Financial Review

Number 9

Sinclair Noe — July 20, 2016

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

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DOW + 36 = 18,595
SPX + 9 = 2173
NAS + .53 = 5089
10 Y + .03 = 1.59%
OIL + .29 = 44.94
GOLD – 16.40 = 1316.30

The Dow Industrial Average is on a 9-day winning streak; its longest winning streak since March 2013. The Dow and S&P 500 have set multiple record closing highs in recent days. But the Nasdaq remains 3.5 percent away from its record close.

A 9-day winning streak for the Dow has only happened 7 times since 1980. In each of the other six instances, the index has been up the following six months with an average gain of 10.41%. Going back to 1900, a 9-day streak has happened 30 times and the average gain in the following six months has been 5.96%.

The dollar is at a four-month high against a basket of currencies, bolstered by strong economic data and growing expectations the Fed may raise rates before the end of the year. The dollar index is trading above 97, its highest level since March 10. Fed funds futures rates now suggest a 40% chance of a rate hike in December, compared with less than 20% a few weeks ago. Treasuries declined, with the 10-year yield rising three basis points to 1.59 percent. The yield has risen from an all-time low of 1.318 percent

According to Thomson Reuters, 64 percent of S&P 500 companies have topped earnings estimates. That compares to a long-term average of 63 percent over the past 22 years. Even though earnings are expected to be down 5.4% when compared with year ago levels, they are beating diminished expectations and that is apparently good enough to fuel the rally that’s added more than $4.5 trillion to the value of equities worldwide in three weeks.

Morgan Stanley this morning reported better-than-expected quarterly earnings and revenue, aided by the financial giant’s fixed income and investment banking businesses.

After the closing bell yesterday, Microsoft reported adjusted quarterly earnings of 69 cents per share, 11 cents above estimates, with revenue also beating forecasts. The software giant’s key cloud product, Azure, saw revenue grow 102 percent for its fiscal fourth-quarter.

Intel reported quarterly earnings that beat expectations, but revenues for the quarter came in slightly lower than expected. In particular, the company reported revenue from its data center and “Internet of Things” segments that slightly missed expectations. Intel has previously cast these businesses as the primary profit-growth engines for the company.

American Express, the biggest U.S credit-card issuer by purchases, said second-quarter profit rose 37 percent as customers increased spending and the company booked a $1 billion gain from the sale of its Costco portfolio. Revenue declined but still beat estimates.

Volkswagen’s operating profit came to €7.5-billion-euro in the first half of 2016, beating market expectations and pushing its shares higher. Adjusted for one-off costs of €2.2-billion-euro, operating profit still came to €5.3-billion-euro.

Meanwhile, Volkswagen is being sued by a handful of states. Attorneys general from Maryland, Massachusetts, and New York have filed a lawsuit against Volkswagen, Porsche, and Audi, alleging a “cover up” that was “orchestrated and approved at the highest levels of the company.” The lawsuit accuses Volkswagen of skirting emissions standards by installing “defeat devices” since the mid-2000s. Additionally, the suit says that the group “made a knowing decision to violate the law” and that Volkswagen “allegedly destroyed incriminating documents” upon hearing about the investigation.

The Bank of England says Brexit isn’t killing the economy. “As yet, there was no clear evidence of a sharp general slowing in activity,” said the BOE’s July “Agents’ summary of business conditions.” The central bank did suggest, however, that there was still a high degree of uncertainty as businesses are just now attempting to formulate their strategies for a British exit from the European Union. The European Central Bank hold a major policy meeting tomorrow.

The purge led by Turkey’s President Erdogan following Friday’s failed coup continues to widen, with, at last count, nearly 60,000 people detained, fired or dismissed. The Turkish lira is rebounding somewhat this morning after trading within 1 percent of an all-time low overnight. Turkey’s central bank cut its overnight lending rate by a quarter point to 8.75%. Today, Erdogan imposed a three-month state of emergency.

Federal agents in New York have arrested Mark Johnson, HSBC’s global head of foreign exchange cash trading. Johnson is being charged with conspiracy to commit wire fraud involving front-running client orders, according to the complaint. Stuart Scott, HSBC’s head of foreign-exchange cash trading for Europe, was also accused in the complaint, which was unsealed Wednesday in Brooklyn federal court.

HSBC is under criminal investigation in the currency case. More than two-dozen traders have been suspended by their banks in the course of the investigation.  The arrest comes more than a year after five global banks pleaded guilty to charges related to the rigging of currency benchmarks. Also on Tuesday, the U.S. Federal Reserve banned former UBS Group AG trader Matthew Gardiner from the banking industry for life for his role rigging currency benchmarks.

U.S. prosecutors have detailed an alleged scheme of international money laundering and misappropriation from 2009 to 2015. The Justice Department is seeking to seize more than $1 billion worth of assets it says went through U.S. banks from Malaysian development fund 1Malaysia Development Berhad, known as 1MDB, and was ultimately used to illegally acquire assets. More than $3.5 billion traveled a trail of fraud from Malaysia through a web of shell companies, fueling a spending binge on paintings and luxury real estate and even funding a movie (ironically the movie was The Wolf of Wall Street), with at least $700 million flowing back into accounts controlled by Malaysia’s prime minister, Najib Razak.

Along the way, some of the money was handled by international banks including Goldman Sachs, JPMorgan Chase, Standard Chartered and Deutsche Bank. Money was pilfered from the government fund based on false representations made by 1MDB officials and shell companies. Even when bank officials raised questions about the beneficiaries of various accounts, compliance departments were unable to detect or halt the alleged fraud. The Malaysia fund is at the center of several international investigations into alleged corruption and money laundering by public officials. Prosecutors in Singapore, Switzerland, Luxembourg and the U.S. are looking into money flows from the investment vehicle, which was established for national development.

Anheuser-Busch InBev won U.S. antitrust approval for its takeover of SABMiller, after the maker of Budweiser agreed to give up ownership of the Miller brand and open the door to greater competition from craft beers. AB InBev will sell SABMiller’s stake in MillerCoors, separating the two brands. The Justice Department and the Federal Trade Commission have recently killed proposed tie-ups in the cable, office supplies and oil drilling industries, among others. In this case, the companies proposed asset sales from the start that helped resolve antitrust officials’ concerns.

Aetna says it is ready to go to court if necessary to proceed with its $37 billion takeover of Humana. By taking over Humana, Aetna would become the largest player in Medicare Advantage, with about 4.5 million customers. The U.S. has been said to be preparing to sue to block the deal because it would limit options for consumers.

Financial Review

Upside-Down World

Sinclair Noe — February 12, 2015

 

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

DOW + 110 = 17,972
SPX + 19 = 2088
NAS + 56 = 4857
10 YR YLD un 1.98%
OIL + 2.28 = 51.12

A ceasefire between Russia and Ukraine is scheduled to start February 15, which apparently means that Putin’s little green men still have 2 days to grab as much land as they can. The agreement follows a 17 hour, four-way meeting between Russia, Ukraine, France and Germany in Minsk. The new deal revived a failed September ceasefire agreement, with commitments from each side to pull back heavy weapons, as well as greater autonomy for separatist regions in eastern Ukraine. IMF chief Christine Lagarde also announced today that Ukraine will receive about $40B in funding over the next four years.

Along with the new cease-fire agreement, that won’t actually end the fighting; there was a non-agreement agreement between Eurozone finance ministers to put off decisions on Greece’s bailout terms until next week. Greek officials were unable to reach a deal over its bailout program yesterday, but will return to Brussels on Monday to try to end the deadlock.

Meanwhile, Sweden’s central bank cut its main interest rate into negative territory and announced a bond-buying program this morning. Sweden now joins Denmark and Switzerland and the European Central Bank in negative rate land. So, now, if you want to make a deposit in Sweden, you have to pay. The reason is lowflation, which is another name for mild deflation. Countries around the world are seeing a sharp slowdown in price growth. In fact, much of Europe is in outright deflation right now, including Sweden if you go by its headline national consumer price index.

Falling prices are great if you are planning to buy something as an individual consumer, but it is problematic for countries or continents. Consumers put off purchases because hey, the price will be cheaper next week. So, nothing gets sold this week. Rinse, lather, repeat next week. Suddenly, there is no economic growth. Negative interest rates are supposed to penalize saving and prompt people to spend and invest instead. The Swedish Central Bank is creating new money electronically and using it to buy government bonds, in an effort to push more money into the economy and weaken the currency, which is another attempt to juice exports while pushing consumers to spend rather than save.

The Swedish Central Bank made a huge mistake in 2010 by raising interest rates to combat high unemployment and low inflation. That didn’t work, so now they turn negative and print money to buy government bonds, and that is supposed to work. In fact, Germany is printing money and buying German government bonds as well, and that is supposed to work; except of course in Greece, where nobody wants to print money to buy Greek bonds, despite outright deflation and depression. Economics is not particularly complicated but economic policy can be insane.

The ECB and the European Monetary Union have no one to blame but themselves. They deployed the monetary policy machinery to uphold the interest of creditors, and they thought the Greeks would remain subservient, but that hasn’t happened. What’s happening to Greece today will happen to Italy tomorrow and then Spain and then Portugal. In Italy, they have the Five Star movement; in Spain, Podemos. They make Syriza look conservative.

Germany thinks it can shut down Syriza here and now, and shut down any further dissent. But the Eurozone is like a house of cards, and if they pull out Greece from the deck, the most likely outcome is that everything falls.

Retail sales fell in January for the second month in a row as drivers spent a lot less on gasoline and didn’t appear to use that savings elsewhere. Retail sales declined by a seasonally adjusted 0.8% last month after a 0.9% drop in December. Sales at gas stations slumped 9.3% to mark the biggest pullback since 2008. Sales fell at auto dealers, home-furnishing stores, grocery chains, department stores, apparel retailers and outlets that sell sporting goods. Internet stores and restaurants, two of the largest retail categories, were among the few sectors to boost sales. Instead of spending the savings at the gas pump, Americans are saving a little; the saving rate increased to 4.9% in December.
Tesla posted quarterly results after the close of trade yesterday.  It was not a good report: deliveries fell short, problems affected production and a strong dollar hurt results. Tesla posted a loss of $0.13 a share, well below analysts’ consensus expectations for a $0.13 a share profit. Elon Musk struck an optimistic tone for the year ahead, however, and went as far predicting a market value of $700 billion by 2025, matching that of Apple. Of course there is nothing concrete to back that up, but when an earnings call is going bad, just say “Apple” and analysts’ eyes glaze over.

SpaceX launched a satellite, but scrubbed its rocket landing. This is Elon Musk’s other company; they successfully deployed the DSCOVR space weather satellite after several delays due to (ironically) bad weather, but had to cancel an attempt to land a rocket on a drone ship due to high seas and bad weather.

The electric car company and rocket company isn’t the only thing Elon Musk is working on. Tesla’s next innovation could take you off the electric grid. Tesla is planning to unveil a new lithium-ion battery pack that homeowners could buy to store and supply their own energy. Details are still sketchy, but the most obvious idea would be to combine battery packs with solar panels. Solar energy company SolarCity already offers Tesla battery packs in some markets that customers can use to store energy and use as a kind of emergency generator. Musk is the chairman of SolarCity and its largest shareholder.

The idea that Tesla could be as big as Apple in 10 years is still pretty preposterous, except it could happen; they already have a $25 billion market cap, and they haven’t even turned a profit. They could grow from here; not just by selling cars, but also by selling batteries, and changing the way we look at the electric grid. If you are looking for a fast growing industry, you can’t get much bigger than energy. And if you look at Tesla as just a car company, you miss the bigger picture.

So, you’re looking for a travel site. What do you do? Well, if you are Expedia, you search the web, compare sites and then buy Orbitz for about $1.4 billion, or $12 a share in cash. It worked out to about a 25% premium for Orbitz; other travel-related websites moved higher as well.

Chief executive John Chambers says “Cisco is back with a vengeance.” Cisco reported impressive Q2 results following five straight quarters of slumping profit and sluggish sales. Cisco shares were up more than 9%.

And while we almost didn’t notice, the Nasdaq Composite has moved to within less than 4% of 5048; that’s the old record high from March 2000. The S&P 500 is just a couple points away from the 2090 record high close of December 29.

For quite some time I’ve talked about how the big banks repeatedly break laws, only to work out a settlement, and then go back and break even more laws. And one of the crazy things about that merry go round is that the banks settlements typically include something know as a deferred prosecution agreement.

For example, UBS, the largest Swiss bank, avoided prosecution in February 2009 when it admitted to helping Americans evade taxes, paid $780 million and handed over 250 secret accounts. In a deferred-prosecution agreement with the Justice Department, the firm promised to follow the law and cooperate with the US. Now investigators are supposedly looking into whether UBS aided wealthy clients in the use or transfer of bearer securities, which can be used to hide assets and potentially evade taxes; bearer securities have been illegal for decades.

Investigators suspect the conduct may have occurred when the bank was still bound by the deferred-prosecution agreement, which expired in October 2010. If that’s true, the Justice Department could reopen the accord and prosecute the bank on the original conspiracy charge. Prosecutors also could file new charges against UBS and seek stiffer penalties and oversight at sentencing for violating the previous agreement. In addition to the 2009 tax-evasion agreement, the bank settled an antitrust case involving the municipal-bond investments market in 2011. It resolved another Justice Department probe in 2012 for rigging Libor interest rates. The Justice Department has never reopened a closed deferred-prosecution agreement.

Meanwhile, last week 60 Minutes reported on the results of an International Consortium of Investigative Journalists’ research into documents leaked from HSBC, detailing tax evasion schemes at their Swiss subsidiary. Things have been pretty quiet following that report. The Department of Justice actually received the leaked documents 5 years ago, but the media only released the info this past weekend.

HSBC has its own recidivism problems. HSBC paid a $1.9 billion fine in 2012, in a deferred prosecution agreement over money-laundering with Mexican drug cartels and breaches of US sanctions; this was so blatant that the bank even got caught buying a smuggling plane for the Sinaloa cartel. Under that deal, HSBC escaped criminal charges and kept the banking charter that enables it to operate in the US. Then there was Libor rate rigging, illegal deals with Saudi banks linked to Al Qaeda, and still no one thought to reopen a deferred prosecution agreement.

And of course, no high level execs from HSBC or any other bank have been charged. It is now becoming sublimely ridiculous. We’re supposed to believe the CEOs never knew about any of the staggering number of frauds and scandals – and in the case of HSBC we are talking about hundreds of thousands of felony criminal acts. And at the same moment we are to believe that these are highly skilled executives capable of managing massive financial institutions.

Ultimately, scandals like HSBC’s Swiss tax evasion scheme are merely flash points offering us a clearer view of the hidden dynamics at work in the world economy: what is taken from one side shows up at the other. The timing of the scandal is delicious; Greece is going to Brussels to beg a reprieve from debtor’s prison and the failed policies of austerity. There is no such thing as austerity; there is only a highly skewed redistribution of scarce resources. In this upside-down world, money simply tends to flow upwards.

Financial Review

A Question for the New AG

Sinclair Noe — February 10, 2015        

              

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

DOW + 139 = 17,868
SPX + 21 = 2068
NAS + 61 = 4787
10 YR YLD + .04 = 1.99%
OIL – 2.10 = 50.76
GOLD – 5.00 = 1234.70
SILV – .06 = 17.01

Small-business sentiment slipped in January on a decline in optimism over sales growth and business conditions, according to a gauge released Tuesday. The National Federation of Independent Business said its small-business optimism index fell 2.5 points to 97.9, with seven out of 10 components declining.

Good news if you are looking for a job. The Labor Department said job openings surged to 5.03 million in December, the highest level since January 2001, from 4.85 million in November. Hiring jumped to a seven-year high and the number of job seekers for every open position, a key measure of labor market slack, fell to 1.73 in December, the lowest since 2007. The bad news is that there are still about 9 million people looking for a job.

Wholesale inventories barely rose in December, up just 0.1%. Together with data last week showing a 0.3% fall in manufacturing inventories in December, today’s report suggests the boost to GDP growth from restocking in the fourth quarter was probably not as large as initially thought.

Halliburton is cutting as many as 6,500 jobs. The oil company, facing up to the reality of crude oil prices, announced that it’s slashing between 6.5% and 8.5% of its global workforce. The cuts are doing little to assuage investors; Halliburton’s stock is down 3% today.

In the past 2 weeks oil prices bounced 20% from lows around $44 a barrel. The recent surge in oil prices is just a “head fake” and West Texas crude as cheap as $20 a barrel may soon be on the way, according to a new research report from Citigroup’s global head of commodity research. The prediction is that oil will drop to $20, then bounce back to $75, all this year. It’s the stuff of a commodity trader’s dream. Wall Street lusts for it. Hedge funds can hardly contain themselves at the mere thought of it. So whose book is Citi talking up?

If the price of oil stays in the current range, liquidity for much of the oil patch will run out in 2016, and that’s when waves of defaults will begin to cascade through bank and private-equity balance sheets. And beyond that, investment banks stand to lose a lot: in 2014, Citi earned $492 million in energy-related investment-banking revenues – more than any other bank; More even than JP Morgan. So Wall Street must have a V-shaped recovery in place by 2016, or else.

Tomorrow we will get a better idea of the direction of oil prices, at least for the short-term, when the Department of Energy releases its weekly report on inventories. US commercial crude-oil supplies stood at a record high of 413.1 million barrels in the week ended Jan. 30. Analysts are estimating that inventories will hit a new record high, up 4 million barrels for the week. Oil dropped, but closed above $50.

So, what are Americans doing with some of the money they’re saving from cheap gas? They are buying more fuel.  Demand is up. At the same time, faster economic growth and a big influx in hiring over the past year means more Americans are now taking part in the daily commute. According to Nicolas Colas chief market strategist of ConvergEx: “We’ve finally discovered where American consumers are spending some of the savings from lower gasoline prices: they are buying more gasoline.” Plunging prices are encouraging Americans to drive more often and buy more trucks. The best-selling vehicle in the US in December was the Ford F-150; SUVs were also popular. Apparently, when gas prices drop, we forget all about conservation.

The squeeze on U.S. farmers is getting worse as low crop prices and rising costs erode incomes that not long ago were the highest ever. Farm income in the U.S., the world’s top agricultural producer and exporter, is poised to drop for a third straight year in 2015. While raising livestock remains profitable, as tight meat supplies keep prices high, growers of corn, soybeans and wheat saw crop and land values fall faster than many of their costs.

Net-cash income from all farm activity will drop 22% to $89 billion, the biggest drop since 1932 and the lowest since 2009, the U.S. Department of Agriculture said in a report today in Washington. Last year’s slump was 12% to $115 billion. Net income, including the value of inventory and non-cash income, was forecast to drop 32% to $73 billion, with expenses at a record $370 billion.

The drought in California continues. We’ve been hearing a lot about extreme weather lately; historic snowfall in Boston, and last weekend saw more than a foot of rain in some parts of northern California. Water is water and anything can make some difference but the rain last weekend was of the tropical variety and it didn’t result in much snow. California meets most of its water needs from the snowpack; as the snow melts in the summer months, it replenishes the reservoirs. For now, the reservoirs remain far below capacity. And the rain in northern California didn’t make it down to southern Cal. Rainfall totals in the south are anemic, and falling further behind. California has two more months in the traditional winter rain season. Trends could flip and several warm tropical storms could barrel into Southern California, evening the score. But for now, residents of the Southland are getting nervous.

Europe is powering ahead with wind. Europe already has quite a lot of wind turbines, and it seems to be the preferred way to generate electricity. Across the 28 countries that make up the European Union, 11,791 megawatts of wind power was connected to the grid in 2014—worth up to €18.7 billion ($21.1 billion)—according to a report by the European Wind Energy Association. New coal added 3,305 megawatts, while new gas capacity totaled 2,338 megawatts—less than half of the wind installed. Germany and the UK accounted for 60% of the new wind installations. The EU could now produce 10.2% of the electricity it needs from wind, up from 8% the year before.

Hoping to defuse a standoff that has set Europe and financial markets on edge, Greek officials intend to propose a detailed compromise plan at an emergency meeting with creditors on Wednesday in Brussels. The plan will include the possibility of tapping part of a bailout loan disbursement of $7.9 billion, which Athens had been saying it would reject. Greece still plans to reject some of the harshest austerity conditions attached to Greece’s bailout loans, but will propose retaining about 70% of the terms. Now, the proposal was just tossed out there and there won’t be a meeting until tomorrow, but already Germany has shot down the idea.

Another big meeting in Europe tomorrow; in Minsk, Belarus, the leaders of Germany, France, Ukraine and Russia are due to meet to try to hammer out a peace agreement. Failure to reach an agreement will lead to further EU economic sanctions against Russia, which were delayed at yesterday’s EU foreign minister’s meeting to allow time for the diplomatic offensive tomorrow. Failure to achieve a negotiated peace might draw the US into the conflict, at least as an arms supplier to Ukraine.

Hopes of an orderly resolution to Puerto Rico’s debt crisis suffered a heavy blow after a court voided the island’s restructuring law, raising fears it may be heading for a longer, messier debt overhaul. A US federal judge ruled that the commonwealth’s so-called Recovery Act, which made some of Puerto Rico’s agencies eligible for court-supervised debt restructuring, violated the US constitution by allowing a state government to modify municipal debt. The decision will likely result in a resolution being dragged out over a longer period of time, having the administrative costs incurred eat into the ultimate recovery for the bondholders. Puerto Rico is expected to appeal the ruling, kicking off lengthy litigation with a hard to predict outcome and possibly delaying for months the matter’s final resolution.

In the final stages of a long-running investigation, the U.S. Department of Justice has recently informed Barclays, JPMorgan, the Royal Bank of Scotland and Citigroup that they must plead guilty to criminal charges that they manipulated the prices of foreign currencies, NYT reports. Last November, regulators fined five major banks a total of $3.4B for failing to stop traders from trying to manipulate the foreign exchange market, following a year-long global investigation.
In a separate probe disclosed today, the NY Department of Financial Services was reported to have sent subpoenas to Goldman Sachs, Credit Suisse, BNP Paribas and Societe General, expanding its investigation of whether the banks’ electronic forex trading platforms allowed them to front-run clients. At issue is a latency period between the time an offer is floated and accepted. The department is already probing Barclays and Deutsche Bank over similar concerns and installed monitors at those banks in recent months.

Reuters reports an unnamed official says HSBC could see its 2012 deferred prosecution deal with US authorities over anti-money laundering reopened as a result of separate, ongoing probes into the bank’s alleged role in manipulating currency rates and helping Americans evade taxes. Obama’s nominee for attorney general, Loretta Lynch negotiated a deal with HSBC two years ago that saw it avoid criminal charges but Lynch says DoJ still has powers to act. In the 2012 settlement HSBC was fined $1.9 billion over money-laundering with Mexican drug cartels, including the notorious Sinaloa Cartel, and breaches of US sanctions; it is the largest money laundering case in history; the fine equals about 5 weeks profits. No individual at HSBC was fined or charged. The harshest punishment appears to be partial deferral of some bonuses.

Lynch has sent a letter to Senator Chuck Grassley of the Senate Judiciary Committee, writing that the 2012 Deferred Prosecution Agreement (DPA) “addresses only the charges filed in the criminal information, which are limited to violations of the Bank Secrecy Act for failures to maintain an adequate anti money-laundering program and for sanctions violations. The DPA explicitly does not provide any protection against prosecution for conduct beyond what was described in the Statement of Facts.”

Lynch is scheduled to replace AG Eric Holder, who essentially avoided prosecuting big banks out of fear that it might create global uncertainty if a bank was criminally prosecuted and lost its charter. I’m not sure how being a bagman for drug cartels and tax cheats promotes global financial stability. Maybe that’s something the new AG can answer.

Financial Review

HSBC – Too Big To Jail

Sinclair Noe — February 9, 2015

 

Podcast: Play in new window | Download (Duration: 13:18 — 6.1MB)

DOW – 95 = 17,729
SPX – 8 = 2046
NAS – 18 = 4726
10 YR YLD + .02 = 1.95%
OIL + .90 = 52.59
GOLD + 5.40 = 1239.70
SILV + .28 = 17.07

Let’s start with oil; OPEC lowered its estimate for non-OPEC supply growth this year by about 400,000 barrels a day, the biggest reduction since the forecast was introduced in August. The US led with a cut of 130,000 barrels a day while estimates for Colombia, Canada and Yemen were also trimmed. The group said it may boost global demand forecasts beyond this month’s slight increase amid rising U.S. gasoline use.

OPEC’s research department said: “The main factors for the lower growth prediction in 2015 are price expectations, a declining number of active rigs in North America, a decrease in drilling permits in the US and a reduction in the 2015 spending plans of international oil companies.”

The United Steelworkers strike continues with walkouts at two of BP’s refineries over the weekend. The strike now encompasses more than 5,000 workers at 11 refineries across the country, which account for about 13% of U.S. fuel-making capacity. Facility owners also hit by the strike include Shell, Tesoro, Marathon Petroleum and LyondellBasell.

Cheap gasoline prices have increased 13 cents in the past two weeks to $2.20 a gallon, nationwide average; but not everybody is buying the idea that oil will keep going up from here. According to US Commodity Futures Trading Commission data cited on Bloomberg. After a two-week rally that pushed oil up 14%, short bets on West Texas Intermediate jumped 1.2% while net-long positions dropped for a third week.

Edward Morse, Citigroup’s global head of commodity research writes that the recent surge in oil prices is just a “head-fake,” and oil as cheap as $20 a barrel may soon be on the way. Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia. The market is oversupplied, and storage tanks are topping out. A pullback in production isn’t likely until the third quarter. Citi reduced its annual forecast for Brent crude for the second time in 2015. Prices in the $45-$55 range are unsustainable and will trigger “disinvestment from oil” and a fourth-quarter rebound to $75 a barrel. According to the report prices this year will likely average $54 a barrel.

Of course that’s just a guess. I don’t know, you don’t know, and Citigroup doesn’t know, but they print their guesses on glossy paper.

HSBC is a British multi-national bank; it used to be called the Hong Kong and Shanghai Banking Corporation; the UK and Hong Kong are considered home markets, but they also have a subsidiary in Switzerland. And it turns out, they have been misbehaving for quite some time.

At its height, HSBC’s secretive Swiss arm hid a total of $120 billion in assets. These funds were collected from wealthy clients all over the world and have already led to criminal investigations and charges against the bank in France, Belgium, the US and Argentina.

In a report released on Sunday, the International Consortium of Investigative Journalists, an organization based in Washington, along with the newspaper Le Monde in France, The Guardian in Britain, the BBC program “Panorama” and CBS News’s “60 Minutes,” said that secret documents revealed that bank employees had reassured clients that HSBC would not disclose details of their accounts to tax authorities in their home countries and discussed options to avoid paying taxes on those assets.

The documents were stolen from HSBC by a former employee in Switzerland in 2007 and were given to the French authorities, who in 2010 shared them with officials in Britain, Spain and the United States, among other nations. The leaked Swiss HSBC files implicate the bank in apparent misbehavior all over the world; some 30,000 accounts, and about 2,900 clients connected to the US, providing the IRS with a trail of evidence of potential American taxpayers who may have been hiding assets in Geneva. The US Department of Justice and IRS have been investigating HSBC’s Swiss banking operations since the documents were first handed over in 2010 but the scale of those inquiries remain unclear. Tomorrow, Maryann Hunter, who is on the board of governors of the Federal Reserve, and has some responsibility for regulation of foreign banking organizations operating in the US, will give evidence to the Senate banking committee. On Thursday, Geoffrey Graber, a deputy associate attorney general at the DoJ who oversees settlements with Wall Street banks, will appear before a House judiciary subcommittee. Both are expected to be questioned about the leak.

HSBC global and its US bank was forced to pay a $1.9 billion fine two years ago after the DoJ uncovered evidence HSBC subsidiaries had enabled clients to breach US sanctions against Cuba, Sudan and Iran and, due to oversight failures, allowed Mexican drug cartels launder billions of dollars. At the time, the settlement allowed HSBC to escape criminal indictments and keep the banking charter which enables it to operate in the US but the bank had to submit to a 5-year plan to stamp out money-laundering and other illicit practices, and the banks’ compliance would be overseen by an independent, court-appointed monitor.

HSBC is now just over two years into its reform plan, and has been deemed to be complying with the terms of the settlement. However, there are some concerns. In November, the bank reached a settlement with the Securities and Exchange Commission in which HSBC agreed to pay $12.5 million to resolve charges that its Swiss private banking division illegally provided investment and brokerage services to US clients.

So much for the idea that the problems are in the past. The huge amount of leaked info is quite bad for HSBC; it includes stories of coaching clients how to evade taxes; stories of clients being assisted in withdrawing bricks of cash from the Swiss bank. The evidence is quite damning, and yet, still no criminal charges. The Department of Justice will soon face a moment of truth, when they will have to decide whether the phrase “too big to jail” was real or just a crock.

And of course, HSBC is not the only bank that has misbehaved. Financial Times is reporting that the US Department of Justice is investigating whether Barclays and UBS sold structured products without disclosing the profit they were making from currency trades used to generate the products’ returns; essentially skimming profits or perhaps even betting against their own clients. Five major banks, including UBS, were fined $3.4B in November to settle forex allegations, although the DOJ was not one of the agencies involved in the deal. Barclays also did not take part in the earlier settlement.

The S&P 500 rose 3 percent last week, the most in seven weeks, as oil rebounded. The Dow posted its best weekly gain in more than a year. Of the firms that have reported profit so far this season, 78 percent beat analysts’ estimates, while 56 percent topped sales projections. Coca Cola, Time Warner, and MetLife are among 66 S&P 500 companies reporting quarterly results this week.

Comcast and Time Warner Cable’s $45B merger still remains in limbo, with the DOJ and FCC scrutinizing the deal and Tom Wheeler’s new net neutrality proposal. Investors began betting against the combination late last month, with shares of Comcast and Time Warner Cable falling sharply before recovering last week. If regulators allow the deal as is, the merged company would control about 35% of the country’s broadband Internet service coverage and just under 30% of pay television subscribers.

The National Association of Insurance Commissioners, a group representing state regulators, has announced the launch of an investigation into the recent data breach at Anthem. The health insurer revealed last week that hackers had broken into its database containing the personal information of about 80 million customers and employees. Anthem said it welcomes the review and “will cooperate fully.”

If you are one of the 80 million,1 of every 4, Americans who has ever had health insurance with Anthem Blue Cross, Anthem Blue Cross and Blue Shield, Blue Cross and Blue Shield of Georgia, Empire Blue Cross and Blue Shield, Amerigroup, Caremore, Unicare, Healthlink, and DeCare; I am sorry to inform you that your privacy and personal identity has been flushed down the toilet; let the class action lawsuits begin. Not all data breaches are created equal, and the Anthem health insurance hack is about as bad as they get for consumers.

Why? This time the crooks got Social Security numbers. For identity thieves, the Social Security number is the key that unlocks the vault, and they now have millions of them, plus they stole all sorts of other info, so they don’t have to guess when it comes to matching the Social Security data to you and everything you’ve ever worked for. If you have managed to save a nest egg for retirement, you will need to defend it, forever. How could this happen? Because Anthem didn’t encrypt our data, and there is no law that says they must.

Harris Poll has released a survey of America’s most- and least-loved corporations. Wegmans, a Rochester, New York grocer, claimed first place, followed by Amazon, Samsung, Costco, and Johnson & Johnson. Halliburton, Monsanto, Dish Network, and AIG were near the bottom of the list. The most hated company: Goldman Sachs.

Samsung’s TVs are listening to your every word. The company disclosed that its smart TVs will automatically capture all nearby conversations as part of its voice recognition features, and potentially transmit sensitive data to a third-party service. George Orwell saw it coming years ago.

A South Korean vacuum robot tried to devour its owner…Firefighters were called after it consumed some of her hair and refused to let go. …Yet Japan is still launching a robot hotel. A 72-room getaway will open this summer, staffed by 10 multilingual humanoids. What could go wrong?

Tuesday, August 19, 2014 - It’s Just a Matter of Time

Financial Review with Sinclair Noe

DOW + 80 = 16,919
SPX + 9 = 1981
NAS + 19 = 4527
10 YR YLD+ .02 = 2.40%
OIL (sept) = 94.48
GOLD – 2.00 = 1296.20
SILV - .18 = 19.50

The consumer price index rose a seasonally adjusted 0.1% in July. Food prices rose 0.4%, but energy costs declined 0.3%; the first drop in energy prices since March. Consumer prices have risen an unadjusted 2% over the past 12 months, down slightly from June. Prices surged in the early spring but have since tapered off. Excluding volatile food and energy prices, the core rate has risen 1.9% in the same span, unchanged from the prior month. Almost all of the increase in consumer prices can be traced back to housing costs, or shelter prices; over the past year, shelter prices are up 2.9%.

Hourly wages have risen about 10% overall since June 2009, to $24.45 an hour. But over the same span they’ve slipped 0.3% in “real” or inflation-adjusted terms. Since the Great Recession ended five years ago, the amount of money Americans earn each hour after adjusting for  inflation has actually fallen. And that largely explains why the economy is growing so slowly.

The Federal Reserve should be in no hurry to raise interest rates because there is no serious threat from inflation, at least not now.

According to the US Travel Association and GfK, a market research firm, you might not take a vacation this year. About 40% don't plan on using all of our paid time off. The share of American workers taking vacation is at historic lows. In the 1970s, about 80 percent of workers took a weeklong vacation every year. Now, that share has dropped to a little bit more than half. The declining popularity of vacation has wide-ranging effects not just on workers, but also on their employers and indeed the overall economy. Studies have found that taking fewer vacations is correlated with increased risk of heart disease; other research has shown that workers who take vacations, or even a small break during the workday, are more productive when they return. This vacation aversion is a North American phenomenon; the US is the only “advanced” economy that doesn’t require companies to give paid vacation days.

Housing starts rose to an eight-month high in July. Groundbreaking for new housing jumped 15.7% last month to a seasonally adjusted 1.09-million unit annual pace; this follows 2 straight months of declines. Groundbreaking for single-family homes, the largest part of the market, increased 8.3% in July to a seven-month high. Starts for the multi-family homes segment, such as apartments, jumped 33%.

Home Depot reported quarterly profit today. Profit rose 14% to $2.05 billion. Sales rose 5.7% to $23.8 billion. The number of transactions rose 4.2%. Home Depot said it expects same store sales to grow faster in the second half of the year, as more people take on remodeling projects. However, Home Depot maintained its full-year sales growth forecast of about 4.8%. Lowe's, the world's second-largest home improvement company, is scheduled to report results tomorrow.

Back in 2006 bust, when the housing market went bust, Phoenix was one of the first cities to get hammered with lower prices; in 2011, Phoenix was one of the first cities to snap back; prices, off by nearly 60% from peak, then rebounded sharply; home prices are up nearly 46% from the 2011 low. The number of homes in some stage of foreclosure has fallen to about 4,300 homes today from more than 50,000 four years ago.

Now, prices and sales are cooling off. Inventories of homes listed for sale have climbed to their highest level in three years while the number of houses sold in June fell 12% from a year earlier. Investors accounted for nearly 15% of homes bought in June, down from about one-quarter last year and one-third of sales in June 2012. The market is moving away from from bargain-hunting investors, who typically pay cash for distressed properties, to traditional buyers with mortgages. The Phoenix market is slowly moving back to normal, but there is still a long way to go.

Employment in Phoenix, after expanding at an average annual pace of 2.6% and 2.8% in each of the last two years, is up just 1.5% so far this year. When people don’t have a job or are not secure in their jobs, they don’t buy houses. The sluggish local economy is compounded by consumers still too battered from the bust to think about getting a loan. Some don't have sufficient equity to turn a house sale into an adequate down payment on their next purchase. Others suffered credit blemishes or income hits that make banks reluctant to lend.

Reuters reports Phoenix based PetSmart is exploring a potential sale of the company. Jana Partners, which has reported a 9.8% stake in PetSmart, has been calling on the company to pursue a sale after what it calls years of financial underperformance. There is no guarantee the review will lead to a deal and PetSmart could still determine that it would be better off on its own.

Today marks the ten year anniversary of Google. The company went public August 19, 2004 at a price of $85 a share; and it’s gone up 1,304% since then. A few stocks have done better over that time, but only a few, and of those, only Apple was in the S&P 500 10 years ago when Google went public. Today, Google’s revenue tops $65 billion, more than all but 40 US companies. Net profit margins exceed 20%, higher than all but three. Ten years ago, Google had a forward PE of 52; today, the forward PE is 20. So as share prices have constantly moved higher, valuation has constantly moved lower; which is a neat trick.

Over the past 10 years, or you could say over the past 25 years, a great deal of wealth has flowed to the tech giants of Silicon Valley; which means that the wealth has flowed away from Wall Street. And the techies have finally figured out they don’t need Wall Street bankers to make a deal. According to data from Dealogic, approximately 70% of the tech deals completed in early August have been sealed without a Wall Street bank consultant helping the buyer identify the transaction. And over the past two years, the trend has been growing, with more than half the tech deals in 2012 occurring without a banker working on behalf of the buyer. This M&A consulting shift highlights a subtle but growing divide between fee-eager bankers and the tech giants of today.

Maybe the problem is that the banks just have a hard time remembering who their clients are. Case in point: you may remember the story of Standard Chartered, the British bank, which back in 2012 paid about $667 million to settle charges that it had engaged in money laundering by making transfers for clients in Iran and other countries that were covered by American sanctions. They had to add compliance monitors. A few months later the bank’s chairman denied any wrongdoing, which was a direct violation of the settlement; and he was forced to quickly recant. Today, it seems that all of those new legal staffers and crime-fighting committees also didn’t get the memo about what they are meant to be doing. New York’s financial regulator slapped another $300 million fine on Standard Chartered for “failures to remediate anti-money laundering compliance problems as required” in its previous settlement.

Part of the bank’s 2012 agreement included hosting an independent monitor permanently installed by regulators on-site to vet anti-money laundering procedures. This monitor was back-testing the bank’s processes and found them lacking, particularly when it came to flagging suspicious dollar transfers from its Hong Kong and United Arab Emirates affiliates.

In a statement, Standard Chartered said that it “has already begun extensive remediation efforts and is committed to completing these with utmost urgency.” And this time they really, really mean it; not like last time. So, this raises the question of how many times a bank can break the law, and get away with a slap on the wrist. What does a bank have to do before they forfeit their charter?

The New York State regulator, Benjamin Lawsky, said: “If a bank fails to live up to its commitments, there should be consequences. That is particularly true in an area as serious as anti-money-laundering compliance, which is vital to helping prevent terrorism and vile human rights abuses.”

So, the penalty is nearly $1 billion in fines over the past couple of years, but actually works out to about 12% of bank profits over the same time.

You might also remember last month when Attorney General Eric Holder announced the $7 billion settlement with Citigroup for its role in packaging troubled mortgages into securities and selling them as investments in the years before the crisis, even though a bunch of Citigroup bankers knew better and did it anyway. And last November, there was a settlement with JPMorgan. And there is a chance that later this week we will see a settlement announced with Bank of America.

It all falls in line with the “too big to fail” idea known as the Holder Doctrine, which stems from a 1999 memo, when then Deputy AG Holder included the thought that big financial settlements may be preferable to criminal convictions because a criminal conviction often carries severe unintended consequences, like loss of jobs and the inability to continue as a going concern. Holder was thinking of the collapse of Arthur Anderson after the collapse of Enron. So, now Holder holds to the idea of settlement over prosecutions.  Instead of the truth, we get from the Justice Department a heavily negotiated and sanitized “statement of facts” about what supposedly went wrong.

The problem is, of course, that these settlements allow for the Wall Street bankers to get away with their bad behavior without being held the slightest bit accountable. And with no real deterrent, as Standard Chartered has just confirmed, it’s just a matter of time until they do it all over again.

Monday, July 14, 2014 - Clearing Up Outstanding Issues

Financial Review with Sinclair Noe

DOW + 111 = 17,055
SPX + 9 = 1977
NAS + 24 = 4440
10 YR YLD + .03 = 2.55%
OIL + .22 = 101.05
GOLD – 32 = 1307.80
SILV - .54 = 21.00

The Dow Industrial Average hit an intraday high of 17,088, but couldn’t close above the old closing high of 17,074 from July 2.

I woke up this morning and checked the Euro markets; the headline read: Global Stocks mostly higher as Portuguese debt concerns ease. Banco Espirito Santo’s parent company sold part of its stake in the bank to pay off short-term debt, so everything is cool. Portuguese bond prices popped. Nothing to see here. Move along, move along.

Just to refresh your memory, Banco Espirito Santo is 25% owned by Espirito Financial Group, which is in turn 49% owned by Espirito Santos Irmaoes, which in turn is wholly owned by Rioforte investments, which in turn is wholly owned by Espirito Santo international. What’s the point of owning a bank if you can’t make loans to yourself; and that’s what happened, until last week, when Espirito Santo International, the parent company failed to make a payment on short-term debt. The collective companies under the Espirito Santo umbrella have borrowed several billion from the bank, and then the bank made about 8 billion euros in loans to Angola, and that has a non-performance rate approaching 90%. And I know you’re wondering why you should be concerned about loans to Angola, and it’s because everything in finance is leveraged. No loan lives in isolation.

Panic ensued. The fear was that creditors and/or depositors might be on the hook in the event of a shortfall; no one could be certain because of a lack of transparency. But the bank says they have a cushion; the parent company sold a few assets to come current on the loan. Hopefully, I’ve cleared up the transparency issue. Regulators say there’s nothing to worry about and they should know because they didn’t see this coming in the first place, and so there’s nothing to worry about; the situation in Portugal is contained, and global stocks moved higher.

Here in the US, we know a thing or two about banks behaving badly. Today, as expected, Citgroup agreed to pay $7 billion to settle civil claims the bank misled investors about toxic mortgage backed securities leading up to the 2008 crash. Citigroup admitted it was aware that "significant percentages" of sample loans did not comply with underwriting guidelines but the bank pooled them into securities anyway. In one 2007 deal, a Citigroup trader told colleagues in an email he had reviewed a due diligence report on the poorest quality loans, and that they "should start praying." Many of the loans listed unreasonable borrower incomes or home values below the original appraisals, the trader wrote, saying he "would not be surprised if half of these loans went down." Citigroup still securitized loans from the pool. Quite simply, they knew the mortgage backed securities were full of bad loans, they lied about it to make the sale.

Under the agreement, Citi will pay $4.5 billion in cash and provide $2.5 billion in aid to low-income tenants and struggling homeowners; details of terms of the help and how many will benefit are not yet known, but there’s no indication people they will go back to help make people whole. Some homeowners with Citi mortgages could see the amount of their loans reduced, or could have their interest rates reduced. There will also be down payment and closing cost assistance to future homebuyers. But none of that starts until 2018. I don’t know why.

Last year Citi settled with the FHFA for $250 million. The regulator of Fannie Mae and Freddie Mac had sued the bank over soured mortgage securities sold to the taxpayer-owned entities. The cash portion consists of a record $4 billion civil payment to the Justice Department, double JPMorgan’s penalty in November, and $500 million to resolve claims from five state attorneys general and the Federal Deposit Insurance Corp.

And there is a little gift for Citi; the state AG and FDIC payments would be deductible, along with any costs Citigroup actually incurs in relation to consumer relief, which could be less than the $2.5 billion amount of relief in the settlement.

As part of the settlement, Citigroup “will take a charge of approximately $3.8 billion pre-tax in the second quarter of 2014." Second-quarter earnings results were also posted this morning, and if you exclude the multi-billion dollar settlement, Citi beat expectations. The settlement wipes out the quarter’s earnings, but if you look the other way, it was a kick ass quarter for earnings. Citigroup exceeded Wall Street expectations in the second quarter with adjusted earnings of $1.24 a share. On that basis, analysts had been expecting Citigroup would earn $1.05 a share. Citi posted a 15% drop in trading revenue. Investment banking revenue rose 16% from a year ago. Mortgage originations were down.

This is a civil settlement, not a criminal settlement. Attorney General Eric Holder at a press conference said: “Citi settlement doesn’t absolve bank, employees from criminal charges.” Of course nobody expects the Department of Justice to pursue criminal charges. Citi is also under investigation for possible fraud and money laundering in its Mexican unit. And if you look at all the wrongdoing, you might come to the conclusion that this is just a corrupt organization.

If you’re wondering where the next subprime meltdown will occur, well you can pick from a wide selection of possibilities. Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give. Debt ratios in the developed economies have risen by 20 percentage points to 275% of GDP, since the Lehman crisis. Credit spreads have fallen to wafer-thin levels. Companies are borrowing heavily to buy back their own shares, and 40% of syndicated loans are to sub-investment grade borrowers, a higher ratio than in 2007, with fewer protections from loss.

The Bank of International Settlements, the central bank for the central bankers of the world, warned it is annual report two weeks ago that equity markets had become "euphoric". Volatility has dropped to an historic low. European equities have risen 15% in a year despite near zero growth and a 3% fall in expected earnings. The cyclically-adjusted price earnings ratio of the S&P 500 index in the US reached 25 in May, six points above its half-century average. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.

Some of you might pick the student loan market, with over $1 trillion in outstanding loans and growing. The deeply indebted college graduate has become a stock character in the national conversation: the art history major with $50,000 in debt, the underemployed barista with $75,000, the struggling poet with $100,000. That’s not really typical of student loan debt. Only 7 percent of young-adult households with education debt have $50,000 or more of it. By contrast, 58 percent of such households have less than $10,000 in debt, and an additional 18 percent have between $10,000 and $20,000.

That’s not to say student loan debt is not a concern, it is, and it is growing. In 2010, 36 percent of households with people between the ages of 20 and 40 had education debt, up from 14 percent in 1989. The median amount of debt, among those with debt, more than doubled, to $8,500 from $3,517, after adjusting for inflation. Student loan debt is a problem, but it isn’t a new problem, it’s just a trillion dollar problem now, but it hasn’t imploded in the past 2 decades and there doesn’t seem to be an immediate catalyst.

How about a bubble in energy? Ambrose Evans- Pritchard writes: Data from Bank of America show that oil and gas investment in the US has soared to $200 billion a year. It has reached 20% of total US private fixed investment, the same share as home building. This has never happened before in US history, even during the Second World War when oil production was a strategic imperative.

The International Energy Agency (IEA) says global investment in fossil fuel supply doubled in real terms to $900 billion from 2000 to 2008 as the boom gathered pace. It has since stabilized at a very high plateau, near $950 billion last year. Output from conventional fields peaked in 2005. Not a single large project has come on stream at a break-even cost below $80 a barrel for almost three years….

There are, of course, other candidates for the bubble prize of the current economic cycle, now into its 22nd quarter and facing the headwinds of US monetary tightening. China’s housing boom has echoes of the Tokyo blow-off in 1989, and is four times more stretched than US subprime in 2006, based on price-to-income…Emerging markets have racked up $2 trillion in foreign currency debt since 2008. They are a much larger animal than they were during the East Asia crisis of the late 1990s, so any crisis would do more damage.

Yet the sheer scale of “stranded assets” and potential write-offs in the fossil industry raises eyebrows. IHS Global Insight said the average return on oil and gas exploration in North America has fallen to 8.6%, lower than in 2001 when oil was trading at $27 a barrel. What happens if oil falls back towards $80 as Libya ends force majeure at its oil hubs and Iran rejoins the world economy?

And that’s before we get to another threat to fossil fuel investments that Evans-Pritchard mentions: that governments might get serious about climate change and impose meaningful restrictions, like hefty carbon taxes. Right now, that seems like a tail risk, but the crisis just past was a tail event as well. And much higher energy prices resulting from restriction on fossil fuel production would slow down economic activity markedly, which again could blow back to leveraged investors in unexpected ways.

Thursday, May 22, 2014 - A Heckuva Business Model

Financial Review with Sinclair Noe

DOW + 10 = 16,543
SPX + 4 = 1892
NAS + 22 = 4154
10 YR YLD + .02 = 2.55%
OIL - .31 = 103.76
GOLD + 1.80 = 1294.70
SILV + .10 = 19.59

Yesterday we told you Russia and China had signed a 30 year, $400 billion dollar deal for Russia to deliver natural gas to China. Today, both countries vetoed a United Nations Security Council Resolution seeking to refer Syria to the International Criminal Court for possible war crimes. In the short-term, the Russia-China gas deal won’t have a big impact. The deal will not be in place until 2018 and even then will only see Russia selling a fraction of its gas exports to China every year, exports to the EU could still well be two to four times the size.

The economic links between Russia and Europe will continue to be significant and they will continue to be reliant on each other when it comes to energy; the former to sell the latter to buy, but this link gives an advantage to Russia, especially when the weather turns cold. At least symbolically the deal highlights Russia’s desire to move away from links with Europe. Combine this with Europe’s desire to increase energy security and the relations between the two sides could become increasingly cold and distant. Although, some countries due to geographical proximity, such as Bulgaria or Hungary; or due to long standing economic links, such as Germany - will surely continue to have good relationships with Russia. The entire Ukraine crisis has brought the return of a Cold War, and the gas deal sets up an East and West Economic Bloc.

It also raises questions over future tie ups between Russia and China. Areas such as payments systems, broader financial markets, transportation and machinery have all been touted as sectors for potential cooperation between the two countries. Again while a long term issue, such ties up may concern the West since Russia and China are currently reliant on their exports in many of these areas. Both the EU and US will need to figure a clearer policy for how to deal with such changes.

Unrest continues in Ukraine. BBC reports at least 11 Ukrainian soldiers were killed during an attack on a government checkpoint in eastern Ukraine. The attackers were described as heavily armed terrorists. Russia has claimed that it was pulling back troops from the Ukrainian border, but that has not been confirmed by satellite photos.

Thailand’s army chief went on television today to announce a military coup, after two attempts to negotiate an end to political impasse failed. The country’s Constitution was “temporarily suspended,” and the military said it terminated the caretaker government but said it expected the nation’s Senate, courts and independent organizations to function normally. The military imposed a nationwide curfew, and ordered all street protesters to leave their rallying sites.

In economic news, the National Association of Realtors reports existing home sales increased 1.3% to an annual rate of 4.65 million units, marking only the second gain in sales in nine months. Sales remain down 15% from a peak of 5.38 million units hit in July. Compared to April last year, sales fell 6.8%.The inventory of unsold homes on the market increased 6.5% from a year-ago to 2.29 million in April. That was the highest level since August 2012. The median home price rose 5.2%, the slowest pace since March 2012.

In this cycle we’ve had enormous price increases before we had the demand, which was a function of institutional buying of homes, which pushed prices higher. One thing we should have learned about housing is that when prices start rising, there is a herd mentality that kicks in. It wasn’t just institutional buying, it was a combination of events that swirled around institutional buying. The institutional buyer bought up distressed properties, resulting in fewer distressed inventory, add in people who were locked into their homes by negative equity or low equity;  and for many would-be buyers, it’s just tough to get a decent mortgage, or any mortgage at all.

This doesn’t mean banks aren’t lending – they are; it turns out that banks are ready, willing, and able to lend to small businesses, but you might not like the deal. Typical interest rates are about 125%.  Subprime business lending, the industry prefers to be called “alternative”, has swelled to more than $3 billion a year; that’s twice the volume of small loans guaranteed by the Small Business Administration. Wall Street banks are helping the industry expand by lending originators money. They’re starting to package the loans into securities that can be sold to investors, just as they did for subprime-mortgage lenders. It’s a heckuva business model.

Manufacturing activity picked up in May; Markit's "flash" US manufacturing purchasing managers index rose to 56.2 from 55.4 in April.

New applications for unemployment benefits rose sharply in mid-May, reversing a big drop earlier in the month that put initial claims at a seven-year low. The number of people who applied for new benefits climbed by 28,000 to 326,000 in the week ended May 17. That number might grow in the coming weeks thanks to HP.

Hewlett Packard announced earnings after the close, sales fell, revenue fell, but profits were higher, and they will cut an additional 11,000 jobs, bringing the total for outstanding job cuts to 16,000.  It’s a heckuva business model.

Yesterday, William Dudley, the president of the New York Fed gave a speech to the Regional Economic Press Briefing in New York, and he said: “There have been significant and long-lasting changes to the nature of work. As a result, many middle-skilled workers displaced during the recession are likely to find that their old jobs will never come back. Furthermore, workers are increasingly facing higher skill requirements in order to land a good job. These dynamics in the labor market present a host of challenges for the region to address. However one thing is clear: workers will need more education, training and skills to take full advantage of the types of job opportunities being created in our region, as well as across the nation.”

No doubt education is important. More education and skills will not stop your fall but it might slow it down. And a point that Mr. Dudley failed to grasp, or at least communicate is that a significant percentage of corporate profits have relied upon the widespread loss of worker economic share over the past few decades.

If you have bought or sold on eBay in the past few months, change your password and monitor your financial information. The company says hackers attacked between late February and early March with login credentials obtained from "a small number" of employees. They then accessed a database containing all user records and copied "a large part" of those credentials.

The hackers stole email addresses, encrypted passwords, birth dates, mailing addresses and other information, though no financial data, nor PayPal databases were compromised. The eBay breach would be larger than the one Target Corp disclosed in December, which included some 40 million payment card numbers and another 70 million customer records. Why are we just hearing about the eBay hack now? That is a very good question and so far eBay hasn’t provided a good answer.

We’ve noted many times that bankers have a get out of jail card. This week, Credit Suisse entered a criminal guilty plea in New York for its role in an ongoing tax evasion scheme, but that was a corporate entity, and no actual human bankers went to jail; in fact, the CEO and Chairman get to keep their jobs; but today we note that the handcuffs have been slapped on a banker, the former head of investment banking for JPMorgan Chase, in China.

You may recall the recent allegations against JPMorgan in China. Jamie Dimon had a clever little business development strategy to hire the children of Chinese politicians, to win support for JPMorgan banking activities in China; it’s a heckuva business model, except apparently the SEC’s antibribery unit thinks this might be bribery and thus a violation of the Foreign Corrupt Practices Act; except the SEC was not behind today’s arrest, and we all know that US law enforcement and regulators would never actually arrest a banker. However, finding jobs for the children of China’s elite in exchange for bank underwriting is apparently illegal in China, too.  And in China they have this strange custom of arresting people who break the law, even if work for JPMorgan.

In case you missed it, this week’s criminal settlement with Credit Suisse marked a turning point for law enforcement in dealing with the big banks. The Department of Justice says it proves they will go after the big banks and slap them with felonies convictions, even though they get misdemeanor punishment. Well, the proof is in the putting.

And now we have a new case that will show whether there is really any crackdown on wrongdoing, specifically money laundering; regulators are investigating Charles Schwab Corp and Bank of America Corp's Merrill Lynch brokerage over whether the brokerages missed red flags that could indicate attempts to move money illicitly or to feed proceeds from illegal activities into the financial system. The SEC is probing Schwab and Merrill Lynch for violations of anti-money laundering rules that require the brokerages to know their customers.

Treasury Undersecretary for Terrorism and Financial Intelligence David Cohen began urging regulators two years ago to make sure financial institutions are identifying the true beneficial owners of their accounts. Cohen's exhortations came amid concerns that bad actors, such as drug cartel members and terrorists, are growing more creative in their attempts to secretly transfer tainted funds.

The SEC's investigation so far has found Charles Schwab and Merrill did not pay close enough attention to their clients' true identities, and accepted shell companies and individuals with fake addresses as clients. In both cases, some of the accounts, whose ownership the brokerages did not adequately investigate, were eventually linked to drug cartels. The investigation is not yet complete, and the only thing we know with certainty is that it’s a heckuva business model.

Monday, April 07, 2014 - I Don’t Know, They Don’t Know

Financial Review with Sinclair Noe

DOW – 166 = 16,245
SPX – 20 = 1845
NAS – 47 = 4079
10 YR YLD - .03 = 2.69%
OIL - .44 = 100.70
GOLD – 5.40 = 1297.90
SILV - .09 = 19.97

The biggest 3 day drop in the markets in about 2 months. All of the sudden we start hearing the Wall Street stock peddlers waxing enthusiastic about the prospects for a correction or a crash or whatever will scare you. Fear sells; with talk about a 1987-like stock market crash, geopolitical unrest in Ukraine and the risk of a debt crisis in China, investors are starting to get jittery. I don’t know, they don’t know.

The big pullback so far has been in the Nasdaq, and especially biotech stocks. As always, you want an exit plan in place before you ever get into a trade; and if you don’t have an exit plan, get one now. You don’t make money by letting profits slip through your fingers.

Earnings season gets underway this week. Expectations have been ratcheted down; at the start of the year, S&P 500 companies were projected to have grown earnings at 6.5%, now that estimate has slipped to 1.2%. We could see companies beat diminished expectations and start a fresh rally or miss expectations and the markets could get a bit ugly. The simple rule of thumb is that when the trailing P/E ratios hit 10, the S&P 500 is likely undervalued; when the P/E hits 20, the market is likely overvalued and that means the market is vulnerable to pullback. Guess where we are on the scale? Does that mean that stock prices are about to roll over and play dead? Not necessarily. All we have to do is add some earnings to the P/E ratio and …

The S&P 500 recently, as in last week, tested highs, even though fewer than 10% of its components were making new highs individually. Despite the fact that the S&P touched new high territory last week, the average stock in the big index is actually down 7%. Then, you can look at volume; down on up days; up on down days, like today. Toss in the presidential election cycle, toss in the old but true idea of “sell in May”, and there are plenty of reasons for caution.

The past couple of years have been easy; buy the dips; buy good names with momentum and ride that pony to profits. Easy. But easy doesn’t last forever. The momentum names look like they’re rolling over. Investors are rolling over into safer sectors. We’ve gone nearly 2 years without a correction of at least 10%, so it just seems like we’re due. So, while there may be value to be found, this does not seem like a good time to load up when high flyers dip. They may bounce back, but they don’t have to; there is no law that requires a bounce. When a momentum play turns, it tends to turn fast and furious.

This continues to be a tale of two markets. While the high flyers stall, the safety of bonds has been drawing bids, and yields have dipped over the past few days, despite the Fed's clear intention to pull back on Quantitative Easing and bond buying. The utility sector has been outperforming, which might be a signal of future volatility. Emerging markets have seen inflows; maybe this is the idea that the US has been the cleanest dirty shirt in the hamper, but the other shirts aren’t ready to be scrapped; call it a reversion to the mean.

Maybe it’s just time to pause and ask why US stocks have priced in so much optimism. Job growth continues but it is not robust and it is not enough to propel the economy to escape velocity; the taper is underway; fiscal policy remains a mess and there is little hope for stimulus from DC.

Corporate America is sitting on a mountain of cash, somewhere between $1.6 and $1.9 trillion, but it’s offshore; they’re afraid to touch it because they might have to pay tax. They could bring that money back home and put it to work, but that would require innovation and sweat and labor. Much of corporate leadership is short-sighted and lazy, and besides, the offshore cash is still good enough to secure a bonus.

One of the key signs of a true recovery is sufficient business confidence to start investing more into their own operations. Many companies have shied away from investing in the future growth of their companies. Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks. If you’re waiting for capital expenditures to revive the economy, don’t hold your breath.

Larry Fink is the CEO of Blackrock, the largest money manager, he says: “Companies only have a finite amount of cash to invest. Whatever gets spent on buybacks and dividends is that much less available to be spent on investments in employees, research and development, and capital expenditure. It's basic arithmetic. When will the next round of capital investment begin in earnest? As soon as you figure out the answer to that question, you will have gained significant insight into the direction of the economy as well as the next phase of this stock-market rally.”

Meanwhile, let’s look at banks behaving badly. Private banking is a staple of the Swiss economy and for decades, as wealthy Americans concealed their assets through clandestine accounts, US regulators turned a blind eye.

In 2011, federal prosecutors indicted 7 Credit Suisse bankers for abetting tax evasion, but the investigation into Credit Suisse dragged on. The quirks of international law prolonged the inquiry, requiring Swiss courts to review Credit Suisse documents before releasing them to the Justice Department. Ultimately, the Justice Department gained access to many of the documents and interviewed bank employees.

And by the time the Senate subcommittee convened its hearing in February, the Justice Department was closing in on a case. Bracing for a settlement, the bank announced last week that it had set aside roughly $528 million for legal expenses. In addition to the Justice Department investigation, Credit Suisse paid $200 million to settle a case with the SEC in February. In a separate matter, in late March the bank agreed to an $885 million settlement to resolve claims that it sold questionable loans to Fannie Mae and Freddie Mac. Apparently a slap on the wrist and a fine haven’t served as a deterrent.

Now, Benjamin Lawsky, New York State’s top financial regulator, has requested documents from Credit Suisse and is expected to demand additional records this week to try to determine if Credit Suisse lied to New York authorities about engineering tax shelters. In the Senate subcommittee hearings in February, Credit Suisse executives apologized for the misconduct and they also argued that the problems stopped in 2008 and were contained to a few low-level rogue bankers. The bank, which said it voluntarily adopted a number of controls against tax evasion, reported that there was no evidence that executive management knew of the problems.

Lawsky has also petitioned a Senate subcommittee for internal Credit Suisse documents.  The subcommittee questioned bank executives at a hearing in February, and produced a scathing report exposing “a classic case of bank secrecy.” In late March, the Senate agreed to release the internal Credit Suisse documents.

The escalating Credit Suisse probe, along with some recent shifts in international law, might also provide momentum to the government’s uneven effort to collect taxes and punish the banks involved. Typically the punishment has been a fine and a slap on the wrist, but that has drawn scrutiny from politicians lately, and so maybe this will be something more.

Meanwhile, federal authorities have opened a criminal investigation into a recent $400 million fraud involving Citigroup’s Mexican unit, one of a handful of government inquiries looming over Citi.

The investigation, overseen by the FBI and prosecutors from the United States attorney’s office in Manhattan, is focusing in part on whether holes in the bank’s internal controls contributed to the fraud in Mexico. The question for investigators is whether Citigroup ignored warning signs, as other banks have been accused of doing in the context of money laundering.

Federal prosecutors in Massachusetts have sent subpoenas to Citigroup, to examine whether the bank lacked proper safeguards against clients laundering money. Citi also faces a parallel civil investigation from the SEC. And it was just 2 weeks ago that Citi fell short in the Federal Reserve’s stress test. The Fed rejected Citi’s plan to increase its dividend based upon questions about the reliability of Citi’s financial projections.

And that brings us to the tale of Kenneth Lewis, the former chief of Bank of America. Back in 2008, as the global financial meltdown imploded, Bank of America rushed in to acquire Merrill Lynch. Lewis called it the “strategic opportunity of a lifetime” and he said the Fed did not pressure him into the deal. He later admitted he lied. Merrill Lynch was bleeding cash while paying huge bonuses. Bank of America required 2 bailouts from Treasury plus extraordinary lending from the Fed. It is a crime to knowingly deceive shareholders about the financial condition of your company.

Bank of America has paid several fines related to cases brought by various regulators, and there is still an outstanding suit, but the case of Kenneth Lewis wrapped up last week. Mr. Lewis agreed to pay $10 million, which was provided by Bank of America. He is barred from being an executive or director of a public company, but he already retired with a sizeable golden parachute. He did not have to admit or deny wrongdoing.