Financial Review

Settling a Score

Sinclair Noe — May 24, 2017

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DOW + 74 = 21,012
SPX + 5 = 2404 (record)
NAS + 24 = 6163
RUT + 1 = 1382
10 Y – .02 = 2.26%
OIL – .15 = 51.32
GOLD + 7.90 = 1259.60
BITCOIN + 4% = 2537.16
ETHEREUM + 1.83% =  185.00

After 5 straight winning sessions, the S&P 500 closed at a new record high. The Nasdaq Comp is near a record.

The Federal Reserve released minutes of their May 3^rd FOMC policy meeting. The statement points toward a rate hike as soon as the Fed’s meeting in mid-June. According to minutes: “Most participants judged that if economic information came in about in line with their expectations it would soon be appropriate for the committee to take another step in removing some policy accommodation.”

Officials opted at the May meeting to leave the target range for their benchmark lending rate unchanged at 0.75 percent to 1 percent. They have projected three rate increases in 2017. They made the first rate hike in March. If they follow with 2 more hikes this year, we would be looking at rates around 1.25% to 1.5% by the end of the year, with a strong possibility for 4 more hikes next year.

Fed officials discussed a brightening global economic picture and viewed recent soft inflation and output data as likely caused by transitory factors. Growth slowed in the first quarter to an annualized pace of 0.7 percent, although the Fed expects the economy to bounce back in the second quarter.

Unemployment continued to decline. Labor Department data released two days after the meeting showed the jobless rate in April fell to 4.4 percent, the lowest reading since 2007 and beneath most economists’ estimates of the lowest sustainable level, or what might be considered full employment.

Policy makers have also said they would like to start shrinking their $4.5 trillion balance sheet by year-end, a move that may lift longer-term borrowing costs and dampen growth. It sounds scary to think that the Fed will soon reduce its war chest of bonds. Still, today after the minutes were released, Treasury values rose and longer-term yields fell.

One interpretation is that traders aren’t taking the Fed seriously. But another is that investors just received an unexpectedly concrete sense of the Fed’s methodology for unwinding its balance sheet, and it clearly indicates moving at a slow, gradual, incremental pace.

Fed members said they favored a method that included allowing a certain amount of their holdings to pay down without reinvesting the proceeds. The Fed would cap the amount of debt they’d allow to roll off at a certain level, and then would adjust that level every three months. Officials agreed they should provide additional details of the plan “soon.”

The dollar weakened slightly. Oil prices posted their first decline in six sessions. US crude supplies fell a seventh week in a row. Following the supply data, the price action became a function of positioning ahead of the OPEC meeting tomorrow. OPEC is expected to extend production cuts for 9 months, until March of 2018.  Data from the U.S. Energy Information Administration Wednesday showed that domestic crude supplies fell by 4.4 million barrels for the week ended May 19.

The last time the Congressional Budget Office scored the Republican health care bill back in March, it forced lawmakers to make major changes in order to prevent millions of Americans from losing their health coverage and lower premiums for the elderly. Amendments were added and another vote was held, this time without waiting for a CBO analysis – and the bill passed in the House.

The Congressional Budget Office today released their updated score for the American Health Care Act (AHCA), and the results are just as ugly as the first time. The report from the CBO on the amendments added just before the AHCA was passed by the House shows that 23 million more Americans could be uninsured by 2026 compared to the current healthcare system, slightly lower than the 24 million estimated under the previous iteration of the bill.

The CBO estimates that 14 million people who are currently covered would be uninsured as soon as the House plan were to be signed into law. And another nine million people would lose coverage over the course of the next decade. The AHCA, would also spike coverage costs in many states for people with pre-exiting conditions, especially for older Americans.

Importantly, the score projects that the AHCA will cut the federal deficit by $119 billion, $32 billion less than the $151 billion cut in the previous report. This was key because Republicans plan to consider the bill under the reconciliation process in the Senate. By these rules, the bill must shave off at least $2 billion from the federal deficit to be considered.

The Senate is expected to craft their own version of a healthcare bill instead of using the current form of the AHCA. The practical ramifications of the CBO’s latest report were more limited than its immediate political implications.

The House bill, as written, will not become law. Whatever proposal the Senate comes up with will have significant differences and will need a separate assessment by the CBO before a vote.

President Trump today continued his overseas tour with a visit to the Vatican. Pope Francis gave Trump a medallion engraved with the image of an olive tree – a symbol of peace, he explained.

Francis also presented Trump a signed copy of “Laudato Si’: On Care for Our Common Home”, the first papal encyclical focused solely on the environment. The two men spoke privately for about an hour-and-a-half. Next stop, Brussels.

Testifying to the House Budget Committee, Office of Management and Budget Director Mick Mulvaney suggested the government’s borrowing limit may need to be raised earlier than originally anticipated, citing “slower-than-expected” tax receipts.

The latest monthly budget report from the Treasury shows receipts are up almost 1% for the fiscal year to date. The year before, receipts were up about 1.2% through April, and the year before that, nearly 9%.

Sales of previously-owned homes sputtered in April after a strong first quarter. Lean inventory continued to constrain demand. The National Association of Realtors said existing-home sales ran at a seasonally adjusted annual rate of 5.57 million.

That was a 2.3% decline from March’s selling pace, which was revised down a tick but still stood at a 10-year high, though 1.6% higher compared to a year ago in April.

The median national sales price was $244,800 in April, a gain of 6% compared to a year ago. It was the 62nd-straight month of annual price gains. Despite that, first-time buyers managed to stage a small comeback.

They represented 34% of all buyers in April, up from 32% in March, though still below their long-time average of about 40%. NAR’s report also showed that 52% of homes sold in April were on the market for less than a month, which is a new high.

Sentier Research reports that median annual household income, adjusted for inflation, was $59,361 in April, a big 1% gain from March and a statistically significant move. For the first time since the U.S. entered the worst recession of the post-war era, the typical U.S. household has more income than it did when the century started.

Moody’s Investors Service downgraded China’s sovereign rating one notch to A1, which is two grades above junk status. The previous ratings cut was in November 1989 in the wake of Tiananmen Square.

In a statement, Moody’s said, “The downgrade reflects Moody’s expectation that China’s financial strength will erode somewhat over the coming years, with economy-wide debt continuing to rise as potential growth slows.” China’s total debt is estimated at around 220% of gross domestic product as of 2015, with a large chunk of it owed by corporations.

Global financial markets shrugged off the news because it is more confirmation than revelation.

Ministerial buildings were set ablaze in the Brazilian capital today as tens of thousands of protesters took to the streets to demonstrate against government corruption, renewing calls for Brazilian President Michel Temer to step down.

The federal government filed a lawsuit against Fiat Chrysler, accusing it of using illegal engine-control software to enable its diesel-powered vehicles to pass emissions tests. The filing occurred days after Fiat Chrysler proposed a modification to the software to ensure correct test results in hopes of resolving the issue.

The Environmental Protection Agency accused Fiat Chrysler in January of installing the software on about 104,000 Ram pickup trucks and Jeep Grand Cherokee sport utility vehicles sold from 2014 through 2016.

The Fiat Chrysler problem is very like the legal woes of Volkswagen, which admitted to using “defeat device” software to enable its cars to pass emissions tests while spewing far more pollutants than allowed in normal driving. Volkswagen ended up paying billions of dollars in fines, several of its executives have been investigated or charged with crimes.

Facebook has signed deals with news and entertainment creators Vox Media, BuzzFeed, ATTN, Group Nine Media and others to make shows for its upcoming video service, which will feature long and short-form content. It is an attempt to deliver on Facebook Chief Executive Mark Zuckerberg’s remarks to investors earlier this month that the company was looking for so-called “anchor content” that would draw people to the video tab on Facebook’s app.

Financial Review

The Vultures Eat

Sinclair Noe — February 29, 2016

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DOW – 123 = 16,516
SPX – 15 = 1932
NAS – 32 = 4557
10 Y – .02 = 1.74%
OIL + 1.12 = 33.90
GOLD + 16.50 = 1239.30

If you missed the past month, you might think things were calm on Wall Street for the month of February. For the month, the Dow rose 0.3 percent, the S&P 500 lost 0.4 percent and the Nasdaq lost 1.2 percent. This marks the first time since 2011 that major indexes posted three consecutive monthly declines.

Chinese shares closed at one-month lows. China cut the amount of cash banks must hold as reserves for the fifth time since last February. The yuan hit a three-week low. China expects to lay off 1.8 million coal and steel workers. 

A weekend meeting of G20 finance chiefs ended without a plan to spur global growth. The G20 issued a statement which basically said the global economy is not as bad as the doomsayers think. G20 finance ministers agreed to use “all policy tools – monetary, fiscal and structural – individually and collectively” to reach the group’s economic goals; but there was no plan for coordinated stimulus.

Participants also repeated previous pledges not to engage in competitive currency devaluations and promised to “consult closely” on exchange markets. Those pledges might not last long, and the Euro Union might be the first to crank up the printing press.

The inflation picture in the Eurozone further deteriorated in February, giving ECB policymakers more bad news to digest just a week before their next meeting. Consumer prices in the 19-nation bloc declined to -0.2% from a positive reading of 0.3% in January, displaying its worst figure in the last year.

Core inflation, which strips out volatile elements such as food and energy, was at 0.7%, down from 1% in the prior month. The deflationary reading in Europe has pushed German yields into negative territory out to nine years.

When the European Central Bank last discussed interest rates in January, Mario Draghi made clear the ECB would pump out more money in March if necessary. He cited a deteriorating outlook for the economy due to uncertainty about global growth, volatile markets and geopolitical risks.

Since then, Japan has introduced negative interest rates to boost an economy that is now shrinking again, and China has told its banks they’re free to lend more cash in the hope of supporting growth. And Britain is gearing up for a vote on whether to leave the EU. At the very least look for the ECB to increase bond purchases.

American and European officials are set to release details about the new trans-Atlantic data-sharing deal that would allow companies to move people’s digital information between the two regions. While the agreement was completed in early February, policy makers will now outline how the new structure will operate in practice. Some disagreement remains, however, regarding the level of protection people should be given over their digital privacy.

The Pentagon is seeking $35 billion through 2021 for cyber-security, in part to beef up offensive military capabilities such as those deployed in newly disclosed operations against Islamic State. The proposed budget would bankroll the Pentagon’s U.S. Cyber Command and its new Cyber Mission Force to assist regional commanders with tools to conduct defensive and offensive operations in their own areas as needed. Who knows, maybe they can hire someone to hack an iPhone.

The National Association of Realtors monthly gauge of pending home sales fell to 106.0 from an upwardly-revised 108.7 in December. It was the 17th straight month in which the index has been higher compared to a year ago, but that gain was only 1.4% in January – and it was a drop from December. The index tracks real estate transactions in which a sales contract has been signed, but the deal has not yet closed.

The median annual household income was $57,173, a gain of $424, or 0.7%, from November.  Incomes are now up 0.4% from where they stood in January 2000—the month that Sentier Research began tracking this data. Before you start thinking everybody got a raise, the data is adjusted for inflation, so volatility in fuel prices can weigh heavily on results.

Another month of volatility for the Chicago PMI which lurched from solid expansion in January to noticeable contraction in February. Today’s report came in at 47.6; any reading below 50 indicates contraction, and confirms other early indications of February softness, not only for manufacturing but for services as well since this report tracks both sectors.

The good news in the report is that new orders have held over breakeven 50 which hints at better readings in next month’s report. Now the bad news. Production is down sharply, backlogs are in a 13th month of straight contraction, employment is down and in a fifth month of contraction, and prices paid are contracting at the fastest pace since 2009.

The big event on this week’s economic calendar is the Friday jobs report. January managed to show a net gain of 151,000 jobs, and February is estimated to come in around 190,000, with a little luck.

Berkshire Hathaway profit hit a record. The Warren Buffett-led conglomerate announced earnings of $3,333 a share, easily beating the $2,529 that was expected by the Bloomberg consensus. Profits surged 32% to a record $5.48 billion. In his letter to shareholders, Buffett noted that Burlington Norther Santa Fe railroad “dramatically improved” after a bad 2014. Additionally, Buffett said the company bought more of its big four investments (American Express, Coca-Cola, IBM, and Wells Fargo) over the past year.

Warren Buffett thinks the gloom is overdone, however, saying politicians are “dead wrong” on the U.S. economy. “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start.” In his closely watched annual letter to investors, Buffett also defended his ties to 3G capital and Clayton Homes, and revisited Berkshire’s biggest takeover ever – Precision Castparts. Buffett reduced Berkshire’s bond portfolio for a sixth straight year, saying bonds should come with a warning label. Missing topics: No mention of a successor, the slump in commodity prices or recent market volatility.

Fifteen years ago Argentina defaulted on its sovereign debt. A couple of years later the vulture funds swooped in and bought some that debt for pennies on the dollar, or peso. During the 15-year legal battle creditors have attempted to embargo everything from Navy frigates to satellite launches to claw back the money a New York court said they were owed from defaulted bonds.

The alpha vulture was Paul Singer of Elliott Management, who demanded full face value on the debt. He won’t get it, but as of today, it looks like he will get 75% of the face value. Argentina will pay out $4.6 billion, and then be allowed to re-enter the international debt market again; they will issue $15 billion in new bonds, part of which will be used to pay off the old debt. Better luck this time.

The European Commission has cleared Dell’s planned $67 billion acquisition of data storage company EMC Corp. Dell unveiled the deal in October last year, the largest ever in the technology industry sector, and designed to enable it to better challenge rivals Cisco Systems, IBM, and Hewlett-Packard in cloud computing, mobility and cyber security.

Citigroup has received a subpoena in connection with the FIFA bribery scandal, making it the first major U.S. bank to disclose a link to probes involving soccer’s governing body. The summons came from the U.S. Attorney for the Eastern District of New York, asking about the lender’s connection to “certain individuals and entities identified as having had involvement with the alleged corrupt conduct.”

Anti-money laundering laws require banks to alert authorities about shady transactions like the ones at the heart of the FIFA scandal. Authorities allege senior FIFA officials used various U.S. banks, including: Citi, JPMorgan Chase and Bank of America to transfer and receive $150 million in bribes and kickbacks.

Taser International reported better-than-expected earnings as its fast-growing body-worn camera hardware and data business notched sharp gains. Over all, Taser’s profit edged up slightly from a year ago to $5.1 million. Its earnings per share remained flat at 9 cents. Sales rose 20% to $56 million.

Amazon is stepping into the British fresh food market after striking a supply deal with grocer Morrisons. Britain’s fourth largest supermarket said the deal would allow Amazon Prime Now and Amazon Pantry customers access to Morrisons’ fresh and frozen products in the coming months. Amazon previously launched a U.K. packaged groceries service in November, but it stopped short of replicating its broader U.S. Amazon Fresh service, which offers about 20,000 items from local shops.

Starbucks is finally ready to take its Americanized version of Italian coffees back to Italy, with its first outlet set to open in early 2017. It’s a symbolic move for CEO Howard Schultz. On a business trip in the 1980s, he visited Milan and Verona and decided to bring espresso drinks to the U.S., eventually forming the world’s biggest coffee chain. The statement from Schultz said: “We’re going to try, with great humility and respect, to share what we’ve been doing and what we’ve learned.”

Whiting Petroleum, the largest oil producer in North Dakota, has announced that it will suspend all fracking in the state and cut its budget for this year by 80 percent. Whiting said it will stop fracking and completing wells as of April 1. Most of its $500 million budget will be spent to mothball drilling and fracking operations in the first half of the year. After June, Whiting said it plans to spend only $160 million, mostly on maintenance. Whiting’s cut is one of the largest so far this year in an energy industry crippled by oil prices at 10-year lows.

Financial Review

Commodity Crush

Sinclair Noe — December 29, 2015

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DOW + 192 = 17,720
SPX + 21 = 2078
NAS + 66 = 5107
10 Y + .08 = 2.31%
OIL + 1.06 = 37.87
GOLD + .50 = 1070.00

The Commerce Department reports the trade deficit grew to $60.5 billion in November – a three-month high – as exports declined more than imports. Exports of goods shrank 1.9% to $121 billion, the second straight monthly decline. Imports dropped a slim 0.2% to $181.5 billion in November. Trade has been a drag on growth in five of the last seven quarters, as the strong dollar and weak global economies have limited exports.

Home values in 20 U.S. cities rose at a faster pace in the year ended October as lean inventories of available properties combined with steadily improving demand. The S&P/Case-Shiller index of property values climbed 5.5 percent from October 2014 after rising 5.4 percent in the year ended September. A limited supply of properties for sale has helped prop up home values.

Prices in Phoenix were up 0.5% from September to October and up 5.7% over the past 12 months ending in October. At the peak in 2006, prices in Phoenix were up 127% above the January 2000 level. Then prices in Phoenix fell slightly below the January 2000 level, and are now up 55% above January 2000 (55% nominal gain in almost 16 years).

The Conference Board’s consumer confidence index rose to 96.5 in December. In addition, confidence in November was revised higher to 92.6 from 90.4, which was the lowest level in more than a year. Consumers remain positive about the current state of the economy, particularly the job market. The number of people who anticipated more jobs in the months ahead increased slightly while the percentage who expected jobs to be scarce declined.

A new report from Sentier Research takes a look at Census data showing the median annual household income was $56,746 in November. That’s barely above October’s median of $56,688, but it was enough to top the $56,688 reached in December 2007, when the recession began. The bad news is that the median income is 1.1% lower than in January 2000, when record-keeping began. The numbers are inflation adjusted.

Still, the labor market has been showing improvement, even if it barely registers as a blip in wages. The unemployment rate is down 4 percentage points from the summer of 2011, to 5.0%; the median duration of unemployment has been cut in half to 10.8 weeks, and a broader measure of underemployment (the U-6) is 9.9%, down from 16.1%.

Saudi Arabia announced plans to shrink its record $98 billion state budget deficit with spending cuts, reforms to energy subsidies and a drive to raise revenues from taxes and privatization. The Saudis are not expected to cut production in 2016. But there are increasing signs that demand might slow much sharper than expected after a spike in 2015. Oil prices higher today after dropping yesterday to near 11 year lows.

Still, it looks like oil is settling in to a range of $30 to $50 a barrel. Energy users everywhere are enjoying an annual income boost worth more than $2 trillion. The net result will almost certainly accelerate global growth, because the beneficiaries of this enormous income redistribution are mostly lower- and middle-income households that spend all they earn.

On the flip side, governments of oil producing countries, such as Saudi Arabia, are cutting public spending even as they run down reserves and borrow from financial markets; and major oil companies are forced to cut back, to the tune of $200 billion this year. And Iran is about to come back online.

A ship loaded with more than 25,000 pounds of low-enriched uranium has left Iran for Russia as part of a deal aimed to limit Tehran’s nuclear program. In a statement, Secretary of State John Kerry said the move was “one of the most significant steps” in fulfilling last summer’s nuclear accord, and it may be only weeks before the agreement takes effect. On “Implementation Day,” roughly $100 billion in Iranian assets will be unfrozen, and the country will be free to sell oil on world markets and operate in the global financial system.

What this means is that the big oil companies like ExxonMobil, Chevron, BP, Shell, and Total are on the ropes. Iran claims it can pump oil for $1 a barrel, and they will, soon. Saudi Arabia claims they can still make a profit under $20 a barrel. The big Western oil companies can’t compete, at least not when it comes to exploration and development of new fields. Shell learned that lesson when it came to developing Artic oil fields, it just didn’t pencil out and they had to abandon that plan at a cost of about $7 billion.

What they could do is provide equipment and technology to oil producing countries, forget about exploration, and maybe go a step beyond and sell their reserves.  That is precisely the strategy of self-liquidation that tobacco companies used, to the benefit of their shareholders. If oil managements refuse to put themselves out of business in the same way, activist shareholders or corporate raiders could do it for them.

As clean energy technology improves and environmental restrictions tighten, it is inevitable that much of the world’s oil reserves will be left in the ground, which means that oil companies are sitting on stranded assets that are, or soon will be, worthless. Redirecting just half the $50 billion that oil companies are likely to spend this year on exploring for new reserves would more than double the $10 billion for clean-energy research announced this month by 20 governments at the Paris climate-change conference. The financial returns from such investment would almost certainly be far higher than from oil exploration.

One of the big themes for 2016 will likely be lower commodity prices. I really don’t like to make predictions and your guess is as good as mine, but here is my thinking: first, commodity prices are in a downtrend and a trend in place is more likely to continue than it is to reverse; commodities, raw materials, the very building blocks of our economies, from oil all the way to copper, are being discounted in price.

Next, demand ain’t what it used to be. For the past 8 years at least demand for raw materials and especially oil has been driven by low interest rate policy which led to over-leveraging and over-borrowing, which led to over-production and over-capacity.

The Federal Reserve threw about $4 or $5 trillion at the economy but they were not alone; the central banks of the Euro Union, Japan, and especially China added in tens of trillions more. In China they built entire cities that sit empty. This over-production is unsustainable and the balloon is now drifting down to earth. And while all the over-production was happening, technology improved efficiency and conservation, further lowering demand.  Eventually, commodities prices will more or less stabilize, but at much lower levels.

And the reality for big oil companies is that they are in a dying business, just like the tobacco companies and the coal companies. Imagine for a moment, the coal company CEO who, ten years ago had the foresight to realize that coal was about to be crushed, and instead had sold off reserves, made big payouts to shareholders and re-invested in almost anything other than coal. It didn’t happen and I don’t expect big oil to do it either, even if it is the smart move.

‘Tis the season to return unwanted holiday gifts — and for retailers to lament the impact of all those boomeranging sales on their bottom lines. Approximately $70 billion worth of products may be returned this holiday season. While retailers can resell some of those items or foist them off on liquidators and discount chains, much of the value of returns is lost as they move through the supply chain. Just how much do businesses lose? Last year, Americans returned about $284 billion in merchandise, according to the National Retail Federation, and anywhere from a quarter to half of that value cannot be recouped, leading to tens of billions of dollars of losses. And fraudulent returns are expected to cost retailers $2.2 billion.

Carl Icahn has sweetened his buyout bid for Pep Boys …, again. And this time the Pep Boys board determined activist investor Carl Icahn’s latest buyout offer was superior to the deal it accepted from Bridgestone. Icahn Enterprises’ latest bid of $18.50 per share values Pep Boys at about $1 billion, while Bridgestone’s previous offer of $17 per share valued the company at about $947 million. The U.S. auto parts retailer has now moved to terminate the Bridgestone agreement.

Two of the world’s largest technology firms, IBM and Microsoft, are vying to tap the fast-growing market for forecasting air quality in China. Bouts of smog enveloping Beijing already prompted authorities to declare two unprecedented “red alerts” this month, and while prediction technology won’t be able to make the air better, it could be a step toward helping the city’s 22 million people live with it. IBM and Microsoft’s advances in “cognitive computing” can provide predictions for the air quality index up to 10 days in advance using data on weather, traffic and factory use.