Financial Review

About Face

Sinclair Noe — August 15, 2017

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

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DOW + 5 = 21,998
SPX – 1 = 2464
NAS – 7 = 6333
RUT – 11 = 1383
10 Y + .05 = 2.27%
OIL + .13 = 47.72
GOLD – 10.50 = 1272.10
BITCOIN + 0.72% = 4174.04 USD
ETHEREUM – 1.28% = 286.10

Several members of President Trump’s manufacturing jobs council resigned following what was widely considered an inadequate response from the president to violence in Charlottesville, Va. over the weekend that led to three deaths.

The executives that have resigned include: Ken Frazier – CEO of Merck, Brian Krzanich of Intel, Kevin Plank of Under Armour, and Scott Paul – President of the Alliance for American Manufacturing. That makes 7 CEOs who have resigned from Trump’s councils this year.

The AFL-CIO, a federation of labor unions that represent 12.5 million workers, said it was considering pulling its representative on the committee. AFL-CIO President Richard Trumka said the council “has yet to hold any real meeting,” and “there are real questions” about its effectiveness.

Several other members of the council issued statements denouncing racism and bigotry. Walmart CEO Doug McMillon issued a statement saying the president “missed a critical opportunity to help bring out country together.” McMillon remains on the council for now.

Trump tweeted a response, “For every CEO that drops out of the Manufacturing Council, I have many to take their place.” Although so far there have been no new additions to the council. That was followed by a tone-deaf tweet storm and a press conference in New York, where Trump said, “I think there’s blame on both sides.” Prompting a thank you tweet from David Duke.

CEOs are loath to alienate customers through politics and never want to be the target of a tweet storm from Trump. But corporate leaders who were once eager for a seat at the Trump table are increasingly deciding the costs outweigh the benefits. There is a herd effect. With each CEO’s announcement, it becomes easier for the next CEO to take a stand — and the pressure goes up to do so.

The Congressional Budget Office says ending government payments that help low-income people afford to use their Obamacare plans would raise total federal spending by billions of dollars over the next decade.

Halting the payments to insurers, known as cost-sharing reductions, would boost Obamacare premiums for mid-level Obamacare plans by 20 percent next year, and by about 25 percent in 2020, as insurers raise their charges to make up for the lack of payment.

Since Obamacare provides separate subsidies to individuals to help them cover the cost of premiums, the overall effect would be to boost government spending, to the tune of $194 billion over the next decade. President Donald Trump has threatened to cut off the payments to force Democrats to negotiate changes to the program.

Without the payments, insurers have said they may drop out of the Affordable Care Act’s exchanges or substantially raise premiums. Already, insurers have said uncertainty over how the Trump administration plans to run the law is contributing to large requested premium increases for next year.

Retail sales recorded their biggest increase in seven months in July as consumers boosted purchases of motor vehicles and raised discretionary spending. Retail sales jumped 0.6 percent last month, the largest gain since December 2016. Retail sales for June and May also were revised higher. Retail sales increased 4.2 percent in July on a year-on-year basis.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased at a 2.8 percent annualized rate in the second quarter after a tepid 1.9 percent pace in the January-March period. That boosted GDP growth to a 2.6 percent rate in the second quarter.

Sales were likely boosted by hefty discounts as auto dealerships try to reduce inventory. Prices for new motor vehicles recorded their biggest drop in nearly eight years in July and have decreased for six straight months.

The retail sales report prompted the Atlanta Fed to raise its third-quarter GDP estimate by two-tenths of a percentage point to a 3.7 percent rate.

Americans are spending more and saving less. The saving rate has dropped to 3.8 percent in the second quarter of this year from a rate of 6.2 percent in the second quarter of 2015. Persistently sluggish wage growth has pushed Americans to dip into their savings to fund spending.

Americans’ debt level notched another record high in the second quarter. According to a Federal Reserve Bank of New York report total U.S. household debt was $12.84 trillion in the three months to June, up $552 billion from a year ago.

The proportion of overall debt that was delinquent, at 4.8 percent, was on par with the previous quarter. However, credit card balances in delinquency “ticked up notably.” Total U.S. indebtedness is about 14 percent above the trough of household deleveraging brought on by the 2007 financial crisis.

Mortgage debt was $8.69 trillion in the second quarter, up $329 billion from last year. Student loan debt was $1.34 trillion, up $85 billion, while auto loan debt came in at $1.19 trillion, up $55 billion.

Analysts have been warning for years that subprime car loans pose a threat to lenders as delinquency rates have edged higher since reaching a post-recession low in 2012. But it wasn’t until last quarter that the least creditworthy borrowers started to show the kinds of late payment profiles that accompanied the start of the financial crisis.

Equifax data show that lenders are extending repayment periods and offering longer terms, with many starting to exceed seven years. There may also be loosening by all lenders on other factors, such as down-payment requirements, lack of third party validation of income and employment.

A second report from the New York Fed showed its Empire State general business conditions index climbed 15.4 points to 25.2 in August, the highest level in nearly three years. Manufacturers in the region reported a jump in new orders and said they were taking longer to deliver goods.

US import prices increased in July after two straight monthly declines, driven by rising costs for petroleum products and food, but underlying imported inflation remained muted. The Labor Department reports import prices edged up 0.1 percent last month after an unrevised 0.2 percent drop in June.

Last month’s increase was in line with economists’ expectations and left the 12-month increase at 1.5 percent. The year-on-year increase in import prices has slowed sharply since hitting 4.7 percent in February, which was the biggest advance in five years.

The report also showed export prices rebounded 0.4 percent in July, the biggest gain since December 2016, after falling 0.2 percent in June.

The Commerce Department that business inventories rose 0.5 percent in June after an unrevised 0.3 percent increase in May. Inventories are a key component of gross domestic product. Retail inventories gained 0.6 percent in June. Motor vehicle inventories increased 0.7 percent. Business sales rose 0.3 percent in June.

At June’s sales pace, it would take 1.38 months for businesses to clear shelves, up from 1.37 months in May.

Home Depot reported a better than expected profit, record quarterly sales and an improved outlook for the full year. This proves two things: The company is still Amazon-proof — and the housing market is still one of the brightest spots of the US economy.

Home Depot said that sales were up 6.6% at U.S. stores open at least a year. Net income jumped 9.5 percent to $2.6 billion, or $2.25 per share. Net sales rose 6.2 percent to $28.1 billion, the highest quarterly sales in company history. Home Depot raised its full-year forecasts but concerns over a looming slowdown in the U.S. housing market due to supply constraints pushed shares down 2.6%.

TJX reported better-than-expected quarterly profit and sales and raised its earnings forecast. As traditional retailers struggle in the face of changing consumer tastes and competition from Amazon, TJX has been posting strong sales for several quarters by offering sharp discounts. TJX said its comparable-store sales rose 3 percent in the second quarter.

Shares of General Electric were down 0.9 percent, at their lowest point since October 2015. While the S&P 500 returned more than 35% to investors over the past three years, GE returned less than 9%. A late Monday quarterly report from Berkshire Hathaway showed Warren Buffet sold his stake in GE.

Without the eye-popping returns of a few high-flying technology stocks, the performance of the market would look very different — and not in a good way; 45 days after the end of a quarter, hedge funds must file 13Fs to disclose their holdings. They are selling the FAANG stocks (Facebook, Amazon, Apple, Netflix, Google).

Between the end of 2016 and July 24, the FAANGs gained some 36 percent as a group, compared with 9.39 percent for the S&P 500 Index. Since then, the FAANGs have under-performed, losing 2.63 percent to the S&P 500’s 0.18 percent decline.

Bill Gates has donated $4.6 billion or 64 million Microsoft shares according to a US Securities & Exchange Commission filing. The recipient of the gift was not specified but it is expected that the money will be directed to the Bill and Melinda Gates Foundation he and his wife set up in 2000 with $5bn funding to improve global healthcare and reduce extreme poverty.

The shares donated represent about 5% of his current $90 billion fortune. The gift reduces Gates’s stake in Microsoft to just 1.3% from 24% in 1996. Bill and Melinda Gates have donated $35 billion since 1994. The Gates Foundation has grown to become the world’s largest private charity with $40.3 billion of funds, before the latest gift.

This latest donation is the biggest charitable gift made anywhere in the world so far, this year, overtaking a $3.2 billion contribution by investor Warren Buffett to the Gates foundation last month.

Turkey Shoots

Sinclair Noe — November 24, 2015

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

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DOW + 19 = 17,812
SPX + 2 = 2089
NAS + 0.33 = 5102
10 YR YLD – .01 = 2.24%
OIL + .89 = 42.64
GOLD + 6.70 = 1076.40
SILV + .05 = 14.30

The US economy expanded at a faster pace in the third quarter than previously reported. Gross domestic product rose at a 2.1% annualized rate, up from an initial estimate of 1.5%. Nearly all of the improvement was because of revised data on inventories, which showed businesses restocking shelves at a faster pace than the government first estimated.

Still, company stockpiles remained elevated compared with sales, indicating that new orders and production will cool further to clear shelves and warehouses heading into 2016. Inventories grew at a $90 billion annualized rate from July through September, almost twice as much as previously estimated, but down from the second quarter.

The improvement in inventory levels was offset by a slight downward revision in consumer spending last quarter. Cheap gasoline is giving households a little extra money, and consumers are spending, just not quite as fast; consumer spending was revised down to 3% from 3.2% in the initial estimate for the third quarter. Consumption during the current fourth quarter, including the holiday shopping season, is expected to increase at an annualized rate of about 3%.

For all of 2015, the rate of economic growth is expected to be about 2.5%, not much different from the 2.4% rate in 2014. Not great but good enough. The GDP report was the one of the last big economic reports before the Fed FOMC meeting December 16^th; the other big report will be the November jobs report, which will be published on Friday, December 4^th. In reality, not much has changed since June or even October, when the Fed did not raise rates.

Corporate profits after tax, without inventory valuation and capital consumption adjustments, fell at a 3.2% pace from the second quarter, the biggest drop since the fourth quarter of 2014. On a year-over-year basis, corporate profit growth was 1.4%, compared with 8.5% year over year growth in the second quarter. That measure of corporate profits tracks most closely with what companies report in earnings statements. Profit data aren’t inflation adjusted.

The Conference Board reports that its index for consumer confidence fell to 90.4 from 99.1 in October. Despite a strong advance in hiring last month, consumers expressed more caution about the job market and future economic conditions in the most recent survey. The fall is in the expectations, not the current conditions, component. The decline in job expectations is dramatic and raises the question whether global effects, which have been negative for the US, are beginning to weigh on the American consumer, which would not be a positive for the holiday spending outlook.

Existing home prices rose in September. The S&P/Case-Shiller 20-city composite index gained 0.2%. Prices rose 5.5% for the year, up from a 5.1% yearly gain in August. The index is still about 12% lower than its 2006 peak. Phoenix home prices were up 0.2% in September, and up 5.3% over the past 12 months.

At the peak, prices in Phoenix were 127% above the January 2000 level. Then prices in Phoenix fell slightly below the January 2000 level, and are now up 54% above January 2000 (54% nominal gain in almost 16 years).

These are nominal prices, and real prices (adjusted for inflation) are up about 40% since January 2000 – so the increase in Phoenix from January 2000 until now is about 14% above the change in overall prices due to inflation.

Turkey has shot down a Russian military jet near the Syrian border. Turkish officials said the jet was downed after it knowingly violated Turkish airspace. The two Russian pilots ejected before the plane crashed but they were shot in their parachutes as they floated to earth. And then Turkish tribesmen reportedly destroyed a Russian helicopter with a TOW antitank missile as it tried to rescue the airmen. The Russian Ministry of Defense confirmed that one fighter pilot had been killed by ground fire and that a marine deployed on the search-and-rescue helicopter died but that the rest of the crew had managed to escape.

Russia’s retaliation so far has been largely symbolic. Russia’s foreign minister canceled a Wednesday visit to Turkey, and a large Russian tour operator announced it was suspending sales to Turkey. The two countries are also significant trade partners, or at least they were. A reminder that Turkey is a member of NATO. Today, French president Francois Hollande was in Washington and conducted a joint press conference with President Obama. They vowed to intensify their nations’ military attacks on ISIS in Syria and Iraq. They also announced that next week’s climate change summit in Paris would be a “powerful rebuke” to terrorists.

In the immediate aftermath markets reacted nervously, with the lira selling off, Russian stocks sliding and global government bonds climbing as investors move to safe havens. Meanwhile, a car bomb exploded outside a hotel housing judges supervising parliamentary elections in Egypt’s North Sinai, killing at least three people and injuring 14. The region is the main area of operations for the Egyptian affiliate of ISIS.

Citing “increased terrorist threats” from militant groups in various regions of the world, the US State Department has issued a global travel alert ahead of a busy Thanksgiving week. The department did not advise people against travel but said US citizens should be vigilant, especially in crowded places. The announcement comes as Brussels remains on lockdown and follows the discovery of an explosive belt near Paris and the mobile phone of a fugitive believed to have taken part in the November 13 attacks.

Ford is the latest automaker to say it will not equip future cars with Takata air bag inflators that use ammonium nitrate, the chemical propellant that has been linked to eight deaths and more than 100 injuries worldwide. Ford’s auto recalls with Takata airbags have so far affected about 1.5 million vehicles, including certain older model-year Ford Mustangs, Ford GTs and North American-built Ford Rangers.

Costco has an E. Coli problem. Nineteen people have been infected with E. coli in California, Colorado, Missouri, Montana, Utah, Virginia, and Washington. They have tracked the source to Costco’s rotisserie chicken salad. You might want to stick with turkey for the next few days.

Skyworks Solutions has withdrawn its agreed takeover bid for PMC-Sierra after an increased offer of $2.3 billion from Microsemi gained the backing of the target’s board. Skyworks said it won’t modify its bid and that the company is entitled to an $88 million termination fee from PMC. Semiconductor makers have pursued mergers at a record pace this year.

China’s securities regulator has canceled a requirement that brokerages must hold a net positive purchase position on daily proprietary trading as the nation’s stock market stabilizes following a summer slump. With the Shanghai Composite now having gained more than 20% from its August low, regulators are withdrawing from a government campaign to prop up shares.

New York Attorney General Eric Schneiderman is clamping down on “spoofing,” issuing subpoenas to interdealer brokers BGC Partners, TFS-ICAP, GFI Group, and Tullett Prebon Financial Services. The investigation is focused on placing offers with the intent to cancel them before they trade in order to trick other investors by creating the illusion of demand. Earlier this month, high-frequency trader Michael Coscia became the first person to be found guilty of spoofing in a criminal case.

National Football League player Dwight Freeney can proceed with his lawsuit alleging that Bank of America was complicit in a fraud scheme that caused him to lose more than $20 million and forced his Rolling Stone restaurant to close. The Arizona Cardinals linebacker last Thursday defeated a bid by the parent company and its Merrill Lynch unit to dismiss, among others, fraud and negligent misrepresentation claims stemming from the bank’s recruitment of him in 2010 to manage his assets. US District Judge Margaret Morrow in Los Angeles didn’t rule on the merits of Mr. Freeney’s claims but agreed that he alleged enough facts to move forward with the case.

Just in time for the busiest shopping week of the year – iSight Partners, a privately held cyber intelligence firm is warning retailers about what they call “the most sophisticated point-of-sale malware seen to date.” The firm had shared information about the malware, dubbed ModPOS, with clients in October, and briefed dozens of companies about its dangers. Some retailers have found digital evidence that linked threat indicators they had previously seen to ModPOS, though that does not necessarily mean they were victims of breaches. Just a reminder that if you are concerned about cyber security while holiday shopping, cash still works.

CalPERS, the California Public Employees’ Retirement System said it paid $3.4 billion in performance fees to its private equity managers since 1990 while the controversial sector generated $24.2 billion in profits for retirees. CalPERS has been hard-pressed to keep up with looming obligations to its 1.7 million current and future retirees.

The CalPERS fund, the largest pension fund in the country now at about $295 billion, is considered about 74% funded, down from 77% as of June 30, 2014, mostly because of weak performance from its global stock portfolio. The global stock portfolio posted returns of 1% for the last fiscal year, ended June 30. Private equity, by contrast, returned 8.9% for the year but not without risk and hefty fees.

Jeff Bezos’s space exploration company Blue Origin achieved a key milestone: sending a rocket into space and then landing it safely back on Earth. Making reusable rockets is a central goal for a generation of companies that are trying to cut the cost of space travel and exploration. A Blue Origin vehicle called New Shepard flew to space on Monday, reaching an altitude of 100 kilometers, and then landed back at its launch site.

Financial Review

Maybe GM Is Too Damn Stupid To Exist

Sinclair Noe — March 12, 2015

 

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

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DOW + 259 = 17,895
SPX + 25 = 2065
NAS + 43 = 4893
10 YR YLD – .01 = 2.10%
OIL – 1.14 = 47.03
GOLD + 1.60 = 1153.50
SILV + .05 = 15.57

Tuesday was one of the worst days for Wall Street in months; today we saw the biggest rally in a month. Go figure. The Dow and the S&P were up nearly 1.5%; the Nasdaq less of a gain as Intel warned that first-quarter sales would be below its previous outlook, given weaker-than-expected demand for business desktop PCs and lower inventory levels in the PC supply chain.

Another day, another central bank jumps on the easing bandwagon.  South Korea joined twenty four countries across the globe by easing monetary policy in 2015. Taking advantage of low inflation, the Bank of Korea cut its base rate by 25 basis points to a record low of 1.75%. South Korea also previously cut its forecast for this year’s economic growth to 3.4% in January from 3.9%, and they are widely expected to lower it again next month as China’s growth continues to slow and much of Europe flounders.

The IMF has approved a bigger bailout for Ukraine, giving Kiev immediate access to $5 billion of the $17.5 billion in emergency funding to keep the country afloat. Kiev’s conflict with pro-Russian separatists has put the country’s economy into a tailspin with a plunging currency, the highest interest rates in 15 years and central bank reserves of just $6 billion.

The euro fell to less than $1.05 before pulling back to trade higher on the day. The European Central Bank’s launch of a 1.1 trillion euro bond-buying program this week has dented the euro’s appeal by driving yields of many euro zone bonds to all-time lows. Light buying in core European bonds pushed Germany’s 10-year yield to less than 19 basis points and France’s to less than 45 basis points. Meanwhile, aggressive buying of peripheral bonds has both Italy (1.04%) and Spain’s (1.05%) 10-year yield flirting with sub-1.00% prints for the first time ever.

After spiking to a 10-month high last month, the number of people applying for unemployment benefits sank below the key 300,000 mark in early March. Initial jobless claims fell by 36,000 to 289,000 in the seven days extending from March 1 to March 7, reversing a sharp uptick last month that was likely triggered by bad weather.

Retail sales fell 0.6% last month, following even larger declines in January and December. Part of the problem was bad weather, but that doesn’t tell the whole story. Sales at gasoline stations jumped 1.5% — the first increase since last May, but that increase was offset by weaker sales of autos – down 2.6% on the month. Unadjusted retail sales were up just 1.7% over the past 12 months.

Combine the lower retail sales number with today’s report from the Commerce Department showing business inventories are at the highest level in almost 6 years, and it would take 1.35 months to clear the shelves at the current pace. That’s bad news because inventories tie up cash. Cash is supposed to be used to make more cash. Cash on the shelf is cash that isn’t working. Maybe we can blame the slow sales on bad weather. If sales pick up, problem solved; but it doesn’t look like American consumers are in a buying mood. If sales don’t pick up, businesses will need to cut back on purchases while they clear their stock. If enough businesses cut back, the supply chain grinds to a halt and all sorts off bad things result. Here’s how it could play out. We wait a month to see if sales pick up; if not we wait another month for the sales promotions and liquidations; if that doesn’t result in sales, then we could see cost cutting (which is another way of saying job cuts), and that puts us right about June, when the Fed might be looking to raise interest rates.

The prices paid for imported goods rose in February for the first time in nine months, largely because oil is no longer in a freefall. The import price index increased a seasonally adjusted 0.4% last month; that follows a 3.1% drop in January. Export prices dipped 0.1 percent in February after falling 1.9 percent in January.

General Motors’ approval this week of a new $5 billion buyback plan will likely delay one of its important goals: achieving a top-tier credit rating. Standard & Poor’s and Moody’s analysts say the carmaker’s next upgrade could be delayed due to its new capital allocation plan. The buyback scheme was pushed by an activist investor, Harry Wilson, and even if it doesn’t make the company stronger, it might make the shareholders more money, or not.

The intentions of a share repurchase plan are simple: to “return capital to shareholders” by spending money in a way that makes the stock go up and shareholders wealthier as a result. The primary idea is that buying back existing shares decreases the supply of outstanding stock, and gives existing shareholders a bigger piece of the company. Each dollar of earnings is spread among fewer shares, meaning that each share should be more valuable. But stock buybacks aren’t all they’re cracked up to be.

For example, ExxonMobil bought back more than $13 billion of its own shares last year. The price of oil went down and ExxonMobil share price dropped about 9% in 2014. Another example is IBM; they bought back more than $13 billion of its own shares last year and the share price underperformed the broader S&P 500 index by about 25%. Not much of an advantage. The problem with IBM is that the one-time tech giant isn’t doing anything very innovative, and a buyback scheme can’t cover that flaw.

General Motors announced today that, beginning with the 2016 model year, they will cut the warranties coverage on Chevrolet and GMC vehicles. The new warranties will be five years or 60,000-miles on the powertrains, including courtesy transportation and roadside assistance, down from five years or 100,000 miles. Free maintenance will drop to two visits within 24 months, from four.

GM issued a statement that said: “We talked to our customers and learned that free scheduled maintenance and warranty coverage do not rank high as a reason to purchase a vehicle among buyers of non-luxury brands. We will reinvest the savings we will realize into other retail programs that our customers have told us they value more than these.”

We don’t know what retail programs they intend to reinvest in, but we do know they plan to invest $5 billion into a stock buyback plan. And that goes against the published research on warranty coverage. According to a study published in the Journal of Business Research curtailing warranties is bad for business. The study found that: “Warranty improvements signal improved vehicle quality and lower maintenance costs. Warranty curtailments signal the opposite.” The authors note that “Korean manufacturers’ share of the U.S. market quintupled from 1% in 1996 to 5% in 2006. Much of the credit for this increase has been attributed to restyling, lengthened warranty, and improved quality.” And cutting warranties results in a 24% decline in market share growth.

The study finds that if you want to sell more cars, restyling gives you the biggest bang for the buck. In other words, build a better car, give it a strong warranty so people know you are confident that it is indeed a better car, and people are more likely to buy it. Sounds like common sense.

Now, keep in mind that GM is still dealing with claims of defective ignition switches that resulted in crashes that killed 64 people and 1571 other claims are in for injuries. The executives at GM knew for 13 years that their cars had a defective ignition switch that would, well, kill people. But they did a “cost-benefit analysis” and concluded that paying off the deceased’s relatives was going to be cheaper than having to install a $10 part per car. They then covered up their findings and continued to let millions drive around with the defective part in their cars.

So, in the real world, GM must now deal with the death and injury claims; they could repair all the defective switches so nobody else dies; they could make sure there are no additional killer design flaws; they could invest in R&D to build a better car, a car that looks great, runs more efficiently, is safer for the drivers, and is so reliable that they could increase the warranty with confidence – or – they can kowtow to one activist corporate raider and gamble $5 billion on a stock buyback scheme that may or may not pay off; and in the process, they are destroying their own credit rating and hamstringing liquidity.

About 7 years ago GM was on the verge of collapse. Back then we had high oil prices and the Big Three US automakers were stuck making big trucks and SUVs and when oil prices jumped, buyers developed an aversion to gas guzzlers. GM was slow to respond and soon they were bleeding cash. They turned to Uncle Sugar for a bailout, to the tune of $49 billion. GM was essentially nationalized. In December 2013, Treasury sold its last GM shares. According to a tally by the US Treasury, taxpayers lost $9 billion on the U.S. government’s automotive industry rescue program. According to another study by the Center for Automotive Research, a couple of million jobs were saved and the government “saved or avoided the loss of” $105 billion in lost taxes and social service expenses, such as food stamps, unemployment benefits and medical care. Of course there were some vendors that got stiffed by GM in bankruptcy. And it might have been cheaper to just give every GM worker a check for $250,000 and tell them to make the most of it.

We could debate whether the bailout was good or bad, but the bottom line is that GM is still around and now they are profitable, at least for Harry Wilson. The bad thing is that they didn’t learn from their struggles. They aren’t setting aside money as a cushion for a rainy day; they aren’t taking the $5 billion for stock buybacks and investing in R&D and innovation and better, safer cars. They didn’t learn any lessons about how to serve their customers, how to treat their employees and vendors, or how to show gratitude for the country that saved their bacon. And so, if GM ever finds itself in the same situation as they were in just 6 short years ago, the debate should not be about whether there should be government intervention or not, we could just look back on their decisions of the past week and we could all agree that GM was too damn stupid to exist.

FINANCIAL REVIEW

Divergence

Sinclair Noe — December 9, 2014

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

DOW – 51 = 17,801
SPX – 0.49 = 2059
NAS + 25 = 4766
10 YR YLD – .04 = 2.22%
OIL + .80 = 63.85
GOLD + 27.80 = 1233.00
SILV + .73 = 17.21

We’ll start with economic news.

The Labor Department reports there were 4.83 million job openings in October, up from 4.69 million job openings in September. The number of available jobs means workers are more likely to leave their current jobs in search of a better deal. The quit rate, the share of total employees opting to quit their jobs was 1.9% in October, roughly the same level it was just before 2007. With 9 million unemployed people in October, there were about 1.9 potential job seekers per opening. In October 2013, there were 11.14 million unemployed people or about 2.8 potential seekers per opening.

The Commerce Department reports wholesale inventories increased 0.4%, despite an energy price-related decline in the value of petroleum stocks. September’s wholesale stocks were revised up to show a 0.4% gain. This might indicate that third quarter GDP could be revised slightly higher.

The National Federation of Independent Business says small-business sentiment reached a seven-year high in November. The index rose 2 points to 98.1, the highest level since Feb. 2007, as expectations for business conditions in six months surged and expectations for real sales volumes also gained. While stocks have soared and GDP and employment figures have returned to pre-recession highs, small business has lagged in the recovery. But that’s changing. Small businesses added more than 100,000 jobs to their payrolls last month, accounting for almost half of the total gains in the private sector.

So the economic news in the US was pretty good today. No reason for a market selloff, but that’s how the morning started, with a 200 point decline on the Dow. Crude oil prices bounced a little higher but nothing outside the norm. Sure the Federal Reserve could put the brakes on a Santa Claus rally; the Fed FOMC meets next week, and they might make minor changes to their language to indicate a willingness to raise rates next year, or Fed policymakers might drop their assurance that short-term interest rates will stay near zero for a “considerable time” and replace it by saying they’ll be patient before moving rates. What’s the difference between “considerable time” and “patience”? Who knows?

And don’t forget that politicians in Washington could always throw a monkey wrench in the works. They’ve done it before. Congressional negotiators were nearing a deal on massive spending legislation that would avert a government shutdown and bring the 113th Congress to a close, but they can’t resist the temptation to add on bits of legislation not directly related to the spending bill. A vote is expected by Thursday. And even if the bill makes it out of the House, the Senate could take up and pass the spending bill shortly after it leaves the House, but only if all senators agree. And this might shock you but it doesn’t look like all senators are in agreement on the bill; which could mean a push for further debate, forcing a continuing resolution and pushing the matter into next week when most of the politicians are planning a trip home for the holidays.

Meanwhile, the rest of the world is having a hard slog. In China the day started with a hard selloff in equities as the country moves to rein in credit as part of a broader set of financial reforms. China’s securities clearinghouse issued temporary restrictions on using lower-rated or riskier corporate bonds as collateral for short term borrowing. Chinese stocks had been surging for months. The Shanghai Composite Index is up almost 50 percent since July. The rally has been largely fueled by individual retail investors, who have been piling into the market and increasingly resorting to margin financing, or short-term borrowing, to purchase shares. While welcoming signs of life in the country’s stock markets, Chinese officials have grown wary in recent weeks of the rising levels of debt that have fueled the rally, and they have cautioned investors against speculation. If the stock market’s credit line is not yet maxed out, the question for investors is whether Beijing is likely to pull the plug and kill the party. The Shanghai Composite index dropped 5.4% today. The Shenzen Exchange dropped 4.2%. That doesn’t mean the bullish trend is over, but it was a gut check.

Then international trading moved to Europe and the Athens stock market crashed, down 11.2% on the day. Greek Prime Minister Antonis Samaras announced that Greece’s presidential elections will be held on December 17, two months earlier than scheduled. And there are no candidates yet. The opposition party Syriza, best known for its opposition to the Eurozone’s bailout of Greece, said the government doesn’t have the votes needed to elect a president. If Greece does not elect a president on December 17, snap parliamentary elections will be called.

Also, a report from The Financial Times said that Greece and finance ministers in the Eurozone agreed to extend Greece’s bailout by two months after the government failed to adopt the economic reforms required to get the last of their rescue funds. And so while the European Central Bank deals with flagging economic growth and rapidly declining inflation, the Eurozone might have to respond to political unrest in Greece, too.

What exactly is the Syriza political party? Well, first, it isn’t a political party, it is a coalition; so they don’t exactly have a party platform. But generally speaking they are opposed to austerity. They are essentially good with sovereign debt default, or at least a haircut for bondholders; they want the ECB to directly purchase Greek bonds; they want to write off the bank debt of people who can’t afford to repay; they want to tax the rich; and in a country with 25% unemployment and 50% youth unemployment, they want the EU to fund a jobs program.

Now, just a quick refresher on Greece, back in 2010 they faced insolvency; the Euro Union and the International Monetary Fund stepped in and extended non-performing loans and pretended there was no problem. In 2012, they continued the “extend and pretend” strategy while extracting a pound of flesh in the form of austerity budgeting, essentially transferring the hundreds of billions in losses from the Greek bankers to the Greek taxpayers. Eventually, the vulture funds moved into Greece to pick over the remains in the Greek bond market. But now, Greek voters may be saying that they won’t play the game anymore and the Euro-crisis is back on the front burner.

So, as we head into 2015, we have a US economy showing signs of solid recovery with a consistently improving labor market; we have China trying to deal with market instability as they try to stabilize at lower growth rates than in recent years; and the Eurozone dealing with economic stagnation which has fueled social and now political disenchantment which bodes poorly for future investment prospects. Where this all ends up in 2015 is hard to guess, but it would be easy to see some extreme volatility if even one of these economies jumps the tracks.

Meanwhile, the Supreme Court is back in session and they are handing down rulings. Today, the Supremes ruled that warehouse workers who fill orders for retail giant Amazon don’t have to be paid for time spent waiting to pass through security checks at the end of their shifts. The unanimous decision is a victory for the growing number of retailers and other companies that routinely screen workers to prevent employee theft. The justices said federal law does not require companies to pay employees for the extra time because it is unrelated to their primary job duties. Writing for the court, Justice Clarence Thomas said the screenings are not the “principal activity” which the workers are employed to perform.

And that brings us to today’s edition of “Banks Behaving Badly”. Federal prosecutors in Manhattan have sued Deutsche Bank, claiming that the bank owes the United States government about $190 million in unpaid taxes, penalties and interest. Prosecutors contend the tax liability stems from a transaction that Deutsche Bank undertook 14 years ago. The bank had acquired a company that held shares of Bristol Myers Squibb, and when the bank sold those shares, they made a profit of about $100 million. Prosecutors say they did not pay tax on the gain. Deutsche Bank claims they made a deal with the IRS in 2009 and paid to settle. The bank did not release the payment to the IRS, but insiders are saying it was $6 million. Prosecutors say the bank used shell companies to artificially inflate the cost basis of the stock so it did not owe any capital gains on the appreciation.

Citigroup will record $2.7 billion in litigation expenses and another $800 million in repositioning charges in the fourth quarter, leaving the bank with a small profit for the quarter. The $800 million in repositioning charges is an interesting way to say they will be firing more workers and close branches. The legal costs stemmed from government investigations into possible manipulation of foreign exchange markets, rigging Libor interest rates, and violating money laundering rules. That’s right, Citi is a repeat offender.

Citigroup adjusted its third-quarter earnings lower on Oct. 30, two weeks after the numbers were initially reported. The company added a $600 million legal charge that it attributed to “rapidly evolving regulatory inquiries and investigations.” Last month the bank agreed to pay $1 billion to settle a probe into currency manipulation with three regulators in the US and the UK. Michael Corbat was named CEO of Citi 26 months ago. Under Corbat’s tenure, the bank has reported earnings of $21.8 billion over 8 quarters. In the past 26 months, Citigroup has had legal expenses and repositioning charges totaling $13.3 billion, or more than half the banks’ earnings.

The Brute Economic Power of Oil

Financial Review with Sinclair Noe — September 12, 2014

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, July 31, 2014 - Ugly Day, Ugly Logic

Financial Review with Sinclair Noe

DOW – 317 = 16,563
SPX – 39 = 1930
NAS – 93 = 4369
10 YR YLD un = 2.55%
OIL – 2.12 = 98.15
GOLD – 14.00 = 1281.50
SILV - .23 = 20.48

Well, this was just ugly. The worst day for the Dow Industrial Average in about 4 months. Back on April 10^th, the Dow dropped 267 points; that same day, the S&P 500 was down 30 points. Today wiped out the gains from July, with July marking the first negative month for the Dow and the S&P since January.

The S&P is still up about 5% for the year to date, but the Dow started the year at 16,576. All those record highs for 2014 have just been washed away. That’s how it goes; the markets scratch and claw, higher and higher, inch by inch it’s a cinch, until the cinch breaks. A couple of weeks ago, we talked about shorting, and the advantage of shorting is that the moves can be quick and severe. Sure enough. And while this might just be one bad day, long overdue, the Dow dropped below its 50 day moving average, which is one of the major measurements of a trend.

So, the question is why did the stock market nosedive today? One recurring theme I’ve been hearing is that traders are afraid the Fed will pull away the punchbowl. Yesterday’s GDP report showing better than expected 4% growth in the second quarter combined with today’s employment cost index, which rose 0.7% in the second quarter, made people nervous about the prospect of an improving economy and the possibility of wages pushing inflation higher.

Now wait just a minute; that doesn’t sound so bad; the economy is expanding at a 4% pace which is certainly better than a contracting economy which we saw in the first quarter; and workers are being paid a little more – not much just a little - and that’s certainly better than watching the middle class shrink into oblivion. If you look at this explanation for the market decline, it is an example of perverse logic, where the stock market traders are in opposition to economic prosperity and are only happy in the face of hardship; other people’s hardship, not their own.

There might be something to that interpretation. Beginning in 2008, the Fed cranked up a series of programs to stimulate the economy. Of course, the Fed didn’t really stimulate the economy but they did stimulate certain financial sectors, such as housing, and very clearly the stock and bond markets. During that time, the Fed added over $3.5 trillion to their balance sheet, which now holds nearly $4.5 trillion. The basic mechanics were that the US government borrowed money by selling Treasuries, and the Fed bought a large portion of those Treasuries with freshly printed money. Since 2013 the Fed’s balance sheet has grown even faster than government debt, which has leveled off, almost. Overlay a chart of the S&P 500 with a chart of the Fed’s balance sheet; the similarities are more than coincidental. A big chunk of the money the Fed was printing sloshed over into the stock market. When the Fed stops printing all that money, who is left to buy stocks?

The accumulated “surplus” of printed money will only last a couple of months. Sooner or later (probably sooner), the stock market will start to feel the pain of this monetary tightening. Of course the Fed isn’t really exiting the money printing business. They won’t sell off the assets held on their balance sheet; they will let those treasuries and mortgage backed securities mature and expire, maybe even roll over a few. And government debt hasn’t disappeared, so the Fed will continue printing money. We don’t know how the Fed taper and eventual increases in interest rates will turn out; neither does the Fed know. It’s a big experiment; the Fed might throw a curveball or two along the way; the stock market traders might throw a tantrum, knocking down your IRA in the process. The recurring theme today was that the Fed might pull away the punchbowl; the Fed hasn’t actually done that; they said this week they would not do that anytime soon. There has been considerable consideration given to a Fed exiting. Imagine when they actually do it.

The big institutional traders may already be headed for the doors. Last week, investors added $379 million into equity mutual funds, the kind that’s popular with retail investors. At the same time, exchange-traded funds focusing on equities; the kind of securities traded by institutional investors because of their liquidity and lower cost, saw a whopping $7.97 billion in outflows. That’s the biggest outflow seen since February.

Anyway, the Wall Street traders’ logic is flawed; the 4% growth in second quarter GDP really isn’t as good as it seems. The 4% growth implies the economy is on a very slow growth path when averaged in with the -2.1 contraction in the first quarter. Taken together, the economy grew at less than a 1.0% annual rate in the first half of 2014. That is hardly cause for celebration on Main Street or trepidation on Wall Street. Also, the strong growth in the second quarter was in direct response to the weak growth in the first quarter. Inventory growth was very weak in the first quarter, subtracting 1.16% points from the quarter's growth, and so a reversion to the mean, or a return to a more normal pace of inventory accumulation in the second quarter was a strong boost to growth, adding 1.66 percentage points. Final sales grew at just a 2.3% annual rate in the second quarter. Even that rate was likely inflated to some extent by the weakness from the first quarter.

But that wasn’t the only demon plaguing the stock market today. If it’s not one thing, it’s another. And there have been a lot of other things.

The bond market has its own demons. Fitch warns a jump in US high-yield default rates looms. There have been 10 LBO related bond defaults thus far in 2014, compared with nine for all of 2013. While most sectors remain relatively calm, the utilities and chemicals sectors are seeing huge spikes in defaults. Since the Fed pushed rates down near zero people have been chasing yield and that means the high yield market has become crowded, and that means the yield on risky debt has dipped to a little less than 6% on average, compared to a more typical yield of a little less than 9% for junk  debt. If or when the Fed starts targeting higher rates, who will be looking for the junk with the not so high yield? A reversion to the mean would result in big capital losses, and it could turn ugly if people start running for the exits and can’t find a bid.

And then we can’t forget the geopolitical problems of the world. A negative July in stocks was matched by a negative July in Ukraine, and Israel, and Gaza, and Iraq, and Syria, and Libya. Toss in sanctions on Russia, which will also hurt the European Union.  And then late yesterday, Argentina put a cherry on top.

Argentina has defaulted, or as S&P described it, a “selective default”. A quick recap: In 2001 Argentina defaulted on its debt and it forced most of its creditors to take a haircut, that is a lot less money than the face value of the bonds. After the default, Paul Singer, a hedge fund manager of NML Capital, bought a lot of the bonds at a big discount, pennies on the dollar, and then demanded the bonds be paid in full. Argentina refused to pay the vulture hedge funds. So Singer took his case to the courts – not in Argentina, but in the US. The case was heard by a judge who didn’t really understand all the fancy talk about bonds, and so he ruled against Argentina. About a month ago, the US Supreme Court said they would not interfere. So now, Argentina can’t pay off the bondholders who accepted the discount, unless they also pay off the hedge fund vultures who demand full payment; which basically negates the whole idea of the default in the first place. So, the US courts have essentially told the sovereign country of Argentina that it is more important to pay off the hedge funds, than it is to default and reboot the Argentine economy on a fresh start.

While Singer’s firm has yet to collect any money from Argentina, some debt market experts say that the battle may already have shifted the balance of power toward creditors in the enormous debt markets that countries regularly tap to fund their deficits. Countries in crisis may now find it harder to gain relief from creditors after defaulting on their debt.

The big question, however, is whether Argentina will ever pay Singer and his vulture fund fellows what it wants. If the firm fails to collect, that would underscore the limits of its legal strategy. There is no international bankruptcy court for sovereign debt that can help resolve the matter. Argentina may use the next few months to try to devise ways to evade the US courts. In dire economic crises countries need to be able to slash their debt loads. The idea is similar to bankruptcy for individuals, a chance to restructure debts and start fresh because we long ago learned that throwing people in prison for the debts didn’t help anybody. The legal victories of the holdouts may embolden creditors to drive harder bargains after future defaults, which in turn could prolong or postpone debt restructurings and extend the economic misery of over-indebted countries. So, the problem in Argentina is not unique to Argentina, it affects the global economic system, we just don’t know to what extent.

Wednesday, July 30, 2014 - GDP, Fed, Vultures, and Banksters

Financial Review with Sinclair Noe

DOW – 31 = 16,880
SPX + 0.12 = 1970
NAS + 20 = 4462
10 YR YLD + .09 = 2.55%
OIL - .72 = 100.25
GOLD – 4.30 = 1295.50
SILV + .06 = 20.72

Last week we told you that this week would be very busy. Well, here we are; today we had a big report on second quarter GDP and the Fed wrapped up a policy session, and that’s just the beginning. 

This morning, the Commerce Department reported the gross domestic product grew at a 4% pace in the second quarter. Boom. First quarter GDP was revised from negative 2.9% to negative 2.1%; but any way you look at it, this was a massive turnaround.

The government also published revisions to prior GDP data going back to 1999, which showed the economy performing much stronger in the second half of 2013, growing at a 4% pace, the strongest 6 months since late 2003. This was the first estimate of second quarter GDP, and the first revision will be released August 28.

Inventories added 1.66 percentage points to this GDP report. Stockpiles were rebuilt at a $93.4 billion annualized pace after a $35.2 billion gain in the first three months of the year. That could mean companies will keep tighter control on the number of goods on hand this quarter, which could cut into economic growth. Or it might mean companies are optimistic about sales.

Consumer spending rose at a 2.5% pace last quarter, which also topped expectations, and more than double the 1.2% advance in the first quarter of 2014, in part due to less spending on healthcare. Purchases of durable goods, including autos, furniture and appliances and recreational vehicles, jumped at a 14% annualized rate, the fastest since the third quarter of 2009. Despite the pick-up in consumer spending, Americans saved more in the second quarter. The saving rate increased to 5.3% from 4.9% in the first quarter as incomes rose, which bodes well for future spending.

Corporate spending on structures, equipment and intellectual property such as software increased at a 5.5% annualized rate after rising at a 1.6% pace in the prior three months. In addition to consumer spending and business investment, growth got a boost from the biggest gain in state and local government expenditures in five years. Congress is still debating spending for infrastructure improvements such as roads and bridges, and if they can’t work out differences that could prove a stumbling block later in the year. A widening trade gap subtracted 0.6% from growth. Excluding inventories and trade, so-called final sales to domestic purchasers climbed at a 2.8% rate, the biggest increase since the third quarter of 2011.

Still, the big swing from negative 2.1% contraction to positive 4% growth seems like a very big swing, almost freakish. We know that the first quarter was hit by bad weather and the polar vortex …, still. So, we can smooth out the numbers by looking at the full year growth rate; over the past 12 months the economy expanded at a 2.4% rate, pretty much in line with the past 3 years; in fact, 2.4% growth would be decent in normal times, but the economy is still in recovery mode, and 2.4% is not enough to achieve “liftoff”. The economy is headed in the right direction, it is gathering momentum, but it is still operating below potential. By the Congressional Budget Office’s estimates, the level of output reported for the second quarter is still $770 billion below the nation’s current economic potential, or 4.2% below. That implies that the nation still has plenty of room to grow if a faster expansion ever kicks in.

The economy is far from perfect, we have a long way to go, but today’s report indicates progress, real, honest to goodness progress.

A price index in the GDP report rose at a 2.3% rate in the second quarter, the quickest in three years, after advancing at a 1.4% pace in the prior period. A core price measure that strips out food and energy costs increased at a 2.0% pace, the fastest since the first quarter of 2012. The inflation picture should lend support to the Fed hawks who want to hike interest rates sooner rather than later, but for now the Fed is standing pat.

The Federal Reserve Federal Open Market Committee reaffirmed it was in  no rush to raise interest rates, even as it upgraded its assessment of the economy and expressed a level of comfort that inflation was moving up closer to its target, and the taper is  still on track. The Fed has kept overnight rates near zero since December 2008 and has more than quadrupled its balance sheet to $4.4 trillion through a series of bond purchase programs. The Fed announced, as expected, that it would reduce its monthly bond purchases to $25 billion per month, but it gave no indication that recent signs of stronger economic growth had changed its previously announced plan to hold short-term interest rates near zero well into 2015.

The Fed acknowledged both faster economic growth and a decline in the unemployment rate, but expressed concern about remaining slack in the labor market. The Fed’s statement said: "Labor market conditions improved, with the unemployment rate declining further… However, a range of labor market indicators suggests that there remains significant underutilization of labor resources."

Some Fed officials see evidence that the economy is settling into a pattern of slower growth, and that monetary policy has substantially exhausted its power to improve the situation. They want the Fed to retreat more quickly from its stimulus campaign, fearing higher inflation, or that it will encourage bubbles in financial assets. Fed chairperson, Janet Yellen, and her allies have taken a more cautious view, arguing that the decline in the unemployment rate appears to overstate the improvement in the labor market, because it counts only people who are looking for work. Yellen expects some people who had been discouraged about their job prospects will return to the labor force as the economy continues to improve, and she has pointed to weak wage growth as evidence that it remains easy to find workers.

More optimism for the economy came in a report from ADP, the payroll processing company; private employers added 218,000 jobs last month, which was down from 281,000 in June. It was the fourth straight month of job gains above 200,000. While ADP’s numbers offered reason to be hopeful, the company’s figures cover only private businesses and often do not track with the government’s jobs report, which will be released Friday.

The ratings agency Standard & Poor’s says Argentina has defaulted after it failed to make a $539 million interest payment due on its discount bonds. The downgrade came late this afternoon as representatives for Argentina and New York hedge funds sought to reach a last-minute agreement on Argentina’s debt. Yet after more than five hours of mediated talks, neither side appeared closer to a deal. Standard & Poor’s lowered its rating on the country’s debt to “selective default”, noting that Argentina had a 30-day grace period following the June 30 scheduled interest payment date to make payment.

This story goes back to 2001, when Argentina defaulted on tens of billions of dollars of sovereign bonds. It later exchanged those bonds for discounted ones with most of its bondholders, but a small group of traders, mainly hedge funds, led by Paul Singer’s Elliott Management refused to take the new bonds, even though they had purchased the discounted bonds after the default, at pennies on the dollar, they demanded full payment, and they have not backed down, and they took it to court in the US.

In 2012 a US federal judge ruled that Argentina could not make payments to bondholders who had agreed to discounted bonds, without paying the holdouts. Argentina appealed and took its case to the United States Supreme Court, which rejected the appeal last month. Argentina had until the end of the day to pay the holdouts or risk defaulting for a second time in 13 years.

A federal judge has ordered Bank of America’s Countrywide unit to pay $1.27 billion in penalties for defective mortgage loans sold to Fannie Mae and Freddie Mac in 2008. US District Judge Jed Rakoff in Manhattan issued the civil penalty against BofA in the first mortgage-fraud case brought by the federal government to go to trial. A jury in Manhattan found Countrywide liable. The judge determined that Fannie and Freddie had paid Countrywide nearly $3 billion for HSSL loans, but determined that 57% of the loans were of acceptable quality. HSSL refers to a Countrywide loan program called the High Speed Swim Lane, which fast-tracked almost any loan; it was also known as a “Hustle” loan.

In today’s decision, Judge Rakoff wrote: “While the HSSL process lasted only nine months, it was from start to finish the vehicle for a brazen fraud by the defendants, driven by hunger for profits and oblivious to the harms thereby visited, not just on the immediate victims but also on the financial system as a whole.”

Separately, Bank of America is reportedly nearing a settlement with the Justice Department to resolve an investigation into its sale of mortgage backed bonds centered on faulty loans the company inherited from Countrywide and Merrill Lynch, which it purchased in 2008. The discussions include how much money will be paid in cash and how much in consumer relief. Potential terms have ranged from $13 billion to $17 billion. The DOJ has been trying to work out a settlement for some time, and was reportedly dissatisfied with a $13 billion deal that included $5 billion in consumer relief. The consumer relief portion of these settlements has typically been an easy out for the banks. The amount of any settlement would come on top of the $9.5 billion the bank agreed to pay in March to resolve Federal Housing Finance Agency claims.