Financial Review

Inside the Stagecoach

Sinclair Noe — September 13, 2016

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DOW – 258 = 18,066
SPX – 32 = 2127
NAS – 56 = 5155
10 Y + .06 = 1.73%
OIL – 1.39 = 44.90
GOLD – 9.00 = 1319.40

Stocks opened in negative territory and then slipped further. Any rallies were half-hearted at best. Two months of tranquility was pierced Friday when the S&P 500 tumbled in its worst rout since the Brexit vote.

Things aren’t any better in the $13.6 trillion Treasury market. Ten-year notes were stuck in their tightest monthly range in a decade up until September.

Stocks exited the tightest trading range in history last week when European Central Bank President Mario Draghi downplayed the need for more measures to boost growth and Boston Fed President Eric Rosengren warned against waiting too long to raise interest rates. Fed rate-hike expectations are falling.

Dovish commentary from Federal Reserve Governor Lael Brainard has pushed back expectations for a September interest-rate hike. In a note out late Monday, economists at Goldman Sachs cut their forecast for a rate increase at the Sept. 20-21 meeting to a probability of 25% from 40% previously. It also lifted the odds for a December tightening to 40% from 30%. This is the third time this month the Goldman economists have changed their stance on the September meeting.

But don’t expect the volatility to just vanish. Abrupt breaks in calm have not been easily resolved in the past. In the five prior instances when turbulence spiked as it did Friday, the S&P 500’s daily swings averaged 1.5 percent in the next 20 days. That’s 2.5 times the move in the previous 20 days.

Oil futures dropped after the International Energy Agency cut its crude forecast, warning that supply will continue to outpace demand well into 2017. Global oil consumption growth sagged to a two-year low in the third quarter as demand faltered in China and India, while record output from OPEC’s Gulf members is compounding the glut.

As recently as last month, the IEA had expected the market to return to equilibrium this year. The agency downgraded its global oil demand predictions by about 100,000 barrels a day for this year to growth of 1.3 million barrels a day and cut its forecast for 2017 by 200,000 barrels to growth of 1.2 million a day. And as demand weakens, “Global inventories will continue to grow: stockpiles in July smashed through the 3.1-billion-barrel wall.”

With its first long-range electric car, General Motors has released figures that show it’s focused on beating Tesla at its own game. The new Bolt will be rated at 238 miles on a single charge when it comes to showrooms later this year, giving it a longer range than the Model 3, which is expected to have a range of least 215 miles and isn’t expected to go on sale until 2017. The Bolt is also likely to be priced at about $37,500, close to the same price point as Tesla’s first mass-market car.

The record-breaking installations of solar panels in the U.S. continues with 2 gigawatts installed in just the second quarter of this year, according to new data from GTM Research and the Solar Energy Industries Association (SEIA).

The solar industry installed 2,051 megawatts between April and June, marking the eleventh consecutive quarter in which the U.S. saw more than a gigawatt of solar capacity added to the grid. The volume of installations also marks 43 percent growth from the same quarter in 2015.

Nevada regulators are set to decide this week on a settlement between Berkshire Hathaway’s utility, NV Energy, SolarCity and the state’s consumer advocate to roll back rate increases for customers who installed rooftop solar systems prior to this year.

The three-member Nevada Public Utilities Commission has scheduled a September 16 vote on a proposal to shield more than 32,000 rooftop solar customers from increases that took effect in January.

Last year, NV Energy proposed increased charges and reduced payments to rooftop solar customers, saying the existing model forced non-solar customers to subsidize those who did use the green power. SolarCity, Sunrun and other solar installers stopped taking customers in the state soon after a December decision by the commission to raise rates on all solar homes.

They sued after regulators denied an appeal of the ruling. The proposal would put existing solar homes back onto the rates they paid before the increases started. NV Energy asked the PUC to grandfather those rates for as many as 20 years.

Phoenix-based Freeport-McMoRan will sell its deep-water Gulf of Mexico assets to Anadarko Petroleum for $2 billion. The deal is expected to close before year’s end. Freeport’s sale all-but ends a disastrous diversification from copper and gold mining into energy drilling, a move that received widespread investor criticism and is at the heart of the company’s 66% share price collapse over the past three years and the suspension of its quarterly dividend.

Fewer Americans lived in poverty in 2015 and median incomes charted their first increase since the Great Recession, according to data released today by the Census Department. The official poverty rate fell 1.2 percentage points between 2014 and 2015 to 13.5%, and the number of people in poverty fell by 3.5 million.

The threshold for a family of two adults and two children to be considered living in poverty was $24,036. Real median household income rose 5.2% during the year, the first annual increase in median household incomes since 2007. Earnings also increased: 1.5% for full-time year-round male workers, and 2.7% for female workers. That was the first significant annual increase in median earnings for either gender since 2009.

A measure of small-business sentiment declined in August as owners became more hesitant, with election worries at the forefront. The National Federation of Independent Business small-business optimism index fell 0.2 points to 94.4. The outlook for business conditions in the next six months had the most dramatic change, dropping seven points.

Boeing reports Chinese airlines are likely to purchase 6,810 planes worth just over $1 trillion in the next 20 years as they expand fleets to cater to growth in tourism.  Boeing will also unveil its T-X trainer plane today, designed jointly with Sweden’s Saab AB. The company is counting on the model to train generations of U.S. fighter pilots, and keep alive its St. Louis manufacturing base.

A second Hanjin vessel will dock and unload at the Port of Los Angeles after more than a week stranded off the Southern California coast. The move raised hopes that gridlock could be easing after a U.S. bankruptcy judge issued an order Friday allowing the financially ailing Hanjin Shipping Co. provisional protection from creditors so vessels could dock and unload products.

Meanwhile, the South Korean government is sticking to its hard-line stance on Hanjin Shipping. Government money will not be used to bail out the shipping company, although aid may be extended to small-to-medium sized businesses jolted by the process.

Starting in 2011, Wells Fargo employees opened 2 million bank and credit card accounts in customers’ names without their knowledge. The goal was to generate fees for the company and hit aggressive sales targets for employees.

After an investigation, the bank was accused of improperly opening accounts by the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency, and the Los Angeles prosecutor. Last week we told you the bank and regulators had settled for $185 million. But wait, there’s more.

The Senate Banking Committee has scheduled a hearing for September 20^th to investigate the matter. Moody’s, a credit rating agency, issued a warning that the settlement may have a negative effect on Wells’ debt because of image concerns and called the incident “highly disturbing.” Today, Treasury Secretary Jack Lew said Wells Fargo had participated in “bad behavior,” and that the accusations showed bank regulation should not be rolled back.

Wells CEO John Stumpf, in an interview with the Wall Street Journal, said that there “was no incentive to do bad things” at Wells and laid the blame on the employees rather than the culture of the firm.

CFO John Shrewsberry said the fraudulent accounts were not opened in order to generate revenue for the bank. Instead, a few employees opened them to boost their performance. The bank claims that 5,300 lower level employees were fired in relation to the cross-selling shenanigans, however that number is now in question.

That figure covers terminations over the period that the regulators investigated, from 2011 through 2015. The regulators did not start investigating until 2014.

Most of the firings were probably not related to the scandal. Or if they were firing employees for opening phony accounts, it means upper management was aware of fraudulent activity and failed to report it.

But wait, there’s more. Wells Fargo executive Carrie Tolstedt tendered her resignation in June and is scheduled to leave the bank at the end of the year. Wells Fargo says her retirement is not a result of the findings of the investigation.

She is in line to receive roughly $125 million in stock and other compensation from the bank; a golden parachute. Tolstedt was in charge of community banking during the entire time the “sandbagging” operation took place.

Her success in cross selling was repeatedly cited in annual proxies as the reason for her $9 million a year in compensation, plus the retirement package. When she resigned, John Stumpf said Tolstedt had been one of the bank’s most important leaders and “a standard-bearer of our culture and a champion for our customers.”

I’m not sure what kind of culture Stumpf champions, but it looks like modern day bandits are more likely to be inside the stagecoach than outside it.

The UK Economy Is Slowing Down After The Brexit Vote

Financial Review

Un-Zapped!

Sinclair Noe — August 10, 2016

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DOW – 37 = 18,495
SPX – 6 = 2175
NAS – 20 = 5204
10 Y – .04 = 1.51%
OIL – 1.28 = 41.49
GOLD + 5.20 = 1346.80

Job openings increased in June, and more people were hired. The Labor Department’s Job Openings and Labor Turnover Survey, or JOLTS, showed there were 5.62 million openings, up from 5.51 million in May, but still a bit below the all-time high of 5.84 notched in April.

There were 5.13 million people hired during the month, also an increase from the 5.05 million in May. Slightly fewer people quit voluntarily, but the 2.91 million quits in June is nearly double the levels of the worst of the recession. Quits are tracked as a measure of worker confidence in job prospects.

The federal government’s budget deficit is up 10% so far this fiscal year. The government’s shortfall for the first 10 months of the year was $514 billion, up from $466 billion in the same period a year ago.

Lower-than-expected revenues recently led the Congressional Budget Office to increase its estimate of the 2016 deficit to $590 billion, up from $534 billion. That would be about $150 billion more than last year’s deficit. Spending is up only about 2%. The problem is gross corporate receipts have dropped 12% so far this budget year.

The Bank of England revived its crisis-era bond-buying program last week as part of a package of measures to support the economy in the wake of voters’ decision to exit the European Union. It said it would buy $78 billion of British government bonds, or gilts, over the next six months, a policy known as quantitative easing. The aim is to drive down long-term interest rates and prod investors into riskier assets, making borrowing cheaper and easier for businesses and households. Just one problem – they can’t find enough bonds to buy, as yield-hungry pension funds and insurers refused offers to sell gilts to the central bank. The 10- year gilt dropped to a record low yield of 0.54%.

The UK economy is slowing down after the Brexit vote. That’s according to the latest numbers from the National Institute of Economic and Social Research, which shows growth in the UK was 0.3% in the three months up to the end of July, compared with 0.6% growth in the three months to the end of June.

Oil prices started the session moving higher but it didn’t last. The American Petroleum Institute issued a report showing a build of 2.1 million barrels of crude but it also reported a drop of 3.9 million barrels in gasoline, much larger than analysts had forecast.  Saudi production has reached 10.67 million barrels per day, up 120,000 bpd on the prior month. While it is not unusual to see Saudi production ramping up in the summer given higher demand for crude to be used for power generation, what is unusual is that production is now at a record high, above the peak seen last summer.

Also comes word that next month’s scheduled OPEC meeting in Algeria to discuss a freeze on production may be dead in the water. Oman announced it would not participate in a meeting. Finally, despite draws to both gasoline and distillates from today’s weekly EIA inventory report, builds elsewhere have lifted total U.S. crude and product inventories to a new record at over 1.39 billion barrels. This number has risen by 200 million barrels in the last 17 months. Storage tanks are filled to the brim and summer driving season is coming to a close.

One reason why the Saudis have been pumping so much oil is to try to drive US drillers in the shale fields out of business. It’s working. Chesapeake Energy agreed to give away its Barnett Shale holdings to a private-equity backed operator, exiting the birthplace of the shale revolution to escape almost $2 billion in onerous pipeline contracts. Chesapeake will convey all interests in the Barnett region in North Texas. Quitting the gas fields will slash Chesapeake’s shipping and processing costs by $715 million between now and the end of 2017 and eliminate a total of $1.9 billion in long-term pipeline agreements. Shares jumped more than 6 percent.

Brazil’s Senate voted to move the impeachment trial against suspended President Dilma Rousseff to its final phase, as expected, setting the stage for a final vote that could oust her later in August, after the end of the Olympic Games in Rio de Janeiro.

Rousseff is accused of violating budget laws by delaying payments from the government to state-controlled banks, in effect forcing the lenders to provide short-term loans to her administration. She has denied any wrongdoing. Acting President Michel Temer, who was elected as Rousseff’s vice president, would complete the more than two years remaining in her term if she is convicted.

Shake Shack shares fell more than 8% in after-hours trading as the company reported slower same-restaurant sales growth as compared with a year ago.

Hamburger chain Wendy’s reported profit and revenue figures that beat analyst expectations, but those results were offset by 0.4% same-restaurant-sales growth, which fell below the consensus. Wendy’s management blamed a focus on health and wellness is keeping some would-be customers away from fast-food restaurants. Others might be staying away because of … the presidential election.

Uncertainty surrounding the election was one reason business stumbled during the second quarter, adding to the list of areas that claim the Clinton-Trump face-off has gotten people too nervous to spend their money. Todd Penegor, chief executive officer at Wendy’s said, “[W]hen a consumer is a little uncertain around their future and really trying to figure out what this election cycle really means to them, they’re not as zapped to spend as freely as they might have been a couple of quarters ago.”

Sure that sounds like a lame excuse, but really, be honest, haven’t you felt a little “un-zapped” lately?

SolarCity’s loss widened. The company lost $0.56 a share, more than double the $0.23 loss from a year ago. Taking into account onetime adjustments, non-GAAP, SolarCity’s loss grew to $2.32, but that was ahead of the $2.44 loss that analysts were expecting. Revenue surged 81% to $185 million, easily beating the Wall Street consensus of $146 million.

SunPower, the second-largest US solar panel producer told analysts it expects to lose as much as $175 million this year, a shift from May when it expected to earn as much as $50 million. The shares plunged the most in more than seven years. SunPower said demand for utility-scale solar projects is slowing, while competition in the panel market is dragging down prices. The guidance bombshell is leaving a crater in solar shares in today’s trading.

You remember the scandal involving VW? As part of its penalties for equipping hundreds of thousands of its diesel vehicles sold in the United States with software designed to cheat tailpipe emissions tests, VW is required to invest $2 billion in clean car infrastructure, such as a network of electric car charging stations. Now, 28 Electric vehicle charging companies are calling for independent oversight; they want to make sure VW does not gain an edge in the car charging space. While the companies called the money a potential “game changer,” they worry that if it is misspent, it could hurt competition.

What’s the fastest growing devices when it comes to wireless connectivity? Is it tablets, smartphones, or computers? Wrong. It’s cars and other stuff. Internet-connected cars and other everyday products have become the fastest-growing part of the US wireless industry. AT&T dominated revenue in connected devices, with the company connecting cars to its network at twice the pace of tablets.

AT&T should reach 10 million connected car subscriptions soon. For carriers, the Internet of Things – a world in which everything from garage doors to cars to light bulbs connect to the web – has become a major source of revenue growth at a time when phone-related business has slackened. Verizon has been a distant second to AT&T in connected cars, but is mounting a big entry in a related area – connected trucks. Last week, the company agreed to buy Fleetmatics for $2.2 billion.

You know the company Alphabet?  You certainly know its subsidiary, Google? Alphabet has a market cap of $539 billion; it is one of the biggest companies in the world, bigger than some nations. It is one-year-old-today.  The restructuring was supposed to allow Google to focus on the things it knows how to do well and make money on—search, advertising, Chrome, YouTube, the Android operating system—and shifted more pie-in-the-sky projects, like trying to cure death, build robots, and beam the internet from weather balloons, into a new division called “Other Bets.”

One year later, Google is still growing—its revenue last quarter was $21.3 billion, up 21% from a year earlier—but similar signs of life have not been seen in Other Bets. In the last four quarters, it’s lost over $3.7 billion, and only generated roughly $500 million in revenue, which works out to less than 1% of Alphabet’s quarterly sales. Oh well, it’s still young.

Delta Air Lines tried to return to normal operations after a power outage hit its computer systems, causing the cancellation of more than 1,600 flights over two days. But they still had about 300 cancellations today. Most of Wednesday’s delays and cancellations are the result of flight crews being displaced or running up against maximum allowed work hours. According to Georgia Power, Delta’s problems arose after a switchgear, which helps control and switch power flows like a circuit breaker in a home, malfunctioned for reasons that were not immediately clear. In other words, the backup plan failed, and they still don’t know why.

Financial Review

Mind the Gap

Sinclair Noe — June 22, 2016

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

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DOW – 48 = 17,780
SPX – 3 = 2085
NAS – 10 = 4833
10 Y – .01 = 1.69%
OIL – .82 = 49.03
GOLD – 1.70 = 1267.00

Tomorrow, UK citizens will vote on whether or not they want the UK to remain a part of the European Union. This is the referendum, also known as the “Brexit” vote. While opinion polls suggested the vote was too close to call, betting parlors in the UK put the odds of a vote to remain in the EU at 76 percent. Nevertheless, the whole process has been a source of great uncertainty.

The euro currency hit its lowest level vs. the dollar in 12 years. Politicians on both sides of the debate will be making their last arguments today ahead of polling stations opening tomorrow at 7:00 AM London time. We probably won’t know the final vote count until Friday morning, although there might be a decision based on exit polls and early voting trends.

The major issues for Britons who want to leave: sovereignty, regulation, and migration. The major issues for Britons who want to remain in the EU: free trade, investment, unity, and peace. And while the greatest impact will be felt in the UK and the Euro Union, the vote will impact the US as well. The UK is a major trading partner with the US, our seventh largest trading partner last year.

Beyond economic ties, the US government is most concerned about the political instability a Brexit could portend for Europe on the whole. There has been tremendous speculation about how the vote will affect financial markets; everything from a complete crash, to a minor blip, to a big rally. The truth is we don’t know. No states have ever left the EU before, so this is uncharted territory.

Fed chair Janet Yellen was back on Capitol Hill this morning. Yesterday, Yellen delivered her semi-annual Humphrey-Hawkins testimony before the Senate Banking Committee; today she testified before the House Financial Services Committee and she repeated her dovish outlook for the economy. Yellen cited “considerable uncertainty” about the economic outlook, and the potential for a Brexit vote to shake up the markets, she said the employment picture should improve, but she basically took a July rate hike off the table.

Yellen once again stressed the word “patience.” The Q&A session following the prepared remarks revealed a few interesting points: Yellen opposes legislation that would force the Fed to reveal the design of its stress tests, she does not think Fed regulations pose much a headwind for business, the Fed plans a conference on student debt, and she said it is not the Fed’s job to boost the stock market. Yellen did ask Congress for help to boost productivity but she wasn’t very forceful; as if she knew there was no chance of Congress doing anything worthwhile.

Sales of previously owned homes increased in May to the highest level in nearly a decade. The National Association of Realtors said existing-home sales rose 1.8% to a seasonally adjusted annual rate of 5.53 million, the fastest pace since February 2007. Constrained inventory continues to dog the market, pushing prices higher. The median price in May was $239,700, 4.7% higher than a year ago.

In a separate report, the Federal Housing Finance Agency said home prices rose 0.2 percent on a seasonally adjusted basis from March, and 5.9 percent in April from a year earlier. Prices rose from a year earlier in all regions, led by the Pacific — including California, Washington and Oregon — with an 8.6 percent gain. The FHFA says the national median price of an existing single-family home was $233,700 in April.

The rent is too high. A new report from Zillow shows that rents across the U.S. are increasing, and not just in the expected regions of New York City, San Francisco and Boston. Overall, rents increased 3.3% year-over-year as of January. In Phoenix, rents are up 5.3% year-over-year.

Puerto Rico is being sued in New York by a group of hedge funds claiming it’s illegally using an emergency fiscal-crisis law to dodge payments that are supposed to be guaranteed by the island’s constitution. While Governor Alejandro Garcia Padilla has not yet implemented a temporary debt moratorium, many speculate he will soon because the territory is expected to default on a payment of nearly $2 billion on July 1.

Elon Musk’s Tesla is buying Solar City from…, Elon Musk. Tesla Motors, made an offer to buy his solar installation firm SolarCity in a stock deal worth as much as $2.8 billion. Tesla shares plunged more than 13 percent in extended trading – amounting to a loss in value of about $4.3 billion, or more than the value of the offer for the other company. Shares of SolarCity rose about 18 percent.

After the volatility caused by the news settles down, we’ll be able to see how investors really feel about it. But the move is classic Musk; the chairman of SolarCity, CEO of Tesla and the largest shareholder of both companies, described the deal as a “no brainer”; the company could sell customers an electric car, a home battery and a solar system all at once.

But talk about synergies is just short-term. In the long-term, Musk is trying to build a fully vertically integrated energy company, from energy installation to storage to application. It would be a company that generates power from the sun, stores energy in batteries, and uses those batteries to power cars and buildings. On a conference call this morning, Musk said that the cost of sales for SolarCity and Tesla could drop by potentially half, or perhaps by 30% to 40%. On the solar and battery installation set up side, there would be one crew instead of two to three visits. For ongoing maintenance, there would be one point of contact instead of two to three. The cost of hardware would also be lower.

The plan is not without risk. SolarCity is building a massive solar panel factory in upstate New York; this at a time when energy prices have dropped substantially. Tesla has brought many of its development needs in house, moving away from suppliers as much as possible. With the Gigafactory, its massive battery factory under construction outside of Reno, Nev., Tesla will soon be making its own batteries, too, by bringing that core technology in house.

Tesla has taken reservations and deposits for nearly 400,000 Model 3 electric vehicles and now they need to figure out how to manufacture all those cars. And in his spare time, Musk launches rockets into space and plans a mission to Mars. Musk said the deal doesn’t really add debt because SolarCity should be cash flow positive before the end of the year. Still, SolarCity comes with massive debt burdens, and Tesla itself is not cash flow positive.

The SolarCity deal, and for that matter everything about Elon Musk, is risky. Many Wall Street veterans and hedge fund activists seem to hate Musk. At the same time, many Wall Street veterans think the best way for companies to create shareholder value is to scrap spending on research and development and innovation, borrow money on the cheap and buyback their own shares; an obsession with delivering short-term returns to shareholders while ignoring the future of the business.

From 2009 to the end of 2013, corporate investments rose by $400 billion. But those investments were dwarfed by shareholder payouts, which increased by $740 billion. During that same period, companies borrowed $900 billion. The financial system is no longer an instrument for getting money into productive businesses and then increasing profits through growth, but has instead become an instrument for getting money out of them.

Consider the differences between two well-known companies, Apple and Amazon. Apple’s stock has lost about a quarter of its value over the last year, despite a bunch of stock buybacks at the urging of former shareholder and billionaire investor Carl Icahn. Apple needs another billion-dollar product, and no one sees one coming down the pipeline.

Apple spends 3.5% of its revenue on R&D; Google spends 15% of revenue on R&D; Facebook spends 21% on R&D; Amazon consistently denied shareholder profits in order to reinvest in the business. Now, through that constant reinvestment, Amazon has found itself on the cutting edge of not just e-commerce, but also the cloud computing it developed.

Consider Michael Pearson, the former CEO of Valeant Pharmaceuticals; he cut R&D to single digits. He once said that the unfortunate thing about curing cancer was that there was no money in it. And his philosophy on drug pricing was to charge as much as the market could bear. As a result, he drove the price of two lifesaving heart medications up hundreds of percentage points. In 2014 Pearson said, “there’s only one metric that really counts, and its total return to shareholders.” Valeant shares lost 90% of their value. Pearson was fired.

Now consider Elon Musk; he dreams big, he makes the most innovative cars we have seen since the Model T, his products are environmentally friendly, and massive disruptors across several industry sectors (auto, energy, space); and now he faces one of his biggest challenges.

Institutional investors own more than 63% of Tesla shares. Tesla is not following standard procedures on this deal. Musk owns 21% of Tesla and 22% of SolarCity; his cousin, Lyndon Rive, is a founder and the CEO of SolarCity. There are already charges of a potential conflict of interests. It does not appear that Tesla or SolarCity truly formed an independent committee or hired independent counsel. It is a good bet that shareholder lawsuits will be forthcoming.

Whether the deal falls apart or not, you should appreciate that we are watching one of the most compelling characters and one of the most remarkable business stories. Musk, Tesla, SolarCity, and the deal could be the next great thing, or it could all come crashing down harder than a SpaceX Falcon rocket, but it is hard to take your eyes off whatever unfolds.

Financial Review

Falling Knives

Sinclair Noe — March 8, 2016

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

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DOW – 109 = 16,964
SPX – 22 = 1979
NAS -59 = 4648
10 Y – .07 = 1.83%
OIL – 1.67 = 36.23
GOLD – 6.50 = 1261.50

Small business confidence declined further in February as lingering concerns about sales growth and profits hurt capital spending and hiring plans. The National Federation of Independent Business (NFIB) said its small business optimism index dropped one point to a reading of 92.9 last month, with none of the index’s components showing an increase. The index decreased 1.3 percentage points in January.

Spending and hiring plans weakened a bit as expectations for growth in real sales volumes fell. Earnings trends worsened a bit as owners continued to report widespread gains in worker compensation while holding the line on price increases.

China’s February trade performance was far worse than economists had expected, days after top leaders at the National People’s Congress sought to reassure investors. Exports fell 25% from a year earlier, the biggest drop since May 2009, while imports slumped 13%, leaving a trade surplus of $32 billion. It’s easy to blame Chinese New Year distortions, but the numbers point to bigger economic problems.

Japan’s 10-year yield extended its push into negative territory, dropping to an all-time low of minus 0.12 percent, meaning almost three-quarters of Japanese government bonds currently offer yields at or below, zero percent. By far the biggest move in trading overnight was the Japanese 30-year, which saw its yield plunge 22 basis points to a record low 0.468 percent. Japan’s 40-year yield is now lower than the U.S. 12-month yield.

After a long wait for inflation to accelerate, Fed officials face a complex and possibly divisive debate over whether recent evidence of rising prices is strong enough to move ahead with planned rate hikes.

In separate statements on Monday, policymakers at the core of that debate staked out starkly different views, with Fed Vice Chairman Stanley Fischer saying economic data now points to the “first stirrings” of inflation, while Fed Governor Lael Brainard countered that the evidence was not yet clear, and it would be much safer to wait. The Fed is not expected to raise interest rates next week, but they might signal they are looking at a rate increase in April or June.

Mario Draghi, the President of the European Central Bank, who is widely expected to tinker with the Eurozone’s financial plumbing this week in the face of weaker-than-expected inflation and six weeks of volatility weighing on business sentiment. Once again, with the market already pricing aggressive action, there’s a risk of disappointment when the ECB meets Thursday. If the ECB takes action, it sets up a divergence in monetary policy between the Eurozone and the US.

Yesterday we told you that the big jump in iron ore prices was short covering and not based on fundamentals. We have also said that trading in the energy markets has been driven by speculation more than fundamentals. Goldman Sachs tells investors the current commodity rally will fade as higher prices prompt more supply to enter the market. Yesterday, iron ore prices jumped 19%; despite the move, Citigroup says it is still bearish as supply and demand fundamentals remain firmly in place; while Axiom Capital Management said the price jump was probably just a “blip.”

Now normally, when Goldman makes a recommendation, we need to consider the possibility that it is a contrarian indicator, but in this case, they might be right. The commodity markets, especially energy, is a supply driven market, and when prices go higher, supply floods back into the market. But the current oil market is still oversupplied and prices have to remain lower for supplies to meaningfully shrink and re-balancing to take place.

The oil market has been especially volatile. Oil’s 2016 roundtrip is nearly complete. WTI crude started the year at about $40 per barrel, and bottomed around $28.75 a barrel – a double bottom actually in late January and early February. That represents more than a 34% swing.  After a 5.5% gain on Monday, the price returned to just a few pennies shy of $38. Brent crude touched $40 per barrel yesterday for the first time in 2016, and moved up to a three month high today before sliding. Now that is nothing but speculative trading.

When prices move higher it is likely a short squeeze because the fundamentals have not changed; there is still an oil glut; OPEC can’t be trusted to freeze production; and it will take time to winnow the producers and eliminate the weak players.

 Meanwhile, China is looking at extra stimulus, Japan has gone to negative interest rates, and the ECB meets Thursday to consider adding even more monetary stimulus. The net effect should be that all these countries weaken their own currency, and the dollar should strengthen. And commodities are priced in dollars, which should lead to lower prices. Just a reminder, stocks have been trading close to commodities for at least the past few months.

Oil and natural gas producer Chevron will cut its budget by at least 17 percent for the next two years as it finishes construction on major expansion projects and works to save cash. The company said it plans to spend between $17 billion to $22 billion annually in 2017 and 2018. For 2016, the company has already announced it would spend $26 billion. Executives reiterated the company’s commitment to pay its $1.07 quarterly dividend.

Goodrich Petroleum, an oil & gas exploration company said it will not make interest payments due March 15 and April 1 on some of its bonds, and will instead opt to use the 30-day grace period it is allowed before being officially in default. Goodrich said it has already launched an offer to exchange all of its outstanding unsecured notes and preferred stock for its common stock. If the exchange offers are not taken up, the company said it would likely file for Chapter 11 bankruptcy protection.

It can be tempting to look for bargains in the oil patch but some folks think it is tempting to catch a falling knife. I wonder how long it will take before Houston turns into Detroit.

Rooftop solar panel installer Vivint Solar terminated an agreement under which it would have been taken over by solar energy company SunEdison after SunEdison failed to “consummate” the $2.2 billion deal. Vivint said it intended to “seek all legal remedies available” as a result of the “willful breach” of the merger agreement by SunEdison.

SolarCity’s shares popped today after announcing a deal to install solar panel systems in Whole Foods Market stores across the U.S. The plan aims to increase the production of solar power and offset the need for a traditional grid power while helping the organic food store save money. In total, the energy firm will retrofit up to 100 Whole Foods stores with rooftop solar panels.

The U.S. Air Force has selected Pratt & Whitney to build the engines for Northrop Grumman’s new $80 billion long-range strike bomber program. Analysts had expected Pratt to be chosen as the supplier since the company already builds engines for Lockheed Martin’s F-35 combat jet. Other key suppliers for “airframe or mission systems” include BAE Systems, GKN, Spirit AeroSystems, Orbital ATK, Rockwell Collins and Janicki Industries.

Cyprus has become the fourth Eurozone nation to exit an EU-IMF bailout, as finance ministers gave the green light to leave its program without a follow-up fund. Cyprus was forced into a €10-billion-euro bailout in March 2013, due to a toxic combination of broken banks, a soaring deficit and an inability to access market financing. By contrast with Cyprus, Greece (the only Eurozone country left in a rescue program) was caught yesterday in a new disagreement between the EU and IMF regarding the strength of its bailout reform commitments.

In the latest volley in its high-profile fight with Apple, the Justice Department has appealed a decision that protects the company from unlocking an iPhone in a New York drug case. Prosecutors, who say Apple has unlocked at least 70 iPhones in the past, are relying on the same “All Writs Act” in a California court, where a judge ordered the company to unlock a device belonging to one of the San Bernardino shooters. The clash has intensified a long-running debate over how much law enforcement and intelligence officials should be able to monitor digital communications.

The Arizona Regional Multiple Listing Service reports overall sales in February were down 2.6% year-over-year. Cash Sales (frequently investors) were down to 29.0% of total sales. Active inventory is now down 0.7% year-over-year, and inventory is down for the fifteenth consecutive month.

Sportswear giant Nike, Swiss watch brand Tag Heuer and German luxury car company Porsche will end their endorsement deals with tennis star Maria Sharapova after she tested positive for an illegal heart drug at the Australian Open. Sharapova brings in, or brought in, a reported $30 million per year in endorsements.

Sharapova said she’s taken the drug, meldonium for over a decade, long before a 2016 ban by the World Anti-Doping Agency, which outlawed the substance as a performance-enhancer. So you might be wondering why there is a problem with a heart drug. Meldonium delivers oxygen through the blood. This can save lives when poor circulation reduces blood supply and oxygen to tissues. For the same reason, reducing the need for oxygen can enhance athletic performance.

Over the course of a workout, as our bodies use oxygen, our blood becomes oxygen deficient—because we’re using up oxygen at a faster rate than our lungs can replace it. Not so if you’re Maria Sharapova on meldonium. Her blood stays oxygen-rich longer, allowing her to perform longer in practice and in matches. And because the drug changes the actual substance that is metabolized in the body, it changes the way Sharapova feels after a workout, too.

This winter was the warmest on record for the contiguous U.S., according to the National Oceanic and Atmospheric Administration. The average temperature across the lower 48 states was 36.8 degrees Fahrenheit, breaking the mark set in 1999-2000. It was 4 degrees higher than the 20th-century average.

Financial Review

Neutrality Matters

Sinclair Noe — February 26, 2015

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

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DOW – 10 = 18,214
SPX – 3 = 2110
NAS + 20 = 4987
10 YR YLD + .05 = 2.01%
OIL – 2.01 = 48.98
GOLD + 5.00 = 1210.20
SILV – .01 = 16.63

The Federal Communications Commission has voted to regulate broadband Internet service as a public utility. Tom Wheeler, the commission chairman, said the FCC was using “all the tools in our toolbox to protect innovators and consumers” and preserve the Internet’s role as a “core of free expression and democratic principles.”

The new rules, approved 3 to 2 along party lines, are intended to ensure that no content is blocked and that the Internet is not divided into pay-to-play fast lanes for Internet and media companies that can afford it and slow lanes for everyone else. Those prohibitions are hallmarks of the net neutrality concept.

Mobile data service for smartphones and tablets, in addition to wired lines, is being placed under the new rules. The order also includes provisions to protect consumer privacy and to ensure that Internet service is available for people with disabilities and in remote areas.

The FCC is taking this big regulatory step by reclassifying high-speed Internet service as a telecommunications service, instead of an information service, under Title II of the Telecommunications Act. The Title II classification comes from the phone company era, treating service as a public utility. But the new rules are an à la carte version of Title II, adopting some provisions and rejecting others. The FCC will not get involved in pricing decisions or the engineering decisions companies make in managing their networks.

The impact of the new rules will largely hinge partly on details that are not yet known. The rules will not be published for at least a couple of days, and will not take effect for probably at least a couple of months. Lawsuits to challenge the commission’s order are widely expected.

Also today, the FCC approved an order to pre-empt state laws that limit the build-out of municipal broadband Internet services. The order focuses on laws in two states, North Carolina and Tennessee, but it would create a policy framework for other states; about 21 states have laws that restrict the activities of community broadband services.

The FCC says state laws unfairly restrict municipal competition with cable and telecommunications broadband providers. This order, too, will surely be challenged in court.

What does net neutrality mean for you? Well, you will still get your internet service from your provider; they just won’t be able to charge you more for high bandwidth, they can’t discriminate, and they can’t just block or slow access to content on a whim – which has happened in the past. That means that some geek in a garage has the same access to the internet as a big company like Netflix or Hulu; and as we’ve learned over the years, geeks in garages sometimes come up with some brilliant stuff. And nothing in today’s FCC action will raise your taxes.

We’ve been hearing from certain pundits for years now about how high inflation was just around the corner; how the Federal Reserve’s low interest policy and massive monetary stimulus would inevitably lead prices to spike, undermining the economic recovery. The hyper-inflationistas were dead wrong. Consumer prices fell again in January and inflation turned negative year over year. The consumer price index dropped a seasonally adjusted 0.7% last month, marking the third decline in a row. Over the past year prices have actually declined by an unadjusted 0.1%, the first time consumer inflation has been negative since the fall of 2009. Energy prices slumped 9.7%, as the cost of most fuels including gas decreased. Food prices were unchanged. Excluding food and energy, so-called core consumer prices rose 0.2% in January. Core prices are also up 1.6% in the past year, mainly reflecting rising prices for housing. Deflationary pressure from the cost of energy and commodities falling has turned into deflation. Whether this is temporary or a longer-term trend remains to be seen.

As a reminder, the Federal Reserve has that 2.0% inflation target, which is nowhere in sight. Until inflation ticks back up, it is hard to imagine that Janet Yellen and her team will raise interest rates rapidly. Even if they start raising rates sooner than expected, it is hard to fathom that this interest rate hiking cycle will be anywhere as severe as what we saw during the 1990s and in other rate hike cycles. Still, the Fed doesn’t expect energy prices to stay low forever. There is little fear that it will lead to an insidious debt-deflation spiral.

For the moment, lower prices, especially lower energy prices are a good thing. Today, oil prices dropped to the lowest levels in a month; a combination of a stronger dollar and a report yesterday showing record high crude supplies in the US. And it’s not just lower prices at the pump and lower energy bills, the cost of inputs, from plastic bottles to detergent, are edging down. Some of the savings are being passed on: food, which is costly to transport and requires a lot of packaging, is cheapening. These are the hallmarks of a positive supply shock: cheap oil means economies can provide more goods at lower prices. In the services sector, which relies much less on energy, transport and oil-based inputs, prices are still rising.

For companies that sell durable goods deflation can be more of a concern, but so far it hasn’t been a problem.  Orders for durable goods rose a seasonally adjusted 2.8% in January, beating expectations. Orders minus transportation edged up 0.3%. Orders for core capital goods, a proxy for business investment, surged 9.5%.

For many industries, however, falling prices are not new, but a way of life; think about how prices have dropped for technology like phones, cameras, and computers. So deflation is unlikely to shock shoppers. Indeed, the boost in purchasing power from a short period of falling prices is welcome, especially for workers that have seen wages stagnate for decades.

Unemployment rates are now below pre-crisis levels and that should have triggered rising wages but we haven’t seen it yet. The number of people who applied for unemployment benefits jumped by 31,000 to 313,000 in the week ending Feb. 21. It was the biggest weekly increase since December 2013. Next week’s jobs report will likely show another solid gain, but there is still slack in the labor market. Jobs may be up but workers’ bargaining power is not.

Even if it is short-lived, this sort of deflation can dull an economy. Companies are sitting on mountains of cash, about $2 trillion more or less; A little inflation would serve as a prod to put that money more quickly to use. This raises a question about how to spark inflation. Over time, the answer is more jobs; more people with paychecks spend more money, creating more demand; and increased demand is the best incentive to invest.

If falling prices endure, then debts, fixed in nominal terms, are harder to pay. And the whiff of deflation is everywhere, not just in the US but around the globe. And we have seen central bankers responding: with Abenomics in Japan, stimulus in China, QE from the ECB, and negative interest rates across much of Europe. If these attempts fail, then the glee at cheap food and fuel will be short-lived, as debt-ridden economies find themselves using up all the savings from falling prices to keep creditors at bay. And the side effect of central bank stimulus is to devalue the local currency, which has resulted in a much stronger US dollar, which means our exports have to be priced competitively and imports are cheaper; which all means that deflation, even a little deflation can be a tricky thing. Enjoy it while you can.

Earnings season is winding down with reports from retailers. JC Penney reported sales rose 4.4%, topping estimates; that was not enough. JC Penney reported a loss of $59 million, or 19 cents a share.

Sears Holdings lost money for an 11th straight quarter. The company lost $1.50 per share, beating the expected loss of $1.89 per share. Sales dropped 24% to $8.1 billion, short of the $8.3 billion estimate.

Gap said profit rose nearly 4% to $319 million, or 75 cents a share, while sales increased nearly 3% to $4.7 billion. Gap offered a muted earnings forecast for the year, blaming the impact of the stronger dollar and shipping delays at West Coast ports. Separately, Gap said it is increasing its annual dividend and that it is setting aside $1 billion to buy back shares.

Google is making its largest bet yet on renewable energy, a $300 million investment to support at least 25,000 SolarCity rooftop power plants.  Google is contributing to a SolarCity fund valued at $750 million, the largest ever created for residential solar. Google has now committed more than $1.8 billion to renewable energy projects, including wind and solar farms on three continents. What really makes the deal interesting is that technology companies are now taking advantage of investment formats once reserved only for banks. The Google deal is structured as a tax-equity transaction, meaning Google gets tax breaks that flow from solar systems financed by the fund. Renewable-energy projects are entitled to various tax benefits, including a credit for 30% of the installed cost of a solar power system. Unprofitable companies, such as SolarCity, often can’t use the credits and provide them instead to tax-equity investors.

Just a week after apologizing for bundling computers with an encryption-breaking adware program known as Superfish, Lenovo said a cyberattack took down its website, although it was not clear who was behind the breach. Hacker group Lizard Squad, which has taken credit for several recent high-profile outages, including Sony’s PlayStation Network and Microsoft’s Xbox Live, has claimed responsibility for the attack.

(I guess we can file that one under “K” for karma, or maybe “P” for payback.)