Financial Review

The Gravy Boat

Sinclair Noe — November 25, 2015

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DOW + 1 = 17,813
SPX – 0.27 = 2088
NAS + 13 = 5116
10 YR YLD – .01 = 2.23%
OIL + .25 = 43.12
GOLD – 4.50 = 1071.90
SILV – .05 = 14.26

We have a boatload, or at least a gravy boat full of economic data before we get into the holiday. Initial claims for state unemployment benefits declined 12,000 to a seasonally adjusted 260,000 for the week ended Nov. 21. Claims have now held below the 300,000 threshold for 38 consecutive weeks, the longest stretch in years, and remain close to levels last seen 42 years ago.

Orders for business equipment climbed more than forecast in October. Bookings for non-military capital goods excluding aircraft rose 1.3 percent, the most in three months, after an upwardly revised 0.4 percent increase in September; non-defense capital goods are considered a proxy for business investment.

So, today’s report shows businesses are spending more on business. It may be too early to call it a trend reversal but cap ex spending had been weak, in large part due to cuts in the energy sector, and also the tendency for companies to indulge in share buybacks rather than plowing money back into the business.

Orders for all durable goods, items meant to last at least three years, climbed 3 percent. Commercial aircraft orders surged 81 percent in October after dropping 32.2 percent a month earlier. Excluding transportation equipment demand, which is volatile from month to month, bookings increased 0.5 percent in October. Stronger demand for computers, heavy machinery, military hardware and jumbo jets offset a dip in auto sales.

Consumer spending edged up 0.1% in October after a similar increase in September. Personal income increased 0.4% last month. Savings increased to $761 billion last month, the highest level since December 2012, from $722 billion in September. A little extra money in the bank may just mean consumers are saving up for the holiday shopping season. If so, it would bode well for cleaning out some of the excess inventory reported in yesterday’s GDP report. This points to a labor market that continues to show signs of recovery even though consumers remain wary.

Still, inflation remains tame. The personal consumption expenditures index, the PCE, was up 0.2%. Year on year core PCE is holding at 1.3%, which is far short of the Federal Reserve’s target of 2% inflation. Still, we expect the Fed to raise interest rates at the December FOMC meeting, but this means that rate hikes will likely take a long and shallow trajectory.

The University of Michigan consumer sentiment index rose to 91.3 in November, up from 90 in October; and while that is a gain, it falls short of the preliminary reading of 93.1. Consumers are feeling decent but not giddy. This follows yesterday’s report from the Conference Board that showed a big drop in consumer confidence. Both reports show consumers are sanguine about current conditions but a bit nervous about future economic prospects.

New single family home sales increased 10.7% in October to a seasonally adjusted annual rate of 495,000. The median price of a new home fell 6% from a year ago to $281,500. New home sales are a bigger driver of economic activity than existing home sales. Today’s numbers show solid, steady, though unspectacular growth, which seems to be a theme in recent economic reports. Still, you have to think there is a cumulative positive impact.

Investors across the world are also watching rising geopolitical tensions between Russia and NATO member Turkey after a Russian SU-24 warplane was shot down by a Turkish F-16 fighter jet on Tuesday. Russia’s Foreign Minister Sergei Lavrov said Turkey may have planned to shoot down the Russian warplane near its border, calling the act “planned provocation.” Lavrov also said Russia will reexamine the entire spectrum of its relations with Turkey because “we can’t leave what happened without a response.”

Russia supplies about half of Turkey’s natural gas, for which Turkey pay’s about $10 billion a year. No doubt the incident will cool business relations between Russia and Turkey but Russia needs the cash; and remember that Russia still supplies oil and gas to Ukraine despite their differences. Beyond that it is important to remember that Turkey is a member of NATO.

In its twice-yearly Financial Stability Review, the European Central Bank has warned that chances of an “abrupt risk reversal” are increasing due to slowing growth in China and the withdrawal of monetary stimulus in the U.S.

European authorities are proposing a system to share the cost of protecting bank deposits, as the FDIC does in the United States, but the European Deposit Insurance Scheme, which would protect savings accounts of up to €100,000-euro, could face opposition from Germany, which has long resisted sharing fiscal risks with other Eurozone countries.

The ECB has additionally announced it will temporarily pause its asset purchase program over the holiday season (December 22-January 1) “to reduce possible market distortions” during a period of “lower market liquidity,” which is to say, they will be closing shop for the holidays.

Minutes from the Bank of Japan’s latest meeting show that some policymakers believe an output gap was one reason the country was taking longer to meet its 2% inflation target, highlighting a lingering worry that quantitative easing may not be working. An output gap is the difference between what an economy is producing and what it could produce if operating at its most efficient. Separately, Japan announced it will raise the minimum wage by 3% to try to stimulate growth.

Andre Esteves, CEO of Grupo BTG Pactual, the largest investment bank in Latin America, has been arrested in Brazil as part of a corruption probe of the state-run oil company, Petrobras; which has lost 80% of its market cap. The government’s leader in the Senate, Delcidio Amaral, was also arrested this morning. Esteves and Amaral are accused of trying to suppress testimony in the investigation into a bribery scheme between Petrobras and the nation’s biggest builders.

More than 100 people have already been arrested, including former top executives at Petrobras and Brazil’s biggest construction conglomerate. And then they started to cut deals with prosecutors by turning evidence on higher ups. Esteves is widely considered the most high-profile figure in Brazilian finance; he is quoted as saying that his company, BTG, stood for “Better than Goldman.” Now the question is whether Esteves can cut a deal by implicating someone even higher up – the president of Brazil.

A federal judge in Manhattan has ruled that General Motors and its law firm, King & Spalding, need not turn over privileged documents to drivers hoping to show that the automaker intended to commit a crime or fraud by concealing defective ignition switches in their vehicles. Most of the documents related to the law firm’s advice from 2010 to 2013 on three crashes involving Chevrolet Cobalts.

Vehicle owners said the deception justified a waiver of attorney-client privilege. The judge found probable cause to believe that GM committed a crime or fraud by hiding the defect from regulators and the public, but did not go the next step to say that communications between GM and the legal firm were made to further such misconduct.

The World Meteorological Organization announced today that 2015 is the hottest year on record, surpassing last year’s record heat. And we still have more than a month left in the year. They made the proclamation without waiting for the end of the year because it has been so extraordinarily hot, forecast to stay that way and unlikely to cool down enough to not set a record.

The World Meteorological Organization is the weather agency of the UN, and they are not alone in their forecast, the US National Oceanic and Atmospheric Administration, NASA, and Japan’s weather agency all say 2014 is the current record hot year with a global temperature of 14.57 degrees Celsius, 58.23 degrees Fahrenheit.

The years between 2011 and 2015 have been the hottest five-year period on record. The record probably won’t last long. Due to the influence of El Nino, which is set to last into the middle of 2016, and continually rising levels of heat-trapping greenhouse gases, which come from the burning of coal, oil and gas, 2016 will be even hotter. The report comes the week before world leaders assemble in Paris to try to negotiate an agreement to fight climate change.

There is some optimism that the Paris summit can move beyond diplomatic posturing. Significantly, investors are beginning to realize that action on climate presents enormous business opportunities. A briefing paper released through the We Mean Business coalition points out that 277 companies with $6 trillion in revenue, and 144 investors with $20 trillion in assets under management, have collectively now made nearly 700 ambitious climate commitments.

The briefing paper  calls for a series of proposals to be included in the text of the Paris agreement to help unlock further flows of finance. These include a goal of net zero greenhouse gas emissions well before the end of the century, strengthening national emissions reduction commitments every five years from 2020, carbon pricing, and improving public policy to scale up private climate finance.

Here’s one way to look at climate change; the internet has been around since the 60’s, and in the 80’s the idea expanded into the World Wide Web. In the 90’s there was talk about building the information superhighway, even though we weren’t quite sure where that road would take us.

There were debates about the cost of building out digital infrastructure and who would bear this huge expense, not who would make fortunes with the business opportunities. It basically boiled down to figuring out how to make money with the technology. Once we wrapped our brains around that, the money started to flow. The same thing is about to happen with Green technology.

Monday, March 24, 2014 - Dance With the Devil

Dance With the Devil

by Sinclair Noe
Financial Review

DOW – 26 = 16,276
SPX – 9 = 1857
NAS – 50 = 4226
10 YR YLD - .02 = 2.73%
OIL - .15 = 99.45
GOLD – 25.10 = 1310.60
SILV - .34 = 20.03

Manufacturing activity slowed in March after nearing a four-year high last month, but the rate of growth and the pace of hiring remained strong. The flash Markit US Manufacturing Purchasing Managers Index dropped to 55.5 from 57.1 in February.

China's manufacturing engine contracted in the first quarter of 2014, according to the flash Markit/HSBC Purchasing Managers' Index.

This week’s economic calendar includes the Case Shiller home index, FHFA home prices, and new home sales reports tomorrow; plus the March consumer confidence index; Wednesday includes the February durable goods orders; Thursday brings another revision to fourth quarter GDP, and Friday’s reports include the consumer sentiment report, consumer spending, and an update on personal spending.

Ukrainian troops and their families are evacuating from Crimea, as Kiev effectively acknowledged defeat by Russian forces who stormed one of the last of their remaining bases on the peninsula. President Obama is in Europe to kick off a week-long visit that includes a G-7 meeting. He called for European allies to adopt tougher sanctions against Russia, saying Moscow’s actions must have costs.

Mohamed El-Erian, the former co-chief at Pimco says markets have “brushed aside” concerns about Iran, Iraq, North Korea and Syria, to say nothing of rising tensions in Turkey and Venezuela. With Ukraine, the market had a single day of fear over Russia’s annexation of Crimea. He lists four key reasons for market inaction: the countries involved are less systemically important; there’s little will from outside powers to get embroiled with these situations; the story of a recovering economy in developed markets has been a distraction; and extraordinary central bank support for markets has provided a layer of insulation. El- Erian went on to say things could get much worse. Consider how ugly it would be if there was an outright war between Russia and Ukraine. Or if Russia somehow decided to tap dance around US sanctions on Iran.

The point is that things can get dicey, quick. And suddenly 2014 starts to look a bit like 2008. The long lists of visible stresses in the global financial system and the almost laughably hollow assurances that there are no bubbles, everything is under control; the Fed can exit QE with no repercussions. Yea, sure. Remember when the subprime mortgage meltdown was already visible and officialdom from Federal Reserve chairman Alan Greenspan on down were mounting the bully pulpit at every opportunity to declare that there was no bubble. First, he claimed no one foresaw the crisis, and second, he attributed this failure to a lack of insight into “animal spirits,” the emotional drivers of behavior. There are plenty of indicators we could look at, and then it’s just one little spark that gets the herd running toward the cliff.

So far, sanctions against Russia look very weak, but there has been some effect: the Russian stock market is down, the currency has weakened, and sovereign bond yields are up. Russia’s central bank unexpectedly raised its benchmark interest rate by 150 basis points after the armed takeover of Crimea triggered a rout in the ruble. Even before the standoff with the West, the worst since the Cold War, Russia’s economy was facing the weakest growth since a 2009 recession as consumer demand failed to make up for sagging investment. Russia will probably dip into a recession in the second and third quarters of this year as domestic demand is set to halt on the uncertainty shock and tighter financial conditions.

The US doesn’t have a great amount of trade with Russia, so it is credible to talk about the threat of additional sanctions. The biggest damage to Russia would come from lower oil prices, and lower oil prices might be possible if Russia does anything that might hurt developed markets such as the Euro-Union. If the purpose of sanctions was to get Russia out of the Crimea, that ship has already sailed; if the purpose of sanctions is to restrain Russian proclivity for intervention, there is still a chance.

Of course the Euro-zone economies are far from solid, but the European Commission has a plan; they are apparently willing to dance with the devil. In the immediate aftermath of the financial crisis regulators called for a tough crackdown on the $71 trillion global shadow banking sector that also includes debt market repurchase agreements, securities lending, money market investment funds and some hedge funds.

With the worst of the crisis now over, Euro-commission regulators attention has turned to growth and with it the regulatory mood music has also changed; this Thursday they will publish proposals on how to fund long-term investments to boost Europe’s economies; the plan includes a fundamental shift in how the continent raises money for investment in infrastructure like roads and technology (and maybe even energy) while at the same time moving away from over-reliance on banks for fueling economic growth.

A core element involves reviving securitization, or the bundling of loans into interest bearing bonds; you may recall this market took a hit 7 years ago in the financial crisis. Now, the market for asset backed securities is only about half its pre-crisis size, or about 700 billion euros. The EC estimates that a trillion euros is needed in long term finance for transport, energy and telecoms up to 2020 to boost competitiveness and jobs and hopes that by encouraging market-based financing it can reduce the continent's reliance on banks for raising up to 70 percent of funds for the economy.

The developments in Europe come ahead of leaders of the Group of 20 economies (G20) meeting in November to endorse new rules for shadow banking. A harsh, uniform approach across all sectors has now been ruled out; the new plan is to embrace shadow banking and regulate it a little closer. If it sounds risky, well it probably is, but the Euro-zone now recognizes they need the cash and this is one way to get it, and so they are willing to dance, and put up with the heat.

Meanwhile, the United Nation’s World Meteorological Organization is meeting in Japan, and they reckon 2013 was the 6^th warmest year on record. Thirteen of the 14 warmest years have occurred in the 21st century. The UN weather agency says much of the extreme weather that wreaked havoc in Asia, Europe and the Pacific region last year can be blamed on human-induced climate change. A rise in sea levels is leading to increasing damage from storm surges and coastal flooding, as demonstrated by Typhoon Haiyan, and Australia experienced its hottest year on record, with some temps topping 129 degrees.

The costly weather disasters included $22 billion damage from central European flooding in June, $10 billion in damage from Typhoon Fitow in China and Japan, and a $10 billion drought in much of China.

Only a few places, including the central US, were cooler than normal last year, but 2013 had no El Nino, the warming of the central Pacific that happens once every few years and changes rain and temperature patterns around the world.

If climate change continues, here’s what the panel’s report predicts in terms of consequences.

For the first time, the panel is emphasizing the nuanced link between conflict and warming temperatures. Participating scientists say warming won’t cause wars, but it will add a destabilizing factor that will make existing threats worse. Global food prices will rise between 3 and 84 percent by 2050 because of warmer temperatures and changes in rain patterns. Hotspots of hunger may emerge in cities. About one-third of the world’s population will see groundwater supplies drop by more than 10 percent by 2080, when compared with 1980 levels. For every degree of warming, more of the world will have significantly less water available.

Major increases in health problems are likely, with more illnesses and injury from heat waves and fires and more food and water-borne diseases. But the report also notes that warming’s effects on health is relatively small compared with other problems, like poverty. Many of the poor will get poorer. Economic growth and poverty reduction will slow down. If temperatures rise high enough, the world’s overall income may start to go down, by as much as 2%, but that’s difficult to forecast.

Past panel reports have been ignored because global warming's effects seemed too distant in time and location. This report finds "It's not far-off in the future and it's not exotic creatures: it's us and now. According to the report, risks from warming-related extreme weather, now at a moderate level, are likely to get worse with just a bit more warming. While it doesn't say climate change caused the events, the report cites droughts in northern Mexico and the south-central United States, and hurricanes such as 2012's Sandy, as illustrations of how vulnerable people are to weather extremes. It does say the deadly European heat wave in 2003 was made more likely because of global warming.

Earlier this month, the world's largest scientific organization, the American Association for the Advancement of Science, published a new fact sheet on global warming. It said: "Climate change is already happening. More heat waves, greater sea level rise and other changes with consequences for human health, natural ecosystems and agriculture are already occurring in the United States and worldwide. These problems are very likely to become worse over the next 10 to 20 years and beyond."

Scientists in the past may have created the impression that the main reason to care about climate change was its impact on the environment. The reality is that it's going to affect nearly every aspect of human life on this planet.