Financial Review

Fed Day

Sinclair Noe — June 14, 2017

Podcast: Play in new window | Download (Duration: 13:15 — 7.6MB)

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DOW + 46 = 21,374
SPX – 2 = 2437
NAS – 25 = 6194
RUT – 8 = 1417
10 Y – .07 = 2.14%
OIL – 1.78 = 44.68
GOLD – 6.00 = 1261.10
BITCOIN + 1.88% = 2541.31 USD
ETHEREUM – 13.12% = 345.44

Another record high close for the Dow Industrials. Stocks moved lower today after the Federal Reserve announced it was raising interest rates. The move was completely expected, so maybe the markets were reacting to weak retail sales data instead. Stocks recovered from session lows, with the Dow turning positive in the final hour of trade.

The Federal Reserve raised its benchmark lending rate by a quarter percentage point to a target range of 1.00 percent to 1.25 percent. This was the second rate hike in the past 3 months. The hike was widely expected.

In its statement following a two-day meeting, the Fed’s policy-setting committee indicated the economy had been expanding moderately, the labor market continued to strengthen and a recent softening in inflation was transitory. This was in-line with expectations for one more rate hike from the Fed for 2017, possibly in September or December.

The Fed has now raised rates four times as part of a normalization of monetary policy that began in December 2015. The Fed’s decision to raise rates was approved 8-1, with Neel Kashkari, head of the Fed’s Minneapolis regional bank, dissenting in favor of holding rates unchanged. Kashkari sees a very different economy from his colleagues, in terms of both inflation and the labor market.

While Yellen and the members who voted for hikes did so, in part, because they were worried about rising inflation, Kashkari doesn’t share their concern. If Kashkari is right, it means the Fed may be leaving lots of jobs and growth on the table.

The Fed also gave a first clear outline on its plan to reduce its $4.5 trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2008 financial crisis and recession. The Fed will allow its bond holdings to mature and fall off the balance sheet without being replaced or rolled over.

The Fed said the initial cap for Treasuries would be set at $6 billion per month initially and increase by $6 billion increments every three months over a 12-month period until it reached $30 billion per month in reductions to its holdings. For agency debt and mortgage-backed securities, the cap will be $4 billion per month initially, increasing by $4 billion at quarterly intervals over a year until it reached $20 billion per month.

Back of napkin math means the Fed will try to shrink the balance sheet in half over about 4 years, once the process starts. No date given. Fed Chair Janet Yellen said the process could begin “relatively soon.”

It won’t take long until you start to feel the rate hike. Look for interest rates on credit cards to jump relatively soon, probably 60 days, or two billing cycles. The average household now pays a total of $1,292 in credit card interest per year, according to NerdWallet’s research. Now that the Federal Reserve increased its rates as analysts expected, the total will rise to $1,309.

On the flip side, savers can look forward to earning higher rates on deposits, but don’t expect much, bank deposits are paying just over 1% which is not enough to keep pace with inflation.

The Fed also issued updated economic forecasts. The Fed’s revised forecasts reduced its estimate for unemployment by year’s end to 4.3 percent from a March projection of 4.5 percent. Unemployment has already reached a 16-year low of 4.3 percent.

The Fed kept forecast for economic growth this year of 2.2 percent, up slightly from its March forecast, with growth of 2.1 percent in 2018 and 1.9 percent in 2019. In a news conference, Fed Chair Janet Yellen said she still expects inflation to hit a 2% target next year, mentioning that recent declines are coming from such areas as telecom.

Earlier in the session we had some disappointing readings on inflation and retail sales.

Higher interest rates are normally good for a currency, but the dollar’s performance suggest traders see little chance for any more increases this year – at least if the turmoil in Washington distracts the Trump administration from implementing its pro-growth fiscal agenda.

Meanwhile, Treasuries rallied, pushing the yield on the 10-year note down 7 basis points and further flattening the yield curve, an indication that debt traders are cutting their expectations for growth. Bond traders are clearly worried the Fed is on a path to harm the nation’s prospects for growth without meaningfully adding to its arsenal of tools to deal with any downturn.

Meanwhile in the oil market, the price of crude is doing its best to keep inflation under wraps. Oil fell below $45 a barrel to its lowest since November as government data showed that weaker demand at the start of the summer driving season led to another increase in gasoline stockpiles.

Gasoline inventories rose 2.1 million barrels last week, according to the Energy Information Administration. Adding to the market pessimism, the International Energy Agency said new production from OPEC’s rivals will be more than enough to meet growth in demand next year, overwhelming the oil group’s efforts to reduce supplies by cutting its own output.

The EIA forecasts output at major American shale fields will reach a record in July.

Consumer prices declined in May, reflecting a big drop in energy prices. The Consumer Price Index, or CPI, edged down 0.1 percent last month following a small 0.2 percent increase in April. Prices had fallen 0.3 percent in March.

In addition to a drop in energy costs last month, the price of clothing, airline fares and medical care also declined. Core inflation, which excludes energy and food, rose a slight 0.1 percent in May. Over the past 12 months, consumer prices are up 1.9 percent while core inflation has risen 1.7 percent.

In May, food costs edged up a tiny 0.2 percent while energy costs fell 2.7 percent, led by a 6.2 percent drop in the price of gasoline. Over the past 12 months, food costs are up just 0.9 percent while energy prices have risen 5.4 percent.

Clothing costs dropped 0.8 percent in May while the cost of new cars and used cars both fell 0.2 percent. Medical services such as the cost of doctor’s visits dipped 0.1 percent in May but have risen 2.5 percent over the past 12 months.

Those low food costs might not last. Wheat has quietly staged a huge rally, as a prolonged dry spell has left the U.S. spring crop in its worst shape in almost three decades. Forty-five percent of the crop, the high-protein variety grown in northern states, was in good or excellent condition as of June 11.That’s down 10 percentage points from the prior week and marks the worst rating for the time of year since 1988.

Futures have surged more than 15 percent in the past month. Spring wheat futures for July delivery reached $6.45 3/4 a bushel, the highest for a most-active contract since December 2014.

The Commerce Department said retail sales dropped 0.3 percent, the first decline since February and the sharpest since a 1 percent decrease in January 2016. Last month, sales fell 2.8 percent at electronics stores, the biggest such drop since March 2016. They fell 2.4 percent at gasoline stations and 1 percent at department stores, which have struggled with competition from online retailers.

Business inventories fell by a seasonally adjusted 0.2 percent in April, following a gain of 0.2 percent in March. It was the first decline since a 0.2 percent drop in October. Sales were flat after contracting 0.1 percent in March. When businesses increase stockpiles, it is generally seen as a sign of their confidence that sales will increase in the coming months. A decrease in inventories can be a sign of pessimism about future sales.

Financial Review

38,000 Not a Typo

Sinclair Noe — June 3, 2016

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

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DOW – 31 = 17,807
SPX – 6 = 2099
NAS – 28 = 4952
10 Y – .11 = 1.70%
OIL – .39 = 48.76
GOLD + 33.10 = 1244.50

The US economy added 38,000 jobs in May, which is not a typo, it is the fewest jobs added in more than 5 years – just 38,000.  The unemployment rate fell three-tenths of a percentage point to 4.7 percent in May, (again, not a typo) the lowest since November 2007.

The unemployment rate went down for the wrong reason; not because people were finding jobs but because 458,000 people dropped out of the labor force. Most forecasts were calling for 150,000 to 180,000 new jobs, so this was a big miss.

The government revised down the number of new jobs created in April to 123,000 from 160,000. March’s gain was lowered to 186,000 from 208,000, or a downward revision of 59,000. Over the past 3 months, job gains have averaged 116,000 per month. The drop-off in 2016 is the sharpest of the seven-year-old recovery.

Most industries eliminated jobs last month, the first time that’s happened in several years, but there may be some noise in the statistics; 35,000 striking Verizon workers were counted as unemployed but the jobs report was still the weakest in at least two-and-a-half years even if there were no ill effects from the strike.

Now, it seems a bit strange that the unemployment rate dropped from 5% to 4.7%, even as the economy added just 38,000 jobs. Part of this is that fewer people were in the labor pool. The number of Americans not in the labor force surged to a record 94.7 million, an increase of 664,000. The labor force participation rate, or the share of working-age Americans who are employed or at least looking for a job, fell 0.2 percentage point to 62.6 percent.

The participation rate has fallen since the recession, but economists don’t agree on why. Some suggest that demographic shifts, mainly the retiring baby boomers, is the main cause. Others think it’s more cyclical factors or changes in the economy, in other words people can’t find jobs and they give up.

That 4.7% unemployment rate is the headline number, also known as the U-3 unemployment rate. U-3 is defined as the “total unemployed, as a percent of the civilian labor force,” but doesn’t include a number of employment situations. A broader figure is the U-6 rate.

The U-6 rate remained unchanged at 9.7 percent in May. The U-6 rate is defined as all unemployed as well as “persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the labor force.” That means the unemployed, the underemployed and the discouraged.

Involuntary part time workers, that is those who would opt for full time jobs were they available, rose by 468,000 to 6.4 million. Jobs were skewed toward part time, which added 139,000 positions. Full time lost 59,000 jobs. While the U-6 rate has made substantial gains in the past years, it remains stubbornly at pre-recession levels.

Average hourly wages climbed 0.2% last month to $25.59. Hourly pay rose 2.5% from May 2015 to May 2016, just a hair below the post-recession high. The average workweek for all employees on private non-farm payrolls was unchanged at 34.4 hours in May.

In another bad sign, temp employment fell by 21,000 and it’s down 64,000 so far this year. Health care added 46,000 positions. Leisure and hospitality added 11,000. Government gained 13,000. Professional services up 10,000. Financial activities up 8,000.

However, mining (which includes jobs in the oil patch) lost 10,000 jobs, information-related jobs fell by 34,000 — the consequence of the recently resolved Verizon strike — while manufacturing lost 18,000. Construction lost 15,000 jobs.

Treasury prices jumped higher this morning, pushing yields lower, following the release of May’s official jobs report. Spot gold jumped almost 3%.  The dollar dropped more than 1.5% against the euro and the yen. Financial shares were hit; higher interest rates allow banks to earn larger spreads on the deposits they’ve collected. While the Fed’s efforts to reduce rates stabilized asset prices and helped lenders access cheap debt in the wake of the credit crisis, prolonged low rates have crimped banks’ margins.

The surprisingly weak jobs report pulled the rug from under a June Fed rate hike. Traders who use fed funds futures contracts now see only a 4% chance of a rate hike at the FOMC meeting in June, according to CME FedWatch. The odds of a rate hike in July have fallen to 36% from 42% prior to the job report. For September, the odds of a hike are 51%. Add in a UK referendum on a possible Brexit from the EU, scheduled for one week after the June FOMC meeting.

When we look at 38,000 jobs and realize it is not a typo, we then need to look at why we saw such a dramatic drop. One explanation is that it is statistical noise. The Verizon strike skewed things a bit. The jobs report is notoriously imprecise; by some estimates there is a margin of error of about 100,000 jobs, give or take, in any month. It isn’t easy to track all the job changes in the country. There will be revisions. Blah, blah – the economy only added 38,000 jobs. That’s the number for now.

Some claim the recovery is getting long in the tooth. The economy has added jobs for 75 consecutive months.  The economy cannot continue to create jobs more rapidly than the labor force is growing. But it certainly doesn’t feel like we’ve reached a tight labor market. There seems to be an overabundance of slack, as evidenced by part-time jobs and weak wage growth.

Another theory is that we might be seeing early indicators that productivity is increasing. Productivity has been very low over the past five years. If productivity goes back to near normal the jobs numbers are going to deteriorate quite a lot because it takes fewer workers to do the job.

The problem with this argument is that we haven’t seen any uptick in productivity. The Conference Board estimates domestic productivity ticked up an average of only 0.34 percent per year between 2011 and 2015. That’s well shy of the 1.93-percent average maintained between 1990 and 2010. And that recent productivity growth also falls short of several other major world economies.

So, what happened to productivity? Well, one of the things is that following the Great Downturn, workers were locked into their locations; residential mobility evaporated; homeowners with negative equity were unable to sell and move. We have a long history of packing up and moving to new places and new jobs, and historically this mobility has provided the economy with a critical dose of oomph, or the technical term – stimulus.

A slide in job turnover and relocation rates is undermining the economy’s dynamism, damping productivity and wages while making it more difficult for sidelined workers to find their way back into the labor force. Staying put can mean that workers are not moving to jobs where they would be more productive.

At the same time, many are forgoing the raises and ascents on the career ladder that often come with a job switch. Fewer openings can also have a ripple effect, shrinking the bargaining power of workers in general, making it tougher to ask for a bump up in pay. Mobility normally drops during downturns, and that was the case during the Great Recession. Millions of jobs vanished, and those fortunate enough to be working were less inclined to give up the one they had.

Another factor is that business investment has dried up. Many businesses saw Zero Interest Rate Policy as an excuse for stock buybacks, incurring low-priced to repurchase equity. Stock buybacks are a vehicle for returning excess cash to shareholders, without the commitment usually associated with a dividend; also a handy vehicle for executive compensation. According to analysis from Barclays these repurchases, which are a primary source of demand for equities, have contributed to the increase in the S&P 500 2010. Almost 60% of the 3,297 publicly traded non-financial U.S. companies have bought back their shares since 2010, according to a report from Reuters.

Unfortunately, this strategy undermines the companies that use it. Debt producing buybacks mean money is not being reinvested in the company for innovation and improving productivity. And among the approximately 1,000 firms that buy back shares and report R&D spending, the proportion of net income spent on innovation has averaged less than 50 percent since 2009, increasing to 56 percent only in the most recent year as net income fell. It had been over 60 percent during the 1990s.

If U.S. companies continue to dole out their cash to investors economic investment will go where it can be used well. If a company in Germany, India or Brazil has something to do with the money, it will flow there, as it should, and create growth and activity there, not in the United States.

And if the money isn’t being reinvested in R&D, it certainly isn’t going into training employees or providing them tools to be more productive. The productivity in the US is down, not because US workers suddenly got lazy but because companies aren’t giving workers the tools to be productive, opting instead to financialize value over the short-term.

Share repurchases have helped the stock market climb to records from the depths of the financial crisis. As a result, shareholders and corporate executives whose pay is linked to share prices are feeling a lot wealthier. That wealth, some economists argue, has come at the expense of workers by cutting into the capital spending that supports long-term growth – and jobs.

Financial Review

That’s Her Story

Sinclair Noe — February 10, 2016

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

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DOW – 99 = 15,914
SPX – 0.35 = 1851
NAS + 14 = 4283
10 Y – .02 = 1.70%
OIL – .64 = 27.30
GOLD + 8.00 = 1197.80

Fed Chair Janet Yellen delivered her semi-annual Humphrey-Hawkins testimony in Washington today in her first major appearance since the Fed’s rate hike last December. In prepared testimony, Yellen said there are good reasons to believe the United States will stay on a path of moderate growth that will allow the Fed to pursue “gradual” adjustments to monetary policy.

Family incomes and wealth are rising, domestic spending “has continued to advance,” and business investment outside the oil sector accelerated in the second half of the year, she said. Yellen said she expects the labor market to continue to improve and inflation eventually rise towards the Fed’s target despite a recent drop in inflation expectations.

Yellen said that financial conditions “have become less supportive to growth.” If these conditions persist, they could weigh on the economy. In addition, Yellen said there are “downside risks” largely stemming from uncertainty about the health of the Chinese economy. “Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken and financial market conditions could tighten further.”

The Fed chairwoman did not come out and say anything about the U.S. central bank’s own forecast, made in December, that it would raise interest rates four times in 2016. She stressed the Fed was not in automatic tightening mode. Yellen said, “Monetary policy is by no means on a preset course.”

With Wall Street off to an ugly start to the New Year, there has been some speculation the Fed might have to reverse course and cut rates; Yellen addressed this in her Q&A session, saying: “I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy. I don’t think it is going to be necessary to cut rates.” Rather, she said she expected continued US growth would allow the Fed to pursue its plan of “gradual” rate hikes.

To boil it down for you, Yellen essentially said that we won’t see a rate hike in March and we won’t see 4 rate hikes in 2016. Tomorrow, Yellen will repeat the story before the Senate.

Treasury 10-year note yields fell two basis points, or 0.02 percentage point, to 1.70%. Two-year note yields rose one basis point to 0.70%. The difference between two- and 10-year note yields fell to the lowest on an intraday basis since January 2008; just 100 basis points. A shrinking gap is known as a flattening yield curve.

The decline in longer term yields probably doesn’t signal the expectation that short term rates might go even lower, but rather, it signals that bond market participants are seeing the possibility of rates going higher as diminishing. The upside, which in this case is a healthy economy with a healthy demand for money, is being perceived as less likely.

A possible side effect is that low rates equate to cheap money. Now that doesn’t mean that interest rates are dropping everywhere; corporate bond rates have not been dropping, largely because quality has been dropping. And don’t expect to see lower rates on credit cards in the foreseeable future; but mortgage rates are cheap.

Calculatedriskblog reports mortgage applications increased 9.3 percent from one week earlier; purchase applications are up 25% year-over-year; and refinancing applications increased 16% from the previous week. The average contract interest rate for a 30-year fixed rate conforming mortgage dropped to 3.91%, the lowest level since April 2015.

We had a similar flight to safety causing Treasury bond rates to plunge during the Euro-crises of 2012 and early 2013. Those low rates gave rise to the biggest increases in housing construction and jobs during the entire US expansion.

Japanese stocks extended a heavy selloff today, the Nikkei dropped 2.3%, closing in the red for six of the past seven sessions, despite a festive atmosphere across East Asia for the Lunar New Year holiday. Japanese Prime Minister Shinzo Abe defended BOJ Governor Haruhiko Kuroda’s handling of the economy, and said it was up to the central bank to decide what policy instruments to use.

The Supreme Court temporarily blocked the administration’s effort to combat global warming by regulating emissions from coal-fired power plants. The order was not the last word on the case, which is most likely to return to the Supreme Court after an appeals court considers an expedited challenge from 29 states and dozens of corporations and industry groups.

But the Supreme Court’s willingness to issue a stay while the case proceeds was an early hint that the program could face a skeptical reception from the justices. The 5-to-4 vote was unprecedented; the Supreme Court had never before granted a request to halt a regulation before review by a federal appeals court.

The challenged regulation, which was issued last summer by the Environmental Protection Agency, requires states to make major cuts to greenhouse gas pollution created by electric power plants, the nation’s largest source of such emissions. The plan could transform the nation’s electricity system, cutting emissions from existing power plants by a third by 2030, from a 2005 baseline, by closing hundreds of heavily polluting coal-fired plants and increasing production of renewable, clean energy.

Though the first emission reduction obligations do not take effect until 2022, the states said they had already started to spend money and shift resources; and any judicial review will be completed well before 2022.

The Treasury Department reports the federal government ran a budget surplus of $55 billion in January, compared with a deficit of $18 billion in the same month a year ago. Including the monthly surplus, the government is running deficit of $160 billion for the fiscal year to date. That’s 17% less than the first four months of the last fiscal year, which ended in September.

Deficit hawks shouldn’t get too excited by the lower year-to-date number, however. The Congressional Budget Office is projecting a deficit of $544 billion for fiscal 2016, which would be more than $100 billion above the shortfall for 2015. The CBO pegged that expected bigger deficit partly on some tax breaks being made permanent.

China has confirmed its first case of the Zika virus in a man who recently traveled to Venezuela. The World Health Organization declared Zika a public health threat on Feb. 1, and raised the possibility that there could be up to 4 million cases of the virus in the Americas alone.

Deutsche Bank shares recovered about 5% today, leading a surge in European bank shares. Deutsche Bank is considering a bond buyback to help ease investor concerns about its debt. The stock remains down over 30 percent since the start of 2016.

HSBC has been sued by the families of U.S. citizens murdered by drug gangs in Mexico, claiming the bank let cartels launder billions of dollars to operate their business. HSBC already paid nearly $2 billion in penalties in December 2012 to resolve charges that it failed to stop hundreds of millions of dollars in drug money from flowing through the bank from Mexico.

Just last week, the Justice Department announced that it had reached a $470 million settlement with HSBC related to mortgage lending and foreclosure fraud that led to the economic collapse of 2008.

MetLife, the same insurance behemoth that advertises how it is a huge international powerhouse, now says that it really isn’t so big after all, and to prove it, they sued the US government over whether regulators can designate non-banking firms as “too big to fail.” Today, the case went to trial.

Non-bank firms designated systemically important must hold more capital and comply with rules intended to stave off the need for a federal bailout should they fail. The rules have yet to be finalized. Last month, MetLife said it plans to split up due to the “regulatory environment” and pressure is mounting on other firms to also shrink and shed the “too big to fail” designation.


A significant barrier to Google’s plan to put driverless cars on the roads has been removed, after the NHTSA supported its interpretation that a robot could meet the legal definition of a driver. Do they get a driver’s license?

Google has also filed for another potential use of its artificial intelligence system in a patent award that described an “autonomous delivery platform” for trucks. The driverless transport vehicle would carry several lockers that could only be opened by the recipient of a package, using a PIN code or credit card.

Time Warner reported a bigger-than-expected drop in quarterly revenue as subscription revenue for its cable channel HBO and Turner television network disappointed. Time Warner dropped about 4% on the day.

Cisco Systems reported its second-quarter earnings rose to $3.1 billion from $2.4 billion in the same quarter last year. Revenue was flat at $11.9 billion. Cisco beat estimates on the top and bottom line. Shares moved higher in after-hours.

Whole Foods Market said profit declined in its latest quarter, same store sales were down and gross margin continued to deteriorate, but they still topped estimates. Shares moved higher in after-hours.

Twitter said it had 320 million average monthly active users in the quarter, lagging a forecast for 323 million users from RBC Capital Markets. Revenue rose 48% to $710 million in the quarter. Twitter posted earnings of 16 cents per share, versus estimates of 12 cents. But the takeaway is that user growth stalled. Shares moved lower in after-hours.

Tesla reports it will be cash flow positive in 2016, and will turn a profit. Just not today. Tesla posted a loss of $320 million, its 11th straight quarterly loss. But good times are right around the bend. Tesla shares moved higher in after-hours.

Financial Review

Decision Day

Sinclair Noe — October 28, 2015

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

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DOW + 198 = 17,779
SPX + 24 = 2090
NAS + 65 = 5095
10 YR YLD + .06 = 2.09%
OIL + 2.93 = 46.13
GOLD – 11.30 = 1156.70
SILV + .07 = 16.04

It’s Decision Day for the Federal Reserve, and it was an easy decision. The FOMC wrapped up a two-day policy session with a statement that interest rates will remain unchanged near zero; where they have been stuck for 7 full years. The Fed’s statement left open the possibility that the Fed will raise rates at its final meeting of the year, in December. While noting that job growth has slowed, it said that other economic indicators remained relatively strong and the domestic economy “has been expanding at a moderate pace”.

The Fed also signaled that its concerns about the global economy have diminished. In the statement from the meeting in September the Fed said global economic and financial developments might restrain domestic growth. In today’s statement they just say the Fed “is monitoring global economic and financial developments.”

The next FOMC meeting is scheduled for December 15 and 16. Fed chairwoman Janet L. Yellen said in a late September speech that she still expected to raise rates this year, as long as economic growth continued. Stanley Fischer, the Fed’s vice chairman, said much the same a few weeks later. Many Fed policymakers have been saying they will raise interest rates since March, but there are also doves among the Fed, arguing against rate hikes.

Today’s decision to keep rates near zero was supported by nine of the ten members of the Federal Open Market Committee. Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, once again dissented, as he did at the September meeting, arguing the Fed should start to raise rates now. Of course any decision would need to be supported by better economic data, and for now at least, the economy can’t seem to build any real momentum.

The Fed will raise interest rates …, someday. But it won’t be easy. We’ve been locked into near zero since December 2008, but that was during rough times; the economy lost 576,000 jobs that month. Things have improved quite a bit since those dark days. But there are still risks and no guarantees that recovery can continue without monetary stimulus. The recovery has received almost no fiscal stimulus – to the contrary. The lack of fiscal stimulus has been one of the main reasons why the recovery has been so sluggish, even as the economy has shown consistent growth.

Even as the federal debt grew substantially in recent years, the government’s annual interest payments barely increased thanks to the Fed’s efforts to minimize borrowing costs. Higher rates mean higher debt servicing costs which would choke off any possibility of fiscal policy shouldering the burden of recovery.

The labor market has recovered most of the ground lost during the downturn but there is still slack. Full employment is a loose target and the Fed doesn’t really know when we will hit it. We’re close but not there yet. Workers remain underutilized and discouraged. Wages have not shown strength, certainly not enough to push inflation, which remains well below the Fed’s 2% target. And while the price of oil has an outsized influence on broader prices, the Fed has little control over the commodity markets one way or the other.

The Fed also has little control over long term interest rates, they just set the target for very short-term rates; still, if they raise the target, you could expect the rates on everything from cars to credit cards to mortgages to jump, along with a stronger dollar. And this is where it gets tricky. A stronger dollar would hurt US exports while also making imports cheaper; in other words the possibility of a slowing economy combined with disinflation. Further, it could hurt emerging market economies, as their currencies buy less and their resources sell for less.  Higher rates would be good news for savers, who now earn near zero, but for now they have to take on more risk, which is why Wall Street enjoyed a nice rally on today’s news.

The House has approved the reauthorization of the U.S. Export-Import Bank, marking a big victory for business groups that had fought to secure its revival. The bank’s future, however, may not be fully resolved until December. The House bill now goes to the Senate, which recently approved a similar measure as part of an unrelated transportation bill.

Following years of intense debate, the Senate has passed a controversial bill that will see the Department of Homeland Security become a hub for sharing information about cyber-attacks within the government and the private sector. The Cybersecurity Information Sharing Act, known as CISA, would give legal protection to companies that share information about cyber-threats with the government and with each other.

This should help them detect intrusions faster, improve their defenses, and take advantage of government advice and intelligence. It should give law enforcement a clearer picture of the threats facing U.S. networks and help in pursuing cybercriminals. The bill, which has faced privacy concerns from high-tech firms and advocacy groups, must now be reconciled with a separate piece of legislation that was passed by the House of Representatives earlier this year. In the end, Senator Harry Reid summed it up best: “The bill, which is okay, is better than nothing.”

The Energy Information Administration said U.S. commercial crude inventories rose by 3.4 million barrels to a total of 480 million barrels in the previous week, but gasoline and distillate inventories fell. Also, Mexico’s state oil company Pemex said it had received a license from the United States to import U.S. light crude to be refined at Mexican refineries in exchange for its own heavier crude oil. Now, oil was up today, which seems a little counter-intuitive because the EIA had reported weekly jumps of eight million and 7.6 million barrels in its past two reports and today’s data marked a fifth weekly rise in a row.

Volkswagen reported a net loss of $1.84 billion in the third quarter, its first quarterly decline in more than a decade. Volkswagen subtracted €6.7 billion-euro from profit to cover the cost of recalling and repairing about nine million cars equipped with illegal software intended to cheat on emissions tests. The effect of the deceptive software on sales and revenue is likely to worsen in coming quarters.

Fiat Chrysler Automobiles reported a better-than-expected 35 percent jump in quarterly earnings helped by strong performance in North America, and confirmed its full-year guidance.

A successful contract pitch, that included a Super Bowl ad, has landed Northrop Grumman as much as $80 billion to build the U.S. Air Force’s Long-Range Bomber. Northrop beat out Boeing and Lockheed Martin for the contract.

As reported yesterday, Walgreens Boots Alliance is acquiring Rite Aid for $ 9.4 billion, or $17.2 billion after factoring in debt. Walgreens expects the transaction to close in the second half of 2016.

Separately, Walgreens Boots Alliance reported a better-than-expected quarterly profit, helped by lower costs achieved through its cost-cutting plan. Walgreens in April launched a plan to cut $1.5 billion in costs by the end of fiscal 2017, which would include store closures and freezing salary hikes for senior U.S. executives.

Confirming earlier rumors, Toshiba has announced the sale of its image sensor business to Sony as it tries to recover from a $1.3 billion accounting scandal. Sony recently said it would spin off its image sensor business into a new wholly-owned subsidiary called Sony Semiconductor Corporation, and Toshiba’s operations are set to come under that umbrella. No financial details of the deal have been disclosed.

Amazon, which has rapidly built a network of on-demand workers for its Prime Now service, now faces a lawsuit over how those workers are treated. The action potentially thrusts Amazon into the center of a debate roiling Silicon Valley over whether on-demand workers should be treated as employees or independent contractors. Companies such as Uber and Postmates, which consider their workers contractors and thereby avoid some expenses, have faced similar suits.

IBM announced it will acquire the digital and data assets of The Weather Company in a deal valued at about $2 billion. The Weather Company is currently owned by the Blackstone Group, Bain Capital and NBC Universal, which paid $3.5 billion for the firm in 2008. IBM will use the Weather Company’s digital assets to boost its Watson cloud and Internet of Things platforms.

It’s an interesting idea. The Weather Company gathers data from 147,000 weather collection stations, and that process could be improved through the Internet of Things and then analyzed by Watson. The result: Airlines use it to manage turbulence. Insurance companies use it to judge risk. Agricultural companies use it to manage crops. A side benefit to the deal is that much of the Weather Company’s data is managed on the computing systems of IBM competitors, including Amazon and Google, and now it will move to IBM’s cloud, called Softlayer. That is not enough to right the ship at IBM, but it might give us a hint of how some companies will commoditize the cloud.

Now, just a reminder that the third Republican debate starts in less than one hour, so this is a good time to remind you of the rules for the drinking game. Whenever you hear the phrase that starts with: “I’m the only candidate on this stage….” You take a drink. Also, you should take a shot of something, your choice, whenever a candidate mentions Ronald Reagan. If Reagan is mentioned along with Tip O’Neil, it’s a double shot. Remember to watch responsibly and hydrate.

Financial Review

Labor Day Jobs Report

Sinclair Noe — September 4, 2015

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

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DOW – 272 = 16,102
SPX – 29 = 1921
NAS – 49 = 4683
10 YR YLD – .04 = 2.13%
OIL – .71 = 46.04
GOLD – 2.30 = 1123.70
SILV – .13 = 14.70

This is a Jobs Report Friday, and I tend to get a little wonkish about the monthly jobs reports, mainly because I believe jobs are pretty much the most important part of the economy; we’ve even set aside a holiday to recognize the importance of labor. Today’s report is especially important because it comes right before a Federal Open Market Committee Meeting where the Fed just might raise interest rates.

The US economy added 173,000 jobs in August, and the unemployment rate dropped to 5.1%. While this was the smallest increase in new jobs since March, the June and July numbers were revised higher by 44,000 jobs. The Labor Department said 245,000 new jobs were created in July instead of 215,000. June’s gain was revised up to 245,000 from 231,000. The 173,000 new jobs missed estimates of 210,000 to 220,000 but the August numbers are notorious for underestimating – only to be revised higher in following months. The unemployment rate of 5.1% is down from July’s 5.3% rate, and beats estimates that the rate would hold steady.

Between 2005 and 2014, August was the month with the lowest first estimate for job growth relative to revisions that were published in the employment reports for the subsequent two months. Over that period, on average the government found 58,000 more jobs added to payrolls in August than initially figured. Job growth in August was revised lower only in 2005 and 2008. One reason why August is difficult to calculate is because it marks the start of the school year, which varies from town to town.

So, one way to get a better grasp on the numbers is to look at longer-term trends. Over the last three months the economy added 221,000 new jobs on average – fairly solid gains. In August, the year-over-year change was over 2.9 million jobs – again, fairly solid gains. The economy has been adding jobs every month going back to March 2010 – a nice streak. The U.S. has added an average of 212,000 jobs a month in 2015 and the economy is on track to generate more than 2 million jobs for the fifth year in a row.

The bulk of the hiring in August, one-third of all new jobs, took place in health care. Healthcare added 56,000 jobs; Professional and business services added 33,000 jobs; employment in eating and drinking places gained 26,000 job; financial firms hired 19,000; retail added over 11,000, wholesale trades hired almost 8,000, construction gained 3,000. Government hired 33,000 workers and it looks like the declines in government hiring are now over. Federal payrolls were unchanged in July, and Federal employment is up just 6,000 year-to-date. Mining and logging, an industry that includes oil exploration and drilling, lost 10,000 jobs; and manufacturing was the big loser – down 17,000 jobs for the month.

The average hourly wage paid to American workers rose 8 cents, or 0.3%, in August to $25.09 an hour. From August 2014 to August 2015 hourly wages rose 2.2%, matching the best gain of the past four years. The Federal Reserve has targeted a 2% rate of inflation, but in the 12-months through July, the Consumer price Index climbed just 0.2%. This means that workers are seeing wage increases that are running faster than inflation – that means real gains – but wage pressure has not been strong enough to push inflation throughout the economy.

But there is another, shorter-term trend in place, wage gains in the past 3 months have only been running at 1.9%. The average workweek for all employees on private nonfarm payrolls edged up by 0.1 hour to 34.6 hours in August. The manufacturing workweek was unchanged at 40.8 hours, and factory overtime edged down by 0.1 hour to 3.3 hours.

Full-time jobs climbed to 122 million, exceeding the prior peak reached in November 2007. The U-6 unemployment rate fell to 10.3%, the lowest level since June 2008; U-6 includes unemployed plus underutilized workers, or people working part-time for economic reasons, plus discouraged workers who aren’t counted under the U-3 measure, or the headline number.

The headline or U-3 unemployment rate doesn’t capture workers who, because of a difficult job market, have stopped looking for work.  The labor force participation rate – the share of the population that is either working or actively looking for work – dropped off sharply during the recession, from about 66 percent to about 63 percent.  While some of those folks left for retirement, others–maybe a third to a half by some measures–can be enticed back into a more welcoming job market.

The nation’s unemployment rate, meanwhile, fell to 5.1% from 5.3%, marking the lowest level since April 2008. The jobless rate is determined by a separate survey of households that showed a sharp 237,000 drop in the number of people who said they were unemployed. Only a smattering of people dropped out of the labor force. The labor force participation rate was unchanged at 62.6% – which is still a historically low rate. There are 2.19 million workers who have been unemployed for more than 26 weeks and still want a job. This was up slightly from 2.18 million in July.

What this means is that there are still lots of potential workers ready to jump back in the labor pool and it is possible that the economy could add new jobs, but see the unemployment rate move higher as workers are encouraged to look for work.

In less than 2 weeks the Federal Open Market Committee will meet to determine monetary policy, and the strength or weakness of the labor market will be a major factor in their deliberations. The Fed has set a target of 5.2% unemployment as the level that might warrant a rate hike, but that won’t be their only concern. An increase seemed all but certain just weeks ago before the stock market’s slide amid fears of a softening Chinese economy and stagnant growth worldwide. Janet Yellen has repeatedly suggested the FOMC was waiting to see data showing a sustained economic recovery.

In a speech just before the jobs report, Richmond Fed president Jeffrey Lacker said the labor market supported the case for raising rates sooner rather than later. But this report was unlikely to “materially alter the labor market picture or, for that matter, the monetary policy outlook.”

Fed-funds futures, used by investors and traders to place bets on central-bank policy, showed Friday a 34% likelihood of a rate increase at the September meeting, compared with 27% before the jobs report. The odds had been around 50% a month ago.

Finance ministers and central bankers of G20 member states have gathered in Ankara, Turkey today. The  Federal Reserve is coming under pressure from emerging markets not to raise rates too soon as turmoil in China threatens global growth, but the G20 will not publicly call for any delay. This G20 comes at a very good time because it gives the Fed an opportunity to gauge all the elements at stake.

In addition to China and emerging markets and all the other concerns, the Fed will likely consider the impact on Wall Street; back when the Fed hinted at ending Quantitative Easing, Wall Street threw a Taper Tantrum. And as the Fed has been inching closer to raising interest rates, Wall Street has thrown what might be called a Rate Ruckus, (you’re welcome to come up with a better name if you wish). In the U.S. stock market, the S&P 500 had its sixth decline exceeding 1 percent in 12 days.

Prior to that there had been 10 such declines since January. The benchmark gauge has moved up or down by an average of more than 2 percent a day since falling out of its 2015 trading range on Aug. 20; almost four times as much as in the prior nine months. September is historically the worst month of the year for the S&P 500, with the equity gauge falling 1.1 percent on average based on data going back to 1927. So, you could blame the declines today on anything, including history, but part of it was a Rate Ruckus.

And there are plenty of reasons why the argument can be made that more needs to be done to improve employment: the Labor Force Participation rate is too low, wages aren’t going up enough, millions have just given up on the prospect of a job, and the jobs created are not quality jobs. The current pace of job growth would result in an extremely low unemployment rate of 4.2% a year from today, with other factors such as labor-force participation held constant. The rate has dropped by about a percentage point over each of the last four 12-month periods.

So even though the Fed targeted 5.2%, as if this is the magical full employment rate, it doesn’t paint a complete picture. The unemployment rate says “raise!” The payroll number says “hold!” The markets will whine and complain no matter what the Fed does.

This month’s jobs report showed signs of strength and signs of weakness, along with very little clarity. One month’s job data is not enough to seal the deal one way or the other. The Fed could just as easily claim victory with the unemployment rate at 5.1%. And like T-Ball athletes, everybody gets a trophy. For many on Wall Street, they can’t imagine a rate hike; after all, it has been almost 10 years since we’ve seen one, so there are actually traders on Wall Street who have not seen a rate hike from the Fed. It’s like the anticipation of ripping off the Band-Aid is worse than the actual act. At a certain point, and we don’t know where that point is, the Fed will likely just raise rates; just do it and be done. That’s my guess.

The Financial markets will be closed on Monday. So, have a safe and happy Labor Day holiday weekend.

Financial Review

Countdown to Liftoff

Sinclair Noe — June 17, 2015

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

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DOW + 31 = 17,935
SPX + 4 = 2100
NAS + 9 = 5064
10 YR YLD – .01 = 2.31%
OIL – .22 = 59.75
GOLD + 3.60 = 1186.10
SILV + 11 = 16.22

The Fed has wrapped up its June FOMC meeting. No surprises. The economy is getting better, so they say. While the Fed says they have made “considerable progress” toward its goal of maximum employment, “the committee wants to see evidence of some further progress.” They are not hiking rates right now; they will probably hike rates in September, but don’t worry about the exact date because it will be so small and gradual you will hardly notice. That’s the quick version from the Fed.

Further wage and job gains could give Fed officials confidence that inflation, which has lingered below their 2 percent goal for three years, is likely to move higher. Growth is poised to pick up as consumers start spending a windfall from lower gasoline prices, even though that hasn’t happened yet. The economy is likely to expand at a 2.5 percent annual pace in the second quarter after shrinking 0.7 percent in the previous three months. Officials now expect the economy to grow this year between 1.8 percent and 2 percent.

Just a few months ago, in March, they had predicted growth of 2.3 percent to 2.7 percent. The contraction in the first quarter was caused in large part by temporary forces, including unusually severe winter weather and a slump in energy-industry investment brought on by lower oil prices. The Fed is aware of risks overseas, such as the slowdown in China and the danger of a Greek default. The FOMC statement has dropped explicit forward guidance and now they say rate decisions will be data dependent and will be made on a month to month basis.

And so we can conclude from this that the Fed will raise interest rates in September. Based on new economic forecasts we can anticipate two quarter-point rate rises this year but a shallower pace of increases in 2016. They maintained their projection that the benchmark rate would rise to 0.625 percent in 2015, while dropping it to 1.625 percent next year, just a little lower than their March median forecast of 1.875 percent.

The end of free money is in sight. Markets have been feeding from the Fed’s free money trough for about 7 years, and soon that will change. Money will still be cheap but not free. We know that monetary policy has been a key to market performance for the past 7 years; just overlay a chart of the Federal Reserve’s balance sheet on the S&P 500 and it is easy to see the relationship. The Fed’s influence on markets can be measured on a macro level or a micro level. On days when Yellen has spoken to markets, the stock market’s performance has typically been positive. According to analytics firm Kensho, after her last 19 speeches since becoming Fed chair, the S&P was positive 63 percent of the time with an average return of 0.24 percent. On the 10 days when the Yellen Fed issued a post meeting statement, the S&P was higher 60 percent of the time with a return of 0.19 percent. Today, the S&P was up 0.2 percent. So, how will the Fed’s moves affect the markets?

Well, free money has been a boon to debtors, and one of the biggest debtors is the government; as interest rates inch higher the government will have to pay out about $2.8 trillion more in interest over the next 10 years, according to the Congressional Budget Office. Higher interest rates will directly lead to larger budget deficits. One way to reduce the deficit is to bring in more revenue, and the best way to do that is to have more people working. If the Fed were to allow the unemployment rate to fall to 4.0 percent and remain at that level, it would lead to substantially higher tax revenue and reduced payments for unemployment benefits and other transfer programs. The cumulative difference over the 10- year budget horizon is nearly $1.9 trillion. There is still considerable debate about the positive effects of a Zero Interest Rate Policy on unemployment, but working on the idea that easy money results in more jobs, it feels like the Fed is hasty in its desire to raise rates; certainly in terms of demand growth from more workers, plus a boost in wages, plus the positive impact on the federal budget.

But it doesn’t look like the Fed will wait for 4% unemployment; and a Fed rate hike might actually hurt job seekers because a rate hike would result in a stronger dollar. Other central banks are cutting rates and expanding the money supply, weighing down their currencies. The Fed hikes, the dollar appreciates; at least that is the theory. In today’s press conference Yellen said the dollar has largely stabilized, and I suppose you could make that argument for a roller coaster that is no longer at its highest point, but the ride isn’t over just yet. A stronger dollar makes it tougher for companies to sell their goods overseas. A stronger dollar from the rate increase will boost U.S. demand for products from Asia and Europe, helping lift corporate profits in those regions; imports will be cheaper but that helps global stocks, not US multinationals.

But higher rates and a stronger dollar won’t help all global stocks; emerging markets will likely be hurt. The Fed usually gives short change to emerging markets, but they may have reason to fret about something known as “spillback”. The term, coined by the International Monetary Fund, describes the threat to U.S. output from slumping import demand in emerging markets. As the Fed pushes borrowing costs higher, capital could flee developing countries, forcing them to cancel investment and settle for slower growth. That would be the spillover. But a buyers’ strike could rebound on U.S. exports of software, machines and services, undermining domestic recovery. That would be the spillback – and it could be quite significant. If you want strong growth in the US, you need emerging market buyers. Higher borrowing costs in emerging markets and a stronger dollar would further reduce U.S. exports, and the spillback risks of Fed monetary tightening are both real and large enough to cause serious concern.

Banks will like higher interest rates because they’ll be able to profit more from making loans. That, in turn could be bad news for mortgage rates, and by extension, the housing market. The good news on mortgage rates is that the Fed will move slowly, so rates will creep higher, not a quick rise. Insurance companies also like higher interest rates, because they invest customers’ premiums to be able to cover losses with the profits from those investments. If they can realize a higher yield on those investments, that goes directly to profits. Come on, you don’t think they’re going to lower the premiums.

Free money has been a boon for borrowers, and corporations have taken advantage. American corporations issued $757 billion in debt from January through May, a record volume 12 percent higher than during the first five months of last year. Companies have been borrowing at low rates and then buying back their own shares, or paying dividends, or buying up other companies. All that will dry up as the cost of money increases. Fed policymakers have expressed concern that an accommodative monetary policy has encouraged speculation in equity markets. With the prospect of higher rates, they are effectively calling for an end to financial engineering; think of buybacks and M&A as low hanging fruit. The stock market could still go higher but companies are going to have to work harder for their returns.

The Fed’s Zero Interest Rate Policy has been a nightmare for savers. Once upon a time money market funds paid almost 5%; that was 8 years ago. And don’t expect relief from the Fed any time soon. As the Fed begins tightening, yields on all short-term instruments won’t recalibrate higher, at least not soon. Right now, short-term Treasury bill rates are locked in just a smidgen above zero, and demand is strong, in part because financial institutions are required to have a little more of a liquid and safe cushion in the event of problems like 2008. Also, if rates move higher on the longer-maturity instruments, that means losses in price for bond funds or bond ETFs. Bond markets do not respond predictably to interest rate increases. There have only been a handful of tightening cycles in the Fed’s 100-year history, and on the whole, the differences have outweighed the similarities.

And there is concern that changes in financial markets since the crisis have reduced liquidity, or the ability of sellers to find buyers. The International Monetary Fund warned in its Global Financial Stability Report in April that central banks, by pumping money into markets, were concealing the decline of private participation in those markets. They concluded that: “Markets could be increasingly susceptible to episodes in which liquidity suddenly vanishes and volatility spikes.” And when liquidity dries up and volatility spikes, investors can run for the exits. That doesn’t necessarily mean a big sell-off or a crash; that might happen if the Fed surprised the markets, but this Fed seems content to telegraph every move and then move very slowly. Of course, we never know how markets will respond, and something like a Greek default or some other event could change the storyline very quickly, but the anticipated change is likely to be a more subtle shift from offense to defense.

A quick update on Greece; Prime Minister Alexis Tsipras said he’s ready to take responsibility for rejecting the terms of a deal on aid if creditors’ demands are unacceptable. Tsipras told reporters that without a satisfactory deal, he “will assume the responsibility to say ‘the big no’ to a continuation of the catastrophic policies for Greece.” Meanwhile, a Greek government committee has issued a report that determined public debt is illegal, and anti-austerity protestors are taking to the street in Athens. Negotiations between Greece and its creditors continue tomorrow in Luxembourg.

Financial Review

Rotate This

Sinclair Noe — June 10, 2015

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

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DOW + 236 = 18,000
SPX + 25 = 2105
NAS + 62 = 5076
10 YR YLD + .06 = 2.48%
OIL + 1.29 = 61.43
GOLD + 9.20 = 1186.60
SILV + .07 = 16.11

The yield on 10-year German government bunds broke above 1% overnight for the first time since September 2014; part of a broader global bond sell-off that’s been deepening since late April. Last week, ECB President Mario Draghi said investors should get used to periods of higher bond market volatility and stated the central bank wouldn’t do anything about it. US government bonds are selling off – which is sending yields higher as they move inversely to price – as part of the global bond rout that was started back in April. The size of the US corporate-bond market has ballooned by $3.7 trillion during the past decade, further siphoning demand from US Treasuries. And some of that money is just getting out of bonds, which might explain the rotation into stocks today.

Of course, I have no idea why the stock market moved higher today. I don’t know, you don’t know, and the talking heads on TV don’t know. It is nearly impossible to know what might spur or spook the herd of millions of investors to suddenly move in any given direction at any given time. Is it a new trend or just a bounce on pent-up demand? We don’t know. What we do know is that markets fluctuate, and they also rotate.

And while US equity markets have been trading in a tight range, there’s still plenty of action under the surface. A closer look at the 10 main sectors in the S&P 500 index reveals that investors have continued to move out of one sector into another, rotating in an anticipation of an interest-rate hike this year and subsequent rise in borrowing costs. The process of dumping interest-rate sensitive stocks such as utilities and consumer staples have accelerated over the past few weeks thanks to gyrations in government bond markets. The utilities sector is already in correction territory, having dropped more than 10% from its late-January peak, and down 4.6% since the start of the month.

Internal rotation isn’t the only problem with the current market. Deterioration in market breadth – markets rising on the back of fewer and fewer stocks – is something a lot of investors are watching. Less than 60% of S&P 500 components are trading above their 200-day moving average. Trading above the average implies an upward trend while trading below it implies that the stock may be losing support and is likely to fall further. Today, the 10 main sectors in the S&P 500 were all higher. Yesterday, the Dow Industrial Average went negative year to date, bouncing back into positive territory today with all 30 Dow stocks posting gains. Pfizer, Apple, United Health, and Disney have posted double digit returns this year. Wal-Mart, Intel, and American Express have posted double digit losses for the year.

Anyway, the selloff in bonds has pushed people into real estate.  While that may seem counter-intuitive, there’s a reason: fear that rates will move even higher. Total mortgage application volume jumped 8.4 percent last week. Refinance volume increased 7 percent on the week, and applications to purchase a home jumped 10 percent, both seasonally adjusted. Purchase volume is now 15 percent higher than the same week one year ago.

The selloff in bonds gets people all worked up, even though it has not been particularly dramatic. There was more volatility in the bond market in 2013 with the “taper tantrum”; you may remember a brief spell where just the hint of exiting QE saw the 10 year note spike above 3%. Still, the yield on the 10-year Treasury note has climbed from 1.65% in January to 2.49% today as the markets anticipate the Fed raising the Fed funds target rate; but if or when the Fed hikes rates, it will likely be small, incremental, well-communicated increases; and it might not be anytime soon. Today, the World Bank joined the IMF in asking the Fed to wait until 2016 before it raises rates, citing an uneven US recovery and the risks to emerging markets of tightening policy any sooner.

I read today that higher yields were a sell signal. No. The sell signal was when the yield on the 10-year bund dropped to 0.05% back in April, or when US Treasuries were floating around 1.65%. There is certainly a chance that yields could breakout, and prices could breakdown when yields hit 2.5%, and if that results in redemptions at bond funds and bond ETFs, we could see a domino effect, or what trader’s call “spontaneous combustion” that could push yields much higher with added volatility. But that’s the exception, not the norm. Usually, the bond market has a built-in self- correcting mechanism. A deep selloff will have economic consequences. Rates typically rise when the economy is improving; higher rates tend to cool economic growth before it can get overheated, and as the economy slows, rates drift lower. Of course markets can and do overshoot.

And all this speculation is based on the assumption that there is a certain efficiency and the markets are not rigged. You know what they say about assumptions. The Justice Department has begun an examination of trading in the US Treasury market. The government is also continuing to look into possible collusion in gold and silver markets and in trading around certain oil benchmarks. The investigation into Treasury trading is in the very early stages, but this follows guilty pleas from some of the biggest banks on charges of rigging the Forex markets, and the Libor markets, and the ISDA Fix; which means banks are in no position to be anything other than cooperative with investigators.

I also read today that the stock market rallied on positive news regarding Greece. German Chancellor Angela Merkel’s government may be satisfied with Greece committing to at least one economic reform sought by creditors to open the door to bailout funds. While the Germans still insist on a package of steps that includes higher taxes, state asset sales and less generous retirement benefits, they may settle for a clear commitment by the Greek government to a measure up front to unlock aid.

Merkel sounded a positive tone, saying:  “Where there’s a will, there’s a way. The goal is to keep Greece in the euro area.” Of course, we’ve heard many times that we are nearing a settlement on the Greek problem, usually followed by Teutonic demands for discipline and austerity. I’ve been saying that the only intelligent solution involves giving some sort of break to the Greeks. It might happen, but don’t hold your breath. And I doubt the hint of resolution will lift global markets, even though a breakdown in negotiations could cause serious damage.

Index provider MSCI will not add Chinese A-shares to its widely tracked emerging markets index. The Shanghai Composite ended almost flat after falling as much as 2.2%. MSCI said it aims to add the yuan-denominated equities at “some point”, just not today.

Spending on health care in the US fell at a 0.4% annual rate in the first quarter, suggesting gross domestic product will be revised even lower. Health care is the second biggest service sector by spending after finance. The U.S. economy contracted by 0.7% in the first three months of the year, but the government will revise the data for a second time at the end of the month. And even though spending was down in the first quarter, over the past year health-care spending has risen at an unadjusted 7.2% pace.

Workers’ wages and benefits may be picking up faster than previously thought. The Labor Department reports employer costs for employee compensation jumped 4.9% from a year earlier in March, the second consecutive increase at that relatively robust level. Average cost per hour worked rose to $33.49 in March, versus $31.93 a year earlier. Wages and salaries climbed 4.2% to $22.88 while benefits rose 6.4% to $10.61. Health insurance, one component of benefits, was up 2.5%. That’s well above a 1.2% gain as recently as the third quarter of 2013 and a sign the labor market is getting tighter.

US crude oil inventories continue to fall. The latest data from the Energy Information Administration showed that inventories fell by 6.81 million barrels in the week ending June 5. Last week’s decline brought the total to 470.6 million barrels, keeping inventories at the highest levels for this time of year in at least 80 years.

The US is now the top oil and gas producer in the world. US oil production rose to a record last year, gaining 1.6 million barrels a day, according to BP’s Statistical Review of World Energy. The US now passes Russia in total oil and gas production; and the US has passed Saudi Arabia as the top crude producer. The BP report also shows China’s energy demand growing at the slowest pace since the Asian financial crisis of the late 1990s, as the economy slows. And while there has been a boom in US oil production, we’ve seen an even bigger boom in non-fossil fuels and renewables. Last year non-fossil fuels, including nuclear, accounted for more of the increase in global energy consumption than oil, gas and coal combined. Particularly notable are record installations of solar panels.

The EIA released its latest short-term monthly outlook report on Monday, which forecasts that US crude production will fall from 9.6 million barrels per day in May until early 2016. Meanwhile, US oil production is on the rise for now. And at the same time, we are seeing demand destruction. Just this week, we saw the G7 agree to cut carbon emissions a record amount in the next three-and-a-half decades and end fossil fuel use altogether this century. In the past few years, we have already seen an extended flat period in oil demand, due to the financial crisis, that has only recently shown modest gains as prices dipped. The age of oil has now begun to end; that may seem like an exaggeration and it doesn’t mean the age of oil is dead today; it will take time and at the very least it means more volatility, so be aware and beware, because the world is changing in a massive way.

Financial Review

The Sun Might Come Out in 2Q

Sinclair Noe — April 29, 2015

 

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

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DOW – 74 = 18,035
SPX – 7 = 2106
NAS – 31 = 5023
10 YR YLD + .06 = 2.04%
OIL + 1.47 = 58.53
GOLD – 7.20 = 1205.60
SILV – .07 = 16.64

Economic growth slowed in the first quarter.  Gross domestic product expanded by 0.2%, down from 2.2% growth in the fourth quarter. The Commerce Department reports consumer spending rose by 1.9%, but economic activity was constrained by bad weather in many areas, the West Coast port closures, a drop in exports (in part due to a stronger dollar), and a big decline in business spending. It is widely expected that the economy will rebound in the second quarter, much like what happened in 2014, when first quarter GDP contracted by 2.1% only to bounce back with a second quarter gain of 4.6%. Exports sank 7.2% in the first quarter, while imports edged up 1.8%. The plunge in oil prices, meanwhile, forced a resurgent U.S. energy industry to retrench. Overall, business investment on “structures” sank 23.1% in the first quarter, the biggest drop in four years. Companies did boost investment on equipment, but just barely so. Equipment spending rose a scant 0.1%.

For all of last year the economy grew at a 3% pace and that dropped down to just 0.2% in the first quarter. We can break it down to three major areas. Weather accounted for about a 1% drop; those winter storms closed roads, and stores, and offices. Some of that lost economic activity will be made up in the second and third quarters, but not all. The strong dollar also accounted for about a 1% drop in GDP. Although the dollar has weakened in the past couple of weeks, it is still fairly strong against major currencies and central banks from Europe to Japan to China are continuing to pump money into the markets and push the value of their currencies lower.  This means we probably won’t see an increase in US exports anytime soon. Oil prices moved to a four month high today, but they were lower in the first quarter and lower oil prices meant less money spent in the oil patch, but it didn’t translate into drivers spending the money they saved at the pump; that knocked about 0.6% from GDP.

But don’t worry, be happy. That’s the Federal Reserve’s new mantra. The Fed’s FOMC policy-setting committee wrapped up its third meeting of the year, and the impression from their statement is that the weak economic data from the first quarter is transitory, the sun will come out tomorrow, don’t worry. The Fed has said they would rely on economic data to determine when they might raise rates, and the first part of today’s statement listed a smorgasbord of weak data. There was no indication that the economy was about to “lift-off”, no sense of urgency to act. So, we do not expect a rate hike at the June FOMC meeting, and futures contracts only seem to give about a 60% chance of a rate hike by the end of the year. The Fed seems to think the economy will come roaring back after a long winter’s sleep. It could happen but it hasn’t happened yet.

Delivering the first-ever speech by a Japanese prime minister to a joint session of Congress, Shinzo Abe laid out his vision for deeper Japanese involvement in Asian security and global diplomacy. He made a pitch for the Trans-Pacific Partnership, a massive free trade deal that the United States, Japan and 10 other countries are now negotiating.

First-quarter earnings are on track to post a slight gain following many stronger-than-expected results. With reports in from 47% of S&P 500 companies as of Tuesday, Q1 earnings are now expected to have risen 0.02% from a year ago, beating a Thomson Reuters forecast for a 2.9% decline. Still, the raised outlook has been mainly attributed to one company – Apple. Without the tech giant, the S&P 500 forecast would show a profit decline of 1.6%.

Lumber Liquidators  said it’s been advised the Justice Department is seeking criminal charges against the company relating to the importation of certain products that possibly contain harmful chemicals, and the DOJ probe will likely cost the company about $10 million; the company also faces more than 100 pending class action lawsuits. Lumber Liquidators also reported a loss for the quarter and sales dropped more than 8% so far in April. This morning, the company announced its CFO will resign in June.

California governor Jerry Brown issued an executive order aimed at curbing greenhouse gas emissions, saying it was critical to address “an ever-growing threat” posed by global warming to the state’s economy and well-being. Under Brown’s order, by 2030, emission levels will have to be reduced by 40 percent compared with 1990. Under existing state law, emissions are supposed to be cut 80 percent from what they were in 1990 by 2050. In his State of the State address in January, the governor called for reducing gas consumption by cars and trucks by up to 50 percent over the next 15 years. California’s target reflects those set by other governments, including the European Union, ahead of the United Nations conference on climate change in Paris this year.

The Supreme Court has been hearing arguments and issuing rulings; there have been some high profile cases before the court; the issue of same sex marriage for example. And today, the justices heard a challenge of lethal injection as a violation of the ban on cruel and unusual punishment.

There is another case that hasn’t received much publicity but you might find it interesting. The Supreme Court agreed on Monday to spell out Congress’s authority to give someone a right to sue in federal court, even if that individual cannot show that a specific harm was done.  That is an issue under Article III of the Constitution and arose in the case of Spokeo v. Robins, which will be heard and decided in the Court’s next Term.

Under Article III, federal courts only have authority to decide a case or controversy that has something real at stake – a “live” issue, rather than a theoretical claim.  Normally, a case cannot satisfy that requirement unless the suing individual can show some actual or imminent personal injury, or harm.

At issue in the newly granted Spokeo case is whether an individual can sue based on a simple claim that a right created by federal law has been violated, without proof of an additional injury growing out of that violation.  This particular case tests a lawsuit by a Californian, Thomas Robins, who sued under the federal Fair Credit Reporting Act of 1970, claiming that an online search engine put out inaccurate personal information about him. The search engine, operated by Spokeo, gathers information about individuals from public sources, such as telephone books, social networks, marketing surveys, real estate listings, business websites, and other databases.  It makes the information available to those who search for it online, but cautions them that it does not verify the accuracy of the data.

Robins, who filed a class-action lawsuit, claimed that Spokeo had provided flawed information about him, including that he had more education than he actually did, that he is married although he remains single, and that he was financially better off than he actually was.   He said he was unemployed and looking for work, and contended that the inaccurate information would make it more difficult for him to get a job and to get credit and insurance.

A federal judge dismissed his lawsuit, concluding that Robins had not offered sufficient evidence that he was harmed by the information available through Spokeo.  The U.S. Court of Appeals for the Ninth Circuit overturned that result, clearing the way for the lawsuit to go forward.  It concluded that Congress had created a right to sue under the Act, and that was sufficient to show an injury if a violation of the Act was claimed. The Supreme Court asked the U.S. Solicitor General for the federal government’s views on the case, and the government urged the Court not to grant review.  While not embracing the Ninth Circuit’s view of the Article III “standing” issue, the Solicitor General argued that the Ninth Circuit’s ruling could actually be understood as going beyond that to find a genuine claim of injury. The Justices granted review, despite the government’s suggestion.

Litigation makes strange bedfellows. Google, eBay, Yahoo, and Facebook all filed briefs in the Spokeo case, because of course, they all post information about individuals through their sites, and some of that information might not always be accurate; such is the nature of the internet, or at least that was what the tech companies tried to argue. The companies complain that they process so much data about so many people that the decision opens them up to liability from too many people if they violate the law – as if their control of so much personal data in the first place is not part of the problem.

The brief is fascinating since it details the large number of lawsuits the companies are already facing that they hope a favorable Supreme Court decision could just make go away. Google, Facebook, Hulu, and several other tech companies are facing various and assorted suits, and their defense seems to be that it would be difficult for them not to break the law. The arguments also lay bare the fact that even though there have been laws written to respect our privacy or to protect consumers, the laws are almost never enforced, and they only are considered after grievous harm has taken place; which may serve as a form of compensation but doesn’t seem to qualify as protection.

So, this case is a pretty big deal. If the Supremes overturn the Ninth Circuit, laws meant to protect user privacy, as well as consumer and financial protection laws will become unenforceable. If the Supremes rule with the Ninth Circuit it could change the business model and content of the entire internet.