Financial Review

Thus Spake Yellen

Sinclair Noe — October 14, 2016

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DOW + 39 = 18,138
SPX + 0.43 = 2132
NAS + 0.83 = 5214
10 Y + .03 = 1.77%
OIL – .11 = 50.33
GOLD – 7.30 = 1251.50

Sales at US retail stores rebounded in September, with auto dealers and gas stations racking up the biggest gains. Retail sales rose 0.6% last month to snap back from a small decline in August that was the first in five months.

In September, receipts at auto dealers increased 1.1%. Still, auto dealers relied on sharply higher discounts to lure buyers, as demand for new cars and trucks appears to be leveling off after a years-long boom in sales. Auto purchases account for about one-fifth of all retail spending.

Sales at gas stations climbed a seasonally adjusted 2.4%. We weren’t buying more gas, just paying more.

Department stores suffered a 0.7 percent sales decline in September, part of a long-term slowdown for the anchor tenants at many shopping malls that increasingly must compete with online outlets. But even online sales were soft. They rose a mere 0.3 percent in September, compared with recent monthly gains averaging nearly 1 percent.

The University of Michigan Consumer Sentiment Index dropped to 87.9 from 91.2 in early October. Blame the presidential election. The sub-index of consumer expectations fell to 76.6, its lowest level in two years, mostly from households with incomes lower than $75,000. The index of current economic conditions ticked up to 105.5 from 104.2 last month. In other words, people think things are pretty good now, but they will surely get worse.

By the way, this idea that consumer sentiment is down because of the presidential election – there may be something to it. The American Psychological Association, which is the largest psychological organization in the US, conducted their annual “Stress in America” survey and found that tension regarding the upcoming presidential election is exceedingly high. Fifty-two percent of over 3,500 adults surveyed said they felt stressed by all the politicking and campaigning leading up to the approaching election. It doesn’t matter if you are Democrat or Republican, the election is driving us crazy.

Producer prices rose again in September as wholesale inflation keeps creeping higher. The producer price index advanced 0.3% last month. Energy prices rose 2.5%. But even if you strip out volatile food and energy costs, the core rate also advanced 0.3%, indicating that food costs partly offset higher energy costs and inflation is creeping into the broader economy.

American businesses increased inventories by a modest 0.2% in August as they continue to work down an excessive build up last year. Business sales also increased by 0.2% in the same month. Companies have scaled back production in many areas such as manufacturing to bring inventories back in line, and that’s been a drag on the U.S. economy in the first half of 2016.

The U.S. Treasury has issued final inversion amendment rules in its effort to tackle “earnings stripping” – a tax-reduction technique employed by multinationals. In an inversion, a U.S. company moves its legal address abroad in order to pay lower taxes. Under earnings stripping, a foreign parent company lends money to its U.S. operation, and the interest is then deducted. The rules were initially proposed in April. The final regulations contain some exceptions to the initial proposal, including for certain entities where the risk of earnings stripping is low.

Earlier this week, the Fed released minutes of the September FOMC policy meeting; which we know was a split decision not to raise rates. Boston Fed President Eric Rosengren, one of the hawks, this morning said that he expects the unemployment rate to decline to 4.5% next year, an unsustainable level that may force the Fed to act. This afternoon, Fed chair Janet Yellen spoke at a Boston Fed conference. Yellen said she thinks it might be possible to temporarily run a “high-pressure economy, with robust aggregate demand and a tight labor market.”

Yellen made no mention of when the Fed might raise rates but she did question some of the most fundamental principles of economics, including the nature of inflation and the influence of financial markets. Among the questions raised were whether the severe downturn could erode the skills of the nation’s workforce, impeding future growth.

Yellen also suggested that changes in spending and behavior among some groups could have outsize effects on the health of the broader economy — a nuance that current mathematical models may not capture well.

Central bank officials are debating the best strategy for approaching such a slow recovery. Yellen said today, “If strong economic conditions can partially reverse supply-side damage after it has occurred, then policymakers may want to aim at being more accommodative during recoveries than would be called for under the traditional view that supply is largely independent of demand.”

It sounds like Yellen is a little confounded and annoyed by the sluggishness of the economy, and is willing to test the dovish boundaries of monetary policy and maybe even err on the side of overshooting the recovery.

Before the opening bell, we saw earnings reports from JPMorgan, Citigroup, and Wells Fargo. JPMorgan Chase reported a profit of $6.2 billion, or $1.58 a share. That compares with a profit of $6.8 billion, or $1.68 a share, in the same period of 2015. Revenue rose 8.4% to $25.5 billion. Analysts had expected $24 billion. Earnings and revenue beat estimates. The bank had record earnings in commercial banking and record loan balances in asset management.

JPMorgan is conducting a “deep dive” into the cross-selling of retail products; you know, the kind of stuff that landed Wells Fargo in hot water for opening bogus accounts. JPMorgan’s self-investigation has revealed a few instances; they say they can’t have “zero defects” but claim they do not have systemic problems. Quite a claim from a business that has paid more than $27 billion dollars in fines and legal costs over the past 5 years.

Citigroup said third-quarter profit and revenue were down, but results were still better than what analysts had predicted. Citi reported a profit of $3.8 billion, or $1.24 a share. That compares with the $4.2 billion, or $1.35 a share, it reported in the same period of 2015. Revenue was down to $17.7 billion from $18.6 billion a year ago. Trading revenue rose 16%. Investment banking revenue was up 15%.

Wells Fargo said its third-quarter profit fell to $5.6 billion, or $1.03 a share. That compares with $5.8 billion, or $1.05 a share, in the same period of 2015. Revenue rose to $22.3 billion. Both earnings and revenue topped estimates. The bank faces a raft of federal and state investigations. The earnings presentation addressed the fraudulent account openings in detail. Compared to August, consumers decided to apply for 30% fewer credit cards. And compared to last September, 25% fewer.

Consumer checking accounts also took a big fall. Year-over-year, the bank saw 25% fewer checking accounts opened and a whopping 30% fewer in comparison to August. And that’s just the beginning. We’ll probably learn more when fourth quarter earnings are announced in January. We did not learn how many customers have left the bank.

Wells Fargo said it is looking into how customers’ credit scores may have been affected by the 565,000 unwanted credit cards, and that it’s working with credit bureaus to expunge the fraudulent files and restore credit, or furnish the card connected to the account for the people who decided to keep their cards. In addition to that, the San Francisco-based bank will be looking into the indirect and more costly consequences of how the new accounts impacted consumers’ credit scores – for example, the effect it might have on a loan’s interest rate.

It will take more than the retirement of Wells Fargo CEO John Stumpf to make California State Treasurer John Chiang change his mind about doing business with the bank again. Chiang said, “We are beyond the point of tweaking. We want to see fundamental reform of Wells Fargo before we make a decision.” In September, the state suspended its relationship with the lender after it was accused of defrauding customers.

Today, Ohio jumped on the bandwagon, announcing that the Ohio state government will ban all business with Wells Fargo for 12 months. This will include using Wells Fargo to issue debt or bid for financial-services contracts. The decision applies to state agencies.

Verizon says Yahoo’s hack could have “material” impact on their planned acquisition. “If they believe that it’s not, then they’ll need to show us that,” so says Verizon general counsel Craig Silliman. Verizon agreed to buy Yahoo’s core assets for $4.8 billion in July, but the deal has yet to close.

Meanwhile, Twitter can’t find a bid. Salesforce will not put in an offer for the company. Salesforce was the last remaining bidder for Twitter after Disney and Google lost interest last week.

Tech giants including AMD, Dell/EMC, Google, Mellanox, Micron, Nvidia and Xilinx have joined forces to give Intel a good kick in the datacenters. The group has come up with an open specification, dubbed OpenCAPI, which can boost server performance by up to 10x. Effectively, they are moving away from PCIe – the current industry standard – to something that is both more open and vastly more powerful.

FINANCIAL REVIEW

War, Inversions, and Climate

Sinclair Noe — September 23, 2014

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Financial Review

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

DOW – 116 = 17,055
SPX – 11 = 1982
NA – 19 = 4508
10 YR YLD – .03 = 2.53%
OIL + .06 = 91.62
GOLD + 8.10 = 1223.90
SILV + .05 = 17.88

First up: war. You’ve probably heard by now that the US launched several airstrikes against ISIS targets inside Syria and, separately, in potentially averting an imminent threat to the homeland from an al Qaeda group called Khorasan. Many of the targets were in and around Raqqa, Syria, believed to be an ISIS stronghold. Several Arab nations took part in the US-led operation: Jordan, Saudi Arabia, Bahrain, Qatar and the United Arab Emirates. A spokesman for the Pentagon said they are still assessing the effectiveness of the bombing campaign but the Pentagon believes they were “successful in hitting what we were aiming at.”

The airstrikes against Khorasan was in response to threats, however officials so far have provided no details about the terrorists’ planned attack or the credibility of the intelligence they had on it. A Pentagon spokesman said “the individuals plotting and planning it were eliminated.”

The Syrian government says the US told it of plans to carry out airstrikes. The State Department immediately denied that it gave prior notification. Reuters reports Iranian officials were informed of the airstrikes in advance, but not specific targets. Meanwhile, the Israeli military said that it had shot down a Syrian fighter jet that had “infiltrated into Israeli airspace,” the first such incident in at least a quarter of a century. It is thought that the jet wandered into Israeli airspace accidentally. Maybe, but it also illustrates the possibility of unintended entanglements coming out of the conflict.

In economic news: manufacturing activity is near a 4-1/2 year high in September and factory employment is up, but housing prices were sluggish in July.

Financial data firm Markit said its preliminary or “flash” factory purchasing managers index came in at 57.9, unchanged from August when it touched its highest level since April 2010. A reading above 50 indicates expansion. Manufacturing activity in the third quarter was the strongest since Markit started tracking it in mid-2007. Factory jobs rose for a second straight month, and new orders held steady above 60 for the third time in the last 4 months.

The Federal Reserve Bank of Philadelphia said its new general activity index for non-manufacturing firms in the mid-Atlantic region jumped sharply. The increase in activity reflected more new orders, sales and full-time hiring. Service sector employees also worked longer hours, while firms increased their capital spending.

The Federal Housing Finance Agency said home prices increased 0.1% in July, and 4.4% in the 12 months through July, the smallest gain since September 2012.

Further data showed euro zone business activity in September was the weakest this year, while factory activity in China picked up only slightly.

The Treasury Department today announced new rules to crack down on corporate tax inversions. The idea behind inversions is that a US business merges with or is acquired by a foreign company in a country with a lower tax rate; by redomiciling, or moving their headquarters to the lower tax rate country, they can lower their tax bill, even if they keep most of their business in the US. Obama applauded the Treasury for taking steps to reverse the trend of companies seeking to “exploit this loophole” to avoid paying their fair share in taxes. Yet he said he was still calling on Congress to pursue broader tax reform that would reduce the corporate tax rate, close loopholes and make the tax code simpler.

The new rules will mean little for companies that have already inverted, but for at least 10 companies in the midst of completing such deals, and for those considering inversions, the impact will be significant. Most pending deals could become more costly for the buyers, such as AbbVie, and its $54 billion deal to acquire Ireland’s Shire, as well as Medtronic and its $42 billion takeover of Covidien. Neither of these transactions, the biggest of the year, was expected to fall apart completely, partly because paying a break-up fee to walk away would likely be even more costly. AbbVie would have to pay Shire a $1.6 billion penalty if it were to renege on their merger agreement. Medtronic has a contract that lets it or Covidien walk away from their deal if the US Congress changes tax law. The Treasury’s new rules fall short of that, so a break-up fee likely would loom in this case, too, if the merger were called off. Burger King said it will proceed with its $11 billion deal with Canada’s Tim Hortons, stressing that the transaction was not about tax benefits.

There are also some new rules unveiled by the Treasury today, and some of these tax evasion schemes have names that sound like they came right off the playground. One rule will prevent inverted companies from using “hopscotch” loans that allow them to avoid dividend taxes when tapping tax-deferred foreign profits. Another rule will bar inverters from gaining access to offshore profits by using “decontrolling” strategies that restructure foreign units so they are no longer US-controlled. The Treasury is also tightening limits on the levels of ownership that the former US investors can have in an inverted company for it to qualify for foreign tax treatment under US law, a move that will make it harder to do the deals. And then there’s the “spinversion” which is a partial inversion where the US company transfers some of its assets to a newly formed foreign corporation. That corporation is then spun off to public shareholders. New rules would treat the spun-off company as a domestic corporation.

Ultimately, this is an issue that will require legislative action, but for now, it will be more difficult for companies to skip out on their tax obligations by moving offshore; more difficult but not impossible. I suspect there are a lot of tax attorneys working overtime today.

The United Nations Climate Summit kicked off today in New York. The summit was convened to lay the groundwork for nations to sign a binding emissions treaty late next year during climate negotiations in Paris. In speeches delivered at the summit, diplomats from 120 countries laid out a series of new, nonbinding climate commitments. Here is an overview of what world leaders have pledged so far: President Obama delivered an address at the summit this afternoon where he announced an executive order requiring federal agencies to take climate change into account when doling out dollars for international aid and investment abroad. The US has previously pledged to curb emissions 17% from 2005 levels by 2020.

The EU unveiled a new commitment to slash greenhouse-gas emissions 40% from 1990 levels by 2030. British Prime Minister David Cameron said that the U.K. is on track to cut emissions by 80% by 2050. Cameron did not, however, announce any new targets not already agreed to by the country. China’s Vice Premier repeated China’s previously stated goal of cutting carbon emissions by 40 to 45% from 2005 levels by 2020. Iceland said that it aims to power its economy entirely with clean energy, but did not set a date. Mexico announced that it aims to generate more than one third of its electricity from zero-emissions sources by 2018. Costa Rica will be powered purely from clean energy by 2016. And a whole bunch of countries pledged hundreds of million to the Green Climate Fund.

Sounds familiar, right? But maybe this time will be different, and the reason is because this time it might actually pay to go green. All things considered, the cost of curbing carbon emissions may be considerably cheaper than earlier estimates had suggested. For all the fears that climate change mitigation would put the brakes on growth, it might actually enhance it.

Last week, an international commission published the “New Climate Economy” report concludes that efficient investments could deliver at least half of the emission cuts needed by 2030 to keep global temperatures in check. And they could do so while delivering extra economic gains on the side. Side benefits include things like lower health costs.

And it looks like corporations are getting on the climate change bandwagon. Tim Cook, CEO of Apple was in New York, and he said: “The long-term consequences of not addressing climate are huge,” he said. “I don’t think anyone can overstate that.” Google executive chairman Eric Schmidt announced Google would stop funding the American Legislative Exchange Council, or ALEC, claiming the Council had been “literally lying” about the reality of climate change. Schmidt said: “The company has a very strong view that we should make decisions in politics based on facts — what a shock,” said Schmidt. “And the facts of climate change are not in question anymore. Everyone understands climate change is occurring and the people who oppose it are really hurting our children and our grandchildren and making the world a much worse place. And so we should not be aligned with such people — they’re just, they’re just literally lying.”

The basics of climate change have been understood for a long time, don’t seem to be budging much and yet remain challenged by many non-specialists. What’s significant then, in such a public debate, is who acknowledges those basics, as much as what is said. That’s why it was news when former Treasury Secretary Hank Paulson called for a carbon tax, when the Rockefellers, the first family of oil pulled out of oil sands or, the head of the world’s largest company by market cap endorses a brand new climate and business initiative by showing up and saying absolutely anything at all. Tim Cook also challenged the still-common fallacy that good business and environmentalism are mutually exclusive. “Too many people believe you can do this or that,” he said. “If you innovate and you set the bar high you will find a way to do both.”

The World Bank yesterday released a list of 73 countries and more than 1,000 companies that support a price on carbon dioxide pollution. Apple, which now powers 73% of its facilities with renewable energy and has raised its environmental profile, was not among the signatories.

Monday, August 25, 2014 - Tax Weasels

Financial Review with Sinclair Noe

DOW + 75 = 17,076
SPX + 9 = 1997.92 (record)
NAS + 18 = 4557
10 YR YLD - .02 = 2.38%
OIL - .27 = 93.38
GOLD – 4.60 = 1277.20
SILV - .05 = 19.45

The S&P 500 crossed above 2000 intraday, closing off the high for the day, but still closing in record territory. We recognize it but we don’t have a big celebration. It’s just a number, a nice big round number. For reference, the S&P 500 topped 1,000 back in February 1998.

Economic data today includes:

Sales of new single family homes dropped for a second month in June. New home sales slipped 2.4%, but data from the past 3 months was revised to show 33,000 more new homes were sold than previously reported. The median sales price increased 2.9% from a year ago. At July’s sales pace it would take 6.0 months to clear the supply of houses on the market, the highest since October 2011. Tomorrow, we’ll see the latest data on existing home sales from S&P/Case-Shiller.

Separately, financial data firm Markit said its preliminary services Purchasing Managers Index dipped to 58.5 this month from 60.8 in July.A reading above 50 indicates expansion.

Last Friday ECB President Mario Draghi delivered the luncheon speech at the Jackson Hole Symposium; Draghi said the ECB had done all it could for now and the governments of the EU needed to step up. Today a survey was published from the National Association for Business Economics and the conclusions show most economists surveyed think the Federal Reserve’s monetary policy is on track but the US needs to enact structural policies in order to stimulate stronger economic growth.  The Fed’s expansionary monetary policy has been at odds with a sharply restrictive fiscal stance that saw budget deficits declining from 11% of GDP in 2009 to less than 3% this year.

Economists overwhelmingly expect the Federal Reserve to hold off raising short-term interest rates until at least 2015. But nearly a third say doing so would mean the central bank waited too long. While many economists appear at ease with the “steady-as-she-goes perspective” from the Fed, “almost 40% say the stimulus policies are no longer necessary and should be curtailed or sunset.” On other topics, business economists say immigration reform is one of their top priorities, and the US needs to let more immigrants in. Meanwhile, the economists surveyed support the idea of lifting the ban on exports of US-produced crude oil and nat gas. The industry is pushing for the right to export more fuel overseas to ease the threat of overproduction, a move that could also help reduce the US trade deficit. The White House moved this summer to loosen restrictions on crude exports, but an outright end to the ban faces higher hurdles, and would require Congressional approval.

A new academic paper from economists from the University of Chicago and the University of Maryland suggest the weakness in employment is not just a result of the Great Recession, but a longer-term structural change in the economy; the share of Americans with jobs has declined because the labor market has stagnated in recent decades; fewer startups creating new jobs; fewer people losing or leaving jobs, fewer people landing new ones. This suggests the US has been headed to higher unemployment even before the financial crisis, and even if we add jobs, we still have problems that can’t be overcome by Federal Reserve monetary policy alone. The paper says that a 1 percentage point decline in the churning of the labor market lowers the employment rate by 0.77 of a percentage point, a huge effect.

It’s Monday, and so we have some mergers to cover. The Swiss drug maker Roche agreed to buy InterMune for $8.3 billion. InterMune is based in California; it has one drug called pirfenidone to treat idiopathic pulmonary fibrosis, a fatal scarring of the lungs. It is licensed to sell the drug in Europe, and hopes to get approval in the US later this year. About $87 billion in pharmaceutical acquisitions were made in the first half of this year, eclipsing the total for all of 2013.

If you are Canadian or have ever been to Canada or know Canadians, then you probably know Tim Hortons; it’s a chain of coffee and donut shops; kind of like Starbucks but the coffee is actually good. And it may be the new home of the Whopper. Burger King wants to buy Tim Hortons. If completed, the deal would mean Burger King’s corporate headquarters would move to Canada, where it would qualify for a corporate inversion, with the idea of lowering Burger King’s corporate tax bill. The actual headquarters and the executives go nowhere, but the nominal address changes so the company can avoid US tax rates. Burger King says the deal is not about the taxes, but about the coffee, and the fast food breakfast business. Coffee may be an especially important attraction for Burger King and its majority owner, the Brazilian investment firm 3G Capital. In Tim Hortons, Burger King would be getting a restaurant chain that is essentially synonymous with coffee in Canada. Yea, that’s the reason; it’s the coffee, not the taxes; or maybe they’re trying to create a new donut-burger. Yea, that’s it. They’re just trying to compete with waffle tacos and sausage pancakes.

With the 15% nominal rate in Canada, this is absolutely a move about taxes; rooted in the lie that American corporations pay the highest tax rates in the world, which is not true when you consider the effective rates rather than nominal rates. When it comes to effective rates, what corporations actually pay, the US ranks 17^th out of 27 developed countries. Walgreens recently scrapped an inversion deal because of public blowback. Once one of these brands pulls off an inversion deal without blowback that actually hurts sales, it will be a run for the exits.

There are so many companies trying to weasel out of taxes that the inversion trend is the hot new thing on Wall Street, so hot that JPMorgan is backing a new online broker that has bundled up 25 companies seen as inversion targets. The basket of companies is called the Tax Inversion Targets, or TIT; I am not making this up. Count on JPMorgan to go for the most weasely product and then tack on a bit of tacky.

Late Friday, Goldman Sachs agreed to buy back $3.15 billion in mortgage bonds from Fannie Mae and Freddie Mac to end a lawsuit filed in 2011 by the Federal Housing Finance Agency. The FHFA accused Goldman of dumping low-quality mortgage bonds during the run-up to the financial crisis. Goldman is not paying a penalty, but it is estimated the bonds are worth only about $2 billion today. Last month, lawyers for the FHFA presented evidence showing that Goldman was aware of weakness in the subprime mortgage market but did not pass that info to clients buying subprime bonds, even as Goldman was shorting the bonds. Just to be clear, Goldman was selling the bonds and simultaneously betting the bonds would fail.

AP is reporting that a column of Russian tanks and armored cars crossed into Ukraine’s far southeast, which is away from the fighting that has been taking place. The markets have been worried about a Russian invasion of Ukraine; now it looks like it is happening, and the markets seem to discount it.

ISIS, has been fighting in Iraq, and even though US airstrikes are inflicting damage, they are still entrenched. Meanwhile, they have taken over a key government airbase in Syria. BBC says government forces evacuated the airbase. Syrian state television confirmed that government troops had lost control of the base. The US has not been targeting airstrikes against ISIS in Syria.

Twice in the last seven days, Egypt and the United Arab Emirates have secretly teamed up to launch airstrikes against Islamist-allied militias battling for control of Tripoli, Libya. Responsibility for the airstrikes was initially a mystery. After the first set, several American officials initially said that signs pointed to the United Arab Emirates, but clearly American intelligence was surprised.

Workers are assessing quake damage and starting to clean up after a 6.0 magnitude quake in Napa California; it was the strongest quake in the San Francisco area in 25 years. Approximately 172 people were treated for mainly minor injuries; two people had serious injuries; no deaths have been reported. Several building were badly damaged and a mobile home park caught fire. The biggest economic damage may come to wineries.

Meanwhile, a large 6.9-magnitude earthquake has struck a sparsely populated area of central Peru. There were no immediate reports of damage or injuries, and authorities were still surveying the region.

Hackers again showed how powerful electronic attacks can be when they forced Sony's PlayStation Network and Blizzard's Battle.net offline over the weekend. The same group responsible for shutting down the gaming platforms, which calls itself the Lizard Squad, also claimed credit for sending a bomb threat via Twitter that grounded a plane carrying Sony Online Entertainment president John Smedley. The plane was traveling from Dallas to San Diego but was diverted to Phoenix. No bomb was found.

Earlier this month, the computer systems at 51 UPS stores were found to have been infected with malware that could potentially allow criminals to gain access to consumer data. The FBI says that up to 1,000 retailers could have malicious software on their sales systems, potentially exposing sensitive information to identity theft and financial fraud.

And that raises the question of why companies continue to get hacked? The most probable answer is that corporate executives just don’t want to spend the money on security because they consider it a cost without a financial benefit; at least until after the fact.

And finally, John Sperling has died at the age of 93. Back in 1978, Sperling founded the University of Phoenix. The University of Phoenix has a presence in 38 states and in Puerto Rico, and at one point touted 242,000 students, although that number has significantly dropped. Sperling became a billionaire, and he used his wealth on several philanthropic projects, including research into seawater agriculture and anti-aging medicine. He was also an outspoken critic of the government's war on drugs, advocating for treatment instead of criminalization.