Financial Review

New Ways to Hail a Taxi

Sinclair Noe — August 18, 2016

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DOW + 23 = 18,579
SPX + 4 = 2187
NAS + 11 = 5240
10 Y – .02 = 1.53%
OIL + 1.44 = 48.23
GOLD + 3.70 = 1353.10

The US stock market hit all-time highs this week despite the second quarter of 2016 being another quarter with negative earnings growth. While there are still a few more earnings announcements to be released before the quarter is closed out, it looks as if earnings were down approximately 5% from the same quarter a year ago. This will be the sixth consecutive quarter with declining earnings – not the stuff of which record high stock prices are made.

The stock market continues to sleep walk. The S&P 500 finished up 0.2% today at 2187, making today our 29^th straight day without a 1% move. Energy stocks led the way. The Russell 2000 outperformed by a significant margin, and transports also impressed.

On August 3^rd, oil hit a low of $39.96 per barrel; since then it has gained more than 20% – technically a bull market in oil. Although it should be noted that bull and bear markets in oil are becoming the norm; we’ve seen 20%-plus swings in January, April and June this year. We have seen an oil glut push prices lower, pushing some producers out of business, shutting down rigs in the oil patch; we have heard OPEC jawbone about freezing output.

When we hear about production cuts we also hear that Saudia Arabia has increased output to an all-time high to gain leverage in those OPEC talks. You might be forgiven if you believe the wild swings in oil are a result of supply-demand changes, but the fundamentals haven’t changed enough to justify the dramatic price changes.

It seems like everyone forgot that OPEC disappointed at the June meeting, when many market observers were looking for a production freeze. Traders remain encouraged by the Fed’s dovish twist yesterday, which is pushing down the dollar. But at the heart of the big price moves in oil, is pure speculation – gambling.

Still, the price of oil is approximately half what it was 2 years ago, and that is having some very real repercussions. During the second-quarter earnings season, several companies that aren’t in the energy sector continued to mention declines in their businesses in oil-producing areas.

Harley Davidson saw a jump in the number of people in oil-heavy regions who were defaulting on loan payments. Caesars Entertainment said a lot of weakness was in the southeastern US. And Popeyes demonstrates that it’s not only consumer spending on big-ticket items that has fallen. Seems workers in the oil patch are less likely to buy fried chicken and biscuits. It’s a pretty good excuse anyway.

The Fed is worried about a couple of things. The minutes from the July FOMC meeting had a little bit of everything, suggesting the Fed still wasn’t sure when the next rate hike would occur. While there were numerous positives, the Fed suggested it was particularly worried about banks in Italy and stretched valuations in the US commercial real estate market. That left Fed fund futures implying balanced odds that there’ll be a rate hike by the end of 2016 — a probability that’s not much changed from before the minutes.

Jobless claims last week fell by 4,000 to 262,000, representing a one-month low, marking the 76th straight week that claims have been below 300,000 – that hasn’t happened since 1970, when the economy and the population was much smaller.

Employment figures for Arizona for the month of July showed the state lost 14,800 jobs and the unemployment rate increased two-tenths of a percentage point from 5.8% in June to 6.0% in July; the national rate is at 4.9%. Still, Arizona Nonfarm employment grew by 3.0% (76,100 jobs) over the year in July.

Meanwhile, the Federal Reserve Bank of Philadelphia’s barometer of regional manufacturing activity rebounded slightly into positive territory in August.

Five years after the housing recovery began, 5.9 million borrowers still owe more on their mortgages than their homes are worth. The negative equity rate is falling, now at 12 percent of all mortgaged homeowners, according to Zillow, down from more than 14 percent a year ago and more than 30 percent at the worst of the crisis. The numbers, however, are still well above normal levels and equally spread across urban and suburban communities.

Walmart got even bigger during the second quarter, as the company’s revenue and earnings topped Wall Street forecasts, and it reported its biggest same-store sales gain in four years. Walmart raised its full-year outlook in wake of the strong results after reporting earnings of $1.07 a share in the fiscal second quarter, slightly lower than last year’s $1.08 a share. Revenue grew 0.5 percent to $120.85 billion.

Cisco is cutting jobs. The company announced adjusted earnings of $0.63 a share on a 2% jump in revenue to $12.64 billion. Both numbers were ahead of estimates. Additionally, Cisco said it would eliminate 5,500 jobs, or 7% of its workforce, well below the job cuts of 14,000 job that were reported on Tuesday.

Nestlé had a distinctly average first half. The Switzerland-based maker of Kit-Kat candy and DiGiorno frozen pizza reported first-half revenue of $45 billion, and 3.5% organic growth. Net profit fell to $4.2 billion, missing estimates despite healthy sales in North America.

Lenovo had a stellar first quarter. The world’s biggest PC maker enjoyed a 64% leap in profit from the same time a year ago, boosted by $132 million from the sale of some Beijing real estate. It’s not all sunshine: Lenovo reported a 30% slowdown in global smartphone sales, and doesn’t expect its mobile division, which includes Motorola handsets, to make a profit before October 2017.

Just six months after it emerged from Chapter 11 bankruptcy, American Apparel has hired investment bank Houlihan Lokey to explore a sale. At least eight teen apparel retailers filed for bankruptcy this year amid fierce competition and stagnating sales, including Aeropostale, PacSun and the Wet Seal.

As earnings season winds down, you may have noticed that earnings reports are almost impossible to decipher. The Securities and Exchange Commission also noticed and they are cracking down on made-up numbers and vague language in U.S. companies’ earnings filings, sending the first of what is expected to become a steady flow of letters to finance heads requesting more information for investors.

The new letters also address issues regarding how metrics are defined by individual companies, as well as violations of rules about the kind of metrics allowed. The SEC updated its guidelines after becoming concerned that the proliferation of non-GAAP metrics and difficult-to-follow releases was confusing investors.

Shares of private-prison providers plunged in trading on Thursday following news that the Department of Justice plans to end the use of such facilities. Corrections Corporation of America, the largest publicly traded prison provider, fell 50% before trading was halted. Geo Group, a Florida-based provider of corrections facilities, also tanked by as much as 40% and was halted.

Deputy Attorney General Sally Yates instructed officials in a memo to withdraw or not renew contracts for private-prison operators when they expire. The goal is to scrap their use completely because the Justice Department found them to be less safe than those run by the Federal Bureau of Prisons and the private prisons are not cost effective.

The move won’t dislodge private prisons altogether from the American criminal justice system because they can still contract with states. Also, the Department of Homeland Security runs more than 100 immigration detention centers around the country, many of which are owned and operated by the same companies that run private prisons.

Sixteen banks, including JPMorgan, Citigroup and Morgan Stanley, are being sued by funds in the U.S. for allegedly manipulating a key Australian interest rate benchmark to generate hundreds of millions of dollars in illicit profits. The class action claims they sought to fix the bank bill swap rate, the local equivalent of Libor, which is used to price floating-rate bonds and syndicated loans.

The Department of Justice and the Environmental Protection Agency announced that motorcycle manufacturer Harley-Davidson has agreed to pay a $12 million civil fine after selling illegal after-market devices, called super tuners, that increased vehicles’ emissions. The settlement also requires that Harley-Davidson pay $3 million in a deal with the EPA to help mitigate air pollution caused by the super tuners, buy them back from its dealers, and destroy them.

Starting later this month, Uber will allow customers in downtown Pittsburgh to summon self-driving cars from their phones, crossing an important milestone that no automotive or technology company has yet achieved. Uber’s Pittsburgh fleet, which will be supervised by humans in the driver’s seat for the time being, consists of specially modified Volvo XC90 sport-utility vehicles outfitted with dozens of sensors that use cameras, lasers, radar, and GPS receivers.

Aerospace giant Airbus is designing a flying driver-less taxi that you can summon via an app on your smartphone. Airbus believes the global demand for the “flying cars” will run in to millions of vehicles and that demand will help reduce development costs. Airbus chief executive Tom Enders says, “In a not too distant future, we’ll use our smartphones to book a fully automated flying taxi that will land outside our front door – without any pilot.”

The vertical-takeoff-and-landing (VTOL) air taxi would use electric propulsion and multiple-ducted propellers, and would be piloted initially, before transitioning to fully autonomous operations. The prototype is scheduled to take flight sometime next year. Meanwhile, Airbus said it was also developing a drone-like helicopter which could ferry multiple passengers around a city. CityAirbus is slated to have a pilot on board at first but would switch to full autonomous operations when the technology developed.

Financial Review

Underwater

Sinclair Noe — June 12, 2015

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

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DOW – 140 = 17,898
SPX – 14 = 2094
NAS – 31 = 5051
10 YR YLD +. 01 = 2.39%
OIL – .74 = 60.03
GOLD – .70 = 1182.30
SILV – .07 = 16.06

The Trans Pacific Partnership trade deal hit a major roadblock today. The House rejected a key part of a package to fast-track the trade deal. The House voted today on two measures, both of which had to pass in order to send the legislation, which was already approved by the Senate, to the president. A bill to give the president fast-track authority to negotiate future trade deals was approved by a 219-211 vote. But another measure regarding funds to retrain workers failed, 126 to 302. Because the Senate had approved both measures, the failure of the retraining program prevented the package from advancing. The measure would give the Obama administration the ability to wrap up negotiations on the Trans-Pacific Partnership, a free-trade deal years in the making, and present a final agreement to Congress for expedited consideration and an up-or-down vote with no amendments.

In one of the more unusual coalitions of the Obama administration, the trade agenda found strong support with Republicans, while Democrats ended up blocking the measure. Democrats had repeatedly asked for the administration to make the trade deals public before seeking the fast-track power. Democrats also complained that the fast-track measure fails to protect workers, environmental standards and financial regulations, and does nothing to stop unfair currency manipulation. The failure does not necessarily mean an end to the battle. House Speaker John Boehner can bring the measures back if he can find a way to whip up more support.

New information reveals that more personnel records were hacked than previously reported during the federal cyber theft in December. Already considered one of the largest thefts of US government personnel data in history, investigators now estimate that it may include data on as many as 14 million people, more than triple the 4 million current and former government employees reported by the Office of Personnel Management last week. Officials are now weighing responses ranging from counter-intelligence initiatives to destroying the data in the intruders’ servers.

The producer price index increased 0.5 percent in May, the biggest one-month increase since September 2012. Prices at the wholesale level were pushed higher by a sharp jump in the cost of gasoline and a record increase in the price of eggs because of the avian flu. Core prices, which exclude energy and food, rose just 0.1 percent in May. Even with the advance in May, producer prices over the past 12 months are 1.1% lower.

Consumer confidence rose more than forecast in June. The University of Michigan preliminary consumer sentiment index increased to 94.6, from a final reading of 90.7 in May that was the lowest in six months. Consistent gains in the labor market are cited as a major reason for increased confidence, and likely helped underpin household spending, reflected in yesterday retail sales report which showed sales increased 1.2 percent last month.

Yesterday, there were reports that Greece might be nearing a deal on its debt problems. Then late yesterday the International Monetary Fund recalled its negotiating team from talks in Brussels, which might signal doom for any resolution. In response, Greece ruled out cutting pensions and demanded a debt restructuring. So, the battle lines are drawn, or redrawn, and next week EU officials will meet again in Luxembourg for a likely showdown, or it might be part of the game of chicken that both sides seem to be playing. The Greek tragedy could drag out for quite some time or it could come to a head at almost any time, and if a resolution is not found, there will almost certainly be a domino effect.

More bad news from the Eurozone today; Standard & Poor’s says Britain’s “economic policymaking could be at risk of being more exposed to party politics than we had previously anticipated.” The Credit rating agency says it is “similar to the situation in the U.S. in 2011.” Not exactly. The situation in Britain deals with a possible referendum vote on leaving the European Union in 2017. S&P lowered the outlook on the Britain’s AAA rating to “negative” from “stable.” That means there’s a one-in-three chance of a downgrade in the next two years. In its analysis, S&P said that PM Cameron’s pledge for a vote, made to placate elements of his Conservative Party, “represents a risk to growth prospects” for U.K. financial services, exports and the economy as a whole.

The number of borrowers who owe more on their home than it’s worth is falling, but there are still a number of borrowers who are deeply underwater. Zillow released its 2015 Q1 Negative Equity Report, which showed that negative equity fell in the first quarter of 2015 to 15.4% from 16.9% in the fourth quarter of 2014, and 18.8% during the same time period a year ago; negative equity peaked nationally at 31.4% in the first quarter of 2012. The rate of negative equity improved in all of the 35 largest housing markets in the first quarter of 2015. The rate of underwater homeowners is much higher among the homes with the least value. More than 25% of those who own the least valuable third of homes were upside down, compared to about 8% of the most valuable third of homes.

At the peak of the crisis, more than 15 million homeowners owed more on their mortgages than their homes were worth. Since then, foreclosures, short sales and rapidly rising home values freed nearly half of those homeowners, leaving 7.9 million homeowners upside down at the end of the first quarter; of those that are still underwater, over half or about 4 million owners, still owe 20% more than the value of their home, making it difficult for them to get out from under their mortgage.

For Phoenix, the negative equity rate in the first quarter was 19%, which works out to almost 147,000 homes in negative equity, and 56% of those owners were underwater by more than 20%. And 12.9% of underwater homeowners in Phoenix owe more than twice their home’s value to the bank. While home prices in Phoenix have recovered, according to Zillow valuations, prices are still down 26.9% from the peak.

Actually, it’s worse than that. Realistically, a homeowner needs roughly 20 percent equity in their home to afford the taxes and fees associated with listing and selling it and still have enough left over to afford a reasonable down payment on another home. When including these homeowners with less than 20 percent equity in their home, the national “effective” negative equity rate is 33 percent. Put another way, a third of all homeowners with a mortgage don’t have enough equity to list their home for sale and buy another. And while it’s great that the level of negative equity is falling, there are still so many homeowners underwater that it will likely be years before we get back to more normal levels of around 2% negative equity; and while we wait, many homeowners are stuck in their homes.

Next week the Federal Reserve FOMC will meet to determine monetary policy. No change is expected, although we will watch for any hint about when they plan to hike rates in the future. Also next week, the Fed will publish new quarterly forecasts, and all eyes are going to be on where they set the natural rate of employment; that’s the level of employment that is just strong enough to lift the economy without setting inflation on fire. Many people think the natural unemployment rate is about 5%. The current unemployment rate is 5.5%; so we are close. A new paper by Fed board staff shakes up this view by suggesting the number could be as low as 4.3%; the reason being that wages have not been keeping pace with hiring.

The bigger news next week will be Thursday, when Pope Francis will publish his much anticipated encyclical on the environment and climate change. An encyclical is a letter to followers, about 1.3 billion in this case.

An encyclical is not a scientific document, rather one that explores a particular issue in the light of Catholic social teaching. Yet the Pontifical Academy of Science has thoroughly investigated the research, producing its own documents on topics such as glacier retreat, and it is clear that we must take on board what the science is telling us. Francis will not approach the issue of ecology as a scientist (though he is a trained chemist) or as a politician (though he clearly has excellent political instincts). Rather, he will address his flock as a pastor, a teacher, theologian and spiritual guide. He will remind us that Creation is a gift from God, and that we have a moral responsibility to be responsible stewards. Creation in this instance means more than the ground we walk on and the air we breathe. It also means all of humanity, including the poorest, who are also the most vulnerable to climate change.

By tying climate action to the Christian mandate to aid the afflicted and give comfort to the needy, Pope Francis will be doing much more than merely acknowledging the severity of the problem. By virtue of his moral authority, the pope has the singular ability to mobilize people all over the globe to take whatever form of action they can. No other figure of our time can claim that degree of influence. The climate change narrative is about to change; no longer a debate about science or business; now it will be a moral issue, a religious issue; a simple matter or right or wrong. And with Pope Francis leading the charge, the climate change deniers and fossil fuel apologists will soon realize they haven’t got a prayer.

Financial Review

Buckle Up

Sinclair Noe — March 17, 2015

 

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DOW – 128 = 17,849
SPX – 6 = 2074
NAS + 7 = 4937
10 YR YLD – .04 = 2.06%
OIL – .42 = 43.46
GOLD – 5.70 = 1149.60
SILV – .10 = 15.63

The FOMC will wrap up its two-day meeting on interest rate policy tomorrow. The key question: will the Fed give a hint about raising interest rates? IMF Director Christine Lagarde says even if the Fed is able to manage expectations about an interest rate hike, “the likely volatility in financial markets could give rise to potential stability risks.”

ECB President Mario Draghi says, “Most indicators suggest a sustained (eurozone) recovery is taking hold.”  Draghi is urging governments to use the brighter outlook to advance reforms that would improve the region’s long-term growth prospects. Draghi claims, “Confidence among firms and consumers is rising. Growth forecasts have been revised upwards. And bank lending is improving on both the demand and supply sides.”

Draghi sounds a little overly optimistic. A couple of weeks of bond buying have not changed the overall economies of the Eurozone. Unemployment is still rampant in Spain and Italy and Greece and Portugal and several other countries. No doubt QE is increasing liquidity in the sovereign debt markets; the private banking system are surely pleased with cheap money policy, but it hasn’t changed the jobs picture, it hasn’t resolved the underlying problems of the economy, and it hasn’t resolved the problem of deflation.

Many people thought that QE would result in inflation, or even hyper-inflation. Wrong. Just this year, 23 central banks have cut rates due to sluggish growth. In the process their currencies will weaken. The Bank of Japan maintained its massive 80-trillion-yen stimulus program today, and noted inflation could fall into negative territory because of the continued weakness in energy prices; however, it also said any return to deflation would not last long. A return to moderate inflation might just be wishful thinking.

Meanwhile, the euro is tanking against the dollar as the ECB buys covered bonds from the Euro-banks, while Greece is left to dangle from a short and sharp hook, locked out of the capital markets. Today, Greece began debate on emergency measures to deal with $2.1 billion in debt payments due Friday. Euro quantitative easing has nothing to do with helping Greece attain a stronger economy and everything to do with rewarding speculators and the Euro-banks that sold them bonds. Included in the amount due Friday, payments on a swap originally arranged by Goldman Sachs in 2001. The derivative, now held by the National Bank of Greece, masked the country’s growing debt, helping it meet European Union rules for entering the euro area.

There are only so many entities that can buy so many bonds and filter so much cheap capital into the system for so long. Eventually the ECB will quit QE. Eventually the Federal Reserve will raise interest rates. And then what? Well, the central bankers will look for new ways to finagle the financial sector, but we might reasonably expect more volatility. Maybe the Fed will give us a hint tomorrow.

When we think about volatility in the markets, we tend to default to the stock market, but don’t forget bonds. Consider that the 10 year US Treasury note yields 2.06%. The Japanese 10 year bond yields 0.41%. Germany at 0.28%, and Spain 1.25%. These are historic lows.  So, with the bond market appearing ripe for a dramatic correction, many are wondering whether a crash could drag down markets for other long-term assets, such as housing and equities.

According to Nobel economist Robert Schiller, long-term rates in the US should be even lower than they are now, because both inflation and short-term real interest rates are practically zero or negative. Even taking into account the impact of quantitative easing since 2008, long-term rates are higher than expected. The history of bond markets crashes have been relatively rare and mild. So, there should be no reason for bonds to crash from here… unless, there is a major spike in inflation, or the central banks tighten monetary policy very sharply by hiking short-term interest rates.

For now, the markets are trying to make sense of where everything is headed. The result has been volatility. The Dow Jones Industrial Average was down a bit over 100 points last week, but that hardly does justice to a week with multiple triple digit swings. Three of the last six trading days have seen a move of at least 1%. Today the Dow dropped 128 points, and that was just a move of 0.7%. Still, it can be a bit unnerving. Volatility in and of itself isn’t necessarily a bad thing as markets can continue to climb even as volatility does the same. A rising VIX doesn’t have to correspond with a lower stock market. The VIX (volatility index) trended higher from 1996 right to the end of the dotcom mania. Maybe that is not reassuring, but this is not the internet bubble.

One reason for the volatility is because earnings outlook has turned lower, but even more so because earnings outlook has turned very uncertain; and the reason behind the uncertainty is the volatility of the dollar. Yes, the dollar has been getting stronger; remember that volatility can apply in up or down markets. The strength of the dollar raises questions about whether companies have properly hedged earnings in other countries. Will a higher dollar create a debt crisis outside the US as it has in the past? What will central banks do in response? Which central bank will win the race to the bottom of currency valuations? How will that affect the US economy?

Economic data in the US has been on the weak side lately. A strong dollar doesn’t help. Inventory to sales ratios have now jumped to levels that are comparable to late 2008. Sales were down for the third month in a row led by declining auto sales (-2.5%). Sales were down across a wide swath of industries. The economic expansion since the 2008 crisis may have been disappointing, but it has been remarkably steady. Annual GDP growth has been eerily consistent, between 2 and 2.5% for years. The last time we had such a run of consistent growth was the late 90s; the growth rate was higher, around 4%, but very consistent.

Maybe the strange part of the past few years is just how consistent the recovery has been. Maybe the lack of volatility is a result of the accommodative monetary policy of the Federal Reserve, well balanced against a weak economy, just enough to push forward, but not enough to reach escape velocity. The one thing we know is that markets fluctuate, they don’t move in a straight line. So buckle up, it should be interesting.

Construction on new homes in the United States slumped 17% in February, mostly because of heavy snowfall that sidelined builders in the Northeast and Midwest. Housing starts sank to an annual rate of 897,000 in February from a revised 1.08 million in January. But nationwide permits for future construction rose, suggesting construction will pick up in the spring. The biggest increase in applications for new construction once again involved multi-dwelling projects such as apartment buildings and townhouse rows. Permits for projects of five units or more jumped nearly 20%, reflecting a post-recession trend in which more people are renting instead of owning.

Another factor weighing on housing is negative equity. According to CoreLogic, there are 5.4 million homes, or 10.4% of all homes with a mortgage, underwater in the fourth quarter of 2014. This is down considerably -18.9 percent, from a year ago-but it still keeps these borrowers from putting their homes on the market, because they would lose money. Additionally, of the 49.9 million U.S. homes with a mortgage, approximately 10 million (20 percent) have less than 20 percent equity, and 1.4 million have less than 5 percent. These homeowners also would have a difficult time selling because not only would they lose money in the process, but they also might not qualify for a new mortgage. Arizona is still one of the top 5 states for negative equity, with 18.7% of mortgaged homes underwater.

Exit polls show Israel’s elections are too close to call. Those waiting to find out who will be the next prime minister of Israel need to wait. Binyamin Netanyahu—the serving PM—won the same number of seats as Isaac Herzog’s Zionist Union according to several exit polls. Netanyahu is claiming victory, based on the idea that he can cobble support from other parties, but really, it’s too close to call right now.

American Airlines was added to the S&P 500. The airliner replaces Allergan, which has been taken-over by. The addition will take place after the close of trading on March 20.

Over the past few years we have talked about deferred prosecution agreements or non-prosecution agreements; a common tool used by the Justice Department in investigations ranging from sanctions violations to market manipulations. Such settlements require the banks to admit responsibility and cooperate with ongoing investigations. It is a bank or corporate equivalent of probation. The banks pay a fine and promise not to break the law for a few years, and if they can keep their nose clean, then all is forgiven. The problem is that the banks are repeat offenders.

For example, a few years back several banks were found to be rigging benchmark interest rates, the Libor scandal. Fines were paid and deferred prosecution agreement signed. Barclays, Royal Bank of Scotland, UBS, and HSBC are operating under such agreements. But now, the banks appear to have rigged the forex markets, or the currency exchange market, just within the past 2 or 3 years; which would be a violation of the agreement to stop breaking the law.

Leslie Caldwell, the head of the Justice Department’s criminal division, said in a speech Monday that the US is prepared to tear up settlements and charge banks for conduct covered by the settlements. “Where banks fail to live up to their commitments, we will hold them accountable,” Caldwell said. “The criminal division will not hesitate to tear up a DPA or NPA and file criminal charges.”

Of course prosecutors have talked tough in the past and then followed it up with the vicious pugnacity of a timid meter maid; the results have been predictable; the banksters’ recidivism rate has regularly topped 100%. So, don’t hold your breath.