dark malls, former grocery stores and shuttered art galleries, according to real estate brokers, landlords and tenants.

The rise in pop-up stores is adding another element of change to a retail industry facing upheaval from profound shifts in consumer habits and powerful new competitors, especially online. In the past, short-term tenants focused on holidays like Halloween: Costumes were hot items in October, but sales evaporated once the calendar turned to November.

For retailers, the stores can offer lower rents and far less commitment. For the landlords, the reason is just as clear: A short-term tenant is better than no tenant at all.

The Brazilian Supreme Court has order President Michel Temer must respond within 24 hours to federal police questions about his alleged involvement in a sprawling political graft probe. Executives from the world’s biggest meatpacker JBS SA said in plea-bargain testimony to police that Temer condoned bribing a potential witness in the “Car Wash” corruption case and they paid the president nearly $5 million in bribes in recent years.

Goldman Sachs has confirmed it has bought $2.8 billion worth of bonds from Venezuela’s central bank. According to the Wall Street Journal, Goldman paid just $865 million for bonds valued at $2.8 billion – paying about 31 cents on the dollar for the bonds. Venezuela is experiencing the worst financial crisis in its history and has been rocked by months of violent demonstrations that have led to at least 55 deaths.

Inflation has soared past 400%, there are widespread shortages of essential supplies including food and medicines, a quarter of the country is unemployed. The bond sale will likely help finance the administration of the embattled president Nicolas Maduro.

The Federal Reserve said it had fined Deutsche Bank $41 million for failing to ensure its systems would detect money laundering regulations and it said the lender agreed to increase its controls. The New York Fed found that the German bank had faulty systems to detect suspicious transactions between 2011 and 2015

The Supreme Court today placed sharp limits on how much control patent holders have over how their products are used after they are sold. The case concerned Lexmark International, which makes toner cartridges for use in its printers. The court ruled that the company could not use patent law to stop companies from refilling and selling the cartridges.

Lexmark sold the cartridges on the condition that they not be reused after the ink ran out. Impression Products, a small company in West Virginia nonetheless bought Lexmark cartridges in the United States and abroad, refurbished and refilled them and sold them more cheaply than Lexmark does.

Lexmark sued for patent infringement. Chief Justice John Roberts wrote: “The purchaser and all subsequent owners are free to use or resell the product just like any other item of personal property, without fear of an infringement lawsuit.”

Financial Review

Spring Break

Sinclair Noe — April 6, 2017

Podcast: Play in new window | Download (Duration: 13:15 — 7.6MB)

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DOW + 14 = 20,662
SPX + 4 = 2357
NAS + 14 = 5878
RUT + 12 = 1364
10 Y – .02 = 2.34%
OIL + .55 = 51.70
GOLD – 3.80 = 1252.60

Yesterday saw a big reversal – from triple digit gains on the Dow to a loss at the close. Today’s trading followed that pattern, but not the magnitude.

President Trump flew to Florida to hold his first meeting with Chinese President Xi Jinping, facing pressure from a crisis with North Korea, and working to make good on promises for trade concessions. The US and China account for one-third of the global economy.

The two countries not only drive the world economy but also rely critically on one another, a fact that should moderate the decisions of these two strong-willed leaders. Overall, the U.S. rang up a $347 billion trade deficit with China last year, with California responsible for roughly a third of that amount.

About 30 states imported at least $1 billion more in Chinese goods than they exported, per data from the International Trade Administration, an arm of the U.S. Department of Commerce. Tough actions could end up harming many American consumers and businesses. Bloomberg Intelligence Chief Economist Michael McDonough writes: Shoppers at Wal-Mart and Target would see an immediate surge in imported goods costs. U.S. corporations selling into or producing in China would see lower profits. The promised benefits — a return of U.S. manufacturing jobs — appear uncertain.

High labor costs, automation and sticky supply chains all make it difficult for firms to relocate back to the U.S. This suggests the Trump administration might be content with symbolic wins, rather than major sanctions.

The Pentagon and the White House are in detailed discussions on military options to respond to a poison gas attack in Syria that killed scores of civilians, and which Washington has blamed on the Syrian government. Trump said today that “something should happen” with Assad after the attack, but stopped short of saying he should leave office.

Secretary of State Rex Tillerson said however, there was no role for Assad in Syria in the future. Any US action against Syria’s government would open a new front in Syria’s fighting, with consequences that are difficult to foresee. Entering such a confrontation might complicate the fight against ISIS and potentially draw in Russia. Possibilities for military action reportedly include striking the Syrian air force or specific military targets.

Senate Republicans voted to strip Democrats of the power to filibuster President Trump’s nominee to the Supreme Court, invoking the so-called nuclear option. Senators voted 52-48 along party lines to change the Senate’s precedent, lowering the threshold for advancing Neil Gorsuch from 60 votes to a simple majority.

They then immediately voted 55-45 to advance the nominee to a final confirmation vote, which is expected to happen Friday afternoon. Senators on both sides lamented the escalation of partisan tactics over Gorsuch’s nomination and warned it would erode the fabric of the institution, which has traditionally protected the rights of the minority party.

House Intelligence Committee Chairman Devin Nunes temporarily recused himself today from all matters related to the committee’s ongoing probe into Russia’s interference in the presidential election, as House investigators look into ethics allegations against him.

Nunes said in a statement that he decided to recuse himself after complaints were filed with the Office of Congressional Ethics about his leadership. Nunes called the charges “entirely false and politically motivated,” but said his recusal would be in effect while the House Ethics Committee considers the matter.

The House Ethics Committee released a statement saying it had “determined to investigate” allegations that “Nunes may have made unauthorized disclosures of classified information, in violation of House Rules, law, regulations, or other standards of conduct.”

White House economic adviser Gary Cohn said he supports bringing back the Glass-Steagall Act, a Depression-era law that would revamp Wall Street banks by splitting their consumer-lending businesses from their investment arms. The National Economic Council director, also a former Goldman Sachs president, expressed support to lawmakers for a banking system where firms would focus primarily on trading and underwriting securities or issuing loans.

Big banks have strongly opposed such a move that would fundamentally overhaul their business. Reinstating the law, which was repealed in 1999, has not attracted significant attention in Congress, but advocates in the White House and both parties now argue it would provide critical safeguards to prevent another financial crisis.

Minneapolis Federal Reserve President Neel Kashkari criticized JPMorgan Chase CEO Jamie Dimon over what he contends are unrealistic views on core U.S. banking regulations. Dimon’s assertions in a letter to shareholders this week that government-imposed capital requirement for big banks are holding back lending and that relaxing them could spur economic growth “are demonstrably false,” Kashkari said in a blog entry posted to the Minneapolis Fed’s website.

In his letter, Dimon lamented that JPMorgan is constrained in lending because of capital demands. In response, Kashkari noted that the bank has bought back $26 billion of its own stock in the last five years, using money that he says could have been loaned to customers.

One thing Kashkari and Dimon did agree on: “reducing regulatory complexity.” But Kashkari is continuing to argue that higher capital can replace other regulations while Dimon said that there is already “excess capital in the system.”

A federal judge in Detroit said he plans to name former FBI director Robert Mueller to oversee nearly $1 billion in Takata Corp restitution funds as part of a Justice Department settlement. In January, Takata agreed to plead guilty to criminal wrongdoing and to pay $1 billion to resolve a federal investigation into its air bag inflators linked to at least 16 deaths worldwide.

As part of the settlement, Takata agreed to establish two independently administered restitution funds: one for $850 million to compensate automakers for recalls, and a $125 million fund for individuals physically injured by Takata’s airbags who have not already reached a settlement.

Even with the US economy boasting impressive job growth and domestic equity markets near record highs, a fragmented recovery has left many states struggling to close budget deficits nearly a decade after the 2008 financial crisis.

The broad recovery has benefited large, economically diverse states like California and Texas, ratings agencies say, while states heavily dependent on oil revenues, like North Dakota and Alaska, and those like Illinois that are grappling with large unfunded pension obligations, have seen budget deficits bloom.

That has left those struggling states with painful decisions over spending cuts and tax increases, and ill prepared to deal with another economic downturn or cuts to federal money tied to the Medicaid program.

S&P Global has downgraded 11 states compared to just two upgrades since January 2016. It has 11 states on negative outlook, which means the ratings agency believes more than 20 percent of states are in danger of a credit downgrade.

Per a recent report by the Center on Budget and Policy Priorities, half of the states face budget shortfalls despite overall economic growth and lack the revenue needed to maintain services at existing levels in 2018. No state has defaulted on its public debt since the 1930s. Despite many near misses more recently, the possibility of any state going under financially is remote at best.

Wall Street’s bet against empty malls is getting too crowded, per Citigroup analysts, who instead recommend wagering against individual retailers as the “next big short.” The strategy differs from the one pursued by a growing number of hedge funds, which have wagered against mall properties through CMBX derivatives indexes that tracks commercial mortgage-backed securities.

The prevailing theory is that failing brick-and-mortar retailers will mean higher vacancies and bankruptcies for mall operators, with losses inflicted on CMBS holders. But the trade has become so crowded in recent weeks that betting the index will drop even further is a longshot.

Retailers have been struggling for years as consumers defect to online merchants such as Amazon and shift spending to experiences such as dining and travel instead of merchandise. Mall operators are under pressure from anchor stores such as J.C. Penney and Macy’s, which have announced plans to shutter stores, and Sears Holdings has raised doubts about its survival.

Yesterday we told you Payless ShoeSource was filing for bankruptcy protection and closing nearly 400 stores. The list of store closures was released today, and 7 stores in Arizona will be shut down.

Taser International  will change its name and ticker – the new name is Axon. A-X-O-N and it is launching a program to equip every US police officer with a body camera, including supporting hardware, software, data storage and training, all free for one year.

Axon’s aim is to provide police departments in the United States with the technology so that officers — frontline officers in particular — can effectively try it, learn how to use it and offer insight on how best to implement it. While Taser will remain one of the company’s trademark products, the company attributed its name and ticker change to changing times and a shift in the focus of their business. The new ticker symbol is AAXN

The number of Americans who applied for unemployment benefits near the end of February fell by 19,000 to 223,000, setting a fresh post-recession low and illustrating the strength of the labor market. We’ll find out more tomorrow with the release of the March Jobs Report.

Economists’ estimates are calling for still-solid gains of 175,000 in the public and private sectors, but that would be down from an average pace of about 237,000 the first two months of the year. The recent strength in the labor market could make it tougher for employers to find skilled workers.

Financial Review

Take 63

Sinclair Noe — April 4, 2017

Podcast: Play in new window | Download (Duration: 13:15 — 7.6MB)

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DOW + 39 = 20,689
SPX + 1 = 2360
NAS + 3 = 5898
RUT – 1 = 1368
10 Y + .01 = 2.36%
OIL + .94 = 51.18
GOLD + 2.70 = 1256.70

The U.S. trade deficit fell in February as exports increased to a two-year high and slowing domestic demand weighed on imports. The Commerce Department reports the trade deficit declined 9.6 percent to $43.6 billion. Some of the decline in imports in February likely reflects slower consumer spending.

Trade will probably be either neutral or impose a small drag on gross domestic product in the first quarter after subtracting 1.8 percentage points from fourth-quarter growth. In addition to trade, weak consumer spending also likely constrained the economy in the first three months of the year. The Atlanta Federal Reserve is forecasting GDP rising at a 1.2 percent rate in the first quarter, a deceleration from the 2.1 percent pace logged in the fourth quarter.

In a separate report, Factory orders rose 1% in February for the seventh increase in eight months, a sign of the rebounding fortunes of the manufacturing industry.

The U.S.-China trade deficit dropped 26.6 percent to $23.0 billion in February. The decline in the U.S.-China trade deficit comes ahead of Chinese President Xi Jinping’s visit later this week. President Trump has declared China the “grand champions” of currency manipulation. Trade relations with China are further complicated by growing tensions with North Korea.

The outcome of their talks could have longstanding ramifications for two of the world’s most important currencies. The valuation of a given currency can make stocks and bonds denominated in that currency attractive to foreign investors. Cheaper currencies can help to boost stocks by making companies’ goods more competitive on the global market.

President Trump vowed  today to cut red tape to speed up approval of infrastructure projects and said his overhaul could top $1 trillion on roads, tunnels and bridges, one of his 2016 election campaign promises. Trump did not provide further details on the amount or where the money would come from when he spoke to a White House meeting of 50 chief executives and other business leaders.

U.S. Transportation Secretary Elaine Chao said at the forum that the administration plans to release a legislative package in May. The administration wants to improve the electrical grid and water systems, rebuild airports, bridges, roads and potentially hospitals for military veterans and broadband. National Economic Council director Gary Cohn told executives that privatizing air traffic control, which the administration proposed in its budget outline in March, “is probably the single most exciting thing we can do.”

The Washington Post reported this morning that the White House is looking at the possibilities of creating a carbon tax and a value-added tax as part of tax reform. The Post’s report cites administration officials and “one other person briefed on the process.” Administration officials told the Post that no final decisions have been made about whether a value-added tax or a carbon tax would be included in a tax-reform plan.

Trump will need to come up with ways to raise revenue if he wants to lower tax rates without adding to the deficit. House Republicans have proposed raising revenue through a tax on imports known as border adjustment, but that proposal is opposed by several GOP senators.

Value-added taxes are a type of consumption tax, while carbon taxes would be imposed on the manufacturing of some types of fuel. Later in the day, the White House issued a statement saying, “As of now, neither a carbon tax nor a VAT are under consideration.” One thing is certain though, tax reform will not be easy.

Take 63. There is a new plan to repeal and replace Obamacare. Vice President Mike Pence and two top White House officials made an offer in a closed-door meeting with members of the House Freedom Caucus.

The proposal under discussion  would allow states to opt out of two key Affordable Care Act provisions: essential health benefits, which require insurers to cover certain services, and community rating, which bars carriers from charging consumers based on their medical history or gender. Eliminating these federal requirements could wipe out the safeguards requiring insurance companies to offer insurance to people with pre-existing conditions – one of the most popular provisions of the Affordable Care Act.

The benchmark 10-year Treasury yield fell Tuesday to as low as 2.31 percent, within a basis point of its 2017 low. The level to watch now is the Feb. 24th low at 2.308%. Anything below this pivot, even on an intraday basis, signals that a meaningful top was put in at the March high. And if support falters, the next support is 2.13%.

For all the talk of consumer confidence, it isn’t translating to sales at brick and mortar stores. Retail is the worst performing sector so far, this year. Today, Ralph Lauren said it was shutting its flagship Fifth Avenue store in New York and cutting jobs; Urban Outfitters announced a decline in same store sales; Citigroup downgraded L Brands; First Data Corp., the payments processor, said point-of-sales data for department stores slumped 10.9 percent in March.

Payless ShoeSource is the latest retailer to file for Chapter 11 bankruptcy protection. Payless will close nearly 400 stores as it attempts to boost its balance sheet and restructure its debt load. Payless has 4,400 stores in 30 countries and employs nearly 22,000 people. It was bought in 2012 by private equity firms Golden Gate Capital and Blum Capital partners.

Federal Reserve Bank of Richmond President Jeffrey Lacker said he’s resigning immediately and he regrets his role in disclosing confidential information related to the U.S. central bank’s deliberations in 2012 in an interview with an analyst from Medley. That info, dealing with the Fed’s planned purchase of mortgage securities, was published by the analyst; followed by various investigations over the years, leading to today’s resignation. In a statement emailed by his lawyer, Lacker wrote: “In 2012, my conduct was inconsistent with those important confidentiality policies.”

JPMorgan Chase CEO Jamie Dimon is out with his annual letter to shareholders, in which he discusses not only the bank’s business outlook but also various current economic and political issues. Dimon said he has high hopes for the U.S. but believes there is “something wrong” with the country as well, writing: “Our problems are significant, and they are not the singular purview of either political party. We need coherent, consistent, comprehensive and coordinated policies that help fix these problems.”

Dimon added: “The solutions are not binary — they are not either/or, and they are not about Democrats or Republicans. They are about facts, analysis, ideas and best practices (including what we can learn from others around the world).”

Dimon noted that the U.S. is “an exceptional country,” but there are numerous areas where the country needs to improve. Among them are low wage growth, high health-care costs and overcrowded prisons. Businesses are overburdened with regulations, the nation’s infrastructure needs help, and the education system “is leaving too many behind,” he added.

Among the other ills: Taxes are making U.S. companies less competitive globally, income disparity is widening, and social mobility is decreasing. “The lack of economic growth and opportunity has led to deep and understandable frustration among so many Americans,” Dimon said. “It is understandable why so many are angry at the leaders of America’s institutions, including businesses, schools and governments — they are right to expect us to do a better job.”

Dimon listed 11self-inflicted problems for the economy: excessive regulation, high spending on wars, student loan growth, high health care costs, high-skilled immigrants leaving the US, felony convictions leaving millions with criminal records, a tight mortgage market, the labor force participation rate is too low, education leaves too many behind, the need to invest in infrastructure, and a flawed corporate tax system.

On other issues; Dimon said he’s concerned the U.K.’s departure from the European Union might trigger political unrest throughout the region that could split the currency union, resulting in “devastating economic and political effects.” Dimon devoted more than a third of his letter to deregulation.

Dimon asserted that the Dodd-Frank Act effectively ended the possibility of government bailouts for “too big to fail” banks. He also called for modifying the Financial Stability Oversight Council — the panel of regulators created by the Dodd-Frank Act, however he did not call for repeal of Dodd-Frank.

Separately, JPMorgan said in its annual report that it expects $49 billion of net interest income this year, up from about $46 billion in 2016, assuming additional loan growth and no changes in interest rates. Average core loan growth will be about 10 percent, and loan write-offs will remain close to historically low levels.

In what appears to be a reference to Warren Buffett, Dimon talked about the “secret sauce” that powers the American economy: trust. In the past, Buffett has also talked about the “secret sauce”. Dimon wrote: “A strong and vibrant private sector (including big companies) is good for the average American. Entrepreneurship and free enterprise, with strong ethics and high standards, are worth rooting for, not attacking.”

Dimon is right, trust is important, but it can’t be cajoled or demanded. It must be earned.

Wells Fargo has been ordered to reinstate a former bank manager who was fired after reporting suspected illegal behavior to his superiors and a company hotline. The manager, who wasn’t identified, was dismissed in 2010 after reporting on incidents of suspected bank, mail and wire fraud by two bankers in the Los Angeles area.

Wells Fargo was also ordered to give the whistle-blower about $5.4 million in back pay, compensatory damages and legal fees after OSHA determined his warnings were at least a contributing factor in the termination.

Wells Fargo said they would immediately issue a check along with thanks to the whistle-blower for alerting them to the problems. No, just kidding about that last part – Wells Fargo said they would appeal the order.