Markets Remain Resilient

Charles Schwab: On the Market

Posted: 8/31/2017 4:15 PM ET

Markets Remain Resilient

U.S. equities continued their advance despite a jump in gasoline prices amid the impact of Hurricane Harvey, as well as a mixed bag of economic news and continued anxiety surrounding political and global monetary policy uncertainty. Treasury yields were little changed and the U.S. dollar was modestly lower, while crude oil prices and gold were solidly higher.

The Dow Jones Industrial Average (DJIA) advanced 60 points (0.3%) to 21,952, the S&P 500 Index gained 14 points (0.6%) to 2,472, and the Nasdaq Composite rallied 60 points (1.0%) to 6,429. In moderately heavy volume, 905 million shares were traded on the NYSE and 1.9 billion shares changed hands on the Nasdaq. WTI crude oil rose $1.27 to $47.23 per barrel and wholesale gasoline jumped $0.14 to $1.78 per gallon. Elsewhere, the Bloomberg gold spot price was $14.36 higher at $1,322.96 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—declined 0.2% to 92.69.

Campbell Soup Co. (CPB $46) reported fiscal Q4 earnings-per-share (EPS) of $1.04, or $0.52 ex-items, versus the $0.55 FactSet estimate, as revenues declined 1.0% year-over-year (y/y) to $1.7 billion, roughly in line with expectations. The company noted that the packaged foods industry remains challenging. CPB issued full-year EPS guidance that came in below the Street's forecasts. Shares were solidly lower.

Dollar General Corp. (DG $73) posted Q2 EPS of $1.08, or $1.10 ex-items, compared to the estimated $1.09, with revenues growing 8.1% y/y to $5.8 billion, mostly matching expectations. Q2 same-store sales rose 2.6% y/y, versus the projected 1.6% increase. DG raised the low end of its full-year profit outlook and noted that it expects same-store sales growth will be toward the upper end of its previous guidance. However, shares were sharply lower as the company's gross margin declined more than expected, due to higher markdowns and sales of lower margin products.

Costco Wholesale Corp. (COST $157) announced August same-store sales grew 7.3% y/y, above the forecasted 6.1%. Excluding the impact of changes in gasoline prices and foreign exchange, same-store sales increased 5.9%. COST traded higher.

Shares of Ciena Corp. (CIEN $22) came under heavy pressure as the network strategy and technology company issued Q4 revenue guidance that came in noticeably below estimates, which overshadowed its stronger-than-expected Q3 results.

Personal income and spending data mixed

Personal income (chart) was 0.4% higher month-over-month (m/m) in July, above the Bloomberg forecast of a 0.3% gain, and compared to June's unrevised flat reading. Personal spending rose 0.3% last month, below expectations of a 0.4% gain, and versus June's upwardly revised 0.2% gain. The July savings rate as a percentage of disposable income was 3.5%. The PCE Deflator expectedly moved 0.1% higher, after the prior month's unrevised flat reading. Compared to last year, the deflator was 1.4% higher, matching estimates and June's unrevised figure. Excluding food and energy, the PCE Core Index was 0.1% higher m/m, in line with expectations, and the index was 1.4% higher y/y, matching estimates. June's y/y figure was unrevised at a 1.5% increase.

Weekly initial jobless claims (chart) rose by 1,000 to 236,000 last week, below forecasts of 238,000, with the prior week’s figure revised higher by 1,000 to 235,000. The four-week moving average declined by 1,250 to 236,750, while continuing claims fell 12,000 to 1,942,000, south of estimates of 1,951,000.

Pending home sales declined 0.8% m/m in July, versus projections of a 0.3% increase, and following June's downwardly revised 1.3% gain. Compared to last year, sales were 0.5% lower. Pending home sales are used as a gauge of the pipeline of existing home sales, which unexpectedly fell in July.

The Chicago Purchasing Managers Index (chart) continued to show solid expansion (above 50) for August, after remaining at July's unrevised 58.9 level, versus expectations calling for a decrease to 58.5.

Treasuries were little changed, as the yields on the 2-year and 10-year notes, along with the 30-year bond, were flat at 1.33%, 2.13% and 2.73%, respectively. Bond yields have been quiet though the U.S. Dollar Index has rebounded from recent pressure on eased concerns toward flared-up tensions toward North Korea, lingering global monetary policy and U.S. political uncertainties, and the impact of Hurricane Harvey.

Schwab's Chief Fixed Income Strategist Kathy Jones offers a look at the bond markets in her article, What's the Bigger Risk: Bond Market Bubble or Complacency?, on the Fixed Income page at www.schwab.com, and for analysis of investing styles, see Schwab's Chief Investment Strategist Liz Ann Sonders' latest article, Radioactive II: Could the Tide Finally Be Turning for Active vs. Passive on the Markets & Economy page. Follow Kathy and Liz Ann on Twitter: @kathyjones and @lizannsonders.

Tomorrow, the domestic economic calendar will end the week with a bang, courtesy of a plethora of August reports, such as the ISM Manufacturing Index, Markit's Manufacturing PMI Index, the final University of Michigan Consumer Sentiment Index, and auto sales. Manufacturing activity is expected to continue to depict growth and consumer sentiment is projected to remain near January's thirteen-year high. However, the headlining report will likely be the release of the August nonfarm payroll report, projected to show jobs grew by 180,000 after July's 209,000 gain, and employment in the private sector is expected to increase by 170,000 jobs after the prior month's 205,000 advance. The unemployment rate is expected to remain at 4.3%, while average hourly earnings are estimated to rise 0.2% m/m after growing 0.3% in July. Compared to the last year, earnings are forecasted to be up 2.6%, after July's 2.5% gain. Construction spending for July is also on tap for tomorrow.

Yesterday's stronger-than-expected Q2 GDP report caused Fed rate hike probability for December to tick higher but remain below 50%, per Bloomberg, and another dose of strong economic data could move the needle a bit further. Employment has been solid but inflation—the other side of the Central Bank's dual mandate—has been stubbornly low, setting the stage for the wage component of the labor report to continue to garner the most scrutiny. Fed rate hike uncertainty remains but our latest Schwab Market Perspective: Volatility Returns!, notes that the Fed is expected to move into uncharted territory by embarking on unwinding its behemoth $4.5 trillion balance sheet, which we continue to believe will be an additional volatility driver. Read more on the Markets & Economy page at www.schwab.com.

Europe and Asia higher following positive day in U.S.

European equities gained ground, with the euro continuing to give back a recent rally following reports that showed European Central Bank members were getting concerned with the currency's recent surge, and despite a hotter-than-expected read on eurozone inflation for August. In other economic news, the eurozone unemployment rate remained at 9.1% for July and German retail sales fell more than forecasted for last month. The British pound lost ground on the U.S. dollar and bond yields in the region dipped. The latest round of U.K. Brexit negotiations are wrapping up, while geopolitical, monetary policy and U.S. political uncertainties continue to fester. For a look at Brexit talks, see our article, Brexit Begins: What's Next for the U.K.? on the Insights & Ideas page. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA offers a look at a potential milestone for global profits in his latest article, Earnings may be about to do something they've never done before, on the Markets & Economy page at www.schwab.com and his video with Vice President of Trading and Derivatives, Randy Frederick, Is An Optimistic Outlook for Global Equities Warranted? on the Insights & Ideas page. Follow Jeff and Randy on Twitter: @jeffreykleintop and @randyafrederick.

Stocks in Asia finished mostly higher after another positive session in the U.S., aided by a stronger-than-expected read on Q2 GDP growth for the world's largest economy, which helped overshadow lingering global monetary policy and U.S. political uncertainties, and lingering geopolitical concerns. For analysis of this backdrop, see Schwab's Jeffrey Kleintop's, CFA, article, Missiles and Markets: An investor guide to geopolitical risks, on the International Investing page at www.schwab.com, as well as his video with Randy Frederick, Political Risk: How Should Investors Respond?, on the Insights & Ideas page.

Japanese equities advanced, with the yen extending a pullback from a recent jump and despite a larger-than-expected decline in the nation's industrial production for July. Mainland Chinese stocks and those traded in Hong Kong declined, with a stronger-than-expected Manufacturing PMI Index being met with the non-Manufacturing PMI Index that showed growth slowed for August. Australian securities rose, while listings in South Korea declined. Meanwhile, markets in India advanced ahead of the nation's report on Q2 GDP growth after the closing bell, which showed expansion decelerated to a 5.7% y/y pace, versus forecasts of a 6.5% gain and compared to the 6.1% increase posted in Q1.

The Markit manufacturing PMI reports from across the globe will dominate tomorrow's international economic calendar while other reports of note that deserve a mention include CPI, trade data and GDP from South Korea, consumer confidence from Japan, and GDP from Italy.

Financial Review

GDP

Sinclair Noe — March 30, 2017

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DOW + 69 = 20728
SPX + 6 = 2368
NAS+ 16 = 5914
RUT + 10 = 1382
10 Y + .03 = 2.42%
OIL + .86 = 50.37
GOLD – 10.90 = 1243.50

We are nearing the end of the month and the first quarter. The Dow Industrial Average is on track for a small loss in the month of March, but after a strong rally in February, the Dow is still looking at year-to-date gains of 4.75%.

The S&P has risen 10.3 percent since the U.S. election. The S&P 500 moved into positive territory for March, up 0.2%, while the Dow remains down 0.4% for the month.

The Nasdaq is up 1.5% in March.

The rapid climb in equities has raised concerns regarding valuations, with the S&P 500 trading at nearly 18 times earnings estimates for the next 12 months against its long-term average of 15 times. The market will be looking at quarterly earnings to see if the lofty valuations can be supported. First-quarter earnings for S&P 500 companies are expected to rise 10.1 percent, per Thomson Reuters I/B/E/S.

Today, the market found a catalyst in the form of slightly stronger GDP numbers. Economic growth slowed less than previously reported in the fourth quarter. Strong consumer spending provided a boost that was partially offset by the largest gain in imports in two years.

Gross domestic product increased at a 2.1 percent annualized rate instead of the previously reported 1.9 percent pace. The economy grew at a 3.5 percent rate in the third quarter. Despite the upward revision to the fourth quarter, the economy grew only 1.6 percent for all of 2016, its worst performance since 2011, after expanding 2.6 percent in 2015.

The government also reported that corporate profits after tax with inventory valuation and capital consumption adjustments increased at an annual rate of 2.3 percent in the fourth quarter after rising at a 6.7 percent pace in the previous three months.

Imports increased at a 9.0 percent rate. That was the biggest rise since the fourth quarter of 2014 and was an upward revision from the 8.5 percent growth pace reported last month. Exports fell more than previously estimated, leaving a trade deficit that subtracted 1.82 percentage point from GDP growth instead of the previously reported 1.70 percentage points.

Robust domestic demand and import growth meant stronger inventory investment than previously estimated. Business investment was revised lower.

Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity, was revised up to a 3.5 percent rate in the fourth quarter. It was previously reported to have risen at a 3.0 percent rate. Consumer spending is being supported by a tightening labor market. A separate report from the Labor Department on Thursday showed initial claims for state unemployment benefits fell 3,000 to a seasonally adjusted 258,000 for the week ended March 25.

The Atlanta Federal Reserve is forecasting GDP rising at a rate of 1.0 percent in the first quarter. Of course, there is always a chance that first-quarter growth could surprise the doubters.  For all of 2017, the economy is expected to expand by roughly 2 percent; meaning activity is expected to show much stronger growth in the second half.

In other words, it looks a lot like a repeat of 2016. And the forecast for 2018 is in the 2 to 2.5% range. Again, that could change, but it looks a lot like the last 8 years. The sluggish growth rate has been good enough to keep unemployment at 4.7%. And now the Federal Reserve will be looking to raise rates in a slow growth environment, while they may already be behind the curve of the labor market.

And despite the talk about “animal spirits,” corporate America is not investing heavily, at least so far, in new plants and equipment. At the same time, demand in many industries is growing only modestly, while a few sectors like retail chains are having to make painful adaptations to a rapidly evolving consumer landscape.

Government debt and budget deficits are both set to spiral higher in the coming three decades if current patterns hold, per new projections released today by the Congressional Budget Office. The total current debt held by the public of $14.3 trillion is 77 percent of GDP.

The current total debt level of $18.8 trillion is about 101 percent of GDP (the CBO computes debt to GDP based on public debt). The debt-to-GDP ratio would rise to 89 percent in 2027, per current projections. In its new long-term budget outlook, the CBO said debt would reach 150% of gross domestic product in 2047. The report warns, “The prospect of such large and growing debt poses substantial risks for the nation and presents policymakers with significant challenges.”

In addition to debts, the CBO also said the budget deficit will more than triple from the projected 2.9 percent of GDP in 2017 to 9.8 percent in 2047. The deficit at the end of fiscal 2016 stood at $587 billion.

The report said, “Large and growing federal debt over the coming decades would hurt the economy and constrain future budget policy,” in other words, bad news for growth prospects. Rising interest rates could pose a big problem for the increasing debt burden. The Fed has kept rates low since the financial crisis struck in 2008 but is on track to gradually hike rates over the coming year.

Tomorrow, the we’ll get more information on the personal consumption expenditures inflation data (that’s the Fed’s preferred gauge of inflation); the PCE is expected to come in at 2 percent year-over-year (that’s the Fed’s target for inflation).

The market expectations for Fed rate hikes have bounced around, but many Fed watchers now see two more rate hikes for 2017, as the Fed has forecast. If people start looking at inflation being already over target, there maybe a reconsideration of expectations for the Fed.

It has been a busy week for Fed jawboning and today, Cleveland Fed President Loretta Mester forecast GDP growth above 2% in 2017, and sees a “sustained return” to 2% inflation “over the next year or so.” Mester also expects the Fed to raise interest rates again this year, but didn’t say how many times might be likely.

Dallas Fed President Rob Kaplan says the biggest risk facing the economy is… Washington. Kaplan said he was worried about policy, such as on trade or healthcare, that would cause consumers to pull back. For instance, seniors may curtail spending if they see they may have to pay more for their health care.

Kaplan said he was also worried actions to roll back trade openness might cause U.S. jobs to be lost to Asia, especially if companies must supply chains and logistics that have helped them become productive. Kaplan defended the existing U.S. trade relationship with Mexico, saying it has improved U.S. competitiveness and added jobs.

Kaplan said Congress could also do positive things like cutting red tape and boosting spending on infrastructure. Corporate tax reform, if done right, might boost investment. The Dallas Fed president, who is a voting member of the Fed’s policy committee this year, said three interest rate hikes in 2017 is his “base case.”

William Dudley, the president of the New York Fed delivered a speech in Florida today, said the federal funds rate is in a “still unusually low” range of 0.75%-1%, and “In such circumstances, it seems appropriate to scale back monetary policy accommodation gradually.” Dudley said, “I don’t think we’re removing the punch bowl yet. We’re just adding a bit more fruit juice.”

The oil market might be looking at a supply crunch as producers cut spending on major projects to focus on short-term low-cost shale output in the US. After jumping 20 percent in the weeks following the decision by OPEC and 11 allies to curtail output to end a three-year surplus, prices have slipped as US shale producers fill the gap.

With current and future prices depressed, spending decisions on major projects have been delayed.  Oil companies are reviving investment after a two-year rout, easing but not eliminating the risk of a future supply crunch. Investment will likely increase this year after back-to-back declines of about 25 percent slashed global investment to $433 billion in 2016, per the IEA.

US producers are leading the spending revival, and will contribute most of the growth in supplies outside OPEC through to 2022. Still, a lot depends on price stability; stable prices at current levels or slightly higher might find more willing investors.

Gasoline prices could see a significant springtime jump of 20 to 45 cents per gallon, pushing retail pump prices to their highest level since June 2015, per energy analysis at Oil Price Information Service. The factors behind the increase: anticipated higher crude prices, higher demand from US drivers and a higher level of gasoline exports.

Macro factors support higher gasoline prices, include: high employment, consumer purchases of SUVs instead of more fuel-efficient cars and strong consumer confidence, which jumped to a 16-year high this month. Global oil supplies appear to be rebalancing and demand for crude could soon outstrip supply, despite the huge amount of US oil in storage.

That should help prices, but so should demand for gasoline, which usually rises by about 100,000 barrels a day in April, though it fell last year. The forecast calls for gas prices to rise to around $2.50 to $2.75 a gallon, with a few states looking at $3 gas. According to AAA, the national average for unleaded gasoline as of today, is $2.30 per gallon.

Financial Review

Manufacturing Breaks Bad

Sinclair Noe — September 1, 2016

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DOW + 18 = 18,419
SPX – 0.09 = 2170
NAS + 13 = 5227
10 Y un = 1.57%
OIL – 1.18 = 43.52
GOLD + 5.10 = 1314.60

The Institute for Supply Management said its manufacturing index in August fell to 49.4% from 52.6% last month, below expectations for a 52% reading. Any reading below 50% indicates contraction, and the index was below that level for the first time since February.

Today’s ISM report is one of the most important data releases. The ISM index is a leading indicator, which tells us what is going to happen. In other words, it is leading both economic news and stock prices. New orders are down 7.8 points, production is down and employment is contracting faster.

Overall, manufacturing is contracting again. Only six out of 18 industries were able to report growth. Eleven reported contraction. Cyclical industries like machinery and transportation equipment continue to underperform.

The poor ISM report comes on the heels of another weak report. Earlier, the government announced a steeper-than-initially expected decline in worker productivity, in what has been the longest dip in productivity since the 1970s. Nonfarm business productivity fell at a 0.6 percent seasonally adjusted annual rate in the second quarter, from an earlier estimate of a drop of 0.5 percent.

But the Labor Department also reported a surprise jump in labor costs, with the annual rate of unit labor costs rising to 4.3 percent at nonfarm businesses. The initial estimate was a 2 percent pace. Hourly compensation in the second quarter grew at a rate of 1.1 percent on an inflation-adjusted basis, from an earlier estimate that it had declined at a 1.1 percent rate.

The crummy data comes a day before the important August employment report, expected to be a major indicator for whether the Fed could raise rates in September. While some traders speculated the manufacturing report was a one-time blip, the data definitely subdued some talk that the economy was strong enough for the central bank to hike.

The number of Americans who applied for unemployment benefits last week rose 2,000 to 263,000. The average of new jobless claims over the past month, meanwhile, fell by 1,000 and also totaled 263,000. The less volatile four-week average is seen as a more accurate measure of labor-market trends. New claims fell below the key 300,000 threshold in early 2015 and have remained there for 78 straight weeks, the longest stretch since 1970.

The number of announced layoffs by U.S.-based companies fell in August to the lowest level since May. Global outplacement consultant Challenger, Gray, and Christmas reports US employers announced they planned to hand out 32,188 pink slips last month, a 29 percent decline from July.

The August total was also 22 percent below the number of job cuts at this time last year. The computer sector was the biggest job-cutter, with Cisco Systems accounting for most of its 6,103 payroll reductions. The industrial goods sector – which includes the oil patch – was also hard hit, losing 3,073 jobs.

Wal-Mart said it will cut about 7,000 back-office jobs, mostly in accounting and invoicing positions at its U.S. stores, continuing a program it announced in June of cutting such jobs on the West Coast. Wal-Mart will now cut back-office workers in all its approximately 4,600 stores over the next several months. The retailer employs about 1.5 million people in the United States.

US auto sales fell 4.2% in August as some major automakers said a long-expected decline due to softer consumer demand had begun. The top three sellers, GM, Ford, and Toyota reported declines of at least 5%. Of the seven top manufacturers by sales, only Fiat Chrysler Automobiles reported a gain versus a year ago. Auto sales account for about one-fifth of all retail sales. Look for car companies to offer incentives to entice buyers.

A barrel of West Texas Intermediate for October delivery has been trading under the $44 a barrel level, with the commodity dropping about 7.5% this week. Russia’s Energy Ministry said it sees no need for talks on capping production with oil prices around $50 in a statement ahead of OPEC talks in Algiers later this month.

Russia, the world’s biggest energy exporter, was a key negotiator in talks on an oil-output freeze with Saudi Arabia and other OPEC producers in April. That proposal failed after Iran declined to attend the meeting in Doha and Saudi Arabia refused to proceed with the deal without the participation of its Persian Gulf rival.

With gasoline prices rising at the pump as the summer driving season draws to an end, drivers can take solace in the fact that they shelled out less for the fuel this summer than they have in over a decade and that prices will fall back soon as fuel demand drops.

The U.S. national average for a gallon of gasoline is likely to end the summer driving season at about $2.24, and that means drivers enjoyed the cheapest summer at the pump since 2004; and it’s a big drop from Labor Day 2012 when the average price was $3.86 a gallon. Now, with the usual drop in gasoline consumption following the Labor Day holiday, drivers can expect to prices decline as demand softens.

What Brexit effect? British manufacturing staged one of its sharpest rebounds on record in August as factories recovered from the initial shock of June’s vote to leave the European Union. The Markit/CIPS purchasing managers’ index for the sector soared to 53.3 from July’s figure of 48.3. Data over the past couple of weeks has further shown consumer demand holding up in the face of the referendum result.

More than $7 billion was wiped off the market value of Samsung Electronics today after it delayed shipments of its Galaxy Note 7 phone. Samsung announced the delays after several people posted images and videos of charred Galaxy Note 7s online and said their phones had caught on fire. Several South Korean media reports, without citing direct sources, said Samsung will soon announce a plan to recall affected Note 7 phones and replace their batteries as opposed to giving the users a new device.

The collapse of South Korea’s Hanjin Shipping is sending ripples through world supply chains, as manufacturers scramble for freight alternatives to the world’s seventh-biggest shipping line. Hanjin’s bankruptcy is the biggest ever in container shipping history. Hanjin filed for court receivership after its banks decided to end financial support, and ports across the globe have refused entry to its vessels in what is traditionally the industry’s busiest season ahead of the year-end holidays. Another theory is that Hanjin’s ships are staying out of port to avoid being confiscated.

The Securities and Exchange Commission fined RBC Capital Markets for $2.5 million for allegedly making materially false and misleading disclosures in its fairness opinion valuation analysis for a proxy statement for Rural/Metro Corporation’s sale in 2011 to a private equity firm. An SEC investigation found that RBC’s presentation as the lead financial adviser to Rural/Metro, a medical transportation services provider, contained allegedly materially false and misleading statements which made the bid look more attractive.

The investment bank that advised SolarCity on its $2.6 billion sale to Tesla made a “computational error” in its analysis that discounted the value of the solar company by $400 million. Despite the mistake by Lazard, the companies agreed it would not change their view of the deal. SolarCity has until September 14 to actively seek other acquisition proposals, at which time its “go-shop period” ends. The filing also revealed that in recent weeks, 15 institutional investors passed on either acquiring SolarCity or injecting equity into it. The company is having difficulty tapping the public markets amid the proposed merger and is facing a liquidity squeeze.

SpaceX’s Falcon 9 rocket has exploded as part of a test on a launch pad in Cape Canaveral, Florida. The company was scheduled to do a static test-fire of the rocket, which it previously landed safely on a ship in April after it delivered supplies to the International Space Station. So, this would have been the first recycled rocket.

The first step in Facebook’s grand vision to connect the entire world to the internet, or at least connect to Facebook, has gone up in flames. That SpaceX rocket that exploded was carrying a satellite that Facebook planned to use in its internet.org initiative. Facebook had planned to lease some of the bandwidth on the satellite, Amos 6, from its operator, the Israeli company SpaceCom, to beam internet to sub-Saharan Africa.

The satellite was intended to fill in until Facebook’s more ambitious plans for internet access are ready, including developing and launching massive solar-powered drones that use lasers to beam internet to the ground. This is the first time Facebook had planned to use a satellite.

It’s been a rough week for Facebook. Last Friday, it fired the entire editorial staff on its Trending news team, and replaced them with an algorithm, which has since promoted fake news and could potentially be gamed into promoting hate speech. At the same time, CEO Mark Zuckerberg is insisting the company is not a media company, even though many of its 1.7 billion users rely on it to get their news. He also made a voice-activated thermostat for his house that doesn’t respond to his wife’s voice.

The last hurricane to strike Florida was Wilma in 2005; that’s about to change. Hermine will soon hit the northern Gulf coast packing winds around 75 miles per hour, and dumping too much rain, possibly up to 20 inches in some parts of the state. Isolated tornadoes and storm surges as high as 8 feet were also forecast.

Towns, cities and counties along the Gulf Coast have been hastily preparing shelters for people and pets, setting up centers where residents could fill sandbags for personal use and placing electric line repair crews on standby ahead of the storm. Water spilling from rough seas already was inundating roads in some waterfront communities in the Tampa Bay region.

Financial Review

Because it’s Friday

Sinclair Noe — August 14, 2015

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DOW + 69 = 17,477
SPX + 8 = 2091
NAS + 14 = 5048
10 YR YLD + .01 = 2.20%
OIL – .10 = 42.13
GOLD + .10 = 1115.80
SILV – .18 = 15.34

For the week, the Dow rose 0.6 percent, the S&P 500 added 0.7 percent and the Nasdaq gained 0.1 percent.

Wholesale prices climbed at a slower pace in July, as energy prices dropped. The 0.2 percent increase in the producer-price index followed a 0.4 percent gain in June. Even with the recent increases, producer prices dropped 0.8 percent over the past 12 months. Wholesale prices excluding food and energy rose 0.3 percent for a second month, and those costs were up 0.6 percent from July 2014.

Industrial production climbed 0.6% in July; there were also upward revisions of 0.1% each in February, May and June. Capacity utilization for the industrial sector increased 0.3 percentage point to 78%. The auto sector posted a 10.6% surge in production.

Looking to capitalize on rising demand, General Motors has increased its rate of production on larger trucks and SUVs, and added Saturday overtime shifts at a Texas plant. The move could see 48,000 to 60,000 additional vehicles for the 2016 model year. Make hay while the sun shines.

The University of Michigan’s consumer sentiment index edged slightly lower to a reading of 92.9 in August from 93.1 in July.

Secretary of State John Kerry is in Havana, where he helped raise the flag over the US embassy in Cuba for the first time in 54 years. The flag was raised by three men who as US Marines lowered it when the US embassy closed 54 years ago.

The Eurozone’s economic recovery unexpectedly slowed in the second quarter, as expansion in its three largest economies fell short of estimates. First quarter gross domestic product in the 19-nation region rose 0.3%, which was just short of estimates. On an annualized rate, the Eurozone grew at a 1.3% pace. For the quarter Germany’s economy grew 0.4%, Italy’s 0.2%, while France stagnated. With oil prices sharply lower, the euro at multiyear lows and the European Central Bank on a $1.3 trillion bond-buying spree to keep market interest rates low, there were hopes that the Eurozone had turned a corner after years of crisis. You can’t really blame the weakness on Greece. The Greek economy grew 3.1 percent, from only 0.1 percent at the beginning of the year. They are not out of the woods just yet.

Greek legislators have approved a new €86 billion-euro bailout agreement, which is said to include sweeping economic reforms and budget cuts mandated by the country’s creditors. The deal is expected to be cleared by Eurozone finance ministers today, but may face a harder challenge when Germany votes on it next week.

Ukraine and a group of its largest creditors have agreed to continue debt discussions after holding two days of negotiations in San Francisco.

The yuan halted a three-day slide after China’s central bank raised its reference rate for the first time since Tuesday’s devaluation and said it will intervene to prevent excessive swings.

Fifteen US states, led by coal-producing West Virginia, are seeking a stay order, or injunction, against President Obama’s Clean Power Plan, which calls for power plants to cut carbon emissions 32% (from 2005 levels) by 2030.

Earnings season marches on. JC Penney posted a smaller than expected second-quarter loss.

Nordstrom reported a better than expected second-quarter profit.

Chip equipment maker Applied Materials fell short of Wall Street expectation on both profit and revenue.

Restaurant chain El Pollo Loco missed Wall Street estimates on revenue for the quarter and same-store sales.

King Digital Entertainment posted a sharp slowdown in sales and bookings.

Aflac is increasing its stock repurchase program by 40 million shares, or about $2.5 billion.

Tesla Motors has boosted its stock offering to about 2.7 million shares, hoping to raise more than $640 million as it prepares to start selling its Model X sport-utility vehicle.

Nelson Peltz’s Trian Partners has taken a more than 7 percent stake in the food service company Sysco, worth around $1.6 billion, or about 42 million shares.

German prosecutors charged seven current and one former Deutsche Bank employees over a scheme to help the lender and clients evade taxes on carbon-emissions trades. The bankers are charged with being part of a group that tricked the authorities about value-added tax refunds on carbon-emissions trading in 2009 and 2010. If it’s not one thing it’s another; Bloomberg calculates Deutsche Bank’s bill for fines and legal settlements surpassed 11 billion euros in the second quarter.

The company said last month that the cost of litigation will “remain a burden in the coming quarters.” The lender has yet to resolve investigations into its role in attempts to manipulate foreign exchange markets as well as a probe of whether it broke US laws on processing payments for countries subject to trade sanctions. It also faces lawsuits that claim the company didn’t make adequate disclosures about US mortgage-backed securities. The bank said last month that it is cooperating with regulators in these matters.

After previously aiming for a fall launch, Apple is now looking to bring its Web TV service to market in 2016. The delay is blamed on slow-moving licensing talks with TV networks and the need for capacity upgrades. Sources suggest Apple wants to charge about $40/month for its service, in comparison to Dish’s Sling TV (which provides a limited number of channels) for $20/month and Sony’s more expansive PlayStation Vue service for $50-$70/month.

A US administrative judge has ruled that BP manipulated the Texas natural gas market in 2008 and then conducted an inadequate internal investigation, opening the possibility of more fines against the company.

US crude futures have lost 30 percent since the start of June, set for the biggest drop since the West Texas Intermediate crude contract started trading in 1983. That beats the summer plunges during the global financial crisis of 2008, the Asian economic slump in 1998 and the global supply glut of 1986. It even surpasses the decline of 2011, when prices fell as much as 21 percent over the summer as the US and other large oil-importing nations released 60 million barrels of oil from emergency stockpiles to make up for the disruption of Libyan exports during the uprising against Muammar Qaddafi. It looks even worse when you consider that summer is supposed to be peak season for oil. Total gasoline supplied to the US market rose to an eight-year high of 9.7 million barrels a day last month.

So, why is the price at the pump so high? One reason is that we export gasoline. In January 2010 the US exported 6.8 million barrels of gasoline. By January 2011 it had doubled. In January 2015 the US exported 16 million barrels of finished motor gasoline. Still, in 2004, the average price of oil was $37.66 a barrel.  In 2004, the average price of gasoline was $1.85 a gallon. So, if you think the price at the pump should be a bit lower, you are probably right.

Domestic equity funds surrendered $20.4 billion in July alone and have seen $158.6 billion in redemptions over the past 12 months. Meanwhile, international equity funds have attracted $179.3 billion. Don’t confuse international funds with emerging market funds. Depositors may be looking forward to an increase in Federal Reserve interest rates and the commodity bulls may be fearing it, but what about all those emerging markets that are heavily exposed to commodities as their principal export and heavily exposed to overseas borrowings in US dollars.

For them, the fall in commodity prices has been dramatic and damaging while the rise in the US dollar has started to increase debt repayments just when they can least afford it. The emerging markets have been clobbered over the last month. In July, China dropped 11.2%, Brazil tumbled 12.2%; South Africa, Colombia, Chile, Thailand, Taiwan, Turkey, Peru, and Korea all dropped by more than 5% on the month.

You might not have noticed but the junk bond market is looking a bit dicey. Average yields for low-rated companies have jumped to 7.3 percent and spreads between such debt and comparable duration Treasuries have widened dramatically. The average yield is the highest since mid-December and has risen 120 basis points, or 1.2 percentage points, just since June. Spreads are at 580 basis points, a level hit only twice in the last three years. Since the most recent lows in June, spreads have widened a full percentage point. Then again, maybe you have noticed; retail investors have been pulling money from US focused mutual funds – $155 billion in outflows over the past 12 months, and high yield corporate funds have watched billions walk out the door.

And it’s not just the junk; investors yanked $1.1 billion from US investment-grade bond funds last week, the biggest withdrawal since 2013. Dollar-denominated company bonds of all ratings have lost 2.3 percent since the end of January.

Once upon a time, Treasuries paid a high yield; 30 years ago to be precise. The last Treasury bond with a coupon above 10 percent was issued on August 15, 1985.

Social Security turns 80 today. President Franklin Delano Roosevelt signed the Social Security Act on Aug. 14, 1935. Last year, Social Security paid benefits of nearly $850 billion— about a quarter of all federal spending. The average monthly payment is $1,221. That comes to about $14,700 a year. For most retirees, Social Security accounts for the majority of their income.

Two Cows, because it’s Friday.

Financial Review

Milk and Cookies

Sinclair Noe — May 18, 2015

 

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

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DOW + 26 = 18,298.99 (record)
SPX + 6 = 2129.20 (record)
NAS + 30 =  5078
10 YR YLD + .09 = 2.23%
OIL – .14 = 59.55
GOLD + 2.30 = 1226.80
SILV + .19 = 17.78

Record high close for the S&P 500 and the Dow Jones Industrial Average. The rationale behind these record highs is suspect. Last week’s economic news was disappointing, and the bad news moved the markets higher, mainly on the idea that the Fed will be slower to raise rates. Retail sales were weak, industrial production was flat and capacity utilization decreased.

Consumers aren’t spending what’s left over after lower oil prices, instead, they are increasing personal savings. A new survey from Princeton Research shows 19% saved the difference from the gas pump, 4% invested, and only 14% took the savings from lower gas prices and went out and spent it on discretionary items such as dining out or vacations; while 40% spent the savings on necessities such as rent and groceries.  Lower oil prices were supposed to provide an economic boost; instead, it was the windfall that wasn’t.

And now it is long gone. Gas prices rose another 22 cents over the past three weeks to $2.82 per gallon, according to the latest Lundberg survey. The cost of regular gasoline has risen 32 of the past 34 days. And ISIS has just city the city of Ramadi, the provincial capital of Iraq’s largest region, about 75 miles from Baghdad. And Baghdad’s actions before and after the setback are raising red flags about the strategy to fight ISIS. Violence in the Middle East puts a floor under oil prices; it also makes for some strange coalitions. The US and Iran and even Saudi Arabia are on one side fighting against ISIS, even as they are on opposite sides in Yemen. And despite it all, the global oil market remains oversupplied. Crude oil inventories remain plentiful and stand some 86 million barrels higher than a year ago. Gas prices are still lower than they have been for this date since 2009. In fact, they’re down nearly a full dollar from a year ago.

Trying to estimate the cost of energy is likely a fool’s errand. The International Monetary Fund today issued a report saying the fossil fuel industry is subsidized to the tune of $5.3 trillion per year, largely due to polluters not paying the costs imposed on governments by the burning of coal, oil and gas. These include the harm caused to local populations by air pollution as well as to people across the globe affected by the floods, droughts and storms being driven by climate change.

The IMF report said that ending subsidies for fossil fuels would cut global carbon emissions by 20%. That would be a giant step towards taming global warming, an issue on which the world has made little progress to date. Ending the subsidies would also cut the number of premature deaths from outdoor air pollution by 50% – about 1.6 million lives a year. Furthermore, the IMF said the resources freed by ending fossil fuel subsidies could be an economic “game-changer” for many countries, by driving economic growth and poverty reduction through greater investment in infrastructure, health and education and also by cutting taxes that restrict growth.

Homebuilder sentiment fell in May but still showed more builders view market conditions as favorable. The National Association of Home Builders Index fell to 54 from 56 the month before. Readings above 50 indicate more builders view market conditions as favorable than poor. NAHB economist David Crowe said: “Consumers are exhibiting caution, and want to be on more stable financial footing before purchasing a home.”

The retail sector jumps into the spotlight this week with heavyweights Target, Home Depot, Lowe’s and Wal-Mart scheduled to report Q1 earnings. As we near the end of the earnings season, the S&P 500 revenue numbers show a decline of 3.7%. The P/Es of the SPY and QQQ are 21.4 and 22.8, respectively. And the forward numbers are also high, coming in at 17.8 and 19.3.

The dollar climbed from a four-month low on speculation reports this week will bolster the case for a Fed interest-rate increase. At a speech in Sweden this morning, Fed Bank of Chicago President Charles Evans repeated his call to hold interest rates near zero until early 2016. Evans, who votes on monetary policy this year, said borrowing costs should rise gradually thereafter because inflation is still well below the Fed’s goal.

Ann Inc. jumped 20 percent after Ascena Retail Group agreed to buy the women’s apparel retailer for about $2.2 billion. Altera has reportedly resumed talks with Intel about a potential buyout. Endo International has agreed to buy Par Pharmaceutical Holdings in a deal valued at $8.05 billion.

A U.S. appeals court reversed part of the $930 million verdict that Apple won in 2012 against Samsung. The Court upheld the patent infringement violations found by the jury. But the $382 million awarded for trade dress dilution will have to be reconsidered by the lower court. Trade dress is a legal term for a trademark on the way a product is packaged or presented. That wasn’t the reason Apple was leading the markets again today. Carl Icahn sent a new letter to Apple CEO Tim Cook. Icahn wrote: “Apple is poised to enter and in our view dominate two new categories (the television next year and the automobile by 2020) with a combined addressable market of $2.2 trillion.” He went on to write that Apple is grossly undervalued and should be worth $240 a share, not the current $130.19.

MasterCard is preparing for an antitrust complaint from European Union regulators probing card-payment fees. EU antitrust regulators have targeted swipe fees on credit-and debit-cards for more than a decade, warning that the way the charges are collectively agreed on is anti-competitive. Retailers have campaigned for years against interchange fees, saying that they push up the final costs of goods and services, and amount to a hidden charge on consumers. Card companies insist that the fees ensure that retailers make a fair contribution to the underlying costs of electronic payment systems. The EU has passed a law that would cap interchange fees on card payments and cut costs on such card transactions by $6.8 billion per year.

U.S. airlines expect to carry a record 222 million passengers this summer, up 4.5% from last year, Airlines for America says. The companies are increasing seating 4.6% to cope with the demand, which the trade group says is being boosted by improved employment and consumer sentiment. In Q1, 10 listed U.S. passenger airlines grew net profit 1.1% to $3.1B, helped by a 3.1% increase in revenues as the number of travelers rose 3.9%.

Gucci, Yves Saint Laurent and other luxury brands have sued Alibaba in Manhattan, alleging that the Chinese e-commerce giant has knowingly allowed the sale of counterfeit goods by merchants using its marketplaces. The brands are seeking a court order that would block the sale of the products along with damages that could include $2 per counterfeit item.

The art market hit a new milestone last week, with a record $2.7 billion sales frenzy and a single Picasso selling for $179.4 million, the highest price paid for any artwork at auction. And it seems especially pricey when you consider that you can get a cheap knock-off on Alibaba for a couple of bucks.

And apparently there is a correlation between record art sales and the stock market. According to a research note from Sundial Capital Research, finds: “previous bouts of expensive art sales have indicated over-confident conditions in the stock market as well. There is broad overlap between the markets, now more than ever. Wealth concentration is near an all-time high, and with stocks doing so well, it has helped to fuel massive confidence in other ‘greater fool’ markets like art. Like any trend in an unhinged market, it’s next to impossible to predict when the confidence will peak. Based on previous peaks, it could (should) be any time. The market is relatively isolated and a plateau in art prices wouldn’t have much effect on broader assets, though it would likely be coincident with a plateau in stock and bond markets.”

FINANCIAL REVIEW

Halloween Treats

Sinclair Noe — October 31, 2014

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

Financial Review
DOW + 195 = 17,390
SPX + 23 = 2018
NAS + 64 = 4630
10 YR YLD + .03 = 2.33%
OIL – .44 = 80.68
GOLD – 25.90 = 1173.90
SILV – .28 = 16.28

Record highs, again.

Back on September 19th, the Dow hit a record high close of 17,279. And then we watched the market tumbled for nearly a month. On October 17th we told you about a bullish reversal pattern, and it has been a strong move to new highs; up 1,100 from when I called the reversal, and up 1,545 from the lows of October 15.

Also, a new closing high for the S&P 500, however, we did not take out the intraday high of 2019 from September 19. Let’s break down the moves for the month of October. The Dow is up 248. The S&P added 46 points. The Nasdaq is up 137 points for October to a 14-1/2 year high. In October we saw the yield on the 10 year note drop 18 basis points from 2.51%. Gold took a hard fall on Friday, at one point trading at levels not seen since 2010. And of course, a big move in oil down 10.75 a barrel. If you are looking for a really dramatic move, the Russell 2000 index of small cap stocks has bounced from a low of 1046 on October 13, to close today at 1173, a 127 point gain; and once again above the 50 day and 200 day moving averages.

For the week the Dow rose 3.5 percent, its best percentage weekly gain since January 2013. For the week, the S&P 500 was up 2.7 percent and the Nasdaq was up 3.3 percent.

And if you think the rally of the past two weeks is impressive you should see the 2-day rally on the Nikkei, up almost 5% today. The Bank of Japan announced it expand its QE purchases and will now buy about $720 billion worth of Japanese bonds each year. So, the Federal Reserve ended QE3 large asset purchases on Wednesday, but really they just passed the baton to Japan.

Here is what has happened in Japan. December 2012, Shinzo Abe was elected as Prime Minister in Japan. Abe appointed Haruhiko Kuroda as governor of the Bank of Japan, and they set out on a very aggressive stimulus campaign to lift the Japanese economy out of decades of funk. They called it Abenomics. It started with promise. In early 2013, the yen fell, and the Japanese stock market rallied. And then the politicians got involved and started making a mess of things; they raised a consumption tax to try and rein in budget deficits. The economy contracted and disinflation returned. This has now become a familiar pattern. We’ve seen it here in the US; the central bank tries to stimulate the economy; the politicians tighten the belt. We’ve seen it in the Eurozone; Draghi promises to do whatever it takes; the austerians slam on the brakes.

In Japan, Abe is going all out. International commodity prices have been falling, and so the idea is to weaken the yen. Japan’s public pension system will also step in with direct purchases of exchange traded funds to prop up the equity markets. The idea is to mitigate deflation risks while also creating price inflation in other asset markets. The target is 2% inflation, and Prime Minister Abe seems hell-bent to make sure it happens.

So, the Fed ends QE, The Bank of Japan doubles down on QE (literally, they don’t even call it QE, it’s called QQE2); next up is the European Central Bank; next week the ECB will likely announce something, exactly what is still a guess. The main refinancing rate is already at 0.05%, a level ECB boss Mario Draghi several times has described as the “lower bound”. And with deposit rates at -0.2%, consensus is also for no changes there. As for full-scale QE? Well, Draghi has said he’ll do whatever it takes, but Draghi doesn’t have the same clout in Europe as Abe does in Japan. Draghi will surely face opposition from the Germans. Earlier in the year, the central bank laid out plans to buy asset-backed securities and covered bonds, dubbed private or mini QE. It started purchasing covered bonds in October, but has yet to push the buy-button for ABS.

Today, the Commerce Department reported that inflation in the US remains subdued. The price index for personal consumption expenditures, which is the Fed’s preferred way to measure inflation, held steady at 1.4% in September. Excluding the often-volatile categories of food and energy, prices rose 1.5% on the year. Annual core inflation has been steady at that level since May. The PCE inflation index has been under 2% for the past 29 months. The Fed warned in its policy statement on Wednesday that “inflation in the near term will likely be held down by lower energy prices and other factors.” Still, the Fed said that the chances of inflation “running persistently below” the 2% target had “diminished somewhat since early this year.”

The final October reading on the University of Michigan/Thomson Reuters consumer-sentiment index rose to 86.9, the highest reading since July 2007, from a final September level of 84.6. Consumers have kept their focus on improved job and wage prospects, and lower prices at the pump don’t hurt.

In a separate report, consumer spending fell in September for the first time in eight months, as Americans spent less on energy; and because we were spending less of gas, fewer people felt the need to replace the old gas guzzler with a new, more fuel efficient model, and auto sales dropped. They spent more on services, however. Personal spending dropped a seasonally adjusted 0.2% last month to mark the first decline since January.

By the way, it is estimated that sometime tomorrow, the nationwide average price for a gallon of gas will drop under $3 a gallon. The decline in gas prices is estimated to help consumers save roughly $250 million a day.

Meanwhile, the Bureau of Labor Stats reports labor costs are up 0.7% in the third quarter, matching the gain in the second quarter. Wages increased 0.8%, while the cost of benefits rose 0.6%. Over the past year, employment costs are up 2.3%, the fastest growth since 2008. Real, steady growth in wages is the missing ingredient in the economy right now. For months, economists have been saying the steady decline in the unemployment rate would inevitably lead to higher wages, as employers would have to bid up the wages they offer to recruit and retain productive workers. That prediction was fine in theory, but it didn’t seem to be showing up in anyone’s paycheck, until now, and it is still too early to say that to say it is entrenched, but we are seeing signs. Wages for private-sector workers are up at a 3% annual pace over the past six months. Average hourly earnings for nonsupervisory and production workers (about 80% of workers) are up 2.6% in the past year. And with inflation running at 1.4%, this means workers are actually getting ahead, just a little.

And don’t forget we are in earnings reporting season. And earnings are looking good; data sources vary, but according to FactSet, of the 362 companies that have reported earnings so far, 78% have reported earnings that have beaten the mean estimate of analysts. The blended earnings growth rate for the quarter is 7.3%, well above the estimated growth rate of 4.5% that was expected by analysts as of Sept. 30.

Exxon Mobil said its third-quarter earnings edged up 2.5% as higher refining margins and improvements at its refining and marketing segment helped offset lower production. Shares rose about 2%.

Chevron reported a third-quarter profit that rose well above expectations, offsetting a bigger-than-expected decline in sales. Earnings for the quarter ended Sept. 30 came in at $5.6 billion, or $2.95 a share, up from $5 billion, or $2.57 a share, in the year-earlier period.

AbbVie posted net profit of $506 million, or 31 cents a share, in the quarter, down from $964 million, or 60 cents a share, in the year-earlier period. They beat estimates and raised guidance.

It was a very, very bad week for privatized space travel. On Tuesday, an Orbital Science Antares unmanned rocket blew up on the launch pad in Virginia. Today, one of Virgin Galactica’s spacecraft crashed during a test flight in Southern California, killing one pilot and injuring another. The company was testing a new rocket engine on the craft, which is eventually supposed to carry paying tourists on suborbital flights high above the Earth. The accident is a major setback to Virgin, which had aimed to start regular commercial flights in 2015.

Next week, we have two really big events: the mid-term elections on Tuesday, and the jobs report next Friday.

The Brute Economic Power of Oil

Financial Review with Sinclair Noe — September 12, 2014

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

 

DOW – 61 = 16,987
SPX – 11 = 1985
NAS – 24 = 4567
10 YR YLD + .08 = 2.61%
OIL – .58 = 92.25
GOLD – 11.90 = 1229.30
SILV – .06 = 18.71

For the week, the Dow was down 0.9%, the S&P 500 was down 1.1% and the Nasdaq was down 0.3%.

Let’s start with the economic data: Business inventories rose 0.4 percent in July vs a 0.8% rise in business sales that keeps the stock-to-sales ratio unchanged at a healthy and lean 1.29. In a separate report, retail sales and consumer sentiment pointed at an improving economy. The preliminary September reading on the University of Michigan/Thomson Reuters consumer-sentiment index rose to the highest level since July 2013 and topped consensus expectations. Sales at US retailers rose in August by the largest amount since April, sales were up 0.6%; raising confidence in the economic outlook for the second half of the year. Retail sales would have been higher, but the price of gas dropped; after excluding gasoline, spending rose 0.7% in August.

Of course, one of the reasons Americans spent more money going out and eating and shopping is because the price of gasoline has been low. Spending at gas stations declined an estimated 0.8% in August. That followed a flat July and another 0.8% drop in June. A separate report from the Labor Department on Friday showed that prices of fuel imports fell 4.6% in August, the largest monthly drop in more than two years. If you can save $10 or $20 at the gas station, you’re more likely to spend that money at the mall or a restaurant.

So, in a very strange twist, the volatile situation in Ukraine and the Middle East has actually been a good thing for American consumers as we go to the gas pump. And in another strange twist, the International Energy Agency noted another reason for the lower prices: demand is remarkably low, and falling; and this is due to the weak economic prospects, especially for Europe and China. The Financial Times concluded: The world’s appetite for crude oil slowed at a “remarkable” pace during the second quarter because of weak economic growth in Europe and China, prompting the International Energy Agency to revise lower its demand forecasts for 2014 and 2015. In its widely followed monthly report, the west’s energy watchdog said that global oil demand growth had slowed to below 500,000 barrels a day in the three months to June – the first time it has reached this level in two-and-a-half years. Slowing demand and plentiful supplies have together pushed down the price.

The United States has imposed new sanctions on Russia’s largest bank, and a major arms maker; also there will be sanctions on arctic, deepwater and shale exploration by its biggest oil companies.

Energy stocks were pressured after the Treasury department announced the new sanctions, designed to punish the country for its intervention in Ukraine. The S&P oil sector fell 1.4% today, continuing a downtrend that has taken the group down 3.6% this week.

The sanctions target companies including Sberbank, Russia’s largest bank by assets, and Rostec, a conglomerate that makes everything from Kalashnikovs to cars, by limiting their ability to access the US debt markets. They also bar US companies from selling goods or services to five Russian energy companies to conduct deepwater, Arctic offshore and shale projects. The Russian firms affected are Gazprom, Gazprom Neft, Lukoil, Surgutneftegas and Rosneft.

The energy sanctions are not designed to curb Russia’s current oil production but to hit future production by depriving Russian firms of the expertise of companies such as Exxon Mobil and BP. Exxon has a $3.2 billion deal with Rosneft to develop Arctic oil fields. BP owns 18% of Rosneft and has signed a deal to explore oil shale fields in the Volga and Urals.

The Euro-union has also imposed new sanctions restricting financing for 15 Russian owned companies, plus asset freezes against 24 Russians, mainly politicians. The combined US and EU sanctions effectively shut Russian banks out of the capital markets of the US and Europe for everything except short-term debt.

The United States stressed that the sanctions could be removed if Russia took a series of steps including the withdrawal of all of its forces from Ukraine. Russia denies sending troops into eastern Ukraine and arming the separatists. Russian President Putin called the new economic penalties “strange,” given his backing of peace efforts in eastern Ukraine, and Russia’s Foreign Ministry said it would respond quickly with retaliatory measures against what it criticized as another “hostile step.”

So, today, oil prices continued moving lower to the lowest levels in 2 years, but that might not be the case if the sanctions are extended. Russia’s ruble currency has already fallen to a historic low against the dollar as its economy is hit by sanctions. That increases the price Russians must pay for many imports, from vegetables to luxury goods. And the price of oil might be an even bigger economic weapon than sanctions.

Russia is heavily reliant on oil sales and faces budget shortages at current price levels. It is estimated that the cost of production combined with what the Russian government siphons off to prop up its budget, results in a breakeven price for Russian oil at about $110 to $117 a barrel. Russia may have designs on Ukraine but if they are locked out of the financial markets and if they can’t turn a profit in the global oil market, they will find it difficult to finance their ambitions.

Daily oil production in the United States has risen sharply in the past 5 years. In 2010 the country still imported half of the crude it consumed, but the US Energy Information Administration forecasts that will fall to little more than 20% next year. Increased production of oil in the US combined with weakening demand, has pushed prices closer to $90 a barrel than $100, and prices could drop a bit more.

While US oil output has been rising fast, part of the big jump in supplies has come from countries that remain at risk of supply disruptions, including Libya and Nigeria; and don’t forget Iraq and Iran. Meanwhile, Saudi Arabia and the rest of OPEC is expected to continue to supply oil as needed, at least as long as the price stays above $85 a barrel. The Saudis have long said that they like the price around $100. Meanwhile, US oil companies working the shale fields claim they need $100 a barrel oil to make it worth their while, but a friend in the oil business tells me their real breakeven is closer to $80. For other US oil producers, like those working the established fields in Texas, the breakeven is closer to $30.

Where will prices settle? Well, they won’t. Oil prices constantly fluctuate. In early 2008, speculators jacked up the price to $147 and a year later, after the financial crisis, prices dropped under $40. Oil prices always move and always have an economic impact. If we look back to the 1980s we can see how this played out in the collapse of the Soviet Union.

From 1973 to 1980, when the West went through huge economic problems due to oil price shocks, the Soviet Union did not appear to have any concerns and their economy was fairly strong. In the mid-1980, the Saudis stopped protecting oil prices, and instead increased production fourfold, which resulted in a drop in oil prices by about the same amount in real terms. The Saudis still got the same amount of payment, they just delivered four times as much oil. The price declines hit the Soviet Union hard, resulting in loses of more than $20 billion a year, which was big money back then – not just the price of a startup tech company that makes one stupid little app.

So, the Soviets had a choice; they could cut back food imports, which would have resulted in food rationing and an angry populace; they could stop the highly subsidized oil trade among the Soviet bloc countries and risk dissolution of the Union; they could make radical cuts to the military-industrial complex; or they could go into debt, big time. Like politicians everywhere, they chose the path of least resistance, and started borrowing money from abroad, and avoided actual reforms. They managed to borrow very heavily until about 1989, when the price of oil dropped into the low teens and Soviet oil production dropped by 30%, and the Soviet economy came to a grinding halt. And the international creditors demanded payment, and cut off the credit lines.

The only way that the Soviet Union could have possibly survived such an oil production decline crisis, not to mention a complete loss of oil export revenue for hard currency, as well as cut its internal consumption, and cut off Eastern European exports, would be to shift to a market economy. The Soviet Union did exactly that. First, the Soviet’s cut off Eastern Europe from receiving cheap Soviet oil and forced them to pay in hard currency prices. Then when that was not enough the Soviets themselves had to allow internal oil prices to rise. This forced the Soviets to follow the same transition that Eastern Europe did. Indeed, Soviet and post-Soviet oil consumption declined a staggering 50% from 1985 to 1995.

In November 1989, the Berlin Wall fell. The pictures on television and in the history books imply that the breakdown of the Communist system in 1989 was a result of the peoples’ longing for freedom and democracy, and certainly that is true. The Soviet Union was both corrupt and brutal, the military defeat in Afghanistan had been costly and demoralizing, and don’t forget Chernobyl, the Communists could not compete effectively in new technology. It wasn’t just one thing; but President Reagan’s call to “tear down that wall” would not have had the impact if oil prices had not been torn down first. The transition was not by choice but by brute economic force.

Tuesday, July 01, 2014 - The Good, the Bad, and the Depressing

Financial Review with Sinclair Noe

DOW + 129 = 16,956
SPX + 13 = 1973
NAS + 50 = 4458
10 YR YLD + .05 = 2.56%
OIL - .13 = 105.24
GOLD - .80 = 1327.10
SILV + .02 = 21.08

 

Record high closes for the Dow and the S&P.

The record setting bull market run refuses to stumble. The S&P 500 has not seen a correction, a drop of 10%, for 1,002 days, and counting. This marks the fifth longest stretch without a correction since 1928. The average time between corrections is about 18 months; we’ve now gone 33 months without a 10% pullback.  

The Institute for Supply Management said its manufacturing index registered 55.3% in June, down slightly from May’s reading of 55.4%. Any number above 50% signals expansion. Separately, the research firm Markit said its final reading of US manufacturing conditions in June totaled 57.3, compared with a preliminary reading of 57.5; still the highest reading since May 2010. So the manufacturing sector has expanded for 13 consecutive months, but it wasn’t a month over month increase, and we have to remember that manufacturing was expanding in the first quarter as the broader economy was contracting by 2.9%. Today’s reports were decent news for manufacturing, but hardly great.

The Commerce Department reports construction spending increased 0.1% in May, following a 0.8% increase in April. Construction activity totaled $958 billion at a seasonally adjusted annual rate in May, up 6.6% from a year ago. Single-family home construction was down 1.4% while apartment construction dropped 0.6%. The hotspot for construction was a 4.3% rise in construction of power generating facilities.

The upshot is that the economy is continuing to improve from the deep freeze of old man winter, even if the recovery is tepid. Most economists and analysts had called for 3% growth in the first quarter, not a 2.9% contraction. Now that the weather and the economy have thawed, we’re hearing talk of 3% growth going forward.

The strongest S&P 500 sector this year has been Utilities, up 17%. The S&P 500 Energy sector is up 13%, with the following subsectors: Oil & Gas Equipment and Services rising 28%, Oil & Gas Storage and Transportation up 25% and Oil & Gas Exploration up 22%.The weakest S&P 500 sector so far this year has been Retailing.

June auto sales beat expectations with Chrysler, Nissan, Toyota and Hyundai all posting healthy gains compared with the same month a year earlier. General Motors had a small increase and Ford’s sales declined. June new car sales approached 1.4 million, about the same as a year earlier. Most analysts were forecasting a 2% to 3% decline for the month. GM recalled an additional 8.5 million cars yesterday, which means that GM has now recalled 29 million cars since the start of the year, more than the total number of vehicles it sold in 2011, 2012, and 2013 combined. It’s also more than the 22 million vehicles recalled by all automakers last year.

AAA predicts that nearly 35 million Americans will take a road trip of 50 miles or more on the Independence Day weekend. The current national average price for a gallon of regular gasoline is $3.68, compared with $3.48 a year ago. According to AAA, gasoline prices are 20 cents a gallon higher due to “market fear about Iraq”.

Sunnis and Kurds walked out of the first session of Iraq's new parliament after Shi'ites failed to name a prime minister to replace Nuri al-Maliki; so, the prospects are poor for a new unity government that might prevent Iraq from collapsing. Meanwhile, the ISIS rebels continue fighting; they control suburbs  just west of Baghdad; they have been waging fierce battles in Tikrit, north of Baghdad, and there have been clashes to the south of the capital, leaving the city surrounded on three sides. The United Nations says more than 2,400 Iraqis had been killed in June alone, making the month by far the deadliest since the US "surge" offensive in 2007.

Geopoltical hotspots continue to flare up. Ukrainian forces struck pro-Russian separatists bases in eastern Ukraine with air and artillery strikes. The ceasefire came and went, and won’t be renewed. Russian president Putin accused the Ukrainian prime minister of shunning the road to peace; while Russian foreign minister Lavrov warned of a “new round of bloodshed”.

 A follow-up on yesterday’s Supreme Court ruling in the Hobby Lobby case, which dealt with a closely held corporation’s objection to paying for contraceptives in employees’ health care under the Affordable Care Act mandate. The Supremes said corporations are people, my friend, and they have religious beliefs, and so they are exempt from the mandate. There had already been exemptions for churches and non-profit organizations; in those situations the government determined that contraceptives would be paid by the government. This was the solution put forth in 2012, and revised in 2013, whereby taxpayers could pick up the tab for contraceptive coverage, instead of religious employers, as a solution to the First Amendment issues in question.

Writing for the majority in the Hobby Lobby case, Justice Alito wrote: “[the White House] could extend the accommodation that HHS has already established for religious nonprofit organizations to non-profit employers with religious objections to the contraceptive mandate. That accommodation does not impinge on the plaintiffs’ religious beliefs that providing insurance coverage for the contraceptives at issue here violates their religion and it still serves HHS’s stated interests.”

In other words, while the government can’t compel Hobby Lobby to finance contraceptives, it can compel taxpayers to do so. Another name for taxpayer funded healthcare is “single payer”. I’m not sure if the Supremes intended this, but they just justified the government to establish a single payer health plan, at least for contraceptives.

There was a time when a majority of Americans were confident in the Supreme Court, but according to a new Gallup poll just 30% say they are confident in the highest court. That’s the good news; people have more confidence in the Supremes than in any other arm of government, but that may not be saying that much when confidence in the presidency stands at 29% and in the Congress at 7%. Which means Congress is even less popular than head lice, or T-Mobile, or Facebook.

The Federal Trade Commission says T-Mobile made money the old fashioned way, by charging customers hundreds of millions of dollars in bogus charges. The practice is often referred to as "cramming"; businesses stuff a customer's bill with bogus charges associated with a third party. In its complaint filed in federal court, the Federal Trade Commission claimed that T-Mobile billed consumers for subscriptions to premium text services such as $10-per-month horoscopes that were never authorized by the account holder. The FTC alleges that T-Mobile collected as much as 40% of the charges, even after being alerted by other customers that the subscriptions were scams.

Facebook has its own little scam. It modified hundreds of thousands of users' accounts by prioritizing 'positive emotional content' to see if it could make them happier or sadder, without telling them what it was doing.

Researchers from Cornell University and the University of California filtered information going into the news feeds of 689,000 users; that includes the constant flow of links, videos, pictures, and comments by friends. When positive emotional content from friends was reduced, users would post more negative content themselves, essentially becoming unhappier. The opposite happened when negative emotional content was reduced. The process has been dubbed “emotional contagion”.

The study, published in the journal “Proceedings of the National Academy of Sciences of the USA”, concluded: “Emotions expressed by friends, via online social networks, influence our own moods, constituting, to our knowledge, the first experimental evidence for massive-scale emotional contagion via social networks.”

A spokesman for Facebook said the research was conducted over a single week and none of the data was associated with a specific person's account. Instead, they said the site wanted to make its content more “relevant and engaging”.

Just to be clear, another name for emotional contagion is empathy, something that is in short supply at Facebook. What we really learned from this experiment is that the people at Facebook have spent so much time staring at a computer screen that they have become disconnected from emotional reality, and have to rely on scientists to run secret experiments on hundreds of thousands of lab rats, I mean customers, to discover that people get upset when their friends are unhappy. Even worse, the experiment confirms that social networks now have the power to change the emotional well-being of millions of lab rats, I mean customers, on a whim; just to see what happens; devoid of empathy.

Now that’s depressing.