Financial Review

See What Sticks

Sinclair Noe — May 1, 2017

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DOW – 27 = 20,913
SPX + 4 = 2388
NAS + 44 = 6091
RUT + 6 = 1407
10 Y + .04 = 2.32%
OIL – .56 = 48.77
GOLD – 11.60 = 1257.10

Once again, the Nasdaq hit a record high close. And the VIX, the volatility index dipped down under 10. Nothing to worry about here. Meanwhile, investors braced for another heavy week of quarterly corporate results in an earnings season that has exceeded expectations.

Overall, profits at S&P 500 companies are estimated to have risen between 12 percent and 13.6 percent in the first quarter, the most since 2011. First quarter GDP came in at 0.7 percent. The difference between earnings per share growth and gross domestic product expansion in the first quarter is the widest since the third quarter of 2011.

S&P 500 companies that generate more than half their revenue overseas are posting quarterly earnings growth of 19.9 percent on average, double that of companies that conduct most of their business domestically. About 46 percent of S&P 500 sales overall come from foreign markets. Other factors helping earnings and overseas economic growth are softness in the U.S. dollar and stabilizing oil prices.

The greenback has traded mostly lower this year after sharp gains in 2014 and 2015 that cut into overseas profits. Meanwhile, oil recovered from a sub-$30 a barrel low last February to trade in a range near $50 a barrel. U.S. crude is up about 7 percent over the last 12 months.

To be sure, there’s another reason why earnings look so good: A year ago, they were bad. Last year’s poor results for S&P 500 companies overall, including four straight quarters of earnings decline, set a low bar for companies to overcome.

You’ve heard the old axiom, Sell in May and Go Away; that is the simplified version. If you follow the directions, you could sell in May, or slightly before or after depending on when the market gives a sell signal. The critical reference point for the adage is the MACD. A traditional sell signal occurs when the MACD line crosses below the signal line. The Sell in May refers to the best and worst six month, so the idea is to stay away until the end of October.

The saying may be better at avoiding volatility in September and October than any big downturn in May. If you don’t want to sell in May, you might consider more defensive positions, or even a few short trades.  The next week could provide direction for the markets. We have a Federal Reserve policy meeting on Wednesday, a jobs report on Friday, and Sunday brings the French election between Macron and Le Pen. Buckle up.

Over the weekend, congressional negotiators have hammered out a bipartisan agreement on a spending package to keep the federal government funded through the end of the current fiscal year on Sept. 30. You are probably shocked by the news that congress worked over the weekend. Congress is expected to vote on the roughly $1.1 trillion package early this week.

The White House sought funding to begin building the wall, as well as $18 billion in cuts to domestic agencies, and both demands were rebuffed. The spending deal includes money for Planned Parenthood. The package includes $12.5 billion in new military spending and $1.5 billion more for border security, but not for a wall or additional Immigration and Customs Enforcement agents.

The Environmental Protection Agency, which Trump has sought to shrink dramatically, would receive a 1 percent reduction of $81 million in funding and no staff cuts. The deal also includes steady or slight increases in funding for agencies within the Department of Energy, such the Office of Energy Efficiency and Renewable Energy, which would get a $17 million increase, and the Office of Science, which would get a boost of $42 million compared to fiscal 2016 funding levels.

One provision allows the secretary of Homeland Security to temporarily increase the cap in H-2B visas for temporary labor through the end of September. Agencies Trump has sought to eliminate, like the National Endowment for the Arts and the National Endowment for the Humanities and the Appalachian Regional Commission, would get modest increases in funding instead.

Today, President Trump told Bloomberg News that he’s considering breaking up giant Wall Street banks by reinstating Glass-Steagall, the 1933 law that separates investment banking from traditional banking. Trump also suggested raising the gas tax to fund infrastructure.

The Trump administration released an outline of a tax plan last week that would slash tax rates for businesses and reduce the number of tax brackets for individuals. The plan, however, was silent on gasoline taxes. So, throw it on the wall and see if it sticks.

The European Union’s summit in Brussels ended with EU leaders suggesting that British Prime Minister Theresa May’s ambitions for the looming Brexit negotiations are unrealistic. May stuck to her guns, however, arguing that Britain should be allowed to line up a “comprehensive” free-trade deal with the EU post-Brexit and denying accusations that she’s in a “different galaxy.”

Meanwhile, Marine Le Pen and Emmanuel Macron are kicking off the final week of the French presidential campaign with major rallies in Paris. Macron is still leading the polls, although his margin has slipped slightly in recent days.

Oil and gold moved lower, but in the commodity markets, it was a big jump for wheat. A winter storm dropped more than 12 inches of snow across four Midwest states. While it will take several days before the damage can be assessed accurately as the snow melts, early estimates suggest losses could exceed 50 million bushels but quite possibly more.

Heavy rains are forecast for the region later in the week. Many reports of snapped wheat stems, and for a crop in the early stage of forming grain, that suggests there could be “substantial” production losses. For hard red winter wheat, a variety of the grain used to make bread, futures for July delivery surged 6.5 percent to close at $4.6575.

July futures for soft red winter wheat, which is used to make cookies and cake, jumped 5.5 percent to $4.56, also a record, while corn prices climbed 3 percent in active trading. Wheat has been in a long-term bear market thanks to near ideal growing conditions the past couple of years, and the feeling among many traders was that the only direction for wheat was down. The dominant position for speculative traders has been short. The freak storm caught many by surprise.

America’s largest oil refinery is now fully owned by Saudi Arabia. Saudi Aramco, the kingdom’s state-owned oil behemoth, took 100% control of the sprawling Port Arthur refinery in Texas on Monday, completing a deal that was first announced last year. Port Arthur is considered the crown jewel of the US refinery system.

The Gulf Coast facility can process 600,000 barrels of oil per day, making it the largest refinery in North America. Aramco previously owned 50% of Port Arthur through a joint venture co-owned with Royal Dutch Shell.

The ISM manufacturing report shows manufacturers scaled back hiring plans in April and demand for new products slowed, but most companies said business was still quite brisk, a survey of executives found. The Institute for Supply Management said its manufacturing index slipped to 54.8% in April from 57.2%. Any reading above 50 indicates expansion.

Spending on construction dipped 0.2% in March following an unusually strong pace of spending in February. For the first three months of the year, spending was 4.9% higher than in the same period in 2016. Much of the increase came from housing. Residential construction was up 1.2% during the month, but stood 7.3% higher than a year ago.

Overall private construction was flat in March, as lower levels of spending on public works continued to drag. Overall public construction was 0.9% lower during the month, and 6.5% lower than in March 2016.

Personal income rose less than expected in March while spending was flat, according to the Bureau of Economic Analysis.  Personal income rose 0.2%, missing the forecast for 0.3% growth. The report also included data on personal consumption expenditures, a gauge of consumer purchases that the Fed prefers to measure inflation. The PCE deflator fell 0.2% month-on-month and rose 1.8% year-on-year, slipping from 2.1% in February.

American consumers are holding $1 trillion in revolving credit, mostly in credit card debt. So how well is this segment of consumer debt holding up? Synchrony Financial – GE’s spin-off that issues credit cards for Walmart and Amazon says net charge-offs would rise to at least 5% this year.

Credit-card specialist Capital One disclosed in its Q1 earnings report last week that provisions for credit losses rose to $2 billion, with net charge-offs jumping 28% year-over-year to $1.5 billion. Synchrony, Capital One, and Discover – a gauge of how well over-indebted consumers are managing to hang on – have together increased their Q1 provisions for bad loans by 36% year-over-year. Other worries about consumer debt in the US are piling up.

The $1.4 trillion in student loans are already in crisis, though the government backs them, and they cannot be charged off in bankruptcy. Of the $1.1 trillion in auto loans, subprime loans packaged into asset backed securities are getting crushed by net charge-off rates that are worse than during the Financial Crisis.

In a new study, life insurer and financial services provider Northwestern Mutual found that 45% of Americans that have debt spend “up to half of their monthly income on debt repayment.” Those are the true debt slaves. Excluding mortgage debt, American carry an average debt of $37,000. Of them, 47% carry $25,000 or more, and more than 10% carry $100,000 or more in debt, excluding mortgage debt.

Financial Review

Puerto Rico Screwed

Sinclair Noe — May 2, 2016

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DOW + 117 = 17,891
SPX + 16 = 2081
NAS + 42 = 4817
10 Y + .05 = 1.86%
OIL – 1.14 = 44.78
GOLD – 1.50 = 1290.90

Puerto Rico’s governor said Sunday that he had ordered a debt moratorium, blocking a $422 million payment due today.  The US Congress continues to debate a legislative fix for Puerto Rico’s $70 billion debt load. The default ratchets up pressure on Congress to find a legislative solution for Puerto Rico, which owes another $1.9 billion of debt on July 1, including about $777 million in general obligation debt backed by its constitution.

Meanwhile, Puerto Rico is battling the Zika virus, and hospitals and health clinics are forced to shut down because of debt. New York City has sent one million condoms to help combat the spread of the disease. There is some symbolism there.

The Institute for Supply Management (ISM) said its index of national factory activity fell to 50.8 from 51.8 the month before. A reading above 50 indicates expansion in the manufacturing sector and a reading below 50 indicates contraction. The employment index rose to 49.2 from 48.1 a month earlier. Expectations called for a reading of 49.0. New orders dropped to 55.8 from 58.3. The prices paid index rose to 59.0 from 51.5, compared to expectations of 52.0.

Construction spending increased 0.3 percent to the highest level since October 2007, following an upwardly revised 1.0 percent jump in February. Construction outlays were up 8.0 percent from a year ago. In March, construction spending was supported by a 1.1 percent surge in private construction. Public construction outlays fell 1.9 percent in March.

According to a Federal Reserve survey of senior bank loan officers, credit quality deteriorated in the first quarter on loans to businesses and consumers in energy dependent areas of the country. Low energy prices have led to declining activity in regions of the country where oil and natural gas extraction is a key driver of economic activity.

According to the survey 58% of the banks reported that loan quality is going to continue to deteriorate assuming energy prices remain low. About 15% of banks reported that credit quality had worsened on consumer credit card loans and 14% on loans outside of credit card and autos. Commercial real estate loans were a concern for 16% of the banks. And the hardest hit area is auto loans, where 23% of banks reported credit deterioration. Almost half of the banks surveyed said they were tightening lending policies on firms in the energy sector.

Baker Hughes and Halliburton are calling off their megamerger. Opposition from both US and European regulators has caused the two energy giants to call off their $28 billion deal. The deal’s cancellation means Halliburton must pay Baker Hughes a $3.5 billion termination fee by Wednesday. The cash-and-stock acquisition – valued at $34 billion when it was announced in November 2014, and now worth about $28 billion – would have brought together the world’s No. 2 and No. 3 oil services companies, raising concerns about higher prices in the sector.

Oil-and-gas producers Midstates Petroleum and Ultra Petroleum have filed for Chapter 11 bankruptcy protection, joining several companies that have been unable to meet debt obligations after a steep decline in energy prices. Oklahoma-based Midstates and Houston-based Ultra have a combined $5.8 billion in debt.

The two join dozens of U.S. oil and gas producers that have filed for bankruptcy since the start of 2015. Following this weekend’s bankruptcies of Ultra Petroleum and Midstates, the energy high-yield default has soared to a record 13% rate, surpassing the 9.7% mark set in 1999, according to Fitch Ratings.

Talks for a free trade deal between the U.S. and Europe face a serious impasse with “irreconcilable” differences, according to leaked negotiating texts discussing the Transatlantic Free Trade Agreement. The leaked documents come from the Dutch chapter of Greenpeace show that American trade negotiators had pressed their European counterparts to loosen important environmental, consumer protection and other provisions.

The deal, known as the Transatlantic Trade and Investment Partnership, or TTIP, would cover a huge range of goods and services between the world’s largest national economy and the world’s largest single market, spanning telecommunications, agricultural products, textiles, intellectual property, financial services and regulatory compatibility. The documents were shared in advance with several European publications. When you consider this latest document leak along with the recent Panama Papers, one thing is starting to stand out. Secrecy doesn’t exist in the digital age.

Sports Authority has decided to sell its remaining assets. Rather than attempt to re-organize under Chapter 11 bankruptcy protection, Sports Authority will hold an auction May 16. If a buyer emerges, some locations could be saved. There are 463 Sports Authority stores in 41 states employing more than 14,500. Sports Authority is $1.1 billion in debt and lost $256 million before taxes in fiscal year 2015. In January, Sports Authority failed to make a $20 million debt payment.

Takata shares plunged as much as 16% overnight on reports that the company, already at the center of the biggest safety crisis in automotive history, will soon get hammered by regulators. The NHTSA has told automakers that recalls will expand to all cars with Takata air bags lacking a moisture-absorbing desiccant that keeps the devices from deteriorating. There are more than 100-million such vehicles worldwide.

Verizon is deploying “thousands” of extra personnel, as a strike of nearly 40,000 wireline workers drags on in its third week with few signs of resolution. Some employees are on special assignment and others are coming out of Verizon’s technical training in Virginia. On Thursday, the company made a “last, best and final offer” to leaders of the CWA and IBEW, but union leaders responded that Verizon needs to “get serious about negotiations.”

Hulu is designing a subscription service that would stream feeds of popular broadcast and cable TV channels, in a move that would make the company a competitor to traditional pay-TV providers and other new digital entrants. Until now, Hulu has offered on-demand programming from major networks, similar to Netflix.

Hulu wants to offer what is known as a “skinny bundle” of broadcast and cable channels; in particular, those operated by 21st Century Fox, the Walt Disney Company and Comcast’s NBCUniversal. Those three media companies co-own Hulu. They hope to launch the service in the first half of 2017. While exact pricing details are still being determined, the new service is expected to cost about $40 a month.

Sony is developing a pair of intelligent contact lenses. The tech nerds are calling them “smart eyes,” and they’re supposed to measure a person’s blink, wink, and tilt of the eye to figure out when to record, save and delete video. Sony’s contacts include a camera, a wireless processing component and a storage unit, and differ from Samsung’s smart lenses patented earlier this month, which rely on a smartphone.

Last week I promised more on the old idea of Sell in May and stay away. Stock market returns are far worse from May through the end of October, than they are during the rest of the year. So as May starts, history suggests that (based on market performance as a whole) you might be smart to sell your shares now, and not bother with markets again until November.  Over the past 15 years, stock markets have performed far better between November of one year and April of the next, than between May and October.

MSCI Asia ex-Japan Index, Singapore’s STI, the Hang Seng, Malaysia’s KLCI, the Shanghai Composite and the S&P 500 (as well as the MSCI World) all perform significantly better from November 1to April 30, than from May 1 to October 31.

For example, the MSCI Asia ex-Japan posted a negative return of 1.7 percent, on average, during the May-November period in 2001-2015, and a 9.0 percent return from November through April. Since 2001, on average the STI has fallen 1.9 percent from May through October, and appreciated by 6.7 percent during the period from November to April.

The biggest difference in performance for the two periods was for the Shanghai Composite, where shares fell by 6.3 percent on average from May through the end of October, but rose by 10.4 percent during the other period.

The S&P 500 has a negative 1.4% from May through October and a positive return of 5.1% for November to May, for a difference of 6.5%. Over the past 50 years, the average gain for the Dow was less than 1% from May to October. In contrast, the average gain was more than 7% from November to April.

So, the idea was that you sold Friday, and now you can go on vacation until November 1^st. Is it really that simple? Well, yes. Since 1950, there have only been 9 years when the DJIA Best Six Months failed to delivery market gains. And if you want to get a bit more specific, there is an extra entry-exit strategy. Sy Harding made some minor adjustments to the six-month cycle and added MACD as a timing mechanism (MACD stands for moving average convergence divergence).

First, start the bullish cycle on October 16th, which is two weeks earlier. Starting the cycle, a little earlier makes sense because there have been several October bottoms in the S&P 500. Second, start the bearish cycle on April 20th. Third, add MACD to time signals near these cycle dates (October 16th and April 20th).

So, you would look for a bullish MACD any time after October 16 for you buy signal, or you would look for a bearish MACD any time after April 20 for your sell signal. The S&P 500 crossed its signal line last week on the 26^th. As always, momentum indicators and seasonality always takes a back seat to price action. The Sell in May idea is playing probabilities, not a guarantee. The other nice thing is that you can take a summer vacation and you don’t have to worry about the markets.

Financial Review

Fixing the Unbroken

Sinclair Noe — March 31, 2015

 

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DOW – 200 = 17,776
SPX – 18 = 2067
NAS – 46 = 4900
10 YR YLD – .03 = 1.93%
OIL – 1.15 = 47.53
GOLD – 2.30 = 1183.70
SILV – .06 = 16.73

The S&P/Case-Shiller 20-city home price index showed steady gains in January, up 0.9% from December. Compared to January 2014, prices were up 4.6%.  In Phoenix, resale home prices were unchanged from December to January, and posted a year-over-year gain of 2.6%.

The Conference Board’s consumer confidence index moved up to 101.3% in March from an upwardly revised 98.8 in February. The present situation index, a measure of current conditions, actually fell to 109.1 from 112.1. Yet the future expectations index increased to 96.0 from 90.

We’ve seen quite a bit of volatility in the markets lately. Today marks the 16 session in the month of March where the Dow Industrial Average has closed with a change in excess of 100 points. That is the second most of any month in history; following 20 triple digit moves in October 2008.

Sell in May and go away. You’ve probably heard this stock market advice. The idea is that you can divide the year into the best six months and the worst six months for the stock market; and we are now heading into the worst six months. Like most indicators, it is a measure of probabilities, not a guarantee. Mechanical selling on the last day of March and then buying back in on the last day of October only produces a slight advantage in returns but it eliminates a bunch of risk. Waiting for a market signal, such as a slight downturn in March to sell and a slight uptrend in October to buy produces a significantly better return; and even better, this market-beating return was produced with 39% less risk, which means it’s even further ahead of buy-and-hold on a risk-adjusted basis.

Today ends the first quarter for 2015. The Nasdaq posted gains of 3.5 percent for the quarter, marking the index’s first nine-quarter winning streak. The S&P eked out its own nine-quarter run with a gain of 0.4 percent last quarter. The Dow was negative for the quarter, down about one-quarter of one percent.

The S&P 500  finished the quarter with a small gain; marking the ninth straight quarterly advance for the S&P 500, and the longest winning streak since 1998. The index has only had three other stretches that long since World War II. That’s good news for bulls because the previous three times the market notched a nine-quarter winning streak, the S&P 500 index averaged an increase of 8.1 percent in the 10th quarter. The measure is still down 1.9 percent from a record on March 2 and among the worst performers in 24 developed markets this year.

Of course, the big market mover for the quarter was oil, which dropped from $55.50 a barrel to today’s close of $47.53, a loss of $7.97, or just over 14%. Today marks the deadline for negotiations between Iran and Western Nations to find a resolution to a 12-year standoff over Iran’s nuclear program. And there has not yet been a resolution, so it looks like there will be an extension of the deadline. That is actually considered positive news; the talks would not have been extended if there was no hope for an agreement. There’s some speculation that Iran will be able to release a lot of oil into the world if a deal is reached; good news for drivers, maybe.

The Stoxx Europe 600 index is up 17 percent in the first quarter of 2015. If that gain holds to the end of the day, it will be the best Q1 for European stocks since 1998. German, Italian and Portuguese stock indices are all up more than 20 percent in the quarter.

Asian equities are off to a winning start this year, with China and Japan stealing the show in the first quarter. Abundant global liquidity, provided by the BOJ and ECB, combined with interest rate cuts by several central banks in the region and lower oil prices have bolstered sentiment towards Asian equities. China’s Shanghai Composite has rallied 17% so far this year and expectations of further stimulus will likely buoy the market going forward. Japan’s Nikkei Index was the second top performer in the region, up 13% YTD, benefiting from the central bank’s QE policies and the shift by the country’s pension funds out of bonds and into equities.

Giving his second speech on the topic since Friday, Fed Vice Chairman Stanley Fischer declared that regulators must better monitor and consider new rules for the growing proportion of lending being done within the shadow banking sector. Fisher said: “Non-bank firms and activities can pose the same key vulnerabilities as banks, including high leverage, excessive maturity transformation, and complexity, all of which can lead to financial instability.” The Financial Stability Board stated in a November report that U.S. financial assets held by non-banks reached $25.2 trillion in 2013, exceeding pre-crisis levels.

Recently, we talked about the poor outlook for earnings; both revenue growth and earnings expectations have been ratcheted down for the first and second quarters. Of course one sector feeling the brunt is energy, no surprise there. One of the sectors that had been expected to grow earnings was the financials – but not so fast. Banks, looked to as a bright spot for the upcoming earnings season might not live up to expectations, according to an analysis from Goldman Sachs. The firm’s analysts cut profit outlooks for three of the top four money center banks on Wall Street: BofA, JPMorgan, Citi, and Morgan Stanley. Collectively, Goldman expects the biggest challenge to the banks this year coming from decreased capital markets activity, a worsening macro outlook and increased regulation.

And while we’re on the topic, it is time for today’s edition of “Banks Behaving Badly,” featuring a familiar name, HSBC, the UK’s biggest and possibly worst. HSBC gained notoriety for money laundering a sanctions violations in a 2012 settlement that resulted in a $1.9 billion fine; it was not enough to warrant jail time, but it did result in a deferred prosecution agreement and the Department of Justice installed a monitor in the bank to make sure they operated according to slightly higher standards. The monitor has put together a 1,000 page report that chronicles HSBC’s failure to clean up its act, including failure to upgrade its IT systems, and forging documents. And just to clarify, this report is unrelated to the recent revelations about the way HSBC’s Swiss private banking arm helped clients avoid and evade tax, in some instances by moving bricks of cash around the financial system.

Senator Elizabeth Warren is well known for her opinions on the need for more bank regulation. In 2013, she met with JPMorgan CEO Jamie DImon. In a new afterword for the release of the paperback version of her book A Fighting Chance, Warren recalls that the tenor of the conversation between the two policy adversaries soured when Dimon complained about financial regulations that she has supported. At one point in the conversation, Warren told Dimon, “I think you guys are breaking the law.” Dimon reportedly replied, “So hit me with a fine. We can afford it.”

Indiana Gov. Mike Pence said today that he will back an amendment to the state’s new “religious freedom” law clarifying that it does not allow businesses to deny service to anyone, and insisted that he never intended to discriminate against members of the lesbian, gay, bisexual and transgender community. Pence said he wants the General Assembly to move legislation this week that would make it clear that businesses are not allowed to deny services to anyone. He continued to insist, however, that he does not support adding protections explicitly barring discrimination on the basis of sexual orientation and gender identity. In Indiana, major companies like Twitter and the NCAA, as well as Apple CEO Tim Cook and several others, have spoken out against the law.

Arkansas passed a religious freedom bill today that is similar to an Indiana law that has faced national backlash for legalizing discrimination against lesbian, gay, bisexual and transgender people. The bill cleared the Arkansas Legislature and now heads to the governor’s desk, where it is expected to be signed. In Arkansas, both Walmart and Acxiom, a big data company, have spoken out against the legislation.

Blackstone has agreed to pay more than $1.3 billion to a consortium led by Paulson& for three large hotels. The sale includes the Ritz Carlton and J.W. Marriott in Orlando, Florida and the J.W. Marriott in Scottsdale, Arizona.

Go Daddy is scheduled to hit the markets tomorrow. Go Daddy is expected to price its 22.0 million share IPO within a range of $17-$19, with Morgan Stanley, JP Morgan, and Citigroup acting as lead underwriters on the deal. The ticker symbol will be GDDY. The Scottsdale based company has been around for 18 years. Back in 2006, GDDY tried to launch an IPO but the company cited poor market conditions at the time. Since then there was a shake-up in management with the CEO stepping down in 2011 and then private equity firms acquired the company for $2.25 billion.

The company’s bread and butter is internet domain name registration; they have about 59 million domains under management, or about 21% of all current domain names in the world; they also offer web design services, hosting and security tools. Go Daddy has about 13 million customers, and about 28% are international, mainly Canada, the UK, and India. They still have room to grow in the US; more than half of small businesses in the US do not have a website, and many of the companies that have a website have little or no mobile capabilities. For fiscal year 2014, the company grew revenue 23% to $1.39 billion, which is impressive but still not enough to turn a profit; Go Daddy posted a loss of $61 million, down from a loss of $131 million the year before. And the company is still dealing with debt of around $1.4 billion.

Wednesday, April 30, 2014 - Record Highs in First Gear

Financial Review with Sinclair Noe

DOW + 45 = 16580.84 (record close)
SPX + 5 = 1883
NAS + 11 = 4114
10 YR YLD - .04 = 2.65%
OIL – 1.59 = 99.69
GOLD – 4.60 = 1292.30
SILV - .29 = 19.25

Back on December 31^st, we finished the old year with a record high close on the Dow Industrial Average at 16,576; since then the index has bobbed up  and down, briefly hitting an intraday high of  16,631 on April 4^th, but on that day we finished in negative territory. Today, a record high close. The S&P 500 is closing in on the record high close of 1890, but not today.

Now, when you hear the Dow is breaking records, you might think the economy is roaring, cruising along the highway in fifth gear. You would be wrong; the economy is stuck in first gear and the clutch is slipping. The Commerce Department reports the economy expanded at a mere 0.1% annual pace in the first three months of the year, one of the weakest rates of growth in the nearly 5-year-old recovery.

A slowdown had been expected due to the harsh winter weather that froze business activity across a large swath of the country, but this report was worse than expected. The gross domestic product had been expanding at a 3.4% pace in the second half of last year. No worries, the weather has warmed and everything is returning to normal. Yeah, not exactly.

There has been a rebound in the monthly data for March but there have been some disappointments as well. On the positive side, households have pared down some of their debt, credit is a little more available, and consumer spending should bounce back. Even the 2% growth in consumption spending is not all that encouraging; 1.1% of that consumption growth, more than half, was attributed to higher household expenditures on health care.

Home construction is likely to pick up speed as the weather improves, but the housing market seems to be slowing down, with reports this week on new home sales turning soft and existing home sales turning negative in many areas. Residential investment has been negative for 2 quarters. The housing market probably won’t deliver much horsepower as the engine of economic growth but it should be a little better than the winter months, when many parts of the nation were frozen.

An area of concern is business investment, as company spending on equipment fell in the first quarter, and the 3 quarter average is barely positive. The change in inventories subtracted 0.57 percentage points from growth in Q1, exports subtracted 0.83 percentage points. The outlook for trade is soft; the US is not immune to weakness overseas; China’s economy has slowed; there are problems in the Eurozone; and emerging markets are still struggling. Meanwhile, incomes have flat lined and unemployment remains unpleasantly high.

On Friday we’ll get the monthly jobs report. Today, we got a preview from ADP, the human resources firm, and their data shows the economy added 210,000 jobs in April. The ADP report showed hiring picking up in nearly all industries and company sizes; it just isn’t picking up at a real fast pace.

The Federal Reserve FOMC wrapping up their policy meeting and they issued a statement that they will keep policy on the same track; interest rate targets are unchanged and the taper continues with another $10 billion in large scale asset purchases cut this month, to a mere $45 billion a month. The central bankers said that economic activity “slowed sharply” earlier in the year but noted it has “picked up recently.” And “The committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.”

The disappointing reading on economic growth earlier in the day underscored how bumpy the road back to normal can be. The FOMC statement repeated language from its last meeting in March stating that it will consider the country’s realized and expected progress toward full employment and 2% inflation in determining when to increase rates. The Fed also reiterated that it will take into account “a wide range of information,” including the health of the labor market, inflation pressures and financial developments. In some ways, you could look at the continuation of the taper as a vote of confidence from the Fed. Fed policymakers have said that the phaseout of bond purchases is not on autopilot; the Fed can speed it up or slow it down, depending on how the economy progresses, but apparently the weak GDP number today was not convincing enough to alter expectations; or maybe GDP falls outside the Fed mandate of price stability and maximum employment, and maybe it isn’t something they should specifically pinpoint. Of course, if the economy turns south, they will have to deal with it.

Many Americans are still wondering when the recovery is going to start, but by economic measures, the economy stopped shrinking and started growing in June 2009, the official start of the recovery. That was 58 months ago. Since 1945, the average length of a business-cycle expansion has been 58 months. So if the current recovery continues, it will end up being longer than average, not to mention much weaker. And today’s GDP number was right on the edge of recessionary. The cold weather excuse only goes so far. Already in the second quarter we’ve had deadly and damaging tornadoes, and as the weather continues to warm, we’ll deal with the effects of drought. You have to wonder if the economy was plagued by more than just weather last quarter.

That doesn’t mean we are now entering a recession; we may be close but we aren’t there yet, and we may still rebound, but this affords a good opportunity to think about how you might handle the next downturn in the business cycle. The stock market was up today, and in light of the GDP report, you have to wonder about stock valuations; the earnings reports haven’t afforded much to cheer. Are you still buying or are you looking to sell into strength.

Since Q4 2011, the average peak-to-trough pull-back on the Dow has been roughly -6%, with no correction exceeding -10%. One may ascertain that a "buy-on-the-dip" mentality remains pervasive among equity investors. So why not add to long, risk-on positions once again? Could this pull-back be different? Aren't stocks "the only game in town" with the excessively accommodative Fed monetary policy?

And while you consider market risk, don’t forget the old idea of the best and worst six months in the stock market; we’re entering the worst six months by the way. The old adage "Sell in May and Go Away", warning investors of a seasonal decline in equities, is often attributed to summer vacations and decreased investment flows relative to winter months. According to the Stock Trader's Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period. 

When we look at the 13 cases since 2001, the strategy of selling out just before May would have given rise to successful trades in 9 cases, or about 70 % of the time. Moreover, we observe that the "Sell in May" strategy has not failed in two consecutive years since 1992-1993. Given that "Sell in May" failed in 2013, we estimate the odds for a seasonal decline are even higher for 2014. This is not a perfect indicator, but there are not perfect indicators. You have to think that anybody who doesn’t recognize the odds is just trying to sell you something.

And on the question of valuations, at 18 times forward earnings for the S&P 500 and 36 times forward earnings for the Nasdaq, US stocks are generally closer to the high end of their range; that seems a bit pricey compared to emerging markets with 12 times forward earnings. Still, somebody was buying today, at least enough to push the Dow to a record high close. Investor optimism for US stocks has been trending up since the end of 2011, reaching an extreme level in January. Of course that would be a contrary indicator. There are plenty of voices telling you to stay the course, or even buy, and then buy some more. I’m just saying it is important to consider the possibility of selling into strength.

Friday, April 11, 2014 - Corrupt or Incompetent, Take Your Pick

Financial Review with Sinclair Noe

DOW – 143 = 16,026
SPX – 17 = 1815
NAS – 54 = 3999
10 YR YLD - .01 = 2.62%
OIL - .07 = 103.33
GOLD + .30 = 1319.40
SILV - .07 = 20.06

The S&P 500 closed at its lowest level in two months. The gauge slipped 2.7% this week, the biggest loss since 2012. The Dow Industrial are down 2.4% for the week. The Nasdaq Composite Index dropped 1.3% today, capping its biggest two-day retreat since 2011; and down 3.1% for the week; closing at its lowest level in 4 months. The major US indices are all back in the red year to date. Biotechs fell for the 7th week in a row; the worst run since 1998; and now down 21% from recent highs. About 7.4 billion shares changed hands on US exchanges, 5.8% higher than the three-month average.

We are entering a period that has historically been very poor for stocks. The idea is called “Sell in May” or the worst six months. According to the Ned Davis (NDR) database, had you invested $10,000 in the S&P 500 every May 1st starting in 1950 and sold October 31 of the same year, your initial position would only be worth $10,026. Put another way, by investing only from May through October, a $10,000 stake invested in 1950 would have only made $26.

The Labor Department reports the producer price index, gained 0.5% for March. Excluding the volatile categories of food and energy, core PPI prices rose 0.6% after falling 0.2% in February. The University of Michigan/ Thomson Reuters consumer sentiment rose to a preliminary April reading of 82.6, the highest reading since July, from a final March level of 80.

You’ve probably heard about the Heartbleed bug.  Heartbleed is a flaw in OpenSSL, a piece of code intended to create a secure connection between a server and Web browser; for example, between an online shop and customer. The bug allows an attacker to make the server surrender bits of information out of its memory that should not be accessible. What's more, the exploit leaves no trace. The fear is that the bug may expose credit card numbers, passwords, and more.

By some estimates the Heartbleed bug puts two-thirds of all websites at risk. Millions of smartphones and tablets running Google’s Android operating system have the Heartbleed bug. The government has issued a warning to businesses and banks to be on alert for hackers possibly stealing data.

The Federal Financial Institutions Examination Council, made up of representatives from the Federal Reserve Board of Governors, the Consumer Financial Protection Bureau and other regulators, said: “The vulnerability could allow an attacker to potentially access a server’s private cryptographic keys compromising the security of the server and its users. Attackers could potentially impersonate bank services or users, steal login credentials, access sensitive e-mail, or gain access to internal networks.”

And there’s not a lot you, as a consumer, can do until the websites fix the problem on their end. It may take some time. The Heartbleed bug has been found in the hardware connecting homes and businesses to the Internet. Cisco Systems and Juniper Networks said some of their networking products are susceptible to the encryption bug. Security experts say it might help to change passwords on sites you visit, but fixing the network equipment and software means the companies will rely on customers applying patches as they become available. Cisco said it would tell customers when software patches for its affected products are available.

Now for the scary part.

Bloomberg News reports the National Security Agency has known about the Heartbleed bug for 2 years, and rather than report it, or take steps to close it down, the NSA instead regularly used the encryption flaw to gather intelligence. Putting the Heartbleed bug in its arsenal, the NSA was able to obtain passwords and other basic data that are the building blocks of sophisticated hacking operations. The agency found the Heartbleed glitch shortly after its introduction, according to one of the people familiar with the matter, and it became a basic part of the agency’s toolkit for stealing account passwords and other common tasks.

The revelations have created a clearer picture of the two roles, sometimes contradictory, played by the US’s largest spy agency. The NSA protects the computers of the government and critical industry from cyberattacks, while gathering troves of intelligence attacking the computers of others, including terrorist organizations, nuclear smugglers and other governments.

Questions remain about whether anyone other than the US government might have exploited the flaw before the public disclosure. Sophisticated intelligence agencies in other countries are one possibility. If criminals found the flaw before a fix was published this week, they could have scooped up millions of passwords for online bank accounts, e-commerce sites, and e-mail accounts across the world.

If the reports are true, they would represent a serious breach of the NSA's mission.  There’s no excuse for leaving Americans and businesses vulnerable to breaches on this scale. They should be helping to shore up vulnerabilities, not exploiting them. The NSA has issued a statement denying prior knowledge of the Heartbleed bug; which is not a reassuring denial. This is one of the biggest breaches in the history of the internet, and the NSA, which is supposed to watch this stuff, claims they know nothing. For now, the NSA is sticking to their story that they are incompetent rather than corrupt.

Earnings reporting season is gearing up, with an epic miss from the biggest US bank. JPMorgan Chase said its first-quarter earnings fell 20%, driven by a decline in investment banking and mortgage lending. The bank reported net income of $4.9 billion for the first quarter, after stripping out payments to preferred stockholders. That was down from $6.1 billion in the same period a year earlier. On a per-share basis, the earnings amounted to $1.28, missing estimates of $1.39. Revenue, after stripping out the effect of an accounting charge for credit losses, was $23.8 billion, down 8 percent from $25.8 billion a year earlier. Revenues at the bank's fixed income trading business, part of its investment banking unit, slumped 21% to $3.8 billion. Mortgage originations plunged 68% to $6.7 billion, compared with the same period last year; the bank doesn't expect the trend to change anytime soon.

Wells Fargo posted a profit of $5.9 billion, up 14% from the same period in 2013. Still, the bank’s revenue for the quarter fell to $20.6 billion from $21.3 billion in the same period a year ago.

A federal judge has approved the city of Detroit’s latest attempt to extricate itself from some long-term derivatives contracts that have been costing it tens of millions of dollars a year, holding up a settlement as an example of “the very spirit of negotiation and compromise” that he hoped other creditors would follow. Judge Steven Rhodes of United States Bankruptcy Court ruled that Detroit could proceed with a plan to pay $85 million to UBS and Bank of America to terminate the financial contracts, known as interest-rate swaps, that were used to help finance pensions.

Under the terms of the settlement, the two banks agreed to back Detroit’s overall plan of adjustment, which is critical for the city’s push to resolve its bankruptcy by early fall. Municipal bankruptcy rules say that if one class of impaired creditors votes to approve the city’s plan of debt adjustment, the judge may be able to impose the terms forcibly on everybody else. The judge’s decision gives Detroit leverage for settlements with other creditors.

Earlier this year, Judge Rhodes had rejected a previous attempt to end the swaps that called for Detroit to pay the banks $165 million. He called that proposal “just too much money” and noted that Detroit would have a reasonable chance of success if it sued the banks outright, calling the swaps invalid and refusing to make any termination payments at all. The message was to re-engage in negotiations, and apparently it worked.

Detroit’s emergency manager, Kevyn Orr, and other officials have been calling for creditors to negotiate settlements quickly out of fear that Detroit’s case will become a hopeless quagmire if creditors keep fighting the city’s proposals for resolving their debts. The state law that put Detroit under emergency management is scheduled to expire in September.

Detroit entered into the swap contracts in 2005, when it tapped the municipal bond market for $1.4 billion to put into its workers’ pension funds. Much of the deal was structured with variable-rate debt, and the swaps were intended to work as a hedge, to protect Detroit if interest rates rose. But rates fell, and under those circumstances, the terms of the swaps called for Detroit to make regular payments to UBS and Bank of America. The swaps cost Detroit about $36 million a year.

The 2005 borrowing also required an unusual structure to avoid violating the city’s legal debt limit. In 2009, the debt was downgraded to junk, putting the city out of compliance with the terms of the swaps. So Detroit restructured the swap obligations, offering the two banks the tax revenue that it received from local casinos as a backstop.

When Detroit declared bankruptcy last summer, it estimated the cost of terminating its swaps at about $345 million. Days before filing its bankruptcy petition, Detroit said Bank of America and UBS had given it a break, so that it would have to pay only about $250 million to cancel the contracts. But other creditors, facing bigger relative losses, complained that the two banks were still getting way too much. They argued, among other things, that the interest-rate swaps were invalid from the beginning because the use of casino taxes for financial hedges is not allowed under state law. So, Detroit either got off cheap at $85 billion or the banks just stole $85 billion.

Monday, April 07, 2014 - I Don’t Know, They Don’t Know

Financial Review with Sinclair Noe

DOW – 166 = 16,245
SPX – 20 = 1845
NAS – 47 = 4079
10 YR YLD - .03 = 2.69%
OIL - .44 = 100.70
GOLD – 5.40 = 1297.90
SILV - .09 = 19.97

The biggest 3 day drop in the markets in about 2 months. All of the sudden we start hearing the Wall Street stock peddlers waxing enthusiastic about the prospects for a correction or a crash or whatever will scare you. Fear sells; with talk about a 1987-like stock market crash, geopolitical unrest in Ukraine and the risk of a debt crisis in China, investors are starting to get jittery. I don’t know, they don’t know.

The big pullback so far has been in the Nasdaq, and especially biotech stocks. As always, you want an exit plan in place before you ever get into a trade; and if you don’t have an exit plan, get one now. You don’t make money by letting profits slip through your fingers.

Earnings season gets underway this week. Expectations have been ratcheted down; at the start of the year, S&P 500 companies were projected to have grown earnings at 6.5%, now that estimate has slipped to 1.2%. We could see companies beat diminished expectations and start a fresh rally or miss expectations and the markets could get a bit ugly. The simple rule of thumb is that when the trailing P/E ratios hit 10, the S&P 500 is likely undervalued; when the P/E hits 20, the market is likely overvalued and that means the market is vulnerable to pullback. Guess where we are on the scale? Does that mean that stock prices are about to roll over and play dead? Not necessarily. All we have to do is add some earnings to the P/E ratio and …

The S&P 500 recently, as in last week, tested highs, even though fewer than 10% of its components were making new highs individually. Despite the fact that the S&P touched new high territory last week, the average stock in the big index is actually down 7%. Then, you can look at volume; down on up days; up on down days, like today. Toss in the presidential election cycle, toss in the old but true idea of “sell in May”, and there are plenty of reasons for caution.

The past couple of years have been easy; buy the dips; buy good names with momentum and ride that pony to profits. Easy. But easy doesn’t last forever. The momentum names look like they’re rolling over. Investors are rolling over into safer sectors. We’ve gone nearly 2 years without a correction of at least 10%, so it just seems like we’re due. So, while there may be value to be found, this does not seem like a good time to load up when high flyers dip. They may bounce back, but they don’t have to; there is no law that requires a bounce. When a momentum play turns, it tends to turn fast and furious.

This continues to be a tale of two markets. While the high flyers stall, the safety of bonds has been drawing bids, and yields have dipped over the past few days, despite the Fed's clear intention to pull back on Quantitative Easing and bond buying. The utility sector has been outperforming, which might be a signal of future volatility. Emerging markets have seen inflows; maybe this is the idea that the US has been the cleanest dirty shirt in the hamper, but the other shirts aren’t ready to be scrapped; call it a reversion to the mean.

Maybe it’s just time to pause and ask why US stocks have priced in so much optimism. Job growth continues but it is not robust and it is not enough to propel the economy to escape velocity; the taper is underway; fiscal policy remains a mess and there is little hope for stimulus from DC.

Corporate America is sitting on a mountain of cash, somewhere between $1.6 and $1.9 trillion, but it’s offshore; they’re afraid to touch it because they might have to pay tax. They could bring that money back home and put it to work, but that would require innovation and sweat and labor. Much of corporate leadership is short-sighted and lazy, and besides, the offshore cash is still good enough to secure a bonus.

One of the key signs of a true recovery is sufficient business confidence to start investing more into their own operations. Many companies have shied away from investing in the future growth of their companies. Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks. If you’re waiting for capital expenditures to revive the economy, don’t hold your breath.

Larry Fink is the CEO of Blackrock, the largest money manager, he says: “Companies only have a finite amount of cash to invest. Whatever gets spent on buybacks and dividends is that much less available to be spent on investments in employees, research and development, and capital expenditure. It's basic arithmetic. When will the next round of capital investment begin in earnest? As soon as you figure out the answer to that question, you will have gained significant insight into the direction of the economy as well as the next phase of this stock-market rally.”

Meanwhile, let’s look at banks behaving badly. Private banking is a staple of the Swiss economy and for decades, as wealthy Americans concealed their assets through clandestine accounts, US regulators turned a blind eye.

In 2011, federal prosecutors indicted 7 Credit Suisse bankers for abetting tax evasion, but the investigation into Credit Suisse dragged on. The quirks of international law prolonged the inquiry, requiring Swiss courts to review Credit Suisse documents before releasing them to the Justice Department. Ultimately, the Justice Department gained access to many of the documents and interviewed bank employees.

And by the time the Senate subcommittee convened its hearing in February, the Justice Department was closing in on a case. Bracing for a settlement, the bank announced last week that it had set aside roughly $528 million for legal expenses. In addition to the Justice Department investigation, Credit Suisse paid $200 million to settle a case with the SEC in February. In a separate matter, in late March the bank agreed to an $885 million settlement to resolve claims that it sold questionable loans to Fannie Mae and Freddie Mac. Apparently a slap on the wrist and a fine haven’t served as a deterrent.

Now, Benjamin Lawsky, New York State’s top financial regulator, has requested documents from Credit Suisse and is expected to demand additional records this week to try to determine if Credit Suisse lied to New York authorities about engineering tax shelters. In the Senate subcommittee hearings in February, Credit Suisse executives apologized for the misconduct and they also argued that the problems stopped in 2008 and were contained to a few low-level rogue bankers. The bank, which said it voluntarily adopted a number of controls against tax evasion, reported that there was no evidence that executive management knew of the problems.

Lawsky has also petitioned a Senate subcommittee for internal Credit Suisse documents.  The subcommittee questioned bank executives at a hearing in February, and produced a scathing report exposing “a classic case of bank secrecy.” In late March, the Senate agreed to release the internal Credit Suisse documents.

The escalating Credit Suisse probe, along with some recent shifts in international law, might also provide momentum to the government’s uneven effort to collect taxes and punish the banks involved. Typically the punishment has been a fine and a slap on the wrist, but that has drawn scrutiny from politicians lately, and so maybe this will be something more.

Meanwhile, federal authorities have opened a criminal investigation into a recent $400 million fraud involving Citigroup’s Mexican unit, one of a handful of government inquiries looming over Citi.

The investigation, overseen by the FBI and prosecutors from the United States attorney’s office in Manhattan, is focusing in part on whether holes in the bank’s internal controls contributed to the fraud in Mexico. The question for investigators is whether Citigroup ignored warning signs, as other banks have been accused of doing in the context of money laundering.

Federal prosecutors in Massachusetts have sent subpoenas to Citigroup, to examine whether the bank lacked proper safeguards against clients laundering money. Citi also faces a parallel civil investigation from the SEC. And it was just 2 weeks ago that Citi fell short in the Federal Reserve’s stress test. The Fed rejected Citi’s plan to increase its dividend based upon questions about the reliability of Citi’s financial projections.

And that brings us to the tale of Kenneth Lewis, the former chief of Bank of America. Back in 2008, as the global financial meltdown imploded, Bank of America rushed in to acquire Merrill Lynch. Lewis called it the “strategic opportunity of a lifetime” and he said the Fed did not pressure him into the deal. He later admitted he lied. Merrill Lynch was bleeding cash while paying huge bonuses. Bank of America required 2 bailouts from Treasury plus extraordinary lending from the Fed. It is a crime to knowingly deceive shareholders about the financial condition of your company.

Bank of America has paid several fines related to cases brought by various regulators, and there is still an outstanding suit, but the case of Kenneth Lewis wrapped up last week. Mr. Lewis agreed to pay $10 million, which was provided by Bank of America. He is barred from being an executive or director of a public company, but he already retired with a sizeable golden parachute. He did not have to admit or deny wrongdoing.