Financial Review

Sleepwalking Higher

Sinclair Noe — September 7, 2016

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DOW – 11 = 18,526
SPX -0.32 = 2186
NAS + 8 = 5283
10 Y – .01 = 1.54%
OIL + 1.34 = 46.80
GOLD – 4.40 = 1346.00

World stocks hit their highest in more than a year and the dollar fell against the yen. Emerging market shares led the charge, touching their strongest levels since July 2015. European shares reversed early losses. The Stoxx 600 index edged up 0.1 percent towards eight-month highs hit on Monday, led by a rise of almost 1 percent in oil and gas shares.

Euro zone government bond yields fell as some investors bet the weak U.S. data, which followed weaker-than-expected jobs numbers on Friday, would pressure the European Central Bank to ease monetary policy further. The ECB meets tomorrow. While US markets were mixed, the Nasdaq Composite hit another record high close.

In a follow-up to last Friday’s Jobs Report, the Labor Department released the JOLT survey, or Job Openings and Labor Turnover, which provides detail on the labor market. Job openings jumped to 5.87 million openings, an all-time high, while hires increased to 5.23 million from 5.17 million in June. The number of people quitting jobs voluntarily was flat at 2.98 million, but that’s still up substantially from the depths of the recession, signaling more worker confidence in the ability to find another job.

The Fed published its Beige Book, an anecdotal look at economic conditions around the country, designed to provide guidance two weeks ahead of the next FOMC policy meeting. Overall, the Beige Book had the same modestly positive tone seen in the last few surveys. The latest report gave no hint of a second-half surge in growth or any reason for urgency to raise interest rates. Six Fed districts reported tight labor markets but overall “wage pressures remained fairly modest.” Three districts reported businesses are cautious ahead of the elections.

It “makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later,” San Francisco Fed President John Williams announced late Tuesday. He also said the economy was in “good shape,” predicting unemployment, now at 4.9%, to fall to 4.5% in 2017 and inflation to rise to the Fed’s 2% target in the next year or two.

Richmond Fed President Jeffrey Lacker and Kansas City Fed President Esther George testified at a congressional hearing this morning. Lacker said, “It looks like the case for a rate increase is going to be strong in September.” George said during the hearing she believes the US labor market is at or near full strength. We keep hearing from Fed officials that a September hike is possible but nobody seems to believe what we hear, in part because the data doesn’t seem to support a hike.

British manufacturing fell sharply in the wake of Brexit. Data from the Office for National Statistics showed manufacturing production fell 0.9% in July, missing expectations of a 0.4% decline. While the reading was disappointing, it should be noted that production fell 0.2% in June and 0.6% in May.

Today is an Apple Event Day. I know you’re all excited, so here are the details: the iPhone 7 has two camera lenses (wide angle and telephoto), it does not have a headphone jack but it will ship with a headphone adapter, they also introduced their own wireless headphone, it is water resistant – so go ahead and toss your $649 phone into 50 meters of water without trepidation.

If nothing else, the iPhone 7 packs a punch. With 256 gigabytes of storage for its most powerful version, Apple’s new iPhone has 64 times the amount of space as the company’s original smartphone nine years ago. Increased storage is a critical piece in convincing consumers to upgrade, as anyone with a 12 gig iPhone 5 can attest.  They also unveiled an iPhone 7 Plus for people who don’t want a phone that can fit in their pocket; plus, an Apple Watch 2 for some reason.

Separately, Ireland’s parliament today debated the government’s decision to appeal the €13-billion-euro tax ruling against Apple by the European Commission. They will collect the tax but they will hold the revenue in escrow while they appeal the decision.

South Korea’s Hanjin Shipping has won a temporary order from a U.S. judge extending bankruptcy protections so its vessels can dock at American ports without fear creditors will try to seize its ships. The world’s seventh-largest container carrier and its clients are scrambling to move an estimated $14 billion worth of cargo off ships that are no longer operating normally in the wake of its collapse last week.

More than half of Hanjin’s ships have been blocked from docking at ports and denied service from lashing firms on fears they will not be paid while some vessels have been seized by creditors. With expectations high that Hanjin will eventually be liquidated, there is little clarity on just how the problem of cargo stranded ahead of the peak-year end shopping season will be resolved.

Poland is seeking formal U.S. approval to buy eight Patriot missile defense systems from Raytheon, marking a key move toward closing the estimated $5 billion deal. If cleared, the country will become the 6th NATO Patriot country and the 14th Patriot partner nation. Raytheon has agreed to perform at least half the value of the work in Poland.

Bill Ackman’s Pershing Square hedge fund has taken a 9.9% stake in Chipotle Mexican Grill, the once high-flying company battered by food-safety issues. Pershing Square says the stock was undervalued and attractive. Chipotle shares have dropped about 40% over the past year. Ackman also left the board of Canadian Pacific on Tuesday, marking the end of a four-year tenure that helped overhaul the ailing railroad company.

Apache Corp. stock was among the top gainers today after the oil and gas company revealed an “immense” oil and gas reserve in west Texas. Apache estimated that its more than 300,000 contiguous acres in the region hold about 3 billion barrels of oil and 75 trillion cubic feet of natural gas. It called the field Alpine High.

New York has opened a probe into whether Mylan broke antitrust law under its EpiPen4Schools program, which gives many schools the devices for free, but may have barred institutions from buying rival products for a year. Meanwhile, new reports suggest Mylan pays no more than $30 per EpiPen, while some patients are forced to pay a little over $600 for a two-pack of the lifesaving medication.

Department of Justice prosecutors are considering criminal charges against HSBC related to conduct on its foreign-exchange desk, possibly upending an earlier deal that let the bank avoid prosecution. The new investigation could lead to a step that has often been threatened but rarely taken: prosecutors tearing up a deferred-prosecution agreement if a company fails to comply with the reform plan laid out by the Justice Department. HSBC is essentially on probation: It admitted in 2012 that it helped Mexican drug cartels launder money and did business with Iran and other sanctioned nations.

To avoid charges, it signed the so-called DPA, which required it to improve its internal controls and submit to an outside monitor. If HSBC is found to have broken the terms of the deferred prosecution, then the bank could find itself pulled back into the money laundering and sanctions case that it thought it had put behind it four years ago; prosecutors could invoke a section of the deal that says HSBC could be held responsible for the conduct it admitted to in 2012.

Prosecutors will consider many factors before deciding whether to file a criminal charge against the bank in the currency case, including the severity of the conduct on the foreign-exchange desk and the extent to which the bank moved to address it. A significant argument against charging the bank is that the foreign-exchange conduct on which the charge would be based appeared to be a one-time event that has not been linked to a wider pattern of behavior. Also, the conduct on the foreign-exchange desk predated the 2012 agreement.

Last year, the Justice Department voided a similar deferred prosecution agreement with UBS Group after the bank acknowledged unlawful conduct on its foreign-exchange desk. In 2012, UBS signed a non-prosecution agreement related to accusations that it and other banks attempted to rig benchmark Libor interest rates that affected trillions of dollars of derivatives and loans. But UBS was granted immunity because it self-reported the forex rigging, so…

The nation’s largest investment bank is barring its top employees from contributing to certain political campaigns. The new rules, which went into effect last week, prohibit partners at Goldman Sachs from donating to politicians running for state or local office, or to state officials who are seeking federal office. That applies to Indiana Gov. Mike Pence, Trump’s running mate, which means that the Goldman Sachs partners can’t contribute to the Republican ticket.

The policy, which was spelled out in a memo obtained by The Associated Press, is meant to remove any implication of a “pay for play” scandal. Four years ago, the bank paid $12 million to settle charges that a Boston-based banker had a bond underwriting business in the state while contributing funds to and working for the campaign of Massachusetts gubernatorial candidate Tim Cahill.

The memo specifically highlights the Trump-Pence ticket – and Super PACs supporting the Republicans – as a campaign to which the partners at the New York-based firm can’t donate. But the rules do not apply to the Democratic ticket, since neither Hillary Clinton nor her running mate, Sen. Tim Kaine, are currently state officeholders, though Kaine is a former governor. The new rules apply to 467 Goldman partners and not the approximately 30,000 other employees.

Financial Review

Taxman Bites Apple

Sinclair Noe — August 30, 2016

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

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DOW – 48 = 18,454
SPX – 4 = 2176
NAS – 9 = 5222
10 Y + .01 = 1.57%
OIL – .70 = 46.28
GOLD – 12.70 = 1311.50

Since July 8, when the S&P rose 1.54%, that index hasn’t moved more than 0.9% in any given day, and most of those changes were slight gains, including 10 all-time highs. Since Brexit, the S&P 500 has now gone 43 straight sessions without a daily decline greater than 0.7%.

Compare that with the first 43 days of this year when it happened 15 times. For the month of August, the S&P 500 has managed to gain just 3 points, which means it is about as flat as it can be.

EU antitrust regulators have ordered Apple to pay up to €13-billion-euro ($14.5-billion dollars) in taxes to the Irish government after ruling that a special scheme to route profits through the country was illegal state aid. The EU Commission says Apple paid an effective corporate tax rate of less than five-one-thousandth of a percent (0.005%) on its European profits in 2014.

Apple has previously said it received no special treatment in Ireland. Apple’s tax arrangement with Ireland also meant the company avoided taxation on almost all profits from sales of its products in the EU single market, as the sales were recorded in Ireland rather than in the country where the transaction took place. Apple and Ireland said they would appeal the decision.

Ireland’s Finance Minister said he would fight the European Commission ruling that would force Apple to pay taxes to Ireland, even though €13-billion-euro in back taxes is more than twice the country’s entire 2015 corporate tax take and equivalent to about $3,000 for every man, woman and child in Ireland.

Apple is one of more than 700 U.S. companies that have units in Ireland, employing a combined 140,000 people. The government maintains that even if it were to take the cash, European rules mean it would have to use the money to pay down some of its €180 billion euros of national debt rather than fund spending.

CEO, Tim Cook wrote an open letter about the tax ruling and in it he said that Apple “in Ireland and in every country where we operate, follows the law and we pay all the taxes we owe.” And that is probably very true; no reason to doubt that Apple has hired top accountants and attorneys to figure out all the legal loopholes. And now the EU is closing one of the loopholes.

Tim Cook, that is to say Apple, has reacted with outrage, saying the decision would “upend the international tax system” and promising to appeal and overturn the decision. No doubt years of legal fees lie ahead for all involved. But the writing has been on the wall for Apple’s convoluted corporate structure in Ireland for years.

In 2013, a US Senate committee found that Apple pushed its foreign profits into a “stateless” company, one that paid no taxes anywhere, while using an intellectual property agreement to shift US profits to the subsidiary. In 2015, the EU released its own investigation, with more specificity: Apple had negotiated two special deals with Ireland that allowed it to allocate profits to this untaxed company.

The U.S. Treasury Department said it was disappointed with the European Commission seeking to force Apple to repay tax breaks given by Ireland and the case could undermine the “spirit of economic partnership between the U.S. and the EU.” In other words, the Treasury hopes to collect taxes on Apple’s overseas cash hoard someday and they don’t want to see that money going to Europe. Plus, any money Apple pays in taxes to the EU is deductible from Apple’s US tax bill.

Apple has its tax issues in Ireland but it will hope to put all that behind it next week as a new iPhone is expected to be announced. After all, as long as Apple is selling iPhones, $14 billion is not that much. What will an iPhone 7 look like? Pretty similar to an iPhone 6 but new features will likely include waterproofing, stereo sound, a touch-sensitive home button, a dual-lens camera, and due to its thinner chassis, the headphone jack will be removed. The starting point for storage on the new entry-level model is thought to be 32GB, up from 16GB.

New MacBooks, iPad features and a monitor may also be in the works from Apple – but at least some of those devices may not be seen until after the company’s Sept. 7 event. A thinner laptop, a faster iPad display to work with Apple Pencil, and 5K monitors are among the updates coming to Apple products. But the MacBook, which some tech bloggers had thought might come alongside the iPhone 7, is more likely to be released in October.

Voters are heading to the polls for Senate and House primaries in Arizona. Locations of polling places are assigned by address. The location that coincides with your registered address (on your voter information) is where you can cast your vote on election day. Arizona law allows any voter who is registered as independent to cast a vote in the primary election, but independent voters must choose a Republican or Democratic Party ballot at the polling place. The polls close at 7 PM.

The S&P CoreLogic Case-Shiller 20-city composite of existing home prices recorded a 0.8% gain in June and a 5.1% year-on-year advance; that’s down from a 5.3% pace the prior month. Home prices in three U.S. cities – Denver, Seattle and Portland, Oregon – showed the highest year-over-year gains. Housing prices in Phoenix were up 5.1% over the past 12 months.

The Conference Board’s consumer confidence index rose to 101.1 in August from a revised 96.7 in July. That’s the highest level since September 2015. Short-term expectations regarding business and employment conditions, as well as personal income prospects, also improved, suggesting the possibility of a moderate pick-up in growth in the coming months.

Americans’ view the economy right now was the strongest since before the Great Recession. The present situation index, a measure of current conditions, climbed to 123 from 118.8 and hit the highest level since late 2007. What consumers expect six months down the road, however, was less optimistic. The future expectations index edged up to 86.4 from 82, but it was still well below the post-recession high.

Fed Vice Chairman Stanley Fischer says the US job market is nearly at full strength and the pace of interest rate increases by the Federal Reserve will depend on how well the economy is doing. The Fed has signaled since March it would lift rates twice this year, but investors have been skeptical. Fischer did not comment on the timing of the next Fed rate hike but said “we choose the pace on basis of data.”

The U.S. Labor Department’s monthly employment report on Friday is expected to show the economy added 180,000 jobs in August.  At the end of the day, it always comes down to the jobs number. Yellen can try to persuade us that the case for a rate hike is strengthening, and the other policymakers can chime in with their two cents. But they are all held hostage to the government’s jobs numbers on Friday.

Anything strong (250,000-300,000) and you won’t need anyone from the Fed telling us they are going to raise in September. The number will say it all: below 200,000, and it’s back to a December-only hike.

Trade talks between the European Union and the United States should be halted and a new set started, France’s trade minister said on Tuesday, adding his voice to calls from within Germany for an end to the negotiations. Three years of talks on a Transatlantic Trade and Investment Partnership (TTIP) have failed to resolve multiple differences, including over food and environmental safety.

Critics say the pact would hand too much power to big multinationals at the expense of consumers and workers. But despite a weekend comment by Germany’s Economy Minister that the talks had “de facto failed”, and today’s comments by the French Trade Minister, the European Commission says negotiations are making steady progress and there is an outline of a future agreement.

More than 76,000 people have signed a petition demanding former European Commission President Jose Manuel Barroso be stripped of his pension after taking a job at Goldman Sachs. Organizers plan to present it to current leaders of the EU institutions at the end of September. Critics claim the role is inappropriate given Goldman’s role in the U.S. subprime crisis and Greek debt talks. That’s one way to stop a revolving door.

The FDIC reported that U.S. banks earned $43.6 billion in the second quarter, up from $43 billion a year earlier. Around 60 percent of banks reported an increase in profit from a year earlier. However, the impact of low oil prices on energy companies led banks to continue to post bigger losses on commercial and industrial loans. Only 4.5 percent of banks were unprofitable, down sharply from 5.8 percent in the second quarter of 2015.

Countries including the U.K., Australia and Taiwan have issued travel advisories for tourists to Singapore after the city-state announced a further increase in Zika cases. Singapore’s Ministry of Health confirmed 15 more people with locally-transmitted Zika, bringing the total number affected to 56. Health officials think they will identify even more positive cases.

Financial Review

Pandora’s Box

Sinclair Noe — August 17, 2016

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

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DOW + 21 = 18,573
SPX + 4 = 2182
NAS + 1 = 5228
10 Y – .02 = 1.55%
OIL + .29 = 46.87
GOLD + 2.60 = 1349.40

The Federal Reserve released minutes from their July FOMC meeting. In July, with the Brexit vote over and market turmoil subsiding, the Fed seemed somewhat more open to the possibility of resuming rate hikes. Economic data has been mixed; we had a very weak report on second quarter gross domestic product and we had a very strong July jobs report. A key official, New York Fed President William Dudley,  said yesterday that a rate hike in September was possible – even if markets aren’t convinced that it’s probable.

Apparently the news of a possible rate hike in September was enough to spook the equity markets a little bit. Is a Rate Hike in September two months before an election, with this economic backdrop, possible? Doubtful. The bond market isn’t buying it. Ten-year yields have hardly budged. The currency market didn’t even shrug.

Here’s what the Fed said, quoted from the minutes: “Some other participants viewed recent economic developments as indicating that labor market conditions were at or close to those consistent with maximum employment and expected that the recent progress in reaching the Committee’s inflation objective would continue, even with further steps to gradually remove monetary policy accommodation. Given their economic outlook, they judged that another increase in the federal funds rate was or would soon be warranted, with a couple of them advocating an increase at this meeting.”

Sorry, but that is just a bit too vague to be taken seriously. If the Fed wants to raise rates in September, they need to pound the table and state very clearly that they intend to hike rates. Taken as a whole, then, Chair Janet Yellen is keeping the hawks at bay and the Fed on a course of loose monetary policy, including the current 0.25-0.5 percent range. That’s even despite some clamoring from those wanting to hike. And despite some initial chatter about “some” wanting a rate hike, following the release of the minutes the market quickly adjusted its sights.

Stocks closed higher; treasuries pared losses. Two-year Treasuries, the most sensitive to policy expectations, halted a back-to-back decline. The dollar was basically flat. The greenback has slumped more than 5 percent this year as Fed policy makers have yet to see signs that inflation is moving toward their 2 percent goal. That means the Fed is less likely to diverge from the paths of the Bank of Japan and European Central Bank, which are boosting monetary stimulus as they seek to spur flagging growth.

The minutes once again portray a Fed that can’t seem to find direction or purpose; not confident in holding steady but not ready to embrace new approaches. Fed chairwoman Janet Yellen is scheduled to speak at next week’s annual economic symposium in Jackson Hole, Wyoming. Let’s hope she actually says something.

Time now for a quick lesson in basic economics. Adverse selection is a phenomenon wherein the insurer is confronted with the probability of loss due to risk not factored in at the time of sale. This occurs in the event of an asymmetrical flow of information between the insurer and the insured. Asymmetrical information refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. Or another way of saying it; in any given deal, somebody has the upper hand.

In the case of insurance, adverse selection is the tendency of those in dangerous jobs or high-risk lifestyles to get life insurance. Or in the case of health insurance, it is a situation where “uninsured people with pre-existing conditions often face tens or even hundreds of thousands of dollars in out-of-pocket medical costs annually. If insurers charged everyone the same rate, buying coverage would be far more attractive financially for people with chronic illnesses than for healthy people.

And as healthy policyholders began dropping out of the insured pool, it would become increasingly composed of sick people, forcing insurers to raise their rates. …. But higher rates make insurance even less attractive for healthy people, causing even more of them to drop out. Before long, coverage would become too expensive for almost everyone.”

Yesterday, Aetna announced that it will withdraw from 11 of the 15 state Affordable Care Act exchanges where it sells marketplace plans; leaving some counties with only one option for healthcare, and in Pinal County – no options. Aetna cited mushrooming financial losses and structural problems with the exchange markets as causes for its retreat.

There might be more to the story. A few months ago, Aetna was looking to expand its presence in the ACA exchanges and Aetna also wanted to acquire Humana. In a letter to the US Department of Justice, Aetna CEO Mark Bertolini outlined the company’s plans to roll back much of its Obamacare business if the DOJ blocked a proposed merger with rival Humana. A company spokesman denied that participation in the exchanges was a bargaining chip in its negotiations with the DOJ, saying the decision was driven by losses.

So is this about losses or a merger battle? Is this a confessional, or extortion? It may in fact be true that Aetna can’t envision a way to make a profit in the exchanges without merging with Humana, even if it is true that its losses didn’t prevent it from seeing its earnings increase 20% in 2015.

Aetna executives and attorneys surely knew that government anti-trust lawyers would see the letter as thinly veiled extortion, even if their concerns were entirely sincere. At any rate, Aetna may have opened Pandora’s Box.

A recent report from the Kaiser Family Foundation shows that as many as two states and 650 counties are on track to have just one insurer on the Affordable Care Act exchanges next year. The entire states of Alaska and Alabama will be faced with just one choice in 2017, as well as large swaths of Kentucky, Tennessee, Mississippi, Arizona and Oklahoma. The effects of health insurance company pullouts will be to leave people uninsured.

That’s unfortunate, because it turns out that making health care available to people actually makes them healthier. A new study, published Monday in JAMA Internal Medicine, offers another way of looking at the issue. Low-income people in Arkansas and Kentucky, which expanded Medicaid insurance to everyone below a certain income threshold, appear to be healthier than their peers in Texas, which did not expand. One “solution” to health insurance behemoths threatening to pull out of the ACA exchanges would be to allow them to merge. A second “solution” is to let them hike premiums to ridiculous levels. The third solution is the Pandora’s Box, also known as the public option.

Britain’s job market is shrugging off Brexit, for now. Data from the Office for National Statistics showed that the number of people claiming jobless benefits in the UK unexpectedly fell in July. Additionally, the UK’s unemployment rate held at a record-low 4.9%. Analysts in the coming months will continue to watch the unemployment level as one of the key indicators of how the Brexit vote is affecting the U.K. economy.

Subprime credit-card lending is making a comeback. TransUnion’s Second Quarter 2016 Industry Insights Report shows that 11% of the 10 million new customers entering the credit-card marketplace in the past year were subprime borrowers. Additionally, the data suggests subprime borrowers are seeing the biggest increase in balances, up 14% versus a year ago. Still, TransUnion’s financial services business unit, says delinquency levels are not “alarming.”

Cisco Systems is readying for job cuts. The company is expected to eliminate 14,000 jobs, or about 20% of its labor force, beginning in the next few weeks. Microsoft, HP, and Intel have all announced big jobs cuts within the past year or so.

Target reported disappointing Q2 earnings and management placed part of the blame squarely on Apple. Comparable store sales at Target overall fell by 1.1%, but Target executives noted that electronic sales decreased by double digits and “accounted for 70 basis points [0.7%] of overall comp decline.”

Even more notably, Target specifically pointed out that Apple product sales were down by “more than 20%” year-over-year and were to blame for a third of the overall plunge of electronic sales at Target. Apple’s growth has been running into a bit of trouble recently, as the astounding success of the iPhone 6 has made for tough comparisons; and many customers are probably sitting on the sidelines before the launch of the iPhone 7.

The iPhone 7 might be coming soon. That’s according to a leaked photo spotted by 9to5Mac of “reset hours” at AT&T stores for September. The website speculates that the photo shows September 9 as the date AT&T will begin advertising the iPhone 7 and September 23 as the day when the phone will go on sale.

The Treasury Department issued rules this year that thwarted several tax inversions, but one large deal that managed to get through was the $16 billion acquisition of Tyco by Johnson Controls. The last hurdle for the transaction is a vote today by both sets of shareholders. Johnson Controls shareholders are set to vote in Dallas, while Tyco’s shareholders will do so in Dublin.