Financial Review

Focus on Earnings

Sinclair Noe — July 21, 2017

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DOW – 31 = 21,580
SPX – 0.91 = 2472
NAS – 2 = 6387
RUT – 6 = 1435
10 Y – .03 2.23%
OIL – 1.25 = 45.67
GOLD + 10.50 = 1255.50
BITCOIN + 1.33% = 2703.19 USD
ETHEREUM + 3.41% = 221.94

Stocks pulled back from record highs earlier this week.  For the week, the Dow fell 0.3% but the S&P 500 is up 0.5% and the Nasdaq added 1.2%. The Nasdaq is coming off a 10-day string of gains, matching its longest streak since Feb. 24, 2015 – so a pullback today was overdue.

At long last, tech stocks have finally recovered all the losses they suffered during the bursting of the dotcom bubble in 2000. It only took 17 years. The S&P 500 Information Technology Index closed Wednesday at an all-time high of 992.3. In doing so, it broke the previous record of 988.5, which was set back in March 2000.

In the intervening years, tech shares had lost as much as 80% of their value before beginning the slow ascent back to the top of the market. That ultra-slow recovery highlights how long it can take stocks to come back from bubbles. Tech stocks in the S&P 500 index now trade at a price/earnings ratio of 18.4, according to FactSet, based on projected sector profits in the coming 12 months.

That means tech is now trading at a 28% premium to tech companies’ valuations over the past decade. To be sure, that’s nothing compared to the triple digit P/Es seen in the late 1990s.

The FANG stocks, (Facebook Apple, Amazon, Netflix, and Alphabet-Google) have rocketed up this year, rising nearly 40 percent, four times the gain of the S&P 500. And the trend doesn’t seem to be ending. The technology heavy Nasdaq Composite Index raced ahead of the broader S&P 500 again this week.

And yet as investors pile into the FANG stocks, one measure of the return investors can expect from those stocks has shrunk to a new low. As of the end of the second quarter, the average free cash-flow yield of the FANG stocks, based on the past 12 months, slid to just 1.4 percent. That’s less than half of what that measure was just two years ago and now nearly a full percentage point below the yield on a 10-year Treasury.

Tech is back to being the biggest sector in the market, representing about a quarter of the S&P 500. That’s still well below the one-third share of the market that tech stocks occupied in the late 1990s. But remember that this figure does not include several big stocks that the public regards as “tech” but that S&P classifies as “consumer discretionary” stocks — a list that includes Amazon, Priceline, and Netflix. Moreover, Tesla isn’t even in the S&P 500, despite being valued at more than $53 billion.

If you want to make money in the stock market, you’d better nail earnings season. The reason is simple: Quarterly results are exerting unprecedented influence over stock returns and, by extension, portfolio performance. In recent quarters, reporting companies have seen their shares move four times the normal daily average, the most in the past 18 years, according to data compiled by Goldman Sachs.

The punishment for missing earnings is also the harshest in almost two years. In the first quarter of this year, companies that fell short dropped more than 2.5% in a single day, on average, according to Wells Fargo data.

One possible explanation is the rise of passive investment vehicles such as exchange-traded funds and quant funds. By trading large swaths of the equity market, rather than individual stocks, participating investors are diluting the effects of specific company fundamentals during non-earnings periods. Then, once earnings season rolls around, stock prices are spring-loaded to react more sharply to any new information.

This ETF effect is compounded by how price-insensitive the traders who use them can be — buying and selling based on what their models tell them and ignoring valuations that might otherwise raise red flags. Goldman finds that the FAAMG group that has led the stock market’s latest rally to new highs — consisting of Facebook, Amazon, Apple, Microsoft, and Google — has been realizing more than 50% of its quarterly return during earnings week.

In addition, the tech, materials, and consumer discretionary sectors are also seeing more than 30% of their quarterly returns generated in the five days surrounding releases.

General Electric reported quarterly profits fell 57% to $1.2 billion, as sales in its oil and gas, transportation and lighting divisions fell. Outgoing GE boss Jeffrey Immelt said the company was working in a “slow-growth, volatile environment”. He said a cost-cutting plan and other measures should put the firm on track to hit profit targets for the year. GE is down about 19% year to date.

Honeywell reported a better-than-expected quarterly profit. Net income attributable to Honeywell increased 5.5 percent to $1.3 billion, or $1.80 per share, above expectations of $1.78 per share. Revenue rose about 1 percent to $10 billion, topping expectations of $9.8 billion.

Honeywell also raised the low end of its 2017 earnings per share forecast by 10 cents. Sales in Honeywell’s aerospace business, which activist investor Daniel Loeb wants to be spun off, fell about 3 percent to $3.67 billion in the quarter, but the drop was much smaller than forecast.

The Department of Labor ordered Wells Fargo to pay $575,000 and to rehire a whistleblower the bank had dismissed in September 2011 after the former employee raised concerns over the opening of customer accounts without their knowledge. Despite news reports and lawsuits claiming the bank had retaliated against whistle-blowers, an investigative report by the bank’s board of directors released in April found no pattern of retaliation.

The U.K. cabinet will accept the free movement of EU citizens for up to four years after Brexit as part of a transitional deal. The news comes after a meeting between Prime Minister Theresa May and British businesses, in which companies stepped up pressure to avoid a so-called hard Brexit.

Bank of America has chosen Dublin as its future European Union hub, the latest major financial services firm to outline its plans to deal with Brexit, Britain’s departure from the 28-nation bloc.

Many banks and financial firms have concentrated their European operations in London, taking advantage of deep and liquid markets as well as the wide variety of support industries that have built up in the British capital, including accountants and lawyers. But those companies now face the distinct possibility that they may no longer be able to serve European clients from London after Britain leaves the Euro Union.

With Britain as a member of the EU, companies based in the country have been able to sell financial products across the Continent under “passporting” rules, which allow a lender licensed in one member state to work throughout the European Union. That is no longer guaranteed when Britain leaves in 2019, so financial companies have been moving forward with contingency strategies, and Bank of America is the latest lender to announce its plans.

American and European authorities have shut down two of the largest online black markets, AlphaBay and Hansa Market, and arrested their operators. AlphaBay, the largest so-called dark net market, was taken down in early July at the same time the authorities arrested the reported founder of the site, Alexandre Cazes, a Canadian man who was living in Bangkok.

Cazes committed suicide in his jail cell shortly after he was arrested. After AlphaBay went down, users streamed to one of its largest competitors, Hansa Market. But on Thursday, the Dutch national police announced that they had taken control of Hansa Market in June and had been operating the site since then, monitoring the vendors and customers and gathering identifying details on those involved in the 50,000 transactions that took place.

AlphaBay and Hansa Market were successors to the first and most famous market operating on the so-called dark net, Silk Road, which the authorities took down in October 2013.

You’ve undoubtedly heard that, in reaction to the hiring of Anthony Scaramucci as communications director, Sean Spicer has resigned as White House Spokesperson (leaving the White House to find someone else to not give press briefings).

Sarah Huckabee Sanders will replace Spicer. Given the nature of Trump coverage—and Spicer’s outsized role in it—you probably heard about the resignation within ten seconds of it happening. Scaramucci said he hopes that press secretary Sean Spicer will go on “to make a tremendous amount of money.”

Financial Review

Shut Up

Sinclair Noe — February 24, 2017

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DOW + 11 = 20,821
SPX + 3 = 2367
NAS + 9 = 5845
RUT – 0.1 = 1394
10 Y – .07 = 2.32%
OIL – .42 = 54.03
GOLD + 7.60 = 1257.90

11 days of record breaking closes, the best streak of positive sessions since 1993. The longest streak of record breaking sessions is 14 in a row – back in 1897.

For most of the day, the major indices were in negative territory; Dow futures dropped more than 100 points early in the morning, and then, in the final 17 seconds, buyers jumped in again. The Dow Industrial Average is up more than1,000 points since January 1 and almost 3,000 points since the election.

This was the third up week in a row for the Dow, and the fifth straight positive week for the S&P and Nasdaq. The 10-year Treasury note has its best week since last June. Gold is up 8 of the last 9 weeks and at its highest level since October.

In economic news, U.S. new home sales rose 3.7 percent in January, below the expected increase of 6.3 percent. Meanwhile, consumer sentiment in the U.S. hit 96.3 in February, slightly above an estimate of 96. Earnings season, which is coming to an end, has been much stronger than anticipated.

Per Thomson Reuters, fourth quarter earnings growth is tracking about 7.5%. It seems US equity funds are where the world is parking its money for the time being, with over $25 billion coming into market coffers since January 1.

President Trump spoke before the Conservative Political Action Committee today, and he ramped up his attack against the news media, charging that “fake news” outlets are “the enemy of the people.” And later in the day, the White House fired a shot across the bow, blocking CNN, the New York Times, the Los Angeles Times, Politico and BuzzFeed from an off-camera White House press briefing conducted by White House press secretary Sean Spicer.

The Associated Press and Time magazine boycotted the briefing because of how it was handled. The White House Correspondents Association also protested the move.

Spicer only allowed in reporters from a handpicked group of news organizations that, the White House said, had been previously confirmed. The press session, known as a gaggle, was scheduled as a no-camera event, less formal than his usual briefings that are carried live on cable news. But past administrations have not hand-selected outlets that can attend such sessions.

Two of the barred outlets, CNN and The Times, have been a focus of Mr. Trump’s ire. And during the presidential campaign, some journalists from BuzzFeed News and Politico were prohibited from attending Trump rallies. Representatives of the barred news organizations made clear that they believed the White House’s actions were punitive.

Oil investors have placed the biggest bet in history that prices will rise. Fund managers now hold more Brent oil futures and options contracts than at any time on record, equivalent to some 480 million barrels of oil and nearly double the amount held just two months ago.

The Brent April contract now commands a premium of $1.50 over the December 2018, a condition known as backwardation. Crude inventories held in the world’s richest nations are still high, but they have begun to drain, and traders expect demand for oil to improve to the point where it overtakes supply.

Meanwhile, industry executives, analysts and investors sizing up Saudi Aramco say it may be worth nowhere near the $2 trillion that’s been touted. For example, Wood Mackenzie came up with a rough valuation of Aramco’s core business of $400 billion.

While that is significantly more than Exxon Mobil, with a market cap just under $340 billion; it is not enough to provide the capital the Saudis require to run the national budget. That’s just a guess at valuation because Saudi Aramco has never revealed financial statements.

For the Saudis, the writing is on the wall. Demand for oil will peak in the next 10 to 12 years, according to Royal Dutch Shell projections, as alternative fuels and electric cars gain popularity, putting Middle East energy producers on shakier footing.

Saudi Aramco valuations are premised on a simple calculation: Take the 261 billion barrels of reserves Saudi Arabia says lie under oil fields, and multiply by $8 (a benchmark used to value reserves). By that logic, though, Russian producer Rosneft’s market capitalization would be $272 billion instead of $64 billion, and the valuation of Exxon Mobil would be 53 percent smaller than it is.

Another factor for valuation – those reserves might not be all that they’re cracked up to be. Consider that Exxon Mobil just lost 4.3 billion barrels of reserves this week. Not lost really, just removed from their books. The reserves are still under the ground and controlled by Exxon Mobil but for accounting purposes, they no longer meet the SEC’s criteria for being economic to produce anytime soon, chiefly because oil prices have collapsed. Higher prices could push those reserves back onto the books, but lower demand could keep prices much lower for much longer.

Exxon Mobil CEO Darren Woods (he’s the guy who replaced Rex Tillerson) – Woods is calling for a nationwide carbon tax to discourage use of polluting fuels. In a blog post, Woods writes: It “would promote greater energy efficiency and the use of today’s lower-carbon options, avoid further burdening the economy, and provide incentives for markets to develop additional low-carbon energy solutions for the future.”

In a memo signed Feb. 21 but published late on Thursday, US Attorney General Jeff Sessions rescinded a six-month-old order that was to phase out the use of private prisons by the federal government. CoreCivic and Geo Group, two of the largest for-profit prison operators, both rose in after-hours trading. The companies have more than recovered the steep losses their shares suffered after the former administration’s September directive.

JC Penney will shutter two distribution centers and 130 to 140 stores. The closures announced Friday represent 13% to 14% of the company’s store portfolio, less than 5% of total annual sales and 0% of net income. The company is starting an early retirement program for about 6,000 eligible associates. Chief Executive Marvin Ellison said closing stores will allow Penney to adjust its business to “effectively compete against the growing threat of online retailers.”

Department store operators Kohl’s and Macy’s are betting on a potential money-spinner – carving out prime space within their sprawling stores and leasing them to other retailers. The move underscores the pressing need for the two chains to better monetize their real estate assets at a time when fewer people are visiting malls.

Meanwhile, retailers have been lobbying against a border-tax proposal that would increase the tax bite on any company that imports goods into the US. Retailers would be among the biggest losers if such a proposal were implemented in full, as much of their sales are of imported goods.

Retailers and other critics say the planned 20 percent tax on imports could be passed along in higher prices to consumers, including manufacturers that rely on imported goods to make their products. Some critics have warned of a potential global trade war which would sharply curtail US and world economic growth.

Advocates say U.S. exporters will gain as their revenues will be excluded from federal taxes. They say the tax on imports will encourage domestic production and cause the already strong dollar to rise, offsetting upward pressure on import prices. Yesterday, Trump spoke positively about a border-tax.

Today, Gary Cohn, the president’s chief economic adviser, told a group of executives at a private event in Washington that the White House does not support this initiative. If the administration can’t find unanimity in a tax plan, imagine what happens when an actual plan is subjected to public scrutiny.

Royal Bank of Scotland reported a sharp rise in losses, $8.8 billion for the full-year, marked by higher legal penalties and restructuring costs. RBS took charges to set aside money to cover legal cases in the US where analysts expect it to pay the biggest regulatory penalty in its history for mis-selling US securities backed by toxic mortgage loans.

RBS was the only British lender to fail the Bank of England’s stress test in 2016. The British government, which owns more than 70 percent of RBS, has said it will not resume selling its stake until the bank settles its US fine and resolves its state aid requirements.

MacDonald Dettwiler and Associates has agreed to buy US-based DigitalGlobe for about $2.4 billion to strengthen its position in the satellite imagery market.

China’s state-owned Sinochem is in early talks to buy an equity stake in Noble Group. And now, Iceberg Research has issued critical report that raises concerns about Noble’s accounting practices, claiming the commodity firm is not worth its book value. Noble shares are down about 17% on the news.

Google and Uber started off as friends, then became competitors, and are now adversaries in a bitter legal fight to control the future of transportation. Waymo, the Google self-driving-car group, has accused Uber of using stolen technology to advance its own autonomous-car development. Google filed a lawsuit, claiming that a team of ex-Google engineers stole the company’s design for the lidar laser sensor that allows self-driving cars to map the environment around them.

A software bug leaked encrypted personal data from hundreds of thousands of web-pages hosted by Cloudflare. The company said the bug was fixed quickly and there was no sign that the leak was exploited by hackers.

Foot Locker reported better-than-expected earnings in the fourth quarter despite a slowdown in the retail industry. Same store sales were up 5%, topping expectations.

HP Enterprise’s revenues drops 10%. Sales fell in the first quarter, which ended January 31, with sluggish demand for its storage equipment and servers.

Samsung Electronics is tightening board oversight on donations, as the conglomerate struggles with the fallout from a graft scandal. The flagship of South Korea’s top conglomerate Samsung Group has been at the center of an influence-peddling scandal that led South Korea’s parliament to impeach President Park Geun-hye in December.

Jay Y. Lee, leader of Samsung Group and Samsung Electronics’ vice chairman, was arrested last week after being named a suspect by the South Korean special prosecutor’s office. The Samsung board of directors will now vote on any financial payment of $886,000 or more and disclose any such payments publicly.