Financial Review

Mind the Gap

Sinclair Noe — January 18, 2017

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DOW – 22 = 19,804
SPX + 4 = 2271
NAS + 16 = 5555
RUT + 6 = 1358
10 Y + .06 = 2.39%
OIL – 1.09 = 51.39
GOLD – 12.70 = 1205.00

The Dow Industrials spent most of the day in slightly negative territory. The S&P 500 traded in a tight range between negative and positive. If it seems like the stock market’s crawl to nowhere over the past month has been particularly strange, that’s because it has been. It turns out the gap between the Dow’s high and low prices over the past month is a tiny 1.4 percent — the narrowest gap in data going back to 1957.

On December 13, the Dow crossed 19,900 and pushed toward 20,000 – getting within a fraction of a point, then falling to a low of 19719, or a 1.4 percent range. So, something has to give – the question is whether we will see a break out or a break down. The long-term trend is still higher, but we really must wait and let the market show us.

Consumer prices rose in December as households paid more for gasoline and rent.  Consumer Price Index rose 0.3 percent last month after gaining 0.2 percent in November. In the 12 months through December, the CPI increased 2.1 percent, the biggest year-on-year gain since June 2014.

The so-called core CPI, which strips out food and energy costs, rose 0.2 percent last month after the same increase in November. As a result, the core CPI was up 2.2 percent in the 12 months through December. Rents rose 4% compared to a year ago, in December, the Labor Department said Wednesday.

That’s the strongest yearly gain since December 2007, the month the Great Recession began. Rising inflation comes against the backdrop of a strengthening economy and tightening labor market, which raises the prospects for more, and faster interest rate hikes from the Federal Reserve.

Fed Chair Janet Yellen delivered a speech today and said the economy is close to the Fed’s objective of full employment and stable prices and she’s confident it will continue to improve. That, in turn, means “it makes sense to gradually reduce the level of monetary policy support,” although Yellen said the timing of the next interest-rate increase “will depend on how the economy actually evolves over coming months.” Yellen said, “Right now our foot is still pressing on the gas pedal.”

Meanwhile, Fed Governor Lael Brainard said fiscal policies that boost demand when the economy is already around full employment and 2 percent inflation are “relatively more likely to be accompanied by increases in interest rates.”

Meanwhile, Minneapolis Fed President Neel Kashkari is launching a research institute to generate ideas elected officials might use to help more Americans benefit from a growing economy and address issues such as racial disparity and income inequality.

Meanwhile, the Fed published its Beige Book, reports from all 12 Fed districts which is released 2 weeks before FOMC policy meetings. Manufacturers in “most” of the Federal Reserve System’s 12 regions reported increased sales.

Companies reported uncertainty surrounding the change of administrations in Washington but remained generally optimistic about growth prospects for 2017. Labor markets were reported to be tight or tightening and pricing pressure intensified.

Central bank policy might have a problem, according to the central banks’ bank. A working paper by the Bank for International Settlements found cuts in interest rates and asset purchase programs can help reduce volatility in stocks and bonds, but it also found lower rates, or lower term-premium, doesn’t appear to spark economic growth.

Industrial production rebounded in December due to the biggest jump in utilities since 1989 as temperatures cooled across the country. The Federal Reserve said industrial output rose 0.8 percent last month. The bulk of December’s increase was due to the 6.6 percent rise in the utilities index. Overall industrial production, however, fell at an annual rate of 0.6 percent in the fourth quarter.

The oil market got a stark reminder that rising oil production in the U.S. could upend efforts by major producers to bring global supply and demand for crude back in to balance. The Energy Information Administration released a report on drilling productivity—forecasting a monthly rise of 41,000 barrels a day in February oil production to 4.75 million barrels a day.

Citigroup reported a 7 percent rise in quarterly profit, beating estimates. However, adjusted revenue fell 9 percent to $17 billion due to divestitures and missed the average estimate.

Goldman Sachs Group reported net income of $2.2 billion, a nearly fourfold rise in quarterly profit.  The fifth largest U.S. bank by assets, which relies more on revenue from trading stocks and bonds than other Wall Street companies, posted a 25 percent jump in trading in the fourth quarter compared with the prior year. Goldman beat on the top and bottom lines.

HSBC became the first major bank to detail plans to move jobs out of London after Brexit, saying it will relocate staff responsible for generating around a fifth of its UK-based trading revenue to Paris after Britain leaves the EU.

The United States sued JPMorgan Chase, accusing the bank of discriminating against minority borrowers by charging them higher rates and fees on home mortgage loans between 2006 and at least 2009. Separately, the Labor Department claimed the bank “systematically discriminated” against 93 women technology workers in its investment bank by paying them lower wages since at least 2012.

The Labor Department asked an internal administrative judge to cancel all government contracts and prevent JPMorgan from entering future federal contracts if it fails to provide relief.

United Continental’s fourth quarter profit tumbled. The airline announced fourth-quarter earnings of $1.78 a share on revenue of $9.1 billion but said its profit fell 51% to $397 million because of its tax bill.

American Airlines is introducing its Basic Economy fares, because Economy fares weren’t basic enough. The new fares, also known as Sub-Cattle Class, mean you can’t store carry-ons in the overhead compartments, no assigned seating, last to board, and no changes at all, no upgrades, and no soup for you.

Meanwhile, American’s flight attendants have a problem with their new uniforms – they claim it is causing skin rashes, itchy eyes, sore throat and blisters. The airline spent $1 million on tests and still don’t know what is wrong.

Target cut its quarterly earnings forecast after sales for the holiday season came in lower than expected due to weak demand for electronics, food and other products. Sales at Target stores open at least a year declined 1.3 percent in the November-December period, while total sales fell 4.9 percent. Target follows rivals Macy’s and Kohl’s, which also cut their profit forecasts after reporting disappointing holiday sales.

J.C. Penney shares sank about 2% after announcing a new partnership with Nike to add Nike shops in 600 of its stores. I’m not sure why that would be bad news.

After the closing bell, Netflix report earnings of 15-cents per share, beating estimates by 2-cents. The company said it added 7.05 million subscribers during the quarter, well above its own expectations of 5.2 million. Its stock has risen by a dazzling 35% in the past six months and is tacking on 8% in after-hours trade.

Essilor of France said it would merge with Luxottica Group of Italy, owner of the Ray-Ban and Oakley brands in a $49 billion deal. The combined company would be known as EssilorLuxottica, and would be the largest player in the eyewear market. The new company would have more than 140,000 employees in 150 countries with 2016 revenue of $16 billion.

Navient, the nation’s largest student loan servicer was hit with a Consumer Financial Protection Bureau lawsuit over allegations that it has “systematically and illegally” failed borrowers. Navient, formerly part of Sallie Mae, created repayment obstacles for tens of thousands of student borrowers by providing incorrect payment information, processing payments incorrectly and failing to act when borrowers complained.

British bookies will bet on almost anything, including specific words or phrases Donald Trump might say in his inaugural address on Friday. Ladbrokes, for example, is offering odds of 1/50 for “Make American Great Again”, indicating there’s a good chance Trump will repeat his campaign slogan in Friday’s speech.

That means a $1 bet would only yield 2 cents in case of a win. With slightly longer odds, “Reagan” comes in at 1/5, followed by “tremendous”, “ISIS” and “China” at 1/2. Further down the list sit “fake news” at 3/1 and “totally false” at 5/1. Aside from the buzzword betting, gamblers can also try their luck with Trump’s tie color and speech length.

It’s official, according to the National Oceanic and Atmospheric Administration (NOAA) 2016 was the hottest year on record, again. The planet sizzled to its third straight record warm year in 2016, and 16 of the 17 warmest years have occurred since 2001. The average temperature across the Earth’s land and ocean surfaces in 2016 was 58.69 degrees, a whopping 1.69 degrees above average.

It was the largest margin by which an annual global temperature record has ever been broken. Record high temperatures were set in 2016 on nearly every continent. No land areas were cooler than average for the year. Eight straight months (January through August) were also each the warmest since records began 15 years after the Civil War ended.

Financial Review

Stormy Weather

Sinclair Noe — October 23, 2015

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

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DOW + 157 = 17,646
SPX + 22 = 2075
NAS + 111 = 5031
10 YR YLD + .05 = 2.08%
OIL – .65 = 44.73
GOLD – 1.90 = 1165.00
SILV – .03 = 15.91

After Thursday’s closing bell Microsoft, Amazon, and Alphabet all reported very strong third quarter earnings, and these companies are big enough to lift the entire market; today they added $80 billion in market cap. Amazon and Alphabet hit all-time highs, and Microsoft moved to its highest levels since 2000. Toss in a little central bank easy money and you’ve got one of the best two day rallies in a long time.

The S&P 500 gained 2.1% for the week; its fourth straight weekly gain; moving into positive territory year to date. For the week, the Dow rose 2.5 percent and the Nasdaq gained 3 percent. Oil capped its biggest weekly decline since August as expanding U.S. crude stockpiles exacerbated a global glut, and the dollar moved higher, especially against the euro.

China’s central bank cut interest rates today for the sixth time in less than a year (down 25 basis points to 4.35 percent) , and it again lowered the amount of cash that banks must hold as reserves. Monetary policy easing in the world’s second-largest economy is at its most aggressive since the 2008/09 financial crisis. The People’s Bank of China said it was freeing the interest rate market by scrapping a ceiling on deposit rates; which will, in theory, allow banks to price loans according to their risk, and remove a distortion to the price of credit that analysts say fuels wasteful investment in China.

At a rate review next week, the Bank of Japan will cut its growth and inflation outlook for this fiscal year but only slightly tweak its projections for 2016. The BOJ can still maintain it’s on course to meet its inflation goal of 2% next year without needing to step up its massive asset purchase scheme.

While the Eurozone’s composite PMI unexpectedly increased to 54 in October from 53.6 in September, signaling a pickup in activity, forward-looking indicators point to a risk of a slowdown, according to Markit Economics. Service-sector expectations for the year ahead fell to a 10-month low.

Stocks across the globe extended a rally from the previous session, as central banks exert their dominance on markets. Yesterday, ECB President Mario Draghi signaled his willingness to add more stimulus to the Eurozone’s flagging economies, possibly at the next ECB meeting in December. The euro dropped for a second day versus the dollar, down 2.8% for the week. The euro is down more than 8 percent against the dollar year-to-date, and has fallen by 12 percent over the past year. Call it an accidental devaluation of the euro. The ECB claims it is not their intention to devalue the euro, but there simply doesn’t seem to be much evidence that QE and zero rates have done much to drive inflation higher. Still, the market salivates and sells euros when Draghi says QE.

Against a backdrop of ongoing stimulus in Japan, a big burst of new stimulus in China, and anticipated extension of stimulus in Europe, it becomes increasingly difficult to imagine the Fed will be able to go against the grain and hike interest rates any time soon. Fed funds futures rates show almost no chance next week when the FOMC meets, and less than a 50% chance when they meet in March.

This has implications across the board. The Federal Reserve’s decisions about interest rates will affect every single person and company in the United States. Walmart will like having cheap imports. Boeing won’t like that its planes cost more to foreign buyers. Family farmers won’t like it; big agribusinesses, like Cargill, will. For banks, a Fed rate increase can be good and bad news: In a recent report on the subject, Goldman Sachs argued that some banks, like M&T and Wells Fargo, are going to be in a bit of trouble, while others will make more money from interest rates on loans. On an individual level, Fed rate increases are better for older people who live on savings and worse for younger people who tend to borrow more.

If the Fed added up all the ways a rate increase helped people in the short term and subtracted all the ways it hurt them, they would never raise rates. While there are winners and losers, on balance a Fed rate increase means the economy will slow down, which on average is worse for everybody. Of course Wall Street loves easy money from the Fed. Global markets are as well trained as Pavlov’s dogs.

This week the People’s Bank of China announced easy money, although most of that stays in China, and the European Central Bank announced it would continue with its QE asset purchases; currently the ECB is buying a little over $90 billion in government bonds each month, and Draghi hinted there might be more coming in December. And the funny part is that all this extra money being pumped into the system should result in inflation, but the opposite is happening. Rates in the Eurozone are near zero, and this week the Italian 2 year government note went negative, as did the US Treasury 30-day bill. So where is all that money going?

Well, it’s going into government bonds. And where are the government bonds going? Well, they are being used as collateral for the $700 trillion dollar derivatives market where they are tucked away as collateral. And the lower the central banks pegs interest rates, the more the banks are forced into taking risks to generate returns, and that means risk, and risk is mitigated (at least in theory) with derivatives, backed (again theoretically) by the collateral of government debt.

And so, some off the biggest news of the week that nobody noticed was a new ruling from a couple of regulators, which will greatly reduce the collateral requirements the big banks must set aside in derivatives deals. The rules are still in draft form, but they would cut in half what the companies must post in transactions between their own divisions. The proposed rules are coming from the FDIC and the Commodities Futures Trading Commission, backed by the financial industry and the rules are apparently being drafted by the financial institutions as well.

It’s difficult to estimate how much is at stake for banks, but the derivatives market is estimated at $700 trillion nominal value; the collateral involved is likely in the hundreds of billions in non-cleared swap trades. The banks think this might free up collateral for other purposes. I’m guessing riskier purposes, but time will tell. What this also might address is the remarkable lack of supply of government debt – how else to explain Italian notes going negative?

Best guess is that we will see continued growth in structured financial assets that made synthetic swaps where the casino banks sold protection based upon bonds, rather than actually investing in bonds, and then called it collateral that could be sold as insurance to guarantee payment on insurance contracts. Sure – what could go wrong?

Analyst sentiment on overall third-quarter earnings has improved following the string of strong results from blue chips. S&P 500 earnings for the period are now expected to have declined a more modest 2.8 percent, compared with a decline of 5.5 percent forecast at the start of the reporting season.

American Airlines reported earnings of $1.9 billion, or $2.77 a share; beating estimates. American realized big savings from lower fuel costs. American’s board authorized a new $2 billion share repurchase program to be completed by year-end 2016. They still face an air fare war. American said it will discount tickets in a bid to win market share.

The Environmental Protection Agency regulatory package known as the Clean Power Plan officially became law today. It was immediately challenged by 24 states, led by West Virginia, in a U.S. appeals court filing in Washington. The states are asking for a court order blocking the measure until the lawsuit is resolved. It’s at least the third time the initiative has come under legal fire. Earlier challenges were rejected by federal judges as premature because the measure hadn’t been published.

The U.S. government no longer has that defense, leaving the regulations open to attack. The Clean Power Plan aims by 2030 to reduce power plant carbon emissions 32 percent below where they were in 2005. The rules require states and utilities to use less coal and more solar power, wind power and natural gas. States are required to submit their initial plans for meeting those objectives by Sept. 6 of next year. Final plans must be submitted two years later. EPA Administrator Gina McCarthy, issued a statement saying the Clean Power Plan is based upon “strong scientific and legal foundations” and is within the authority granted to the agency under the Clean Air Act.

Hurricane Patricia is moving onshore right now around Manzanillo on the Pacific Coast Mexico. It is being called the most powerful storm in recorded history, with winds clocked at 200 miles per hour, which makes it a Category 5. The only good news is that this area of Mexico is not heavily populated. Evacuations have been ordered along the coast. The US National Hurricane Center said Patricia was on track to make a “potentially catastrophic landfall.” Storm surge could top 30 feet. The storm is also expected to bring about 20 inches of rain.

So the storm surge will hit the coast, and then a couple of hours later, the rains will wash down from the mountains. The hurricane is expected to head northeast over Guadalajara, then dissipate as it hits the Sierra Madres, and over the next 2 or 3 days, it should make its way to Texas with heavy rains, and that’s on top of flooding in Texas happening now as the result of another storm system.

Black Monday + 28 years

Financial Review

Black Monday + 28

Sinclair Noe — October 19, 2015

Podcast: Play in new window | Download (Duration: 13:18 — 6.1MB)

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DOW + 14 = 17,230
SPX + 0.55 = 2033
NAS + 18 = 4905
10 YR YLD + .01 = 2.03%
OIL – 1.07 = 46.19
GOLD – 7.10 = 1171.60
SILV – .20 = 15.93

Twenty-eight years ago today, the Dow Jones Industrial Average crashed; a one day loss of 508 points, or 22.6%, down to 1,738 on what is now referred to as Black Monday. It was by far the largest one-day percentage drop in US stock market history.

China’s economy grew 6.9% in the third quarter from a year ago, beating forecasts for 6.8% growth. The results add to doubts the country can meet its year-end GDP target of about 7%, and raises pressure on Beijing to roll out more stimulus measures following a summer stock market plunge and devaluation of the yuan. Most China analysts also feel the GDP number is fictional, probably more like 3% than 6.9%, but it’s still the slowest growth since 2009.  China has been cutting its holdings of US Treasuries for the first time since 2001, but so far demand remains strong from other foreign investors and American investors.

Last month, Chinese President Xi Jingping visited Washington and an agreement was announced that China and the US would refrain from cyberattacks by each country on the other or on companies domiciled in the respective countries. Yeah, not so much. Security services provider, Crowdstrike reports it has tracked a number of attacks on American tech and pharmaceutical companies leading up to and after President Xi’s visit to the US, including the 3 weeks since Washington and Beijing signed the cybersecurity agreement.

Of course, it may be foolish to think that anything on the internets is secure. Case in point: a hacker has breached non-government personal accounts associated with CIA Director John Brennan as well as Department of Homeland Security Secretary Jeh Johnson and posted personal info, fortunately nothing classified. The hacker told the New York Post that it was a fairly simple process to hack Brennan’s personal AOL account. The hacker is apparently a high school student who doesn’t like US foreign policy, and probably has job offers already in San Jose.

The slump in oil prices has pushed Saudi Arabia into a budget deficit for the first time since 2009, forcing the country to delay payments to government contractors. Seperately, Iran’s Oil Minister has said that “no one is happy” with prices at current levels and that OPEC members should cut production to boost prices to $70 to $80 a barrel.

The European Central Bank’s Governing Council meets this week in Malta to set monetary policy for the region. There has been plenty of talk about the need for more monetary easing, but most analysts expect a move later in the year, but not at this week’s meeting. Still, if they plan some sort of stimulus plan, they would need to communicate at this meeting – in other words, they might talk down euro strength. Whatever they do, it’s already working the dollar was higher against the euro and a basket of currencies.

Sustained gains in the dollar will come from a more defined increase in hopes for a December Fed rate hike. In other words, while the ECB might jawbone markets for more easing, the Fed might jawbone markets for a rate hike. That could come from a more hawkish Fed at next week’s Federal Open Market Committee meeting or a solid uptick in payrolls for October and November.

The National Association of Home Builders/Wells Fargo housing market index rose 3 points to 64, the highest level since the same month of 2005. The index measuring sales expectations in the next six months rose seven points to 75, and the component gauging current sales conditions increased three points to 70. The index on buyer traffic held steady at 47.

International Business Machines said its third-quarter revenue fell 14%, hurt by declines in hardware sales and the stronger dollar. IBM posted revenue of $19.2 billion in the latest quarter from $22.4 billion a year earlier.  Per-share earnings from continuing operations fell to $3.34 from $3.68. IBM also lowered its earnings guidance for the year as the company reported sales declines across its major businesses, led by a 39% drop in its hardware segment.

Morgan Stanley is the last of the major banks to announce third quarter results, and they saved the worst for last. Morgan Stanley reported both revenue and profit declined more than expected. The biggest hits came from the bank’s bond and fixed-income trading desks and from its hedge fund and private equity business in Asia. Revenue dropped 13 percent from the same quarter a year earlier, and 20 percent from the previous quarter; the drop was even sharper after accounting for certain customary adjustments for debt valuations. That pushed down the profit in the quarter to $740 million, or 34 cents a share, after those adjustments – a 55% decline from a year earlier.

Recently named Deutsche Bank CEO John Cryan is shaking things up at the investment bank. Cryan cleaned house by removing executives close to the former CEO. Deutsche is also abolishing its group executive committee, which is made up of 19 senior managers, and streamlining how its main units are represented on the management board.

U.S. banks are going to new lengths to ward off big cash deposits, judging that the cash may be too costly to keep. For the first time, State Street has begun charging some customers for large dollar deposits, and JPMorgan has already cut unwanted deposits by more than $150 billion this year. The actions are driven by low interest rates and new regulations adopted since the financial crisis, such as reserves of as much as 40% against certain corporate deposits and as much as 100% against some deposits from hedge funds.

Police have raided Volkswagen’s main offices in France as part of an investigation into the automaker’s cheating on diesel emissions tests. The move suggests VW’s legal troubles are spreading across Europe as similar searches have already been carried out at the company’s headquarters in Italy and Germany. On Friday, Volkswagen reported its group sales fell 1.5% in September, although the larger impact from its scandal will likely be reflected in the sales volume of October.

General Motors has discovered another ignition switch problem that causes engines to shut off and disables power steering, power brakes and possibly the air bags. The automaker is now recalling about 3,300 big pickup trucks and SUVs mainly in North America. The issue was discovered by an employee who owned one of the defective trucks and reported it to higher-ups through GM’s new “Speak Up For Safety” program.

Ferrari’s long-awaited initial public offering is finally at the starting line, with the stock likely to be priced Tuesday night and begin trading on the NYSE on Wednesday. Fiat Chrysler is selling about 10% of Ferrari in the IPO. At the top of its projected range of $48-$52 a share, the luxury sports-car maker would have a stock-market valuation of $9.8 billion.

Ahead of a critical vote this week, leaders at the United Auto Workers union have launched a social-media blitz to help sell a new tentative labor deal to Fiat Chrysler workers. While offering a path to higher wages for new hires, many members still find the deal lacking. Voting on the new contract starts Tuesday and concludes on Wednesday.

Shareholders will get their say this week on two proposed health insurer mergers: Aetna’s $37 billion offer for Humana, and Centene’s $6.3 billion bid for Health Net. Although consumer advocates have raised concerns about whether the combinations will lead to less competition and higher prices, proxy advisors ISS and Glass Lewis have given both deals a thumbs-up. Aetna and Humana investors are scheduled to vote this afternoon and Centene and Health Net shareholders will cast their ballots on Friday.

United Continental is still silent on the medical condition of its new CEO Oscar Munoz, who was admitted to the hospital on Thursday after suffering a heart attack, but investors are questioning who will lead the company in his absence. Munoz’s health problems come barely a month after he took on the job of improving the profitability and reputation of United, the No. 2 U.S. carrier by capacity.

Slowing growth and rising costs are driving a historic wave of consolidation in the semiconductor industry as firms look to streamline their organizations and product lines. Chip companies have so far announced just over $100 billion in mergers and acquisitions this year, exceeding the $37.7 billion in 2014, and totals could go even higher. Last week, at least four chip companies were in talks concerning different deal options, including; Analog Devices, Maxim Integrated Products, SanDisk, and Fairchild Semiconductor.

Alibaba is lobbying to stay off the U.S. Trade Representative’s blacklist this year after coming under renewed pressure over suspected counterfeits sold on its shopping platforms. Alibaba.com was removed from the “Notorious Markets” list in 2011.

Over the weekend, US Airways ceased independent operations after more than 75 years in business.  Flight 1939 — the final flight operated using the US Airways name — started at the airline’s Philadelphia hub before flying to Charlotte, Phoenix, San Francisco and Philadelphia. After its final flight, the Tempe, Arizona-based airline combined its flight and ticketing operations with its merger partner, American Airlines. The Flight number, 1939, was the year US Airways started service, delivering mail.

This is the culmination of an $11 billion merger that was first announced in 2013. Prior to the merger, US Airways boasted a fleet of more than 300 jets. The post-merger American Airlines now has the largest fleet in the world, with more than 900 mainline aircraft. In addition to adding capacity and changing the name, the merger involved combining reservations systems and baggage handling, and millions of tiny details. As you might expect, there were a few little hiccups, but really very few. The transition was one of the smoothest, so far, in aviation history. It is easy to find something to complain about regarding the airlines, any airline, but on this point, it looks like they did it right.

Financial Review

Buckle Up

Sinclair Noe — March 17, 2015

 

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

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DOW – 128 = 17,849
SPX – 6 = 2074
NAS + 7 = 4937
10 YR YLD – .04 = 2.06%
OIL – .42 = 43.46
GOLD – 5.70 = 1149.60
SILV – .10 = 15.63

The FOMC will wrap up its two-day meeting on interest rate policy tomorrow. The key question: will the Fed give a hint about raising interest rates? IMF Director Christine Lagarde says even if the Fed is able to manage expectations about an interest rate hike, “the likely volatility in financial markets could give rise to potential stability risks.”

ECB President Mario Draghi says, “Most indicators suggest a sustained (eurozone) recovery is taking hold.”  Draghi is urging governments to use the brighter outlook to advance reforms that would improve the region’s long-term growth prospects. Draghi claims, “Confidence among firms and consumers is rising. Growth forecasts have been revised upwards. And bank lending is improving on both the demand and supply sides.”

Draghi sounds a little overly optimistic. A couple of weeks of bond buying have not changed the overall economies of the Eurozone. Unemployment is still rampant in Spain and Italy and Greece and Portugal and several other countries. No doubt QE is increasing liquidity in the sovereign debt markets; the private banking system are surely pleased with cheap money policy, but it hasn’t changed the jobs picture, it hasn’t resolved the underlying problems of the economy, and it hasn’t resolved the problem of deflation.

Many people thought that QE would result in inflation, or even hyper-inflation. Wrong. Just this year, 23 central banks have cut rates due to sluggish growth. In the process their currencies will weaken. The Bank of Japan maintained its massive 80-trillion-yen stimulus program today, and noted inflation could fall into negative territory because of the continued weakness in energy prices; however, it also said any return to deflation would not last long. A return to moderate inflation might just be wishful thinking.

Meanwhile, the euro is tanking against the dollar as the ECB buys covered bonds from the Euro-banks, while Greece is left to dangle from a short and sharp hook, locked out of the capital markets. Today, Greece began debate on emergency measures to deal with $2.1 billion in debt payments due Friday. Euro quantitative easing has nothing to do with helping Greece attain a stronger economy and everything to do with rewarding speculators and the Euro-banks that sold them bonds. Included in the amount due Friday, payments on a swap originally arranged by Goldman Sachs in 2001. The derivative, now held by the National Bank of Greece, masked the country’s growing debt, helping it meet European Union rules for entering the euro area.

There are only so many entities that can buy so many bonds and filter so much cheap capital into the system for so long. Eventually the ECB will quit QE. Eventually the Federal Reserve will raise interest rates. And then what? Well, the central bankers will look for new ways to finagle the financial sector, but we might reasonably expect more volatility. Maybe the Fed will give us a hint tomorrow.

When we think about volatility in the markets, we tend to default to the stock market, but don’t forget bonds. Consider that the 10 year US Treasury note yields 2.06%. The Japanese 10 year bond yields 0.41%. Germany at 0.28%, and Spain 1.25%. These are historic lows.  So, with the bond market appearing ripe for a dramatic correction, many are wondering whether a crash could drag down markets for other long-term assets, such as housing and equities.

According to Nobel economist Robert Schiller, long-term rates in the US should be even lower than they are now, because both inflation and short-term real interest rates are practically zero or negative. Even taking into account the impact of quantitative easing since 2008, long-term rates are higher than expected. The history of bond markets crashes have been relatively rare and mild. So, there should be no reason for bonds to crash from here… unless, there is a major spike in inflation, or the central banks tighten monetary policy very sharply by hiking short-term interest rates.

For now, the markets are trying to make sense of where everything is headed. The result has been volatility. The Dow Jones Industrial Average was down a bit over 100 points last week, but that hardly does justice to a week with multiple triple digit swings. Three of the last six trading days have seen a move of at least 1%. Today the Dow dropped 128 points, and that was just a move of 0.7%. Still, it can be a bit unnerving. Volatility in and of itself isn’t necessarily a bad thing as markets can continue to climb even as volatility does the same. A rising VIX doesn’t have to correspond with a lower stock market. The VIX (volatility index) trended higher from 1996 right to the end of the dotcom mania. Maybe that is not reassuring, but this is not the internet bubble.

One reason for the volatility is because earnings outlook has turned lower, but even more so because earnings outlook has turned very uncertain; and the reason behind the uncertainty is the volatility of the dollar. Yes, the dollar has been getting stronger; remember that volatility can apply in up or down markets. The strength of the dollar raises questions about whether companies have properly hedged earnings in other countries. Will a higher dollar create a debt crisis outside the US as it has in the past? What will central banks do in response? Which central bank will win the race to the bottom of currency valuations? How will that affect the US economy?

Economic data in the US has been on the weak side lately. A strong dollar doesn’t help. Inventory to sales ratios have now jumped to levels that are comparable to late 2008. Sales were down for the third month in a row led by declining auto sales (-2.5%). Sales were down across a wide swath of industries. The economic expansion since the 2008 crisis may have been disappointing, but it has been remarkably steady. Annual GDP growth has been eerily consistent, between 2 and 2.5% for years. The last time we had such a run of consistent growth was the late 90s; the growth rate was higher, around 4%, but very consistent.

Maybe the strange part of the past few years is just how consistent the recovery has been. Maybe the lack of volatility is a result of the accommodative monetary policy of the Federal Reserve, well balanced against a weak economy, just enough to push forward, but not enough to reach escape velocity. The one thing we know is that markets fluctuate, they don’t move in a straight line. So buckle up, it should be interesting.

Construction on new homes in the United States slumped 17% in February, mostly because of heavy snowfall that sidelined builders in the Northeast and Midwest. Housing starts sank to an annual rate of 897,000 in February from a revised 1.08 million in January. But nationwide permits for future construction rose, suggesting construction will pick up in the spring. The biggest increase in applications for new construction once again involved multi-dwelling projects such as apartment buildings and townhouse rows. Permits for projects of five units or more jumped nearly 20%, reflecting a post-recession trend in which more people are renting instead of owning.

Another factor weighing on housing is negative equity. According to CoreLogic, there are 5.4 million homes, or 10.4% of all homes with a mortgage, underwater in the fourth quarter of 2014. This is down considerably -18.9 percent, from a year ago-but it still keeps these borrowers from putting their homes on the market, because they would lose money. Additionally, of the 49.9 million U.S. homes with a mortgage, approximately 10 million (20 percent) have less than 20 percent equity, and 1.4 million have less than 5 percent. These homeowners also would have a difficult time selling because not only would they lose money in the process, but they also might not qualify for a new mortgage. Arizona is still one of the top 5 states for negative equity, with 18.7% of mortgaged homes underwater.

Exit polls show Israel’s elections are too close to call. Those waiting to find out who will be the next prime minister of Israel need to wait. Binyamin Netanyahu—the serving PM—won the same number of seats as Isaac Herzog’s Zionist Union according to several exit polls. Netanyahu is claiming victory, based on the idea that he can cobble support from other parties, but really, it’s too close to call right now.

American Airlines was added to the S&P 500. The airliner replaces Allergan, which has been taken-over by. The addition will take place after the close of trading on March 20.

Over the past few years we have talked about deferred prosecution agreements or non-prosecution agreements; a common tool used by the Justice Department in investigations ranging from sanctions violations to market manipulations. Such settlements require the banks to admit responsibility and cooperate with ongoing investigations. It is a bank or corporate equivalent of probation. The banks pay a fine and promise not to break the law for a few years, and if they can keep their nose clean, then all is forgiven. The problem is that the banks are repeat offenders.

For example, a few years back several banks were found to be rigging benchmark interest rates, the Libor scandal. Fines were paid and deferred prosecution agreement signed. Barclays, Royal Bank of Scotland, UBS, and HSBC are operating under such agreements. But now, the banks appear to have rigged the forex markets, or the currency exchange market, just within the past 2 or 3 years; which would be a violation of the agreement to stop breaking the law.

Leslie Caldwell, the head of the Justice Department’s criminal division, said in a speech Monday that the US is prepared to tear up settlements and charge banks for conduct covered by the settlements. “Where banks fail to live up to their commitments, we will hold them accountable,” Caldwell said. “The criminal division will not hesitate to tear up a DPA or NPA and file criminal charges.”

Of course prosecutors have talked tough in the past and then followed it up with the vicious pugnacity of a timid meter maid; the results have been predictable; the banksters’ recidivism rate has regularly topped 100%. So, don’t hold your breath.

FINANCIAL REVIEW

Ugly With Snow Flurries

Sinclair Noe — January 27, 2015

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

DOW – 291 = 17,387
SPX – 27 = 2029
NAS – 90 = 4681
10 YR YLD un 1.82%
OIL + .65 = 42.80
GOLD + 10.80 = 1293.10
SILV + .13 = 18.13

New York City was shut down overnight. That “blizzard of the century” was indeed a bad storm but not the predicted “snowpocalyspe”, even though authorities shut down schools, roads, subways, and rail; and more than 8,000 flights were cancelled. Turned out to be an overabundance of caution. New England was socked quite solidly, but not the Big Apple. Weather forecasters got it wrong; not the first time. And once again we were reminded that the news media is centered in New York.

(The bad news is that Wall Street opened this morning.)

Let’s start with a few economic reports. Home prices edge 0.2% lower in November. The S&P/Case-Shiller 20-city composite index dipped 0.2% in November and that lowered the year-on-year advance to 4.3%, down from a reading of 4.5% in October. Phoenix posted a 0.2% increase in home prices in November, but the year-on-year advance was only 1.9%.

The Case-Shiller report looks at resales of existing homes. Also today, the Commerce Department reported a big increase in new home sales; up 11.6% last month to a seasonally adjusted annual rate of 481,000. The gains were not enough to offset essentially flat home-buying over the course of 2014. Just 435,000 new homes were bought last year, a modest 1.2% improvement from 2013.

Orders for durable goods dropped 3.4% in December, the fourth decline in the past five months, and well below expectations. Durable-goods orders for November were revised to show a 2.1% decline instead of a drop of 0.9%. Transportation led the decline in December, dropping 9.2%. Orders for core capital goods – a measure of business investment – fell 0.6% in December for the second straight month.

The Conference Board said its index of consumer confidence jumped to 102.9 in January from a revised 93.1 in December, first reported as 92.6. The index is at its highest since August 2007.

The ruble has recovered slightly, after ending Monday’s session over 6% lower at 68.79. The plunge followed yesterday’s move by S&P to downgrade Russia’s sovereign rating to junk due to weak economic growth prospects, low oil prices and Western sanctions. European Union leaders threatened to tighten sanctions on Russia as soon as Thursday over its support for pro-Kremlin rebels in eastern Ukraine, who are engaged in the worst clashes with government troops since a September truce.

Greek Prime Minister Alexis Tsipras named a cabinet of anti-austerity veterans and halted privatization of Greece’s biggest port. The new finance minister described Europe’s austerity policies as “fiscal waterboarding.” Tsipras quickly demonstrated that Europe must not treat Greece as a weak junior partner. His government denounced a European Council statement in which European leaders blamed Russia for the escalating violence in Ukraine and raised the prospect of new economic sanctions. Further sanctions cannot be approved without a unanimous vote from the leaders of European Union member nations.

Meanwhile, back on Wall Street it is earnings reporting season, and things turned ugly today. Actually, Microsoft got it rolling yesterday after the close. Microsoft’s net profit came in at $5.8B compared with $6.5B in the year-ago quarter. Microsoft also set its financial forecast for the remainder of the fiscal year, which ends in June, below Wall Street estimates.

Caterpillar gave a disappointing outlook for 2015, citing falling commodity prices, as the heavy-machinery maker also reported earnings for the fourth quarter that missed expectations. Caterpillar said it expects to post per-share earnings of $4.75 a share on revenue of $50 billion for the year. Analysts had projected $6.67 a share in earnings on $55 billion in revenue.

Freeport-McMoRan reported a fourth-quarter adjusted profit that missed expectations, and said it was taking aggressive action to defer capital expenditures as it combats the sharp drop in commodities prices. For the quarter ended Dec. 31, the company swung to a net loss of $2.9 billion, or $2.75 a share, from a profit of $707 million, or 68 cents a share, in the year-earlier period.

In other earnings news, Bristol-Myers Squibb forecast 2015 sales that trailed analysts’ estimates as a strong dollar cuts into the drugmaker’s revenue abroad. Pfizer offered downbeat guidance for the new year, citing a stronger U.S. dollar and drug-patent losses. The company posted adjusted profit of 54 cents a share on revenue of $13.12 billion. Analysts had projected earnings of 53 cents a share on $12.9 billion in revenue. DuPont posted a profit of 74 cents a share, but gave a disappointing outlook for 2015, citing a big hit on earnings from the strengthening dollar. Procter & Gamble missed fiscal second-quarter profit expectations and lowered its growth outlook for the year.

Are you starting to detect a theme here? A strong dollar is hurting multinational profits. Over 40% of revenues for S&P 500 companies comes from outside the US. More than 20% of companies in the S&P 500-stock index that have reported earnings have blamed a strong dollar as a negative drag on their profit results. You might expect that a company headquartered in the US that earns much of its revenue abroad would be well-versed in hedging against currency fluctuations, but that does not appear to be the case. And the US economy is not insulated from weak global demand.

Wall Street analysts have revised down their US profit estimates for 16 straight weeks. And that consistent lowering of profit expectations is starting to show up in lower growth expectations for coming quarters. Profit growth for the just-completed fourth quarter is tracking at 3.3%, according to Thomson Reuters I/B/E/S, putting the quarter on track for the slowest quarter of profit growth since the third quarter of 2012. What’s more striking is how quickly the growth projections have come down: On Jan. 1 analysts expected fourth-quarter growth of 4.2%, and back on Oct. 1 the expectation was for 11.2% growth.

A similar sharp slide in growth expectations is now occurring for 2015. Analysts now expect first-quarter 2015 profit growth of 1.9%, down from 5.3% on Jan. 1. Earnings growth forecasts have now been slashed for all four quarters this year. Full-year 2015 profit growth is now forecast at 5.7%, down from 8.1% on Jan. 1.

Falling commodity prices are hurting companies that deal in or provide services to resource related firms, and Big Oil companies haven’t reported yet. One might think that the steady slide in the price of oil that has continued since last July would result in a supply contraction at some point. However, that is not what industry statistics are indicating, at least not yet. In fact, oversupply accelerated in the past seven weeks. In the U.S. alone, the total oversupply increased by over 1.1 million barrels per day, judging by inventory data. Spare storage capacity in the US is quickly shrinking, and the short-term contango is widening. In other words, the majority of cutbacks are still to come.

Of course lower oil prices have a bright side. American Airlines reported higher fourth quarter revenue, while operating expenses fell, primarily because of a 17% drop in fuel cost. That helped the company post a $597 million profit in the final three months of the year, compared with a $1.95 billion combined loss for its two predecessor companies, AMR Corporation and US Airways, in 2013.

Airplanes are more crowded than ever, fares remain at a five-year high despite plummeting fuel costs and airlines are reporting record profits and soaring stock prices. The four major airlines all reported huge profits for 2014 in the past week and made clear that they have no plans to cut airfares or to increase the number of seats. American Airlines Group CEO Doug Parker said: “We’re going to continue operating American as though oil was still above $100 a barrel.”

So, that was the day on Wall Street: generally ugly with snow flurries. Then after the close of trade, Apple reported first-quarter revenue of $74.6 billion and earnings of $18 billion or $3.06 per share, easily surpassed analyst estimates of $67.7 billion in revenue and $2.60 per share for the three-month period ended Dec. 31. So, that was very good, and the details are even better. Apple sold 74.5 million iPhones during the quarter, beating expectations of around 66 million; most sales were the new iPhone 6 and the 6-plus. Demand in China led the way, and revenue from China was up 70% and Apple is now the top smartphone vendor in China.

Mac sales rose 14 percent to 5.5 million units. One sour note; for the fourth consecutive quarter, iPad unit sales fell, dropping 18% to 21.4 million units; but the iPad is a victim of the iPhone’s success. Who needs and iPad if you have a big screen phone? The average selling price of the iPhone beat expectations too. It was $687 last quarter, versus $668 expected. The iPhone alone generated $51.2 billion in revenue for Apple.

So, why was the quarter such a success? This was a “super cycle” for iPhone upgrades. For the first time, Apple launched two new iPhone models with bigger screens, finally catching up to the rest of the industry. Every iPhone competitor already offered phones with screens that were at least 4.5 inches. Apple was the only smartphone maker left that made phones with tiny screens. The only problem for Apple is they have now set the bar very high.

Yea, not a problem. Apple forecast the momentum would continue, with revenue projected to rise to $52 billion to $55 billion from $45.6 billion during the same period a year ago. Gross margins could widen to 38.5 percent to 39.5 percent compared with 39.3 percent a year earlier.

On a side note, not part of the earnings report, Apple apps are now bigger than Hollywood. It’s estimated that App store billings for 2014 will come in around $14 billion dollars, compared to Hollywood’s US box office revenue of around $10 billion. The app economy sustains more jobs (627,000 iOS jobs in the US vs. 374,000 in Hollywood) and is easier to enter and has wider reach.

And that, boys and girls, is how Apple grew to be the largest company on the planet.

Apple Airline: The Only Way To Fly

Now that the fever has broken in the market over the price of Apple (AAPL) stock, it's on its way to test its 50 day moving average of $555. Probably, Steve Jobs has stopped spinning in his grave over how the cash buildup in his company will be desecrated sometime in Apple's fourth quarter through an announced dividend payment of $2.65 a share; let's discuss how Mr. Jobs might have approached the problem of too much cash. It's not too late.

We know what he did not do with Apple's cash. Paying the first dividend since 1995 was not an option or he would have done so while he was alive. Also, we know that he wasn't interested in buying another computer company. Why bother buying someone else's company, especially, if that company is inferior to the one you already own.

Steve Jobs was a riverboat gambler; he only played in the big casino of life. Hanging out with mental midgets and playing it safe (venturing out to the edges of pedantic MBA inculcation and foolish spreadsheets) only bore true Renaissance men busily changing the world. Before discussing what the right move could be let's review what Apple has always been and, hopefully, will remain so.

In my humble opinion, Apple was never a computer company in the traditional sense of the word; they were an industrial design company born at the end of the mass communication era. Computers became Apple's first object of desire just when society and culture leaped from a concentration of knowledge and information to segmentation and individuality. They displayed their affection for computers in this brave new world with a counter-culture homage alternative GUI (Graphical user interface) operating system to MS-Dos. Apple's next perpendicular act of defiance against establishment group thought was the creation of a mouse and a single box computer - Macintosh.

Apple's repeated success came from confronting complacent or flabby markets, myopic industries, and rescuing them and their customers from a future of indifference and mediocrity with radical ideas and borderless visions.

Apple Computer single handedly redefined the aesthetics, sensibilities, and most importantly, the functionality and simplicity of the personal computer; an alien household thing that one day would infiltrate our personal existence and daily lives much like a simple yet, unyielding, powerful idea.

I can recall in the early 1980's when technology journalists and critics wrote about, sincerely, why would anyone want a computer in their home? How would be used? Those were valid questions before social and multimedia; before there were podcast and Google, the Internet, and e-mail. Cable television was barely an infant when Apple began, but I digress.

Were Steve Jobs to seriously consider another opportunity outside of computers, summoning the magic and prowess of his industrial design mastery and vision, this he did in the music and video content distribution industries, the animation film industry, the personal data storage and PDA/mobile telecommunications device industries, the bottom line would be this: which industry can I make the greatest impact and receive the greatest enjoyment? I think Mr. Jobs would strongly consider purchasing American Airlines from creditors through the bankruptcy court and reinvent commercial aviation travel.

From a financial standpoint, a quick back-of- the-napkin calculation shows that American Airlines' $30 billion in outstanding debt, bought by Apple for a generous $.85 cents on the dollar, would generate a far greater return on $25.5 billion invested in short-term treasuries at a one-quarter of one percent. There is zero chance that the new owners of American Airlines Apple Airline will default. Also, the dollars to buy the outstanding debt equals just two quarters, 180 days, of recent net earnings for Apple. Short-term, it's a slam-dunk.

From the April 9, edition of BoydGroup International, a sobering account of domestic air travel and the industry is presented.

The facts are clear:

The "regional airline industry" (a misnomer) is in massive, fundamental, and permanent decline. The reason is simple and cannot be danced around any longer: the services they generally provide - leasing small units of capacity to large airlines - have a declining market need, and deteriorating market economics.

Further into this summary on the regional airline segment:

Going forward, the U.S. airline industry simply cannot afford to support the number of 50-seaters still in operation - regardless. The costs are going up, both in fuel and in maintenance, and therefore the number of viable mission applications are disappearing rapidly.

The bottom line is this:

The U.S. airline industry is no longer in a growth mode. In fact, it is in a contraction mode.

Same, actually with the EU. These markets are mature and saturated. More to the point, changes in the economics of aviation point to actual constriction in many aspects of the industry in these regions.

This is not just a statistic. It is a fundamental change in the dynamics of global aviation. Technology, innovation, and financing are all driven and sustained by one common factor - growth. Investment of money and brainpower generally goes to where the greatest return will be, and that means where the future offers more expansion.

So, the logical question to ask, then, why risk going into a declining airline industry? The answer is simple; if fundamental change is occurring and is inevitable, then, revolutionary things do occur at the intersection of change-agent and fundamental change.

Once upon a time passenger air travel in the U.S. was an elevated event in one's life. People dressed up to fly. Meals on planes were thoughtfully prepared, served on white china. The total aviation experience for airline customers was exciting (and that sensation did not come from TSA pat downs). Unfortunately, traveling today is an experience closer to ridding a Greyhound bus from Bakersfield to Fresno in the summertime; with limited air-conditioning. John Mauldin writes in his latest Thoughts from the Front Line "but air travel has long lost its romance."

The smart move for Apple to approach this endeavor includes purchasing an aircraft leasing company such as Air Lease Corporation (AL) or Aircastle (AYR) before completing the American Airlines transaction. This strategic decision will help manage leasing cost and provide crucial experience in an industry that's about to change. The nature of airline travel will change but it will not disappear.

A subsequent purchase would be for a fuel aviation company such as CVR Energy, (CVI), Valero Energy Corporation (VLO), World Fuel Services Corporation (INT), or PHILLIPS 66® AVIATION. Controlling fuel costs will go far choreographing a successful project. Eventually, the learning curve in these new businesses will translate into new software and hardware products and new business opportunities for Apple. These three acquisitions together provide the pieces necessary to begin redefining commercial aviation for the 21st century on Apple's terms.

Next, Apple cash balance allows management to pick up the phone, call Boeing (BA), and make them an offer they can't refuse. Offer a partnership with Boeing, starting with a commitment to build an identical manufacturing and assembly plant next to Boeing's current facility to double production. Additionally, negotiate a contract with Boeing to purchase 2,640 aircraft over the next 20 years. That's a delivery schedule of 11 aircraft per month from the new Apple/Boeing partnership facility. Finally, Apple will build an Apple-centric design facility on Boeing's grounds, supervising and being responsible for passenger cabin design and electronics.

The public is ready for something new in passenger air travel. As the domestic industry shrinks, competition based on price will lessen. Newer planes will become more efficient to operate and will interact more and more with personal technology. Fewer, but more affluent travelers will demand a better flying experience. As Apple aircraft takes to the skies a 100% business class service can be offered, at a higher price point than the industry average. Apple's global brand has the cache to easily execute this cost differential. They do it now on Apple products.

Imagine how Apple could reinvent the travel experience for airline passengers. Just imagine. Oh wow.

Newly designed Boeing aircraft, state-of-the-art electronics at every seat, and the entire iTunes catalog passengers can sample for free during each flight. Aboard each jet plane is an Apple Genius store concierge answering questions and providing demonstrations. Purchases from iTunes before you deplane are available at a discount. Synchronicity of your flight, itinerary, appointments, reservations, other personal needs can occur before you walk out your front door, leaving for the airport.

I can see decision makers flying the new AA testing their devices while multimedia and graphics software developers such as Electronic Arts (EA), content providers such as Time Warner (TWX), even individual stars like Lady Gaga paying Apple for the exclusive rights to premiere new content on certain flights or coinciding with major events.

In time, the Apple graveyard, home to the Rio mp3 player, Zune, the Palm Pilot, the Blackberry, and the computer laptop, might start digging a new hole for smug 20th century airlines.

This is visionary thinking. Go big or go home. I bet Steve Jobs would smile with approval, and then strengthen the idea.