Financial Review

Batten Down the Bonds

Sinclair Noe — November 14, 2016

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DOW + 21 = 18,868
SPX – 0.25 = 2164
NAS – 18 = 5218
10 Y + .10 = 2.22%
OIL + .26 = 43.67
GOLD – 7.60 = 1221.00

Another record high close for the Dow.

U.S. bond yields are sharply higher across the board following a public market holiday on Friday. The yield on the benchmark 10-year Treasury note topped 2.25%; they surged 37 basis points last week, the most in three years, amid speculation Trump’s plans to boost spending and cut taxes will widen the budget deficit and stoke inflation.

The 30-year Treasury bond yield is over 3% for the first time since January. The two-year yield crossed the 1.00% threshold for the first time since January.

The movement has also lit a fire under the greenback, with the U.S. dollar index up more than 1%, hitting 100 for the first time in almost a year.

The global bond rout is intensifying. Long-dated bonds are getting hit hardest in Europe. The selloff wiped a record $1.2 trillion off the value of bonds around the world last week. Investors rotated into stocks, as global developed-market shares beat investment-grade debt by the most since 2011 amid concern the stimulus will stoke inflation and lead the Fed to increase rates.

President-elect Donald Trump has made the first official appointments to his White House administration after a shake-up on Friday that saw VP-elect Mike Pence replace Chris Christie as the head of his transition team. RNC Chairman Reince Priebus has been selected as Chief of Staff, while Trump’s campaign Chairman and former head of news outlet Breitbart, Steve Bannon, will lead as Chief Strategist and Senior Counsel.

The common view is that the inflation trade has been reignited by the election results. If this were so, the two major inflation markers in the commodity market, gold and oil, would have rallied strongly. Instead, gold sold off approximately $70 or over 3% from its level a week before the election, while the price of oil has been slightly weaker. Industrial metals, especially copper, did see major rallies.

This was not across the board, however. Aluminum, which has almost as widespread commercial use as copper, fell about 3%, while copper was up 17% in the days immediately following the election. Tin was up around 6% and nickel 9% from a week earlier. The inflation argument came mostly from action in the global bond markets.

While it is true yields soared, they have been at unsustainably low rates for years now. Still, it looks like the bond market is sending a message about a fiscally expansive, deficit spending growth agenda – there will be price to pay.

And while the Dow and the S&P rallied following the election, the big winner was the Russell 2000 index of smaller stocks. And while small-cap stocks can outperform in inflationary environments, this rally is probably provoked by the idea that small-cap companies are less likely to do business internationally and more likely to get most of their sales domestically. The companies that tend to have most of their sales overseas are tech companies, and the tech-heavy Nasdaq hasn’t rallied at all. So, the stock rally has been selective and not broad-based.

Next, consider that the Federal Reserve will probably raise rates sooner and later. Fed funds futures rates are pricing in an 84% probability of an interest rate increase at the Fed’s meeting in December. PIMCO said the central bank may move three times by the end of 2017. Those rate hikes will hit the markets much sooner than any legislative action, which tends to move very slowly.

Japan’s economic growth handily beat expectations in the July-September period, expanding for a third straight quarter as exports recovered, but weak domestic activity cast doubt on hopes for a sustainable recovery. While GDP grew at an annualized 2.2% pace, household spending and capital investment were flat on quarter.

Mixed Chinese economic data for October came out overnight, released by the National Bureau of Statistics. Retail sales rose a weaker-than-expected 10%, slowing from the previous month’s 10.7% growth, while industrial output expanded 6.1%, matching September’s pace but remaining a hair below expectations.

After gathering in Brussels to discuss the future of Europe-U.S. relations, EU foreign ministers said the bloc would stand by its key foreign-policy positions on issues including the Iran deal, Russia’s annexation of Crimea and climate change, but vowed to work with the Trump administration. Not everyone attended the emergency meeting. Britain’s Boris Johnson called it “unnecessary.”

Colombia’s government and Marxist FARC rebels have agreed on a new peace pact to end a 52-year war, six weeks after the original was narrowly rejected in a referendum amid objections it was too favorable to the rebels. The new accord, which will be presented to Congress for a vote, includes several new provisions – from requiring FARC to surrender money and holdings to infrastructure development for the countryside.

Just one day after the IEA warned the world could drown in oil if production does not fall beneath demand sometime soon, OPEC released a new market whammy, offering up the cartel’s production figures, which largely jive with figures reported by the IEA yesterday: OPEC has increased its oil production. OPEC’s Monthly Oil Market Report revealed daily oil production for the cartel of 33.64 million barrels for October—up by 240,000 barrels per day in September—largely confirming the IEA’s report.

A little over 90% of S&P 500 companies have reported their quarterly results, and it’s become clear that the recession in corporate profits has come to an end. Since the second quarter of 2015, S&P 500 earnings reports have shown a decline in profits – year-over-year. A decline for two consecutive quarters indicates an earnings recession.

Based on the companies that have reported so far this quarter, S&P earnings will be up 2.75% from the prior year’s third quarter. Leading the comeback is the financial sector, which posted growth of 13.1% in profits from the third quarter of last year. According to FactSet, 71% of companies that have reported beat their estimates, higher than the five-year trailing average of 67%.

Samsung Electronics is buying Harman Industries for $112 a share in cash, or a total equity value of about $8 billion, placing the company in the vanguard of the auto industry. The deal – Samsung’s largest acquisition in its history – will reshape the pecking order in the global automotive supply chain.  Samsung could combine its display and semiconductor operations with a business that already provides sound, electronics, and other smart components for a new generation of digitally connected cars.

In Europe, Novartis AG is said to be in talks to acquire U.S. generic-drugs maker Amneal Pharmaceuticals in a deal which could value the closely-held company at as much as $8 billion. Siemens, meanwhile, agreed to buy software company Mentor Graphics for $4.5 billion, a premium of 21 percent on Friday’s closing price.

American Apparel files for bankruptcy. The retailer filed for Chapter 11 bankruptcy protection for the second time in just over a year, (so maybe we should call it Chapter 22) listing assets and liabilities in the range of $100 million to $500 million. The company exited court protection in early 2016 but quickly encountered trouble again.

Toyota will pay up to $3.4 billion to settle claims that some of its trucks and SUVs lacked proper rust protection, leading to premature corrosion of vehicle frames. The proposed settlement covers about 1.5 million Tacoma compact pickups, Tundra full-size pickups and Sequoia SUVs and estimates the value of frame replacements at around $15,000 per vehicle. However, Toyota admitted no liability or wrongdoing in the proposed settlement.

Hedge fund filings will give investors a chance to see what they were betting on when the third quarter ended. Hedge funds have had a tough time of it recently with some $50 billion flowing out of the industry this year. Hedge fund managers are required to disclose their holdings to the SEC in a Form 13F. Filed four times a year, the reports show which sectors these traders were betting on when the quarter ended, roughly 45 days ago.

Out of 13 western states, California and Texas have the highest number of single-family residential homes in extreme risk wildfire areas, per a new report from CoreLogic. CoreLogic’s scale has four categories: low, moderate, high and extreme risk, and 1.8 million homes across 13 western states fall into the high and extreme risk category.

While only a small percentage of the millions of homes that fall somewhere on the scale, these 1.8 million homes represent a combined total reconstruction value of nearly $500 billion. The other 27 million homes on the scale — those at low and moderate risk — have an estimated reconstruction cost value of $6.7 trillion.

Financial Review

Strange Days

Sinclair Noe — April 13, 2015      

 

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DOW – 80 = 17,977
SPX – 9 = 2092
NAS – 7 = 4988
10 YR YLD – .02 = 1.94%
OIL + .27 = 51.91
GOLD – 9.30 = 1199.00
SILV – .23 = 16.36

A down day as we head into earnings reporting season. S&P 500 earnings per share has come down 8% over the last three months to $around $117.50 from $119.50, according to analysts at Merrill Lynch. Analysts are projecting EPS to fall 4% to 6%, excluding the impact of stock buybacks. Earnings are taking a hit on two fronts: lower oil prices and a stronger dollar. The energy sector takes the lion’s share of the blame for the earnings decline. Excluding energy companies, first-quarter earnings growth would actually be slightly positive. The dollar’s rise over the past year will also have a significant impact as expectations for companies with sizable foreign sales have been revised down 13% year to date while those with sales concentrated in the US witnessed an upward revision.

The Energy sector is the biggest drag on the growth picture this quarter, with the sector’s earnings on track to be down -63.6% on -40.6% lower revenues. Excluding the drag from the Energy sector, total earnings for the S&P 500 index would be up +4.7% on +0.6% higher revenues, according to Zach’s Research. The best performing sector should be Finance, where earnings are expected to be up +9.1% from the same period last year. Excluding Finance, the earnings growth picture for the S&P 500 becomes even weaker, with first quarter earnings expected to decline -6.4%. We have a busier reporting schedule this week, with 32 S&P members reporting results, including several of the big banks.

If estimates for the first quarter were to stay where they are right now, this would mark the first year-over-year decline in earnings since the third quarter of 2012. And negative earnings growth isn’t just expected for the first quarter. Current estimates project a decline in Q2 earnings as well. Two consecutive quarters of negative growth is known as an “earnings recession”, which is something the market hasn’t seen in quite a while.

The euro fell back towards $1.05 today, hitting its weakest in four weeks as the dollar’s resurgence continued on bets the US Federal Reserve will raise interest rates from their historic lows in the coming months. The dollar had dropped 4% after a much-worse-than-expected US payrolls report earlier in the month threw into doubt a 2015 rate rise, but it has since rallied on upbeat comments from Fed officials and better US data. In addition, the dollar is still the global reserve currency and that means there is about $9 trillion in dollar denominated debt around the world. The $9 trillion owed by borrowers outside the U.S. has surged from $6 trillion at the end of 2008, when the Fed cut its benchmark interest rate to near zero, making it cheaper to issue in the currency. Some of that will need to be repaid even if the remainder will be rolled over. And debt that will eventually be refinanced needs servicing in the meantime. To repay the debt, whether corporate of sovereign, requires accumulating dollars; and that is above and beyond growth or interest rate differentials.

As the U.S. job market improves, the risk is receding that an unexpected setback could derail the recovery once the Federal Reserve raises interest rates, San Francisco Fed President John Williams told Reuters in an interview late on Friday. “So even if the economy got some bad shocks, really you are probably just talking about flattening that path out a bit, or maybe raising rates more slowly,” said Williams, who this year is one of 10 voting members of the Fed’s policy panel. In fact, Williams says the Fed now needs to weigh the risks of waiting too long before a rate lift-off. To get that message across Williams has begun giving away T-shirts, printed at his own expense, showing an arrow busting upwards out of a computer and declaring: “Monetary policy — It’s data dependent.” (I have to get me one of those t-shirts.)

In the last two weeks, three Fed governors have laid out the argument that it is the longer rate path, not the date of lift-off that matters. Williams also said that regardless of the timing of the first hike, rates should stay below neutral to help the economy grow at a faster-than-normal pace. Such accommodative policy is necessary to further reduce unemployment, which at 5.5 percent is still too high in his view, and push up inflation, which remains well below the Fed’s 2-percent target. The San Francisco Fed chief expects the U.S. economy to reach full employment in six to twelve months, and forecasts a tighter labor market will start lifting wages and inflation more broadly.

Greece is at risk on running out of cash as soon as this month, unless the leftist government and its international lenders, known as the Troika, agree on a reform plan. At the meeting in Brussels last week, eurozone officials gave Athens six working days to submit a revised list of overhauls. Despite a denial by Greece’s finance ministry, tensions between Greece and its creditors took another turn for the worse over the weekend, following a report that eurozone officials were “shocked” at Greece’s failure to outline detailed structural reforms. If eurozone finance ministers at the Eurogroup meeting on April 24 find the proposals adequate, they can unlock the next tranche of bailout money. That would help Greece meet its debt obligations this spring and avoid a default. Also this week, Greece has to repay €2.4 billion euros ($2.5 billion) in Treasury bills. Last week, the government met its deadline to pay back a loan of roughly €460 million euros to the International Monetary Fund. Once again, negotiations are turning ugly, with one German newspaper quoting Eurozone officials that are allegedly so annoyed that they said Greece acted like a “taxi driver” and just kept asking for cash instead of outlining reform plans. It continues to look like the Greek debt problem might not be worked out.

China’s exports surprisingly tumbled in March while import shipments fell at their sharpest rate since the global financial crisis, setting a poor precursor to the country’s closely-watched first quarter GDP figure due on Wednesday. Chinese exports plunged 15% and imports fell 12.7% last month in dollar terms as weak demand and the impact of the lunar new year weighed heavily on Chinese factories. The soft trade figures sent Chinese shares higher, with the Shanghai Composite closing up 2.2%, as investors bet on more stimulus from Beijing.

Nearly 90% of Americans now have health insurance. The Gallup-Healthways Well-Being Index shows the number is up from closer to 80% as recently as 2013. The new survey included the end of the 2015 period to sign up for health insurance through the public exchanges.

Almost one million people pre-ordered the Apple watch on Friday. They bought an average of 1.3 watches and paid about $503 for each one. How does that stack up in Apple history? Back in 2007, it took the company 74 days to sell its one millionth iPhone, and it took two years to get to that milestone with the iPod. Among those who bought an Apple Watch, 72% had bought an Apple product in the last two years. And 21% preordered an iPhone 6 or iPhone 6 Plus just months ago.

These are strange days indeed. Case in point; organizers have just announced a sail boat race from New York to Victoria, British Columbia; the 7,700 mile race will go from the northeastern part of North America to the northwestern part. The boats will not head south from New York, they will head north to Greenland, then cut across the north of Canada, circle the northern edge of Alaska and then down to Victoria. Impossible you say? Once upon a time; now, not so much. The route used to be unnavigable because of pack ice, which may well still be problematic for the race participants, but there is less ice as of late. Arctic sea ice hit its peak for the year in February—amounting to the lowest coverage on satellite record. Race organizer Robert Molnar told CBC News: “We shouldn’t be able to do it, but because of climate change, we can.”

Space X is the private space exploration company founded by Elon Musk. They had to scrub a scheduled launch of a rocket today due to inclement weather. They will try to launch tomorrow, weather permitting. The tow-stage Falcon 9 rocket is unmanned; it is scheduled to deliver cargo to the International Space Station, which is manned.  The top part of the rocket will deliver the cargo, break away and then burn up as it floats back into Earth’s atmosphere. That will be the easy part. After the launch, SpaceX will try to guide the bottom stage of the rocket upright onto a platform, or what it calls an autonomous spaceport drone ship, in the Atlantic Ocean off Florida. Normally the bottom part would just fall into the ocean and be lost. Recovering the rocket intact would be a big cost savings. Space X says the odds of a successful landing on the platform are about 50-50. And if they don’t land it this time, they’ll just keep trying.

NASA has a little rover, called Curiosity, roaming around Mars, and it has made a pretty amazing discovery. Water. Salt water actually, and lots of it, just beneath the surface of the red planet. The Mars Curiosity rover found frozen water and water vapor in the Martian atmosphere several years ago. Now, scientists have detected the presence of a chemical substance in the Martian soil that absorbs water vapor from the atmosphere to form a brine that keeps being a liquid even when temperatures on the planet fall below the freezing point of water. This might provide future explorers with a source of water, or it might prove more trouble than not. The liquid brine is expected to be highly corrosive. Still, water is considered the source of life as we know it, and now we know Mars has it.