Financial Review

Rocket Science

Sinclair Noe — April 14, 2015

 

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DOW + 59 = 18,036
SPX + 3 = 2095
NAS – 10 = 4977
10 YR YLD – .04 = 1.90%
OIL + 1.38 = 53.29
GOLD – 6.10 = 1192.90
SILV – .13 = 16.23

For the past 3 months, retail sales have been down. There was some speculation that the harsh winter weather was to blame for declining sales; and that appears to be true. Retail sales rose in March for the first time since late last year as consumers stepped up purchases of automobiles and other goods. Retail sales increased 0.9 percent in March. That was the largest gain since March last year and snapped three straight months of declines.

In a separate report, the Labor Department said its producer price index for final demand increased 0.2 percent last month, with rising prices for goods accounting for more than half of the increase. The PPI, which measures prices at the wholesale level, had declined 0.5 percent in February.  In the 12 months through March, producer prices fell 0.8 percent, the biggest year-on-year decline since the revamped series started in 2009. Of course, the Federal Reserve has a 2 percent inflation target, so this data does not suggest the Fed needs to be in a hurry to raise rates.

The National Federation of Independent Business said its small-business optimism index fell 2.8 points to 95.2, the worst reading since June, with all 10 of its subcomponents declining. The biggest decline came in the percentage that say they expect better conditions in six months.

The U.S. ended the month of March with a budget deficit of $53 billion, up 43% from the same period last year, bringing the current fiscal year-to-date deficit to $439 billion at the end of last month. Meanwhile, Fitch has affirmed the U.S.’s long-term default ratings at “AAA,” citing the country’s “unparalleled” financing flexibility as the issuer of the world’s pre-eminent reserve currency and benchmark fixed-income asset. Fitch also expects the U.S. to grow 3% in 2015, before decelerating slightly in 2016.

The dollar’s strength almost perfectly tracks Fed statements about the coming end of easy money. The tightening of US monetary policy (or even the hint that policy will tighten at some point) has driven the dollar up (and oil down) even as Europe’s beginning of its own “QE” or quantitative easing program has driven the Euro down. None of it reflects the economic reality on the ground, but rather the fact that central bankers are, as investment guru Mohamed El-Erian frequently says, the “only game in town.”

A new study from the Berkeley Center for Labor Research and Education at the University of California finds nearly three-quarters of the people helped by public assistance programs actually goes to families headed by a worker; they just don’t make enough money to cover the basic expenses. Taxpayers pick up the difference between what employers pay and what is required to cover what most Americans consider essential living costs. The report estimates that state and federal governments spend more than $150 billion a year on four key antipoverty programs used by working families: Medicaid, Temporary Assistance for Needy Families, food stamps and the earned-income tax credit, which is specifically aimed at working families. As a result, taxpayers are providing not only support to the poor but also, in effect, a huge subsidy for employers of low-wage workers. A report issued last week by the Federal Reserve Bank of Cleveland said that labor’s share of overall income had fallen to record lows in recent years.

New research from the Federal Reserve Bank of St Louis shows nearly one in three Americans now paying down student debt are at least a month behind in their payments; that figure is far higher than official delinquency measures from the Education Department and the New York Fed. And it is probably more accurate because it looks at people who have started to pay and not all outstanding debt, which includes people who have not yet started repayment. It’s estimated there is now $1.3 trillion in student loan debt outstanding.

Greece is preparing to take the dramatic step of declaring a debt default unless it can reach a deal with its international creditors by the end of April. The Financial Times quotes a government official saying: “We have come to the end of the road…If the Europeans won’t release bailout cash, there is no alternative [to a default].” Athens has also decided to withhold €2.5 billion-euro of payments due to the IMF in May and June if an agreement is not struck.

The International Monetary Fund left its projection for global growth in 2015 unchanged from three months ago at 3.5 percent. According to the IMF’s World Economic Outlook, the global economy is being reshaped by swings in currency markets and the drop in oil prices. The strengthening dollar is boosting growth in the Eurozone and Japan while taking some steam out of the U.S. recovery. Both the euro and yen have declined against the dollar as the European Central Bank and Bank of Japan purchase assets to boost the supply of money in their economies. The IMF cut its US expansion forecast by 0.5 percentage point to 3.1 percent, still the fastest among major developed economies. The Japan growth outlook increased to 1 percent from 0.6 percent and the euro area is projected to expand 1.5 percent as weakening currencies provide a boost. The figures show India will grow more quickly this year than China for the first time since 1999. The IMF predicts India will expand at a 7.5 percent rate. China is expected to grow 6.8 percent this year. Brazil will contract 1 percent in 2015.

One of the more important points of the IMF report is that potential output is growing more slowly than before. So, the takeaway is that the global economy is characterized by weak investment, low real and nominal interest rates, credit bubbles and unsustainable debt. Any solution sounds a bit circular, and largely deals with tweaking interest rates one way or another, while avoiding the real questions of increasing sustainable growth and reducing instability. Thanks IMF.

The race for renewable energy has passed a turning point. The world is now adding more capacity for renewable power each year than coal, natural gas, and oil combined. And there’s no going back. The shift occurred in 2013, when the world added 143 gigawatts of renewable electricity capacity, compared with 141 gigawatts in new plants that burn fossil fuels. According to an analysis presented at the Bloomberg New Energy Finance annual summit in New York, the shift will continue to accelerate, and by 2030 more than four times as much renewable capacity will be added.

The price of wind and solar power continues to plummet, and is now on par or cheaper than grid electricity in many areas of the world. Solar, the newest major source of energy in the mix, makes up less than 1 percent of the electricity market today but will be the world’s biggest single source by 2050.

Earnings reporting season kicks into high gear. JPMorgan Chase posted stronger-than-expected earnings growth, helped by a rebound in fixed-income trading. Revenue rose 5 percent. Wells Fargo reported first-quarter earnings that topped expectations. Wells Fargo said low interest rates pushed first-quarter lending margins below 3 percent for the first time since the 1990s. Johnson & Johnson reported adjusted earnings that topped expectations, but the consumer products giant also cut its full-year forecast, citing the impact of a strong dollar. Late Monday, Norfolk Southern forecast a surprise drop in its first-quarter earnings and revenue. Intel reported a 3% growth in first-quarter earnings on flat revenue growth as the semiconductor giant was hurt by softer demand for personal computers and impacts from a stronger dollar. For 2015, Intel said it now expects revenue to be flat from a year ago.

Cyberattacks and cybercrime against large companies – those with over 2,500 employees – rose 40% globally in 2014, according to Symantec’s annual Internet Security Threat study published Tuesday. Attacks on small- and medium-sized companies, which accounted for 60% of targeted attacks, increased 26% and 30%, respectively. Despite the large hacks at Home Depot, JPMorgan, Staples and Sony, Symantec says the mining industry, which includes oil & gas, was the most-targeted sector last year.

Nokia is in talks to buy smaller telecom equipment maker Alcatel-Lucent in a deal that would combine the industry’s two weakest players. In a joint announcement, the Finnish and French companies said they were in “advanced discussions” on a “full combination, which would take the form of a public exchange offer by Nokia for Alcatel-Lucent.” The two, which have been seen as a possible combination for the last several years, cautioned that the discussions could still fall apart. The pair are a good fit in terms of products and geographies, and bulking up would help them cut costs as they try to compete with much larger competitors in the mobile market.

Amazon and HarperCollins have reached a new multi-year publishing deal – expected to go into effect this week – that covers both print and digital titles. The agreement calls for HarperCollins to set the retail prices of its digital books, with incentives for HarperCollins to provide lower prices to consumers. In November, Amazon ended its brutal battle with Hachette over print and e-books, following a six month stand-off that battered the French-owned publisher’s sales.

United Launch Alliance, a joint venture of Lockheed Martin and Boeing, has unveiled a reusable rocket named “Vulcan” that is slated to take off in 2019 and end US dependence on Russian-built rocket engines. Russian-made RD-180 engines currently power ULA’s Atlas rocket, but Congress has banned further imports as part of trade sanctions enacted after Russia invaded Ukraine last year. Vulcan’s reusable engines are likely to slash satellite-launch costs and provide a stepping-stone to various commercial space ventures.

Space X has been working on a reusable rocket, the Falcon 9. After bad weather yesterday forced a delay, the Falcon successfully launched today, and will delivered its cargo to the International Space Station; the reusable part of the rocket then landed on a floating platform in the Atlantic Ocean, but it came in a little hot and the 140 foot tall rocket tipped over and fell into the water. Turns out rocket science is difficult after all.

FINANCIAL REVIEW

Finally, Holograms

Sinclair Noe — January 21, 2015

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

DOW + 39 = 17,554
SPX + 9 = 2032
NAS + 12 = 4667
10 YR YLD + .05 = 1.85%
OIL + .93 = 47.40
GOLD – 1.30 = 1293.90
SILV + .14 = 18.21

Gold moved above $1300 an ounce today. When was the last time you saw that? Last August. For the past 3 years, gold has been shellacked, but it is now testing an important level of resistance, and it coincides with the European Central Bank’s anticipated Quantitative Easing plan, which should be revealed on Thursday. Today we learned that an ECB executive board has called for bond purchases of roughly €50 billion per month over the next 12 months. The final number and details could change after the full board weighs in on the plan on Thursday. And the devil will be in details, and one of the most important is whether the ECB will let Greece play in their QE games.

The Bank of Japan held off expanding its stimulus program today, even as they cut their core inflation forecast to 1% from 1.7%. Two Bank of England policy makers dropped calls for higher interest rates. Elsewhere, the battle against inflation intensified as the Bank of Canada unexpectedly cut interest rates for the first time since 2009, saying the oil price shock will drag down inflation. The Bank of Canada is lowering its target for the overnight rate by one-quarter of one percentage point to 0.75%. The Canadian dollar, also known as the loonie, weakened sharply against the dollar, from around 1.20 down to 1.23.

The International Monetary Fund cut its forecast for inflation in advanced nations almost in half. And it looks unlikely the US will achieve its target of 2% inflation. The Federal Reserve FOMC meets next week, and there is growing consensus that Fed policy makers need to reassess their outlook for the economy as global weakness and disappointing data on consumer spending test their resolve to raise interest rates this year. Federal funds futures markets now show only a 15% chance the benchmark interest rate will be 0.5% or higher in June. And more than resisting inflation, the pressing issue seems to be how to create demand and economic energy.

President Obama delivered his State of the Union address last night. He called for new taxes on high-income earners and large financial institutions to pay for free community colleges. Other topics included foreign policy, healthcare, the Internet, Keystone XL, infrastructure, trade agreements, cyberattacks, climate change, and immigration reform.

Yea, that’s not going to happen. There are some things that will actually get done. Obama proposed reducing mortgage insurance premiums on government-backed loans in order to make it easier for low-income Americans to buy homes. This falls under Housing and Urban Development, which is under Obama’s control. Also, reducing methane emissions in the oil and gas industry by fixing leaky equipment and reducing “flaring” of natural gas; this one is the EPA, again under Obama’s control.

I think we might see congressional authorization of the military action against ISIS in Syria. The bombing of ISIS is already underway and congress is real bad at undoing something that has already started. Congress might not act and just leave the military action in a sort of limbo; don’t be surprised if congress tacks on a resolution indicating that the president acted illegally when he failed to get authorization in advance, because there is nothing like a unified front when you go to war. But there seems to be consensus that ISIS needs to be bombed to hell.

Treasury Secretary Jacob Lew said today he is confident that the Obama administration and Congressional Republicans can agree on a plan to reform a “dysfunctional” business tax code. He put the odds of a deal at “greater than 50-50.” Lew is probably a bit overly optimistic. Apple pie can’t even get 50-50 odds in Washington.

The White House wants to lower the corporate tax rate by closing loopholes. Lew said the top corporate tax rate should be reduced to 28% from 35%, and a new minimum tax on foreign earnings should be created to help make it simpler for businesses to repatriate income. Other proposals include a 25% tax rate for domestic manufacturing and allowing more small businesses to use cash accounting.

If I had to bet on one thing not happening even though it sounds plausible, I might say legislation to prevent cyberattacks. Nobody likes the thought of having credit card information stolen, or malware infecting their computer, so you might think lawmakers could come together on legislation but I doubt congress is up to the challenge. It is a serious security issue; the Pentagon says that nearly every US weapons program tested last year showed “significant vulnerabilities” to cyber-attacks. You have to imagine that utilities, and airports, and almost everything is vulnerable to cyber-attacks. And nobody likes getting hacked, but figuring out what to do might not be easy.

First, there are a lot of legitimate companies that gather information on you and then sell that info and there is fierce industry opposition to new security or privacy rules. Meanwhile, civil liberties and privacy activists think that panic about cyber breaches will lead to surveillance and filtering that would destroy the open Internet in the name of saving it. Accommodating these concerns should not be an impossible task, but in today’s Washington, it has been.

But the fundamental flaw is that nobody is held responsible for insecure systems and bad code. Data breaches cause companies headaches but usually it is little more than bad PR; there are no massive verdicts that have prompted reforms of other defective products. The companies that write bad code have effectively protected themselves through software license agreements, and many companies would still rather hope for the best than spend money to fix their systems.

Here was another strange example in yesterday’s earnings report from Netflix; they report solid earnings growth, not so great on the revenue numbers, but good news on new subscribers. The interesting part was where they talked about competition in the Netherlands. By analyzing Google search terms, Netflix has learned that their biggest competition in the Netherlands is Popcorn Time, which has an unusually strong fan base. Popcorn Time is one of the most popular services for watching pirated movies and television shows. Netflix Chief Executive Officer Reed Hastings wrote a letter to shareholders saying, “Piracy continues to be one of our biggest competitors.”

Twelve years ago, Steve Jobs convinced music labels to sell their songs for 99 cents on iTunes by arguing that was a better solution than losing the sale to music pirates. Popcorn Time shows that as the legal options improve, so do the illicit ones.

Microsoft Windows runs on 91% of the world’s computers, so there is a good chance you use Windows. There is also a good chance that you hate your Windows system because it is old or you hate it because it is the newer Windows 8. Good news. Today Microsoft unveiled the new Windows 10, skipping right past Windows 9 without explanation.

Here’s what you need to know; if you have Windows 7 or 8, you can upgrade to Windows 10 for free in the first year (it won’t be released until later this year, so you have time). The Start Menu returns, it can be viewed as a full-screen Windows 8-like display of tiles or a more familiar Windows 7-like drawer of apps. Windows 10 sticks to desktop mode when it recognizes a mouse and keyboard and tablet mode when there is no keyboard and mouse. The new “Snap” feature will allow Windows 10 users to work on up to four apps at once on the same screen. And there will be a new browser called Spartan.

Now for the cool stuff. Microsoft’s version of Siri will be part of Windows 10. By using voice commands, Cortana can show your notifications, stock information, sports news, and other functions typical of smartphone voice assistants. But you can also say “show me the spreadsheet on January sales” or “show me photos from last month,” and it will quickly run the search query.

And the coolest part: it can make holograms. Windows 10 Hologram will let you play games, watch videos and create virtual elements that will appear in your view. This should be a good way to train people to do surgery or repair plumbing, or learn on-the-go, or play immersive games, or to create 3D toys or devices in a 3D space, which will behave like 3D objects when you interact with them wearing new Microsoft headgear called a HoloLens. HoloLens comes with a holographic processing chip that understands your gestures, voice and where you’re looking. It can map the world around you and display holograms that appear to be in thin air or on objects that surround you. And then of course, you can print them on a 3D printer.

The Commerce Department said single-family housing starts, the largest part of the market, jumped 7.2% to a seasonally adjusted annual pace of 728,000-units – the highest level since March 2008. That offset a 0.8% fall in groundbreaking for the volatile multi-family homes segment, lifting overall housing starts 4.4% to a 1.09 million-unit rate last month.

Time for another edition of “Banks Behaving Badly”. We start with Standard and Poors, the credit rating agency; S&P will be suspended for a year from rating securities in the largest piece of the CMBS market. The Commercial Mortgage Backed Securities probe is separate from a lawsuit by the Justice Department tied to subprime home loans that S&P rigged, or rather rated before the credit crisis. The ratings agency is expected to settle that matter as soon as this quarter for about $1 billion.

In a speech yesterday, Federal Reserve governor Jerome Powell said widespread manipulation of key benchmark interest rates such as the London Interbank Offered Rate, or Libor, threatens public confidence in the financial system, and must be prevented through fines and criminal prosecution. Seriously, I think the man has been asleep for the past five 6 years, and he just woke up.

In 2008, JPMorgan authorized legal counsel to file papers making a loan to GM unsecured instead of secured. While secured creditors were repaid in full during GM’s bankruptcy, unsecured creditors took losses. During bankruptcy proceedings, JPMorgan initially won its argument that the security interest was still in effect, but the appeals court today reversed that decision, and JPMorgan will lose about $1.5 billion. $6.5 billion for the London Whale, about $35 billion in legal expenses since 2009, and now $1.5 billion to GM. This is no way to run a bank.