Financial Review

Walk On

Sinclair Noe — September 9, 2015

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DOW – 239 = 16,253

SPX – 27 = 1942
NAS – 55 = 4756
10 YR YLD – .01 = 2.18%
OIL – 1.79 = 44.15
GOLD – 15.60 = 1106.80
SILV – .19 = 14.71

Wall Street opened higher; part of a global rally for stocks. Japan’s Nikkei index was up 7.7%, bouncing off 11 month lows. Equities in China rose as the finance ministry pledged to accelerate construction of some major projects. European stocks moved higher this morning, with France leading the way. But it didn’t last. The S&P energy sector led declines among the S&P 500 sectors, falling 1.3 percent, as oil prices dropped.

The World Bank’s chief economist is warning that the Federal Reserve risks triggering “panic and turmoil” in emerging markets if it opts to raise rates at its September meeting and should hold fire until the global economy is on a surer footing. Kaushik Basu told the Financial Times that rising uncertainty over growth in China and its impact on the global economy meant a Fed decision to raise its policy rate next week, for the first time since 2006, would have negative consequences.

His warning highlights the mounting concern outside the US over the Fed’s potential “lift-off”. It follows similar advice from the International Monetary Fund. That means that if the Fed’s policymakers were to decide next week to raise rates they would be doing so against the counsel of both of the institutions created at Bretton Woods as guardians of global economic stability.

This moment for the Fed is somewhat reminiscent of September 2013. Officials had been signaling plans to end a bond-purchase program, hesitated after an episode of market turbulence, and then started winding it down that December. You could also draw parallels to the situation in 1997, when the unemployment rate dropped through 5 percent. The Fed did raise rates a quarter point, but then stopped, waiting for inflation to become a problem – which it never did, even though unemployment continued to fall, eventually to 4 percent.

The lesson is that the Fed really doesn’t know what level of U3 constitutes full employment, and should be very cautious about acting preemptively absent any signs of inflation problems. By the way, the Fed still hasn’t reached its inflation goal of 2%.The markets tend to get caught up in the debate. And when the markets rally, it seems like a green light to hike rates; then when the markets think rates might be going up, the markets fall. You could also make the argument that if people are so frantic about a minor interest rate hike they need a reality check.

Puerto Rico said it faces a $13 billion funding shortfall for debt payments over the next five years even after taking into account proposed spending cuts and revenue enhancement measures outlined in a long-awaited fiscal and economic growth plan. The report, released today, said Puerto Rico will seek a consensual compromise with creditors to restructure its debt. No estimates were provided of potential losses for the owners of Puerto Rico’s $72 billion in debt.

Job openings in the US surged in July, even as the pace of hiring cooled. The latest Jobs Openings and Labor Turnover, or JOLT report, shows the number of positions waiting to be filled jumped by 430,000 to 5.75 million from a revised 5.32 million in June. The quits rate came in at 1.9% for a fourth straight month. Quits typically indicate a healthy labor market in which workers feel confident enough to leave one job for another.

Apple has unveiled the latest versions of the iPhone, the 6S and 6S+, at a big, glitzy event in San Francisco. Here is everything you need to know about the new Apple phones…Um, the big change is something called 3D Touch; if you press down hard on the screen you can do different stuff; however, this does not work if you press down with a hammer.  The phone will cost the same as the iPhone 5. The phone has a faster chip and a better camera. It has a new optional case color called rose gold – don’t call it pink. And the phones are gluten free.

Netflix intends to launch its TV and movie streaming services in South Korea, Singapore, Hong Kong and Taiwan early next year as the company continues its plans for world domination. The news comes after Netflix entered Asia last week by opening in Japan and as it explores its options in China. By the end of 2016, Netflix wants to be in 200 countries.

United Airlines Chairman and CEO Jeff Smisek has stepped down from both roles amid a federal investigation into whether the company traded favors with the chairman of the Port Authority of New York & New Jersey. The United States attorney for New Jersey has been investigating whether United, the nation’s third-largest airline, agreed to reinstate money-losing flights to the airport nearest the weekend home of the authority’s chairman, David Samson, in return for improvements the airline wanted at Newark Liberty International Airport, where it is the biggest carrier.

Toyota has introduced a revamped Prius in the first major redesign of the pioneering hybrid car in seven years. Toyota says it has given the vehicle a more sporty look with the addition of a spoiler and has improved fuel economy by 10% to 55 miles a gallon. Although the company is looking to boost flagging Prius sales, the timing of the launch isn’t great – competition has heated up in the alternative-fuels sector while low oil prices have reduced demand for fuel-efficient cars.

European Commission President Jean-Claude Juncker has announced plans that he says will offer a “swift, determined and comprehensive” response to Europe’s migrant crisis. Under the proposals, 120,000 additional asylum seekers will be distributed among EU nations, with binding quotas. It comes after a surge of thousands of mainly Syrian refugees pushed north through Europe in recent days. In a State of the Union address, Juncker told the European Parliament it was “not a time to take fright”. Germany, the main destination for many refugees, supports quotas, but some EU countries oppose a compulsory system. He opened his speech by admitting the European Union was “not in a good situation. There is a lack of Europe in this union, and a lack of union in this union”.

Denmark has suspended all rail links with Germany and shut a section of motorway after refugees crossed the border and began walking north, apparently trying to reach Sweden. In southern Hungary, refugees on the border with Serbia broke through police lines at a refugee camp, forcing the closure of a major highway. The new plans would relocate 60% of those now in Italy, Greece and Hungary to Germany, France and Spain. The numbers allocated to each country would depend on GDP, population, unemployment rate and asylum applications already processed. Countries refusing to take in refugees could face financial penalties.

The United States has vowed to help its European allies with the influx of migrants and refugees coming in from Middle Eastern and African countries ravaged by war, famine, and poverty. Secretary of State John Kerry met today with congressional lawmakers behind closed doors to discuss how many refugees the US government is willing to take in.

After the meeting, Kerry said the US wants to increase the number of refugees it takes in, but he did not announce a specific number. Many of the new European arrivals are coming from Syria, where a lengthy civil war has forced more than 4 million people to flee the country. According to the International Rescue Committee, a humanitarian organization that helps to resettle refugees, the US has been slow to help, only resettling about 1,400 Syrian refugees during the nearly five-year-long war.

The Surgeon General of the US, Vivek Murthy (who knew?) has issued a radical 72-page call to action: we should walk more. That doesn’t sound radical, but these days it is. Regular physical activity reduces the risk of heart disease, diabetes, obesity and a list of other health problems, and can ease symptoms and improve quality of life for people already living with chronic diseases.

Guidelines issued in 2008 recommend that adults get at least 2 1/2 hours a week of moderately intense physical activity. Children should be active at least 60 minutes every day. Most Americans don’t get anywhere near enough physical activity. And one of the easiest ways to get that physical activity is to walk; it is simple, affordable, and it works.

The problem is that most cities aren’t set up for walking; they are designed around cars. In many places, schools, restaurants and shops are located too far from home for people to walk. Busy streets may lack sidewalks, or there may not be adequate time to cross multiple lanes of traffic.

The Surgeon General’s new report offers a few specifics on how to revive to the culture of walking. He wants communities to make it easier and safer for people to walk; that will require efforts from transportation officials and city planners, parks and schools, businesses and health officials, and the public. Options range from zoning decisions and building sidewalks, to promoting worksite activity.

More powerful than any of these specifics, though, is the simple fact that the federal government just acknowledged, even if it didn’t use quite these words, that we need to design lives that have been modeled for decades around driving around our own feet instead.

Financial Review

Somewhere Between Extremes

Sinclair Noe — April 27, 2015      

 

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Financial Review by Sinclair Noe
DOW – 42 = 18,037
SPX – 8 = 2108
NAS – 31 = 5060
10 YR YLD + .01 = 1.92%
OIL – .16 = 56.99
GOLD + 21.30 = 1201.70
SILV + .65 = 16.50

We’ll get to the economic news in a minute, but the big market news today is Apple. Net income in the quarter that ended in March was $13.6 billion, or $2.33 a share, representing a 33% jump in profit from last quarter. Analysts on average had forecast second-quarter profit of $12.6 billion, or $2.16 a share. Revenue rose 27 percent to $58 billion, beating estimates of $56 billion. IPhone sales in greater China outpaced those in the U.S. for the first time. Total revenue from greater China surged 71 percent to $16.8 billion. IPhone unit sales jumped 40 percent to 61.2 million. That topped analysts’ average prediction for 58.1 million.

Apple forecast the momentum will continue in the third quarter, with revenue projected to rise to $46 billion to $48 billion from $37.4 billion a year ago. Apple has $193 billion in cash, with a capital return program, which now totals $200 billion. Apple will increase its share-buyback authorization by $50 billion to $140 billion, and increase the company’s dividend by 11 percent; to 52 cents from 47 cents.

To recap: Apple posted better than expected sales and profit; they will increase their buybacks and dividends; and they upgraded their third quarter guidance. Basically, they did everything except wash your car for you.

The Federal Reserve FOMC is meeting this week. It’s a pretty safe bet that policy makers will not be raising interest rates at the meeting, but investors will still be watching the language of the statement for signs on when such a rate hike might be expected. This is a delicate dance by the Fed; they want to test the waters without getting a single toe wet; they might try to indicate they are in favor of a rate hike in order to get a read on market reaction.

Also on tap for Wednesday is the preliminary first-quarter readout of GDP, along with some early April economic reports. The spotlight in Asia this week falls on Japan, where a central bank decision could provide clarity on the direction of the world’s third largest economy. Following its meeting, the Bank of Japan is expected to cut its 2015 inflation forecast by several tenths of a percentage point from 1%, and shave its growth forecast from the current 2.1%. Despite inflation dropping back to zero, governor Haruhiko Kuroda has argued strongly that the BOJ’s existing QE program is on track. Japan’s prime minister, Shinzo Abe, visits Washington as the US and Japan prepare to sign an expanded defense accord and finalize a major trade pact. On Wednesday, he will be the first Japanese leader since World War II to address a joint session of Congress.

As the monetary easing by central banks across the globe keep yields at rock-bottom, investment officers predict that Japanese demand for U.S. debt won’t ease up in the months ahead given the lack of alternatives. Japanese life insurers – some of the world’s largest institutional investors – plan to keep pouring money into U.S. debt this year, outlining that Japan even overtook China in Q1 as the largest foreign holder of U.S. Treasurys. While the current 2% yield on the U.S. 10-year is a far cry from yields of 5% or more before the financial crisis, it is still miles apart from the 0.16% yield on German bunds and the 0.29% yield on the 10-year Japanese equivalent.

The finance ministers of Slovenia and Germany on Saturday acknowledged for the first time that they are considering plans on what to do if a Greek deal is not reached by the end of June, breaking their long-held stance of insisting that the country must stay in the eurozone. The issue of a “Plan B” was raised during Friday’s Eurogroup meeting in Riga, where Athens was strongly criticized for delaying the list of reforms needed to unlock its next round of funding. A Eurogroup meeting in Riga, Latvia on Friday descended into name-calling as the currency bloc’s finance ministers hurled abuse at Greek Finance Minister Yanis Varoufakis, accusing him of being a time-waster, a gambler and an amateur.

The Eurogroup finance ministers don’t’ have any intention of negotiating; for them it is simple – Greece needs to collect more taxes and crush the workers. For the Greek negotiators it is fairly simple as well – the workers are already crushed and the country has no money. Varoufakis was pulled from day to day negotiations; he will still be involved, but from the sidelines. Varoufakis tweeted: “FDR, 1936: “They are unanimous in their hate for me; and I welcome their hatred.” A quotation close to my heart (& reality) these days.”

Greece’s economy is about 2 percent of Eurozone economy, and a hardline stance from the Euro Union finance ministers would not overwhelm Europe’s economy. Most of the money Greece owes is now owed to governments or the central bank, and not to private banks, insurance companies, or hedge funds. Private interests have long since left Athens; the exception is vulture hedge funds that bought Greek debt for pennies on the dollar, with the idea of dragging the Greeks through the courts to enforce collection. So, as the finance ministers of Slovenia and Germany work on a Plan B, I just hope they realize that Plan B really means a return to nationalism in the Eurozone, which has a poor history in that area.

The game of chicken between Greece and its international creditors is turning into a vicious blame game as Athens lurches closer to bankruptcy with no cash-for-reform agreement in sight. Europe’s political leaders and central bankers and Greek politicians agree on only one thing: if Greece goes down, they don’t want their fingerprints on the murder weapon.

Financial firm Markit said its “flash,” or preliminary, reading of its Purchasing Managers Index for the services sector slipped to 57.8 in April from a final reading of 59.2 in March, which had been the highest level since August. A reading over 50 signals expansion in economic activity.

Chipotle Mexican Grill has eliminated genetically modified organisms from all its ingredients, an unprecedented move for a national U.S. restaurant chain. The company, which began labeling its GMO ingredients two years ago and vowed to remove them, has now taken the final step of stripping them from tortillas and cooking oil. The move coincides with a new Chipotle marketing campaign that will tout its use of simple, unprocessed ingredients.

Meanwhile, Coca-Cola announced it doesn’t have plans to change the sweetener for Diet Coke away from aspartame despite other beverage sellers shifting their focus to the use of natural sweeteners. Sales of Diet Coke fell 6% year-over-year in the first quarter. On last week’s earnings call, Coca-Cola executives said finding the right path to grow Diet Coke sales was still a “work in progress.”

Corinthian Colleges is closing all of its schools. The school is closing its 28 for-profit schools, meaning approximately 16,000 students will have to finish their degrees elsewhere. The Department of Education will “help the stranded students review their options, including possibly forgiving some of their loans.” In recent years, Corinthian has been accused by multiple federal and state authorities of systematically lying about its graduation or job placement rates, misleading potential students into enrolling and forking over tens of thousands of dollars to obtain credentials many critics believe to be of dubious value. The company annually received some $1.4 billion in federal financial aid for its students. A group of roughly 100 former Corinthian students that calls itself the “Corinthian 100″ has been publicly pressuring the Department of Education to cancel all debts owed by current and former Corinthian students because of the company’s alleged deception related to its job placement and graduation rates.

Police officers in riot gear clashed with rock-throwing protesters in Baltimore after the funeral for 25 year old Freddie Gray, the latest victim of police brutality. Gray died a week after his spine was somehow partially severed in police custody. He was initially stopped because he fled upon noticing officers, who later found a knife clipped to his pocket. Cell phone video shows police dragging Gray into a van, but when officers took him out, he wasn’t breathing.

His funeral was today, further sparking the city-wide demonstrations. At least seven officers were injured in today’s protests and one was unresponsive, according to the Baltimore police department. The violence broke out near the church where Gray was eulogized. Groups of angry young people surrounded a police cruiser and smashed it in; another cruiser could be seen burning. A drugstore was also looted. Other protesters pelted the police with items picked up at nearby vacant lots: rocks, bricks, boards and chunks of concrete. Some arrests were made. The unrest comes after a weekend during which an angry mob protesting outside Oriole Park at Camden Yards forced the team to close the stadium to keep people inside safe from the violence outside. Fears over the potential for crowds to become violent forced the closure earlier today of several downtown businesses and offices.

So, we started today’s review with a story about Apple earning almost a billion dollars per week in profit in the first quarter, and we finish with a story about violent protests in Baltimore. And that’s where we are today; somewhere between two extremes.

FINANCIAL REVIEW

A Tale of Three Stocks

Sinclair Noe — October 20, 2014

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Financial Review

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

DOW + 19 = 16,339
SPX + 17 = 1904
NAS + 57 = 4316
10 YR YLD – .02 = 2.18%
OIL – .21 = 81.85
GOLD + 8.70 = 1247.90
SILV + .16 = 17.53

A nice bounce in the S&P 500 index and the Nasdaq Composite. For most of the session, the Dow was in negative territory, clawing its way to positive, barely. There are 3 stocks that had a compelling story today.

We start with IBM, which reported its third-quarter results; a 10th consecutive period of falling sales, marked by weaker performance in growth markets. IBM said its long-standing forecast of earnings per share of $20 for 2015 is no longer achievable. IBM lowered its forecast for free cash flow. The company said it was selling its money-losing chip-making business to GlobalFoundries, a move to further cut costs and focus on its more profitable, faster-growing businesses. Once upon a time, IBM was a pioneer in advancing semiconductor technology, its manufacturing capability fell behind others that produced chips in large volume, but now they will have to pay GlobalFoundries $1.5 billion to take the chip division, while taking a $4.7 billion charge. IBM has been divesting slower-growing and unprofitable businesses, but like many older tech companies, it is caught in the middle; sloughing off the old and expensive without yet having a foothold in the new.

Some customers are trying to move more of their corporate-computing functions to the cloud. The arrival of cheap cloud computing means that corporations don’t need IBM’s big, expensive mainframes. And even if IBM does catch up, the cloud might be such a thin-margined industry that it can’t sustain the profit margins IBM had been telling investors to expect. IBM talked about growth in cloud computing of 50%. But the company’s faster-growing businesses can’t offset its aging businesses. Revenue in hardware systems, including its Z Series mainframe systems, fell 15%. In addition, the once faster-growing services business was off 3%.

IBM earned $3.68 a share on revenue of $22.4 billion, down from earnings of $4.04 a share on $23.3 billion in sales a year ago. Wall Street analysts had forecast IBM to earn $4.31 a share, with sales of $23.37 billion. IBM also cut its earnings outlook for the year to between $15.97 and $16.31 a share from its previous forecast of $18 a share, and said it would no longer stand by its “road map” to reach earnings of $20 a share for 2015. Under previous Chief Executive Samuel Palmisano , the company had pledged in May 2010 to double its earnings to at least $20 a share by 2015 by more aggressively pursuing business in software and high-growth emerging markets.

The company also hinted it may cut back on the massive share buyback program that helped support its earnings targets. In the third quarter, IBM bought back $1.7 billion in stock. The company had $1.4 billion remaining under its current repurchase authorization at the end of September and said it would ask to boost that figure at this month’s board meeting. They might have been better served putting that money into R&D. Sometimes short-term shareholder value leads to longer-term shareholder loses. IBM down 12.95 = 169.10. (-7%). Big Blue is bleeding blue.

Sears Holding, up 6.55 = 34.96 (+23%). Why was Sears up today? It’s a smoke and mirrors move. Sears is bleeding cash; today they got a transfusion of capitol, but this is still one very sick puppy. Sears announced its intentions to conduct a rights offering of units, including senior unsecured notes and warrants. The company will offer shareholders debt and stock warrants worth $625 million, which can be exercised in five years. The exercise price for the rights offering of shares will be the same as the October 17 closing market price of $28.41.

The rights offerings that the company has announced will include 8% senior unsecured notes due 2019, along with the rights to purchase company’s common stock. Sears expects to raise $625 million out of this offering. Sears needed to raise some money because they are burning through cash. The reason they are burning through cash is, well have you been in a Sears store lately? No. Well, that’s why.

The move today also indicates that the cash burn during the quarter might have been higher than the company’s expectations, in turn, urging the company to raise additional capital through these sources. Moreover, the company might be facing pressure from its suppliers to make payments, causing it to try and improve liquidity. And beyond keeping the doors open, why the need to raise cash?

Well, hedge funds are now running Sears, and it has been a bad bet, so now they’re going into salvage mode; scraping cash from the bottom of a barrel. This in addition to already selling its Lands’ End unit, and most of Sears Canada. The bottom line is that Sears needs a big turnaround, and you won’t get that from hedge fund managers; what they will do is slowly and surely chop it up and sell it off.

After the close of trade, Apple said net income was $8.47 billion in its fiscal fourth quarter ended Sept. 27 versus $7.51 billion in the year-ago period. Earnings per share rose more sharply, to $1.42 from a split-adjusted $1.18, because the company’s stock-repurchase program reduced the share count. Revenue rose 12% to $42.12 billion from $37.47 billion in the same period a year earlier. Analysts were expecting earnings of $1.31 per share on revenue of $39.88 billion. Apple started selling the new iPhone6 and iPhone6 Plus on September 19, and they sold 39.2 million; up from 33.7 million units a year ago. Gross margin was 38% in the September quarter, at the high end of the company’s estimated range. Guidance for October through December is strong. Apple finished the quarter with a backlog of orders, and production of the 6 Plus is increasing every week as the company works to balance supply with demand. Apple was up 2.09 = 99.76, and then added another 1.33 in after hours.

Also today, Apple launched Apple Pay. Here’s how it works. With Apple Pay, you’ll be able to hold your iPhone up to a credit card terminal then use Touch ID, Apple’s fingerprint technology, to make a purchase. You’ll also be able to buy stuff within apps, just by using Touch ID at the appropriate time during checkout. It works with iPhone6 and Plus, and the new iPads for apps only; or an older phone with the new Apple Watch. It only works in the US. Both of Apple’s latest phones have Near Field Communication (NFC) chips at the top end of the device. They also both have a separate chip called the secure element (SE). Each time you initiate a transaction, the SE generates a one-use code in lieu of transmitting your debit or credit card number. The secure element found in the iPhones are considered safe from hardware attacks. In fact, if a thief dismantled your phone, the secure element would sense tampering and immediately shut down.

Apple Pay current supports credit and debit cards from Bank of America, Capital One, Chase, Citibank, Wells Fargo and American Express. Support from over 500 more banks will be available later this year, and in 2015. There are already over 220,000 retailers that are compatible with Apple Pay, including McDonald’s, Whole Foods and Walgreens. More stores, including Staples and the Disney Store, will be getting on board later this year. And while that sounds like a lot of stores, it isn’t. You wouldn’t want to think that Apple Pay will replace credit cards and cash in the near future.

Mobile phone payment systems have actually been around for quite some time. If you have an Android phone, you could have been using Google Wallet for the past 2 years, but you probably didn’t. For some reason, when Apple does it, everybody jumps on the bandwagon, and the technology is expected to explode over the next 6 months. But even if Apple can convince consumers to take their money mobile, some merchants aren’t playing ball. Wal-Mart, America’s largest retailer, won’t support Apple Pay at launch. Instead, it and other big-box stores like Best Buy are developing a competing mobile payments platform called CurrentC, set to launch sometime next year. So there will be competition, and the sector will become fragmented.

And then there is the whole matter of setting up the pay system on your phone, and then changing the system if your card changes. And quite frankly, the whole thing seems like a big hassle. Just a reminder that cash still works in a pinch, and the battery never goes dead.

Not much in the way of economic data today, but New York Federal Reserve Bank President William Dudley had some interesting comments at a conference called, “Workshop on Reforming Culture and Behavior in the Financial Services Industry.” Dudley says banks should defer bonus payments for 10 years and tap the bonus pool to pay any regulatory fines.

Dudley asked, “How will a firm know if it is making real progress? Not having to plead guilty to felony charges or being assessed large fines is a good start.” If bad behavior at financial services firms persists, they will have to be “dramatically downsized and simplified so they can be managed effectively.” Dudley said banks should offer longer deferred pay in debt, rather than equity, and added that the bonus pot should be tapped to pay any bank fines so employees would be hit before shareholders.

Fed Governor Daniel Tarullo, the Fed’s top official overseeing bank supervision and regulation, also gave his view on bank compensation saying, “It is important that compensation arrangements, including clawback and forfeiture provisions, cover risks associated with market conduct and consumer protection, as well as credit and market risks.” Tarullo noted that while US bank regulators do not have the power to criminally prosecute, they can remove bank employees from their companies, positions and even the industry.

It almost sounds like the Fed is ready to get tough on banksters, after sitting on their hands for 6 years. Tough talk is good, action is better.

A Messy Business

Financial Review with Sinclair Noe 09-04-2014

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB

DOW – 8 = 17,069
SPX – 3 = 1997
NAS – 10 = 4562
10 YR YLD + .02 = 2.45%
OIL – .98 = 94.56
GOLD – 8.40 = 1261.90
SILV – .11 = 19.16

Wall Street tried to rally but fizzled instead. The Dow and the S&P 500 hit new intraday records, only to close down on the day. The S&P energy index ended down 1.3% as the day’s worst performing sector in the S&P. Crude oil futures lost 1.1% to $94.56 as the dollar strengthened and weighed on commodities. Tomorrow brings the monthly jobs report.

Payrolls processing firm ADP said private-sector payrolls increased by 204,000 last month after rising by 212,000 in July, with gains spread across a range of industries. While the report was a bit softer than expected, it marked the fifth straight month of gains above 200,000. The ADP report does not always predict the government jobs report but it is a general indicator of the report.

The Institute for Supply Management said its services index rose from 58.7 in July to 59.6 last month, the highest reading since its inception in January 2008.

The Commerce Department said the US trade deficit fell 0.6% to $40.5 billion in July, its smallest size since January. When adjusted for inflation, it reached its narrowest point since December 2013.

A new survey from the Federal Reserve shows the gap between rich and poor Americans continues to widen. From 2010 to 2013, average income for US families rose about 4% after accounting for inflation. All of the income growth was concentrated among the top earners, with the top 3% accounting for 30.5% of all income. The disparity was even greater by wealth, with the top 3-percent holding 54.4% of all net worth in 2013, up from 51.8% in 2007 and 44.8% in 1989. Though incomes of the highest-earners rose, none of the groups analyzed by the Fed had regained their 2007 income levels by 2013. Although wealth did not change much overall, many measures of debt decreased, driven largely by declines in home ownership. On average, debt fell 13%.

The European Central Bank finished its policy making meeting today and announced both an interest rate cut and an asset purchase plan. The ECB governing council lowered the bank’s main lending rate from 0.15% to a new low of 0.05%; they also cut the deposit rate from minus 0.1% to minus 0.2%. The deposit rate is normally a positive number and it is the rate the central bank pays banks for parking excess reserves short-term; that idea is flipped on its head with negative rates; now the ECB charges the banks for placing spare funds with the central bank. Also, the ECB announced that in October it would start to purchase asset-based securities (ABS), whose underlying claims are in the private non-financial sector; and they will re-start a program to buy covered bonds, which are bonds issued by banks that are backed by mortgages or public loans.

The decision to cut interest rates was a bit of a surprise because rates were already incredibly low. Back in June, the ECB cut rates and sent the deposit rate into negative territory; and back then, ECB President Mario Draghi said: “for all practical purposes, we have reached the lower bound.” Apparently, today’s rate cuts were not for practical purposes. By the way, the lower bound refers to the fact that there is a limit in imposing negative interest rates since depositors can switch to cash instead. And that is the point, to get money out of the banks, and into cash, and moving through the economy – which hasn’t happened yet.

The ECB had already greased the skids for the purchase of ABS, but now it has set a firm date. The securities will include mortgages as well as commercial loans among the underlying assets. If that sounds a lot like the Federal Reserve’s Quantitative Easing, well, it is – but it is much smaller than QE. The Fed bought more than $1 trillion in ABS under QE; the ABS market in the euro zone is worth maybe €1 trillion, and the ECB won’t be buying everything. The likely size of possible purchases would be €100 billion to €150 billion, which is not enough to make a big difference. The ECB says it will only buy “high quality assets”, but if they’re just going to skim cream off the top, that’s not likely to free up much capital.

The euro hit fresh 14-month lows against the dollar, dropping under $1.30. And this devaluation may be the major benefit of the ECB’s moves. The euro is now becoming a cheap funding currency for the global carry trade, and this may be the best chance to counter deflation. The bigger problem is that central banks haven’t figured out how to boost demand in the real economy.

The Eurozone economy flat-lined in the second quarter and the Ukraine crisis threatens any recovery. Today, NATO met in Wales and demanded that Russia withdraw troops from Ukraine, and vowed to support Kiev, just not with military force because Ukraine is not part of the military alliance; but they are planning tougher economic sanctions against Russia, if needed.

A NATO military officer said Moscow had “several thousand” combat troops and hundreds of tanks and armored vehicles operating in Ukraine. The Kremlin denies it has any forces fighting alongside the rebels. Russia denies it has troops fighting inside Ukraine but has offered a ceasefire. There is cautious optimism about the peace initiative mixed with a healthy dose of skepticism that the move is nothing more than a smokescreen for further Russian intervention.

Yesterday, I implied that the war in Ukraine was all about oil; there is more to it than that of course, but oil is a major motivation, and it isn’t just that Ukraine serves as a pipeline from Russia to Europe and points beyond. Ukraine sits on its own reserves. According to the US Energy Information Administration, Ukraine has Europe’s third-largest shale gas reserves at 42 trillion cubic feet, an inviting target not just for Russia but also for US oil companies; especially since other European nations, such as Britain, Poland, France and Bulgaria, have resisted fracking technology because of environmental concerns. An economically weakened Ukraine would presumably be less able to say no. The fracking could mean both a financial bonanza to investors and an end to Russia’s dominance of the natural gas supplies feeding central and eastern Europe. So the economic and geopolitical payoff could be substantial.

Oil can be a messy business. Just ask BP. A federal judge in New Orleans has ruled that BP’s “gross negligence” and “willful misconduct” had caused the massive oil spill in the Gulf of Mexico in 2010 and that the company’s “reckless” behavior made it subject to fines of as much as $4,300 a barrel under the Clean Water Act. The ruling means that the government can impose penalties nearly four times as large as it could if BP were not found guilty of gross negligence. The ruling could open up the company to fines as much as $17 billion. BP has set aside $3.5 billion for potential Clean Water Act fines.

The question of negligence is the first part of a three-part court case about the fines the government can impose on BP. This part assigns blame. The second part will determine the size of the spill; BP’s estimates are sharply lower than the government’s. And the third part will determine the final amount of the Clean Water Act and punitive fines.

BP has spent about $27 billion so far to clean up the oil spill and compensate people and businesses harmed by the spill. The company has taken $43 billion of charges against earnings so far. All three parts of the ongoing court case are separate from BP’s settlement with private plaintiffs claiming economic damages, which BP expects will top $9 billion. And while that sounds like a lot of money, there must be much more waiting to be made. BP has increased its drilling activity in the Gulf of Mexico and continues to bring new wells online. At the end of 2013, the company was operating 10 deepwater rigs in the Gulf.

As you know, Apple has been the meat and potatoes and gravy trade in the markets for quite some time. The high tech Wall Street darling could do no wrong for the past 5 years, as they led the bull market to become the largest capitalized stock in history. They came out with all the cool new stuff, and when there was a lull, they split the stock 7 for 1, mollified activist investor Carl Icahn, and just kept climbing; until yesterday, when the share price dropped 4.2% and fell below $100 a share, on heavy volume. And this, just ahead of the release of the new iPhone. Maybe Apple has lost its cool or maybe it’s overvalued. Or maybe it just fell into Icahn’s bull trap. While a 7 for 1 split might make the share price a bit more affordable for the average investor, it also makes it easier for existing shareholders to slough off a few shares and pocket some profits. The knife cuts both ways.

The hacking of naked celebrity pictures stored on Apple’s iCloud storage system is the worst of a bunch of bad news that has hit the company at once; toss in a prolonged iTunes outage and a new phone from Samsung, and suddenly the new iPhone Release Day didn’t quite look like the religious holiday of the past.

Wednesday, April 23, 2014 - A Brilliant Future From Cool Ideas

Financial Review with Sinclair Noe

DOW – 12 = 16,501
SPX – 4 = 1875
NAS – 34 = 4126
10 YR YLD - .05 = 2.68%
OIL - .2- = 101.55
GOLD un 1284.70
SILV + .06 = 19.55

It’s earnings season, and this is a chance to compare and contrast. This morning, Facebook posted earnings of $642 million in net income, or 25 cents a share, in the first quarter, versus $219 million, or 9 cents a share in the year ago period. Overall revenue grew 72% year-on-year to $2.5 billion in the first quarter, topping estimates. Facebook now has 1.28 billion active users, and more than 1 billion do their Facebook stuff on a mobile device. Then Facebook announced their Financial Director was resigning. Shares were up about 3%.

Nobody puts on a better presentation than Apple, that’s how they grew to be the most valuable company in the world. Steve Jobs would walk out and announce Apple had created a new mp3 player, and also a new way to connect to the internet, and also a new camera. Wow, three new products, nope…, he would hold up the iPhone – just one very cool thing from Apple; tech geeks heads would explode.

Today, Apple posted earnings of $10.2 billion or $11.62 a share, on revenue of $45.6 billion. Analysts expected the company to report earnings excluding items of $10.18 a share; Apple reported a 4.6% rise in March-quarter revenue to $45.6 billion; Apple sold 43.7 million iPhones in the quarter. Then they announced they were adding to their stock buyback with an additional $30 billion over the next year. Then they announced a 7 for one stock split, to make their $500-plus shares a little more affordable. Wow, the share price exploded in after-hours trade by about 8%.

You see the difference.

The really cool thing that Apple is now working on is something you’ve probably never heard of and wasn’t part of the earnings report today. Apple is making sapphires. Natural sapphire is a gemstone variety of the mineral corundum, a crystalline form of aluminum oxide. Corundum is colorless, but in natural sapphires, various impurities create a range of colors: chromium makes the gem red, becoming a ruby; iron and titanium create the prized cornflower blue of a true sapphire. Synthetic sapphire is colorless, unless deliberately colored.

Sapphire has been used in a variety of specialized applications for years, where its purity, clarity, high stable dielectric conductive properties, and high optical quality, along with its hardness, have made it worthwhile despite its relatively high price. Think lasers and high end, luxury watch faces.  Apple is making a billion dollar bet on sapphire as a strategic material for mobile devices such as the iPhone, iPad and perhaps an iWatch. Though exactly what the company plans to do with the scratch-resistant crystal, and when, is still the subject of debate.

Apple is creating its own supply chain devoted to producing and finishing synthetic sapphire crystal in unprecedented quantities. The new Mesa, Ariz., plant, in a partnership with sapphire furnace maker GT Advanced Technologies, will make Apple one of the world’s largest sapphire producers when it reaches full capacity, probably in late 2014. By doing so, Apple is assured of a very large amount of sapphire and insulates itself from the ups and downs of sapphire material pricing in the global market.

The Arizona project was revealed in November, with Apple paying $578 million for GTAT to install and run its advanced sapphire growth furnaces in a plant built and owned by Apple. The news triggered a frenzy of speculation that Apple planned to use sapphire crystal sheets to replace the glass currently used in touch displays for its 2014 iPhones, iPads or a new line of “wearables” such as the long-rumored iWatch, or all of the above.

That’s only the tip of Apple’s investment. Once the synthetic sapphires emerge from the furnaces, they’ll be shipped to Apple’s supply chain partners in Asia for slicing, polishing, laser cutting, coating and eventual assembly. No one has used sapphire in large-scale consumer electronics or consumer goods products. Apple created a sapphire cover for the iPhone 5 camera lens, and for the iPhone 5s Touch ID fingerprint sensor. It’s mainly the sheer foundry capacity that Apple is creating in sapphire that fuels the speculation that it has big plans for sapphire in bigger uses, such  as a replacement for the cover glass, presumed to be Corning Gorilla Glass, in at least the high-end iPhone model.

A sapphire cover would presumably be less likely to break or scratch, but the big payoff could be the ability to change the underlying LCD technology of the screen, rendering more colors and using less power than today’s LCDs, while improving the speed and accuracy of the touch interface. 

It will cost more, by some estimates about $20 more per screen, but what it shows is that when Apple believes in a new technology or material, they’re willing to take a hit on the bill of materials costs. Of course, to commit for the long term, there needs to be a convincing cost reduction roadmap somewhere.

Some think technology stocks are poised for a 2000-style crash. And if they aren't ready to fall now, they may be soon. What is it about financial bubbles that make them so hard to detect? One reason is that memories are short. Some 20 years ago Wall Street merrily poured into technology stocks, and was horribly burned. Not many years later, the rest of America piled into residential real estate with similar abandon, and similar results. Meanwhile, big tech companies are using their stock to fund eye-popping mergers and acquisitions, most famously Facebook's $19 billion takeover of WhatsApp in February (of which $12 billion is in Facebook shares). Apple seems to be able to continue to do cool stuff, and maybe a billion dollars is a good price for a better iPhone screen. Maybe it’s a sign of over valuation in tech. David Einhorn of Greenlight Capital thinks tech may be ready to resume its slide, but it is a cautionary tale:

We have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods. After all, twice a silly price is not twice as silly; it’s still just silly. This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year.

Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it.

In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm. Some indications that we are pretty far along include:

The rejection of conventional valuation methods;

Short-sellers forced to cover due to intolerable mark-to-market losses; and

Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.

And once again, certain “cool kid” companies and the cheerleading analysts are pretending that compensation paid in equity isn’t an expense because it is “non-cash.” Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?

Given the enormous stock price volatility, we decided to short a basket of bubble stocks. A basket approach makes sense because it allows each position to be very small, thereby reducing the risk of any particular high-flier becoming too costly. The corollary to “twice a silly price is not twice as silly” is that when the prices reconnect to traditional valuation methods, the derating can be substantial. There is a huge gap between the bubble price and the point where disciplined growth investors (let alone value investors) become interested buyers. When the last internet bubble popped, Cisco (the best of the best bubble stocks) fell 89%, Amazon fell 93%, and the lower quality stocks fell even more.

In the post-bubble period, people stopped talking about valuing companies based on eyeballs (average monthly users), total addressable market (TAM), or price-to-sales. When the re-rating occurred, the profitable former high-fliers again traded based on P/E ratios, and the unprofitable ones traded as a multiple of cash on the balance sheet.

Our criteria for selecting stocks for the bubble basket is that we estimate there to be at least 90% downside for each stock if and when the market reapplies traditional valuations to these stocks. While we aren’t predicting a complete repeat of the collapse, history illustrates that there is enough potential downside in these names to justify the risk of shorting them.

So is there a tech bubble, or isn't there? Maybe tech stocks aren’t overvalued; the market is more balanced now than it was in 2000. Back then, tech stocks accounted for 14% of all earnings in the S&P 500, but a third of the index's capitalization. Nowadays the two figures are about the same at 19%.  Nor is the IPO market overly frothy like it was 15 years ago. In the first quarter of 2000, 115 companies went public, raising $18 billion; in the first quarter of this year, 63 IPOs raised $11 billion. Moreover, the IPO market isn't as crazed as it was 15 years ago: The first day run-up in share prices after their IPO is a third of what is was in 2000, evidence that investors haven't lost all sense of proportion.

The problem is that bubbles, tech and otherwise, can easily be analyzed away. No one expects the tech bubble to explode using exactly the same formula it did 14 years ago. Tech is more bubble-prone than other industries. Investing by nature is betting on the future, but in the case of tech, the future is a growth story based on extracting a brilliant future from a cool idea.