FINANCIAL REVIEW

Thanks Hank

Sinclair Noe — October 7, 2014

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Financial Review

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DOW – 272 = 16,719
SPX – 29 = 1935
NAS – 69 = 4385
10 YR YLD – .07 = 2.35%
OIL – 1.91 = 88.43
GOLD + 1.50 = 1209.30
SILV – .16 = 17.29

The S&P 500 dropped below its 50-day moving average last week and has yet to move back above that level. Coincidentally, the S&P 500 has been sliding for a few weeks, going back to September 19, which was the day of the Alibaba IPO, just coincidentally. The Dow is also trading below its 50 day moving average. Welcome to the start of earnings season.

In the past 3 months the US dollar has jumped by 8% against the euro. That makes American goods more expensive relative to European goods. And it wasn’t just the dollar against the Euro, but against a basket of foreign currencies. It is estimated that a 5% rise in the dollar versus the euro results in a drop of about $1 for full-year Standard & Poor’s 500 Index per-share earnings; current estimates for the S&P are running around $118. Partly because of the dollar and the related decline in oil prices, earnings estimates have seen one of the largest downward revisions over the last few years aside from the weather-beaten first quarter of this year.

Earnings-per-share are projected to have grown 4.9% in the third quarter, that’s down from 7.8% earnings growth 3 months ago. At the end of March, third quarter earnings were forecast to grow 9%. The strong dollar may have an even greater impact on guidance for the fourth quarter. Alcoa marks the unofficial start of the earnings season with their report after markets close tomorrow.

US job openings hit a 13-year high in August. According to a report published by the US Labor Department, there were 4.84 million open jobs to fill in the US in August, up from 4.61 million the previous month. The good news is economists were only expecting 4.7 million job openings. The bad news: Hiring in August dropped to 4.6 million from 4.9 million in July.

Americans boosted their use of credit in August by the slowest rate in nine months. Consumers increased borrowing by a seasonally adjusted $13.5 billion in August, or by a 5% annual rate. The gain was the smallest since last November and marks a big deceleration from the 8.1% increase in July. Consumers took out more loans to buy cars or pay for college, with non-revolving credit rising by 7%. Yet Americans actually cut credit-card use a touch, as revolving credit dropped 0.2%. Consumer credit increased by an annual pace of 6.2% in 2012 and 6% in 2013 and it’s on track to grow even faster in 2014 despite the slowdown in August.

A gauge that tracks delinquencies in eight major types of closed-end loans, such as credit to buy cars or pay for property improvements, dropped in the second quarter to 1.57%, the lowest rate in the data’s four-decade history; the data does not include home purchase mortgages.

The International Monetary Fund trimmed its forecast for global economic growth to 3.3%, down from the earlier forecast of 3.4%, forecast in July. The IMF predicts the US economy will grow at a 2.2% pace, which is up from the July forecast. The 17-nation euro zone is expected to expand by just 0.8% this year. If you are thinking you’ve heard this story before, and I’m just repeating myself, well, not exactly; the IMF has developed a nasty habit of missing economic forecasts, and when the misses are exposed, they are forced to revise.

Three scientists win a Nobel for making the world a little brighter. Isamu Akasaki, Hiroshi Amano, and Shuji Nakamura won the Nobel Prize for physics for their discovery of how to produce blue light from semi-conductors, which allowed for the creation of white-light LEDs. So, the Nobel goes to the inventors of a new light bulb, but that is a major deal.

Nearly a fourth of global electricity consumption is used to brighten dark spaces. Traditional incandescent and fluorescent lights are notoriously inefficient with much of the energy used to produce light lost in the form of heat. Meanwhile, LED lamps last longer and use a fraction of the energy to produce the same, if not more, light. That has huge consequences for the developed world, and cities, offices, and homes are already swapping out old bulbs for the brighter, more efficient LEDs. But the technology has perhaps even greater significance for the more than 1.5 billion who lack access to electricity grid. In Sub-Saharan Africa, that’s two out of three people. By requiring less power, LEDs perform better than traditional lights on portable, scale solar energy, which makes spreading electricity to rural, off-grid regions much easier.

Federal officials asked a group of large banks and other financial institutions last month to check if they had seen indicators associated with the cyberattack that resulted in the theft of account information for millions of JPMorgan customers this summer. A number of financial institutions responded that they had seen traffic from the suspect computer addresses linked to the hackers, but that they didn’t believe they had been breached. Rather, the hackers, whose identity remains unknown, appeared to be “probing,” or searching for weaknesses on the firms’ digital perimeters. So, who has the weakest cyber security? Either the other financial institutions have been hacked and they just don’t realize it yet, or JPMorgan was a pathetically weak link.

The New York Times reports that the Department of Justice is preparing to charge several of the world’s biggest banks with colluding to alter the price of foreign currencies; essentially rigging the Forex market. Deutsche Bank, Citigroup, JPMorgan Chase, Barclays and UBS are among the dozen or so banks under investigation. Prosecutors are reportedly planning to indict individual bank employees for currency manipulation. They will not be going after the bank executives, but rather the traders. That is a familiar story. Everyone knows that the CEOs of big banks know absolutely nothing about what’s actually going on in their banks. The execs offer up a sacrificial lamb and go on with their unsavory practices, but this time might be different.

The idea is that prosecutors would use the currency rigging to reopen earlier settlements in the Libor interest rate rigging cases. Those rate rigging cases have already led to settlements with 5 banks, and part of the deal there was not to do bad things like rig markets. Meanwhile, some banks also remain under investigation. In the last major rate-rigging case against a bank, prosecutors are discussing the possibility of forcing Deutsche Bank or one of its subsidiaries to plead guilty to manipulating Libor. And the Libor case could quite easily result in criminal charges, if the DOJ has the spine for it. That remains to be seen. So far the Department of Justice has been afraid of the impact of a wounded bank on the world economy, and so they have done little more than levy “slap-on-the-wrist” fines, essentially taking a cut of the ill-gotten gains; like allowing a Cocaine Cartel to pay its criminal fines in crack.

The AIG bailout trial started last week. The trial is largely the result of former AIG CEO Maurice “Hank” Greenberg arguing that AIG wasn’t treated as well as the banksters when it came time to pass out taxpayer bailouts. The banksters got sweetheart deals, and for AIG, the government demanded 80% of the company stock, and used it as collateral against the loan, and charged 12% on the loan, and later, started sweeping all the dividends. Greenberg and his companies, notably Starr International, were the biggest AIG investors at the time, and the government’s bailout effectively crushed their shares.

Of course, AIG had been playing fast and loose with derivatives of subprime mortgages, and they had been forced to restate earnings, and their entire operation was a big, greedy hot mess that likely would have collapsed without a taxpayer bailout. AIG had become the industry leader in credit default swaps, essentially insuring the big banksters on large swaths of toxic mortgage deals. If AIG did not unravel all that credit default insurance, the entire banking structure likely would have collapsed.

Yesterday, former Treasury Secretary Hank Paulson admitted that certain firms were treated differently than others; AIG was treated tougher than Citigroup; Paulson said that circumstances warranted it because those banks were more essential to keeping the financial system afloat. He said that the government had to treat AIG harshly to win political support. Of course, the government didn’t treat AIG that harshly, gifting them a carryover tax benefit worth $35 billion and letting their executives take bonuses in 2009. Hank Greenberg argues that AIG could have survived; that other potential suitors were ready to step in with offers, but the government made them an offer they couldn’t refuse, and then the government changed the terms of the offer. There has been no testimony that a gun was held to anyone’s head. AIG took the deal at the time.

Today, Tim Geithner took the stand; Geithner was the president of the New York Fed in 2008, before he succeeded Paulson as Treasury Secretary. Geithner admitted that he had described an AIG bankruptcy as an unacceptable option and that the company represented a “systemic risk” in September 2008 that required government intervention. And that seems to be Greenberg’s argument; that the bailout of AIG was punitive and confiscatory. And it looks like it probably was. That’s what it should have been. AIG was forced to pay the credit default swap insurance, the banks survived; the taxpayers were paid back for their bailout of AIG, and now Hank Greenberg and Starr International want an extra $40 billion.

Of course, AIG might have gone completely bust, they could have dragged down the banksters with them, and the entire financial system could have melted down, and Hank Greenberg could be scrounging for a meal in the dumpster. Instead, he was left with a few billion, just enough to hire some high priced lawyers to spit in the face of taxpayers who saved his bacon. Thanks Hank.

http://dealbook.nytimes.com/2014/10/06/big-banks-face-another-round-of-u-s-charges/

Thursday, May 15, 2014 - A Calm Port in a Stormy World

Financial Review with Sinclair Noe

DOW – 167 = 16,446
SPX – 17 = 1870
NAS – 31 = 4069
10 YR YLD - .04 = 2.50%
OIL - .81 = 101.56
GOLD – 8.90 = 1297.80
SILV - .29 = 19.56

Today, it seems there is a lot going on. Let’s start with international hotspots.

Turks are angry following a deadly mine explosion that has killed at least 300 miners and trapped possibly 100 more; thousands of workers joined a protest strike, demonstrators clashed with security forces, and the discontent threatens the government. An aide to the prime minister was photographed assaulting a protester and there are claims that Prime Minister Erdogan himself struck a teenage girl; that after he was forced to flee an angry crowd and seek safety in a nearby grocery store. Turkish trade unions held a one-day strike over safety standards in the mining industry. Security forces deployed tear gas and water canons against protesters.

Meanwhile, reports of dozens of deaths from an explosion along the border between Syria and Turkey. Also, further allegations of ongoing chemical attacks by the Syrian government. Speaking in London today, Secretary of State John Kerry announced the US, Britain, and European and Arab states are increasing efforts to support rebels fighting to overthrow President Assad. Assad still has the backing of Russia, and that makes already tense relations with Russia even more edgy.

Fears of a civil war in Ukraine are mounting. Nobody wants to jump in with troops, and so there are clandestine forays by unidentified groups or squads of soldiers. And the major powers are only explicit with sanctions. Today, Russia announced it will halt the export of rocket engines crucial to US military defense and space programs. It must be very uncomfortable on the International Space Station these days.

Anti-Chinese sentiment has been running high in Vietnam ever since Beijing deployed an oil rig into disputed waters in the South China Sea on May 1st. There have been encounters including ramming and exchanges of water cannon between Chinese vessels operating near the rig and boats from Vietnam, which wants China out of the area. Today, Cambodia reports hundreds of Chinese nationals had poured across the border from Vietnam to escape riots.

Also, Japan’s Prime Minister, Shinzo Abe, has called for a review of how Japan interprets its pacifist constitution to allow its military to participate in conflicts beyond its borders for the first time since the end of the second world war; this in response to a growing conflict between China and Japan over islands claimed by each country; of course, it’s not just islands but the oil reserves around the islands.

Meanwhile, China issued a bunch of economic data this week, and it mostly points to a real estate slump; home sales fell 18%; housing starts were scaled back by 25%. Moody’s Analytics estimates that the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product last year. That is higher than in the US, Spain or Ireland at the peaks of their housing bubbles. The scale of China’s building boom and the country’s reliance on infrastructure investment for growth is unprecedented. In just two years, from 2011 to 2012, China produced more cement than the US did in the entire 20th century, and it all seems to be on shaky ground these days. Each attempt to rein in China’s $25 trillion credit bubble seems to trigger wider tremors.

Brazil has sent army troops to Recife, the capital of the northeastern state of Pernambuco, after strikes lead to riots. State police walked off the job Tuesday. Schools and universities also closed down because of concerns for student safety. Today, further protests in Sao Paolo and Rio de Janeiro drew tens of thousands to the streets. The protests are centered on cities that will host the upcoming World Cup, the quadrennial global soccer championship games. Huge anti-government protests across Brazil last year overshadowed the Confederations Cup, a warm-up tournament for the World Cup. Some of the demonstrations saw clashes between activists and police, and at least six people were killed.

Many Brazilians are angry at the billions spent to host the World Cup. Protesters have said the government should focus spending instead on improving Brazil's woeful health, education, security, housing, and infrastructure systems. The World Cup starts in less than 30 days, and the whole world will be watching.

In one week, Europeans will elect a European Parliament. It’s the second biggest election in the world, after India. Voters look set to choose more assorted extremists, anti-Europeans and oddballs than ever. The Euroland economy is going nowhere, and with the razor thin exception of Germany, most countries are seeing economic contraction; that tends to lead to strange election results.

There are other hotspots around the World. The president of Yemen has declared all-out war on Al Qaeda militants and army troops are now trying to dislodge Al Qaeda from the Arabian Peninsula. Political violence returned to Bangkok Thailand, and the Thai army killed a handful of protesters and threatened more military action if the protests continue. And of course, the Nigerian crazies, Boko Haram, and the kidnapping of hundreds of schoolgirls. And of course, all the old seething conflicts that haven’t been resolved. And don’t forget, the US is still at war in Afghanistan. I know, it’s easy to forget. Apparently, it’s even easier to forget the veterans that have served our country.

Today, Secretary of Veterans Affairs, General Eric Shinseki went before the Senate Veterans Committee to explain the mess that is the VA; this following revelations that as many as 40 veterans died while waiting for medical care at the VA facility in Phoenix.

Since the allegations arose last month that veterans were forced to wait months for appointments at the Phoenix VA medical center and that VA officials were covering up the problem, Shinseki said he has asked the VA's inspector general to investigate. He said he has also launched an intense investigation of scheduling practices at the VA's other 151 medical centers. Shinseki said he was “mad as hell” and the various Senators all acted very indignant. Of course, it wasn’t very believable theatre.

One of the documents brought forth today was an internal VA memo, written in 2008 by a team of VA managers, listing 25 ways that VA scheduling clerks were cooking the books to make it appear that veterans waiting for medical care actually were being seen on time, when in fact they were being made to wait weeks or months.

And then, 2 years ago, the Government Accountability Office reported that VA schedulers were fudging wait times for veterans seeking outpatient care and avoiding using the electronic waitlist as required. The GAO report includes a response from Shinseki's chief of staff at the time, writing that the VA has "proactively taken steps in response to GAO's findings." Clearly that didn’t happen.

Meanwhile, Southern California is on fire. Actually nine fires are burning in the greater San Diego area and they have already destroyed more than 10,000 acres, forcing evacuation of about 125,000 residents. California Governor Jerry Brown has declared a state of emergency to free up resources. It’s hot, it’s dry, and it’s just the start of the fire season.

The 2014 fire season is repeating a pattern of destruction established over the past decade by a combination of high temperatures, parched vegetation and more people living in wooded areas. Fires feeding on plentiful dry grass, brush and hardwood are requiring more personnel and money to bring them under control. More than twice as many acres burned across the US through May 9 this year than during the same period in 2013.

Last week, 96% of California was considered to be under “severe” or worse drought conditions, with about 4% of the southeastern tip of the state still in “moderate” drought conditions. A year ago, only 46% of the state suffered from “severe” or worse conditions. As of today, the National Drought Mitigation Center reports severe drought conditions now engulf 100% of California.

Meanwhile, former Treasury Secretary Tim Geithner is trying to polish his tarnished image; he’s on a book tour peddling the notion that the Wall Street bailout was a huge success. And while it might be argued it prevented a Great Depression, it is delusional to consider it a success. It was at best an experiment that did not result in a worse catastrophe. It did little or nothing for the tens of millions of Americans who lost billions of dollars in home equity and savings, and the millions more who lost their jobs. The toll was greatest on the poor and the middle class. Nor have reforms been enacted that will help the middle class and the poor the next time Wall Street implodes.

Economic data today showed industrial production in the US unexpectedly declined in April, held back by a plunge in utilities as temperatures warmed and a broad-based decrease in manufacturing. That contrasted with a higher-than-forecast reading on the Fed Bank of New York’s gauge of regional manufacturing, which climbed to 19.01 this month, from 1.29 in April.

Initial claims for state unemployment benefits declined 24,000 to a seasonally adjusted 297,000 last week. It was the lowest reading since May 2007.

Consumer prices recorded their largest increase in 10 months in April. The Consumer Price Index increased 0.3% last month as food prices rose for a fourth consecutive month and the cost of gasoline surged. In the 12 months through April, consumer prices rose 2.0%. Stripping out food and energy prices, the so-called core CPI rose 0.2% after advancing by the same margin in March. In the 12 months through April, the core CPI increased 1.8%, the biggest gain since August last year.

Normally you might expect higher inflation numbers to result in lower bond prices, which means bond yields would move higher; not today. The yield on the 10-year Treasury note dipped below 2.5% intraday. Of course, Treasuries are considered a safe haven investment, and it seems a lot of people are looking for a calm port in a stormy world.

Thursday, May 08, 2014 - Monetary Policy Is Not A Panacea

Financial Review with Sinclair Noe

DOW + 32 = 16550
SPX – 2 = 1875
NAS– 16 = 4051
10 YR YLD + .01 = 2.60
OIL – 01 = 100.24
GOLD - .10 = 1290.80
SILV - .15 = 19.25

Stocks were mostly lower today. The closing numbers looked quiet but it was a roller coaster ride with the Dow Industrials up about 150 points. The Nasdaq also squandered early gains to finish in negative territory. The Nasdaq ended lower for a third straight session, its longest losing streak since early April. A late selloff in utilities and energy, among the best performing sectors recently, dragged the S&P 500 lower. Of 445 companies in the S&P 500 that have reported earnings, 68.2% beat expectations, above the 66% beat rate for the past four quarters. Profits are expected to rise 5.3% this quarter.

The number of people who applied for new unemployment benefits last week fell to the lowest level in a month. Initial jobless claims dropped by 26,000 to a seasonally adjusted 319,000.

The federal government had a budget surplus of $114 billion in April. That is $1 billion more than a year ago and would be the biggest April surplus since 2008. For the fiscal year to date, CBO estimates the deficit to be $301 billion, down $187 billion compared to the same period in 2013.

Retailers posted modestly higher sales in April. Results from March and April are generally viewed together because of the shifting nature of Easter, which fell about three weeks later this year and moved into April from March last year. For the two-month period, retailers reported 3.4% growth, down from 3.5% a year earlier.

Consumer credit balances increased by $17.5 billion in March to a total of $3.141 trillion. The gain was a bigger increase than the $15.5 billion expected by economists. This was the biggest month-over-month growth rate since February 2013. Nonrevolving debt like college and auto loans grew by $16.4 billion. Revolving debt like credit cards increased by $1.1 billion.

At 4.21%, the 30-year fixed-rate mortgage is at its lowest since the week of November 7, 2013, so says Freddie Mac in their new weekly report on national mortgage rates. Last week, it averaged 4.29%. A year ago, it was 3.42%. Since the housing market crashed, the Federal Reserve has used extraordinarily easy monetary policy to keep interest rates like mortgage rates low in its effort to bolster the housing market and stimulate the economy.  Lately, various housing-market metrics such as existing-home sales, new-home sales, and mortgage applications have all been flagging. Last week, we learned that the US homeownership rate was at a 19-year low, and some experts think it'll never come back.

Yesterday, Fed Chair Janet Yellen said, "One cautionary note, though, is that readings on housing activity—a sector that has been recovering since 2011—have remained disappointing so far this year and will bear watching. The recent flattening out in housing activity could prove more protracted than currently expected rather than resuming its earlier pace of recovery." That was the big takeaway from Yellen’s Congressional testimony yesterday.

Fed Chair Janet Yellen was back on Capitol Hill today for a second day of testimony. She appeared before the Senate Budget Committee.  Yellen’s favorite new line is, “Monetary policy is not a panacea.” That pretty much says it all.

There are a couple of trends that concern Yellen; long term unemployment; there are about 3.5 million workers who haven’t found a job for at least 6 months. Also, income inequality is pulling down spending and slowing the economy. Yellen would like to do something about these disturbing trends, but you know, “Monetary policy is not a panacea.”

Meanwhile, the European Central Bank was meeting to determine monetary policy for the Euroland; they decided to leave interest rates unchanged at 0.25%. ECB President Mario Draghi’s favorite line is “whatever it takes” and he’s been saying it for a couple of years. Euroland is slogging along with persistently low inflation and high unemployment. Draghi says something should be done, but he did not say what; and the ECB might address stimulus of some sort or another next month or so.

Perhaps Draghi is waiting to see how the situation in Ukraine plays out; right now the picture is smoky and very gray. Rebels in eastern Ukraine say they will proceed with a referendum this weekend seeking autonomy even though Russian President Putin appeared to withdraw his support for the vote. Putin yesterday presided over nationwide army drills, a day after he softened his tone by promising to withdraw troops from the border. The government in Kiev says a referendum would be illegal. Putin also indicated he would pull Russian troops from the Ukrainian border, but satellite images show that probably isn’t happening. The situation involving the tug of war between the West and Russia regarding Ukraine has steadily worsened over time and now involves outright economic warfare; sanctions on one side and the threat of energy shortages on the other.

Even former Treasury Secretary Tim Geithner is coming out of exile to hawk a new book. Geithner says there had been talk about nationalizing banks back in the crisis days. On the legacy of the bailouts, Geithner rejects criticism that the Troubled Asset Relief Program benefited the rich rather than ordinary Americans. And yet he acknowledges that the too big to fail banks are bigger and more dangerous than ever.

Have you ever seen a boxer knocked out? The devastating blow is the one you don’t see coming. Mark Carney, governor of the Bank of England and head of the Financial Stability Board, an international watchdog set up to guard against future financial crises, was recently asked to identify the greatest danger to the world economy. He answered shadow banking. It is huge and growing fast, and little understood, and even less transparent. We don’t even know exactly what counts as shadow banking; basically, it refers to lending by non-bank institutions and it involves more than $70 trillion in assets, up from about $25 trillion ten years ago.

A broader definition, however, would include any bank-like activity undertaken by a firm not regulated as a bank: it could be bond trading platforms set up by technology firms, or payment systems offered by Paypal or financing offered by a retailer such as Sears, or peer-to-peer lending, or money market funds, or who knows what. At the core is the concept of credit and lending. Shadow banking fills a void left by traditional banks, which have become miserly with lending.

Yet shadow banking is poorly or non-regulated. Think of the structured investment vehicles, a legal entity created by banks to sell loans repackaged as bonds. These were notionally independent, but when they got into trouble they pulled in the banks that had set them up. Or money market funds, which seemed like a nice safe place to park cash as a stop-gap measure; they seemed conservative, nearly risk free, until they suffered a run.

Banks must now incorporate structured investment vehicles on their balance-sheets. Money-market funds must hold more liquid assets, to guard against runs. Limits on leverage have been imposed or are being considered for many forms of shadow banks. American regulators are still allowing some money-market funds to create the impression that an investor can never lose money in them. The problem for banks is that they are involved in shadow banking, either in the form of loans to shadow banks, or because the banks buy the products created by shadow banks.

One of the biggest paces for concern is China. Banks there are banned from expanding lending to certain industries, and from luring deposits by offering high returns. So they do both of these things indirectly, through shadow banks of various sorts. Some firms are setting themselves up as pseudo-banks. It is hard to imagine that all the shadowy loans to unprofitable steel mills and overextended property developers will pay off. At which point the Chinese government will likely step in a take control, but there will be a cost.

Nouriel Roubini, the New York University professor and chairman of Roubini Global Economics is known as something of an economic pessimist, and now he thinks we’re on the verge of a bubble, but not a collapse. Roubini says the Federal Reserve will keep its key lending rate low even after it lifts off from near zero, where it has rested for the few years. That slow process of normalization will keep the spigot of borrowing flowing, helping support the economy. But it will also lead to risky lending practices. Hence, a bubble is inflating that could eventually pop.

Roubini cited the return of some of the key characters associated with the period before the last financial collapse: Lots of low quality bond sales, debt without strong protections for bondholders. Roubini says: “All the risky things that were happening back in ’06 and ‘07 are back again to the same level, if not more. So we are in the beginning of a credit bubble, but just the beginning.”

Nonetheless, Roubini doesn’t see the reversal happening immediately, citing money that continues to rush into the market. For now, credit investors appear to be stuck in an uneasy equilibrium.

He’s by no means the first person to make this claim: the question of financial stability is one of the key criticisms of the Fed’s accommodative policies. Roubini didn’t criticize the central bank, so much as say that the Fed is damned-if-you-do, damned-if-you don’t.

Yeah, well, we’ve all learned that monetary policy is not a panacea.