Financial Review

Addiction to Oil

Sinclair Noe — April 25, 2016

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DOW – 26 = 17,977
SPX – 3 = 2087
NAS – 10 = 4895
10 Y + .02 = 1.90%
OIL + .26 = 42.90
GOLD + 5.70 = 1238.90

The Federal Reserve FOMC meets this week to determine monetary policy; they are not expected to raise interest rates this week, however they might set the stage for a rate hike in June. Earlier this month, Fed Chair Janet Yellen said the U.S. economy was on a solid course with some hints of inflation, so the Federal Reserve was on track for further interest rate hikes.

First quarter GDP, to be released on Thursday, is expected to slump to a paltry 0.7% annual rate from a 1.4% rate in the last three months of 2015. It might be tough for the Fed to sound hawkish if it is followed by a weak GDP report.

Traders are also keeping an eye on the outcome of a Bank of Japan meeting on Thursday, with expectations that Japan could push deeper into negative interest rate territory.

Investors have been assessing first-quarter earnings, FactSet just released its latest update of earnings season stats for S&P 500 companies. And the numbers are pretty bad; 76% of companies have beaten analysts’ estimates, but the aggregate earnings decline is -8.9%. That’s actually worse than the -8.6% decline analysts expected on March 31.

This will mark the fourth straight quarter of declining year-over-year earnings, which hasn’t happened since 2009. Throughout this bull market, companies have managed to squeak past very low expectations. Now, we can’t meet lousy expectations.

An avalanche of first-quarter earnings reports is on tap, with 186 companies in the S&P 500 slated to report results. The big news in earnings will be tomorrow, when Apple reports. Apple is expected to report a year-over-year decline in revenue for the first time since 2003. Along with the revenue decline, many are predicting that iPhone sales will fall year-over-year for the first time in the device’s history.

New U.S. single-family home sales fell in March, but the decline was concentrated in the West region. The Commerce Department said new home sales decreased 1.5 percent to a seasonally adjusted annual rate of 511,000 units. Sales were up in the Midwest and the South, and flat in the Northeast, but sales plunged 23.6 percent in the West, reversing February’s 21.7 percent jump; which leads me to believe we’re dealing with some statistical noise in the report.

While the inventory of new homes on the market rose in March to the highest since September 2009, new housing stock remains less than half of what it was at the height of the housing bubble. At March’s sales pace it would take 5.8 months to clear the supply of houses on the market. That was the most since last September and was up from 5.6 months in February.

Saudi Arabia unveiled “Saudi Vision 2030,” a plan to overhaul the kingdom’s economy in order to reduce its massive reliance on oil revenues, which account for 80% of its income but are taking a battering amidst the plunge in crude prices. Prince Mohammed bin Salman said the kingdom will try to break its “addiction to oil” by creating the world’s largest sovereign-wealth fund with over $2 trillion in diversified assets and to sell under 5% in state oil monopoly Saudi Aramco in an IPO.

The existing state-controlled Public Investment Fund will be transformed into a giant sovereign wealth fund to manage the kingdom’s petrodollars. Instead of direct subsidies, Saudis will receive payments as a form of benefit, while the government will attempt to cut unemployment to 7 percent from 11.6 percent by an unspecified date.

While volatility in the oil market may be pushing the Saudis to reform, low oil prices are also cutting the resources they can use to manage the change. And if the Saudis are willing to sell, who will step up to buy? Although the Saudi stock market opened up to direct foreign investment last June, total foreign ownership of the market remains tiny at less than 1 percent.

With prices so low, it hardly seems like a good time for an oil IPO. Perhaps even more important than the price of oil is the political component. The Saudis are not known for openness and transparency; this plan will surely draw opposition both from within the kingdom and from outside investors who will likely demand to see change before investment.

Oil was pretty strong last week in the face of a lot of bad news, including no agreement in Doha to freeze output, so don’t count out a repeat performance this week, especially since oil managed to crawl off the lows today. Crude oil has been the driving force behind equities since the February 11 low.

You may recall a few years back, the US tried to break its addiction to oil; the result was the shale oil revolution, which helped to ease our dependence on foreign oil, even if it didn’t break our addiction. Imagine what could happen if the US actually tried to break the addiction by starting a renewable energy revolution. Today’s announcement from the Saudis tells us that they are imagining that scenario.

China’s debt load is at a record high. The Financial Times reports China’s debt total climbed to 237% of GDP in the first quarter, an all-time high. Data from the Bank of International Settlements shows China’s debt load is far greater than emerging markets as a whole, which carry debt at an average of 175% of GDP. According to the FT, China’s debt has exploded since 2007, when it was 148% of GDP.

Gannett, the publisher of USA Today, said it offered to buy Tribune Publishing Co but the owner of the Los Angeles Times refused to begin “constructive” talks. Gannett said it made an offer to buy Tribune Publishing on April 12 for $815 million, including the assumption of $390 million of debt. Tribune Publishing said in a statement that it had told Gannett it would engage financial and legal advisers to review the proposal and its “numerous contingencies.”

The Justice Department gave antitrust approval to Charter Communications’ proposed purchase of Time Warner Cable and Bright House networks, which would create the second-largest U.S. broadband provider and third-largest video provider. The DOJ says online video will provide competition, and one condition to the deal is that Charter must agree to refrain from telling its content providers that they cannot also sell shows online.

The Federal Communications Commission must also approve the deal, and the agency’s chairman said he, too, is looking to protect competition. It was not immediately clear when the FCC would decide. Charter has valued the deal at $56 billion for Time Warner Cable, excluding debt, and $10 billion for Bright House Networks.

Ball is selling its beverage-can assets. Ball will sell 17 can factories and other facilities to European-based packaging company Ardagh for $3.42 billion. Ardagh will sell $2.85 billion of bonds to help fund the deal. Apollo Global Management, Blackstone Group LP and Madison Dearborn Partners were said to be other interested bidders.

Goldman Sachs has entered online banking. The investment bank is now allowing ordinary citizens to open a bank account. Goldman’s digital savings account offers a rate of 1.05%, and can be opened for as little as $1. The bank accounts are available after Goldman acquired about 150,000 retail customers through its GE Capital deal that closed last week.

Xerox reported a 4.2 percent fall in quarterly revenue, hurt by a strong dollar and lower sales of printers and copiers. Net income attributable to the company fell to $34 million, or 3 cents per share, in the first quarter ended March 31, from $225 million, or 19 cents per share, a year earlier. Revenue fell to $4.2 billion from $4.4 billion.

Halliburton is delaying earnings. The oil services provider announced it’s taking a $2.1 billion charge for the first quarter after cutting more than 600,000 jobs and taking a write off. Additionally, Halliburton’s earnings will be delayed from April 25 to May 3 in order to account for the Baker Hughes deal which is expected to close before the end of the month.

It looks like Chipotle’s free burrito strategy might be working: a survey shows that 41% of respondents who received a free burrito coupon visited Chipotle 3.8-times over the prior 30 days, compared to 1.4-visits for the 59% who didn’t receive a coupon. Brand perception was also higher in the coupon group. Meanwhile, analysts at Credit Suisse found that Google searches for food-safety issues related to Chipotle have dropped sharply since the beginning of the year. We’ll see how the free food strategy is working when Chipotle reports earnings tomorrow after the bell.

Philips is leaning towards holding an IPO of its lighting unit – its original line of business – rather than selling the operations. The divestment of the lighting operations will leave the company to focus on healthcare technology. Philips’ also reported better-than-expected earnings; adjusted earnings before interest, taxes and amortization climbed 14% to $420 million.

Carlyle has joined up with former Barclays CEO Bob Diamond to bid for the U.K. bank’s 62% holding in its African operations. Barclays Africa Group is listed in Johannesburg with a market capitalization of $8.5 billion, putting the value of the stake at $5.27 billion. Barclays is selling the unit due to increasing regulatory pressures.

Google is building a startup incubator called Area 120 in which teams of employees will be able to submit business plans to join the initiative. Those accepted will work on their projects full-time for a few months, after which they’ll be able to pitch Google on creating a new company that the parent firm would take a stake in. Area 120 is an attempt to prevent entrepreneurial employees from leaving Google entirely to found their own businesses.

Financial Review

Sub Zero

Sinclair Noe — January 29, 2016

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DOW + 396 = 16,466
SPX + 46 = 1940
NAS + 107 = 4613
10 Y – .05 = 1.93%
OIL + .46 = 33.68
GOLD + 2.80 = 1118.80
SILV + .02 = 14.34

It’s Friday and also the last trading day of the month.

For the week, the Dow gained 2.3%, the S&P added 1.7% and the Nasdaq increased 0.5%.
That left the Dow down 5.5% for the month, or a loss of 959 points. The Nasdaq lost 7.9%, or 394 points in January, its largest monthly loss since May 2010.

The S&P was down 103 points, or 5%, although at one point last week the S&P was down 11% since the start of the year.

An index of US Treasury bonds returned 1.8% for January, which has been the best month of the year for bonds, at least over the past few years. The yield on the 10-year note dropped 24 basis points for the month.

Gold and silver shared the safe haven spotlight with Treasuries. Gold gain $58.60, or 6% for the month. Silver added 53-cents or 3.8%, year-to-date.

The dollar has gained just over 1% year-to-date, but is still below November highs.
Even with today’s gain, oil closed out the month of January with a loss of $3.37 or 9%.

The U.S. economy expanded at a slower pace in the fourth quarter. Gross domestic product rose at a 0.7% annualized rate in the three months ended in December after a 2% gain in the third quarter. GDP expanded 2.4% for a second straight year, led by the biggest gain in consumer spending in a decade.

Household purchases rose at a 2.2% annualized pace in the fourth quarter, down from 3% in the third quarter; so consumer spending slowed in the quarter, but businesses saw big cuts in spending.

Business investment decreased at a 1.8% annualized rate, the first drop since the third quarter of 2012 and compared with a 2.6% pace in the third quarter. Businesses cut spending on stockpiles to try to pare unwanted inventories. That effort trimmed growth by 0.5 percentage point in the fourth quarter. Home construction grew at a solid 8.1% annual rate.

Separately, the Labor Department reports wages and salaries rose 0.6% in the fourth quarter – the same pace as in the previous three months, indicating gradual tightening in the labor market has yet to put pressure on employers to boost pay. Wages of all employees, including government workers, advanced 2.1% from the same period in 2014.

The Bank of Japan said that it would adopt a negative interest rate policy for the first time, in an attempt to kick start the world’s number three economy. The central bank said it cut the deposit rate it pays on cash parked at the BOJ by commercial banks in excess of legally required reserves, to minus 0.1% from the previous plus 0.1%. The goal was to push down borrowing costs across a broad time spectrum to stimulate inflation.

Just one week ago, Bank of Japan Governor Haruhiko Kuroda said he was not thinking of adopting a negative interest rate policy now, signaling that any further monetary easing will likely take the form of an expansion of its current massive asset-buying program. So, this really was shocking news for global markets.

The yen tumbled after the announcement. The benchmark Topix index closed 2.9% higher. Money is pouring into bonds all over the world, pushing yields lower. Germany’s 10-year yield is off 6 bps at 0.33%, making for the lowest reading in nine months, and yielding about the same as a US 3-month note.

Now, these negative rates in Japan are not being applied at the retail level; this is directed at the banks, and the reserves held by banks with the central bank. But if the negative rates last long enough, it could work to the consumer level. For now, the idea is to nudge banks to make loans and circulate money through the economy, with a little punishment for banks that hoard the cash.

In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good. If banks make more customers pay to hold their money, cash may go under the mattress instead. We have seen negative rates over the past year or so in the Eurozone, and Sweden, Denmark and Switzerland.

We don’t really know yet how it will play out, and we don’t have historic data to guide us. This time it really is different. We’ve heard that before, but it is true this time. For the Eurozone and now for Japan, rates are at the lowest levels in at least 500 years – and, yes, Deutsche Bank did look that far back in sovereign debt records.

So what do negative interest rates tell us about the global economy? We appear to be in a long-term low growth and low inflation environment. Perhaps the central bankers, including the Fed, need to re-think their ideas about acceptable levels of inflation; perhaps a 2% rate of inflation is too low. Today’s action by the Bank of Japan will almost certainly influence the Fed’s thinking on future interest rate hikes.  At the very least it should lead to discussion of how monetary and fiscal policy is conducted and coordinated on a global scale.

And for investors, we need to consider whether the US economy really is so much stronger than our global business partners; and we should also consider the spread between global and international rates and the spread between US long-term and short-term Treasuries (it is flattening, and you know that’s not good); also the impact of negative interest rates on a variety of asset classes, including equities, currencies, and commodities.

Oil prices started the session with big gains but pared losses throughout the day as the dollar index gained more than 1%.  It proved near impossible to prop up oil on the notion of a Russia-OPEC deal to cut production. The Wall Street Journal reported that an Iranian oil official said the country would not join an immediate OPEC production cut. The paper said Iran wants to boost crude exports by 1.5 million barrels a day. Baker Hughes reports energy firms in the US cut oil rigs for the sixth straight week and were expected to shed more.

Puerto Rico plans to propose a debt exchange to investors, offering to swap existing bonds for two new types of securities to help the U.S. commonwealth alleviate its debt burden. Both classes of debt would delay payments, giving the island time to make fiscal adjustments and spur economic growth. One would eventually pay interest at 5%, while the other would carry a value determined by Puerto Rico’s fiscal health.

The World Health Organization is warning that the Zika virus is “spreading explosively” in the Americas, and will convene a special meeting on Monday about whether to declare a public health emergency. While there is no approved vaccine, U.S. health officials and drug makers could start working on an experimental one soon. Both GlaxoSmithKline and Sanofi are considering developing a treatment.

Xerox said it would split into two companies, one holding its legacy hardware operations and the other its business process outsourcing unit, in which activist investor Carl Icahn will get three board seats. The company, whose shares had fallen more than 30% in the past 12 months, has been trying to turn itself around by focusing on software and services as businesses cut costs and a switch to mobile devices hits demand for printers.

Fourth-quarter earnings reporting season is well under way, with S&P 500 companies on average expected to post a 4.1% drop in earnings, according to Thomson Reuters. Excluding energy companies, earnings are seen rising 2.1%.

Chevron reported its first quarterly loss in more than 13 years on Friday as the oil producer struggled to cope with plunging crude prices that are eroding profitability across all its divisions. The company posted a fourth-quarter net loss of $588 million, or 31 cents per share, compared with a net profit of $3.47 billion, or $1.85 per share, in the year-ago period. The last time Chevron posted a quarterly loss was the third quarter of 2002. Chevron last month announced it would cut its 2016 budget by 24% to $26 billion.

It’s time now for another edition of Banks Behaving Badly: In today’s edition we take you back to last summer, when we told you tens of thousands of Malaysians gathered in Kuala Lumpur and demanded to know how almost $700 million linked to the debt-laden government investment fund 1Malaysia Development Berhad (1MDB) ended up in prime minister Najib Razak’s personal bank accounts. 1MDB was set up by Najib six years ago and has been the subject of intense scrutiny for borrowing $11 billion to fund questionable acquisitions. $6.5 billion of that debt came from three bond deals underwritten by Goldman Sachs, which charged nearly $600 million in fees, and resulted in little or no development in Malaysia.

We now have an answer from the attorney general appointed by Najib to investigate Najib. The AG says the $700 million that just appeared in the Prime Minister’s personal bank account was a personal gift from the royal family of Saudi Arabia, and there was no bribery or corruption. So, the Prime Minister has been cleared of all wrongdoing because hey, sometimes wealthy Saudis just hand out really lavish gifts. Meanwhile, Tim Leissner, chairman of the Goldman Sach’s Southeast Asia ops, is taking leave of absence from Goldman and moving from Singapore to LA.  And that’s the way they do it.