Financial Review

Drifting Higher

Sinclair Noe — June 7, 2017

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DOW + 37 = 21,173
SPX + 3 = 2433
NAS + 22 = 6297
RUT + 1 = 1396
10 Y + .03 = 2.18%
OIL  – 2.10 = 45.88
GOLD – 6.80 = 1287.80
BITCOIN – 1.57% = 2736.57
ETHEREUM – 2.04% = 258.86

Major stock, bond and currency markets did little more than drift higher ahead of what many are calling Super Thursday. That’s when the U.K. holds a very important general election, the European Central Bank announces its decision on monetary policy, former FBI director James Comey testifies to the Senate about Russian meddling in the U.S. election, and Brazil’s Electoral Court may issue a decision on campaign corruption that could unseat President Michel Temer.

The Senate Intelligence Committee held public hearings today, with Director of National Intelligence Dan Coats and NSA Director Admiral Mike Rogers repeatedly said they would not discuss their private conversations with President Donald Trump.

Coats and Rogers said they did not feel the public setting of the Senate intelligence committee’s hearing was an appropriate venue to discuss their conversations with Trump. Acting FBI Director Andrew McCabe invoked the probe of special counsel Robert Mueller, when McCabe said he wouldn’t comment on issues in the special counsel’s lane.

Fired FBI Director James Comey is scheduled to appear before the committee tomorrow. Today, Comey released his written prepared opening remarks, saying the President had demanded his loyalty, pressed him to drop a probe into ex-national security adviser Michael Flynn and repeatedly pressured him to publicly declare that he was not under investigation.

The document provides a detailed account of Comey’s private meetings with the President, included direct quotes from Trump and revealed the former FBI chief’s discomfort with the President’s behavior.

President Trump took to Twitter early this morning to break the news about his pick for FBI director. The nominee is Christopher Wray, a private attorney specializing in the defense of individuals and corporations in white-collar criminal cases. He represented New Jersey Gov. Chris Christie during the “Bridgegate” investigation.

This afternoon, Trump traveled to Cincinnati to pitch his 10-year, $1 trillion infrastructure outline as part of a week’s worth of events emphasizing progress on the proposal, though it has yet to be fully fleshed out.

Over the past week, Trump has often undercut and confounded his own aides as they try to shift the conversation toward the infrastructure plan, he was tweeting out new attacks on the news media and feuding with his own Justice Department over its defense of his targeted travel ban.

So far, the infrastructure proposal is not much more than an outline, short on details and specifics, other than a plan announced this week to privatize the nation’s air traffic control. The plan, conceived by the commerce secretary, Wilbur Ross, and economic advisor Peter Navarro, calls on the federal government to spend $200 billion in cash and tax credits that would, they say, result in $800 billion in additional private investment.

In congressional testimony this year, the transportation secretary, Elaine Chao, predicted that a more detailed proposal would be released by late May. But last week she would say only that it was “coming soon.”

Russian hacking of the 2016 U.S. election included sophisticated targeting of state officials responsible for voter rolls and voting procedures, per a top-secret U.S. intelligence document that was leaked and published this week, revealing another potential method of attempted interference in the vote.

The month-old National Security Agency document outlined activities including impersonating an election software vendor to send trick emails to more than 100 state election officials. However, there is no evidence that hackers could manipulate votes, or the vote tally.

Analysts at the NSA believed the hackers were working for the Russian military’s General Staff Main Intelligence Directorate, or GRU. The document’s publication by The Intercept received attention because an intelligence contractor, Reality Winner, was charged the same day with leaking it.

According to Bill Gross, who manages the $2 billion Janus Henderson Global Unconstrained Bond Fund, markets are at their highest risk levels since before the 2008 financial crisis because investors are paying a high price for the chances they’re taking. Speaking at a Bloomberg Investors conference in New York, Gross said, “Instead of buying low and selling high, you’re buying high and crossing your fingers.”

Central bank policies for low and negative interest rates are artificially driving up asset prices while creating little growth in the real economy and punishing individual savers, banks and insurance companies. Despite being concerned about high asset prices, Gross said he feels required to stay invested and sees value in some closed-end funds.

Consumer and business bankruptcies are rising again, after declining for years since the financial crisis. That’s not a propitious sign. For bankruptcy filings by businesses from large corporations to tiny sole proprietorships, the dance started in November 2015. At first it was the energy bust. But bankruptcies of energy companies have tapered off with new money surging into the oil & gas sector once again.

Now bankruptcies in the retail sector are steadily worsening, and other sectors too have picked up the slack. So here we go again. Total US business bankruptcies in May rose 4.7% year-over-year to 3,572 filings, according to the American Bankruptcy Institute. That’s up 40% from May 2015 and up 10% from May 2014.

And there’s another concern: Bankruptcy filings are highly seasonal. They peak in tax season – March or April – and then fall off. The decline in April after the peak in March was within that seasonal pattern. Over the past years, filings dropped in May. But not this year. This year, they jumped.

Sears is closing 72 more stores, in addition to the more than 180 closings that had already been announced this year.  The closings will bring Sears’ store count to about 1,200, down from 2,073 five years ago.

OPEC and other oil producing nations have cut back production in hopes of shrinking a global oil glut. Today, the U.S. government reported an unexpected increase in inventories of crude and gasoline. Crude stocks in the United States grew 3.3 million barrels to 513 million barrels, according to the U.S. Energy Information Administration.

Gasoline inventories also unexpectedly rose, imports increased, and exports dropped. The EIA report pegged total product demand at 19.340 million barrels a day. That included a drop of 505,000 barrels a day for gasoline demand and 520,000 barrels a day for distillate demand from a week earlier.

A 1.4 million barrel-per-day petroleum-demand drop is the kind of shift one associates with a catastrophic storm or economic plunge. Even more shocking, the rise for crude inventories came despite a decline in domestic production and the biggest weekly drop in Saudi imports ever.

Oil has traded below $50 for the past couple of weeks amid speculation that rising U.S. output will counter supply curbs by OPEC and its partners, including Russia. U.S. crude production will average more than 10 million barrels a day in 2018, breaking a record almost five decades old.

Low-cost, long-haul air travel has taken off across the Atlantic. Transatlantic routes are among the industry’s most popular and profitable, and budget carriers are trying to grab a slice of that business by boosting capacity on them by 68 percent this summer.

And that means the flying public may see price wars. Like Boston to London, round trip for under $300. Norwegian Air Shuttle and Icelandic rival Wow have grabbed headlines with one-way fares as low as $69 and $55 this summer, although Wow’s flights involve a stop in Reykjavik.

Lufthansa’s Eurowings budget carrier is in its second year of long-haul flying, while Air France is planning to launch a lower-cost long haul brand this fall in a project dubbed Boost. International Airlines Group launched low-cost long-haul brand Level on Thursday with surprisingly strong ticket sales.

Toshiba aims to name a winner for its prized semiconductor business next week. Sources told Reuters the choice has narrowed to one bid from U.S. chipmaker Broadcom and U.S. tech fund Silver Lake and another from Toshiba chip partner Western Digital and Japanese government-related investors.

Toshiba is rushing to find a buyer for the world’s second-largest producer of NAND chips, which it values at $18 billion or more, to cover billions of dollars in cost overruns at its now-bankrupt U.S. nuclear business Westinghouse Electric.

The British pound sterling gained ground today as the UK saw the final day of campaigning ahead of Thursday’s general election. Polls suggest that Theresa May’s Conservative Party hold a lead of around six points over Jeremy Corbyn’s Labour Party, although outliers suggest that lead could be as big as 12 points, or as small as one point.

While a big move in the price of sterling is expected once results start to come out on Thursday evening, investors in Britain’s currency were largely in wait and see mode ahead of the vote. The polls have been notoriously wrong in recent voting.

Yes, there’s a lot going on tomorrow, but don’t forget to keep an eye on Canada. The Bank of Canada will release its semi-annual Financial System Review and investors will be watching for what the central bank says about the nation’s red-hot housing market. Toronto home prices rose almost 30 percent last month from a year earlier.

In Vancouver, the country’s most expensive real estate market, they’ve climbed 58 percent over four years. Meanwhile, household debt is at record levels, surpassing gross domestic product for the first time. Fitch said Wednesday that banks with greater exposure to those two cities are more sensitive to a market correction.

In the last FSR in December, the Bank of Canada listed elevated household indebtedness, housing market imbalances and fixed-income liquidity as the three main risks to the financial system, and the focus should be similar this time.

Financial Review

Watch and Wait

Sinclair Noe — March 8, 2017

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DOW – 69 = 20,855
SPX – 5 = 2362
NAS + 3 = 5837
RUT – 8 = 1366
10Y + .04 = 2.55%
OIL – 2.95 = 50.19
GOLD – 7.70 = 1208.90

The S&P and Dow are down for 3 straight sessions. Oil closed at a 3-month low. Eight years ago, the Dow Industrial average was barely holding on at the 6,500 level. The S&P 500 index had dropped to 666. Since those dark days in the Spring of 2009, the Dow has climbed over 320%. The S&P is up 354%.

If you had purchased Apple 8 years ago, you would have a 1,000% gain. Home Depot delivered a 608% gain. Not very likely you were buying stocks 10 years ago, this week; a lottery ticket would have been an easier play.

Payrolls processor ADP reports the US economy added 298,000 private-sector jobs in February, the most since April 2014. ADP’s report wasn’t just strong at the headline—it also suggested growth in well-paying fields, as construction and professional & business sectors each added 66,000 jobs.

While the relatively lower-paid education & health and leisure & hospitality each added another 40,000 jobs, manufacturers added 32,000 jobs. The ADP report suggests the official non-farm payrolls report from the Labor Department, which also covers government jobs, might come in well ahead of the current 200,000 consensus estimate.

Productivity increased 1.3% in the fourth quarter. Even with a healthy fourth-quarter boost, productivity only rose 0.2% in 2016. That’s the smallest gain since 2011 and maintains a post-recession trend of extremely weak increases in productivity.

The government’s first revision of fourth-quarter productivity showed little change in output, hours worked or labor costs. Productivity has averaged 1% growth per year since 2007, compared to a 2.6% rate from 2000 to 2007.

The European Central Bank meets tomorrow to announce its latest call on rates and stimulus measures. Eurozone Inflation is finally back at the ECB’s target of around 2% for the first time since 2013. Inflation is one of the key measures the central bank uses to decide on interest rates and other stimulus measures.

And the Eurozone purchasing managers’ index jump to a 70-month high and gross domestic product growth is outpacing that of the US. But that doesn’t mean the ECB will raise rates; most analysts think they will only make adjustments to forward guidance.

The Federal Reserve meets next week to announce monetary policy. Yesterday, Jeffrey Gundlach, chief executive officer at DoubleLine Capital, said he expects the Federal Reserve to begin a campaign this month of “old school” sequential interest rate hikes until “something breaks,” such as a US recession.

Japan’s economy gets an upgrade. The Final GDP reading for the fourth quarter showed the Japanese economy grew at a 0.3% clip, ahead of the 0.2% that was previously recorded. Private business investment grew by 2% in the quarter, making for the fastest growth since the first quarter of 2014.

China reported a rare trade deficit in February equal to about $9 billion. However, the country’s trade data are frequently distorted this time of year, because of the celebration of the Chinese New Year. Still, it’s the first monthly trade deficit China has reported in three years.

An indicator of the health of the global economy grew at its fastest pace in 6 years. Data released by the International Air Transport Association showed that revenue passenger kilometers grew by 9.6% compared with a year earlier, making for the fastest growth since April 2011.

OPEC and non-OPEC producing countries have reiterated their pledge to uphold the terms of the production cut agreement reached late last year; top energy ministers said they were committed to removing 1.8 million barrels from the market. So far, it hasn’t happened.

This morning, the American Petroleum Institute reported oil stocks rose by 11.6 million barrels last week. US crude production is projected to surge to a record 9.7 million barrels a day next year, per the EIA’s monthly Short-Term Energy Outlook released Tuesday.

The US Energy Information Administration on Wednesday reported an 8.2 million-barrel climb in domestic crude supplies for last week, lifting total commercial inventories to a new record weekly level of 528.4 million. That marked a ninth straight weekly increase.

Mexico has canceled existing sugar export permits to the United States in a dispute over the pace of shipments. Reuters report a letter sent by Mexico’s sugar chamber to mills partly blamed the situation on unfilled positions at the US Department of Commerce, which it said has led to a “legalistic” interpretation of rules with no US counterparts in place in Washington for Mexican officials to negotiate with. Mexico is the top foreign supplier of sugar to the US.

A new report commissioned by the federal government accuses Caterpillar of using tax and accounting fraud to prop up its stock price. The New York Times reports no charges have been filed, and it is not clear whether investigators agree with the findings or intend to act on them.

The report, which has not been made public or made available to Caterpillar, outlines a company strategy for bringing home billions of dollars from offshore affiliates while avoiding federal income taxes on those earnings. Last week, federal agents raided three Caterpillar buildings near its headquarters in Peoria, Ill., as part of the investigation.

The company’s tax practices have been a focus of government investigators since a 2014 Senate hearing found that the company cut its tax bill by $2.4 billion over 13 years, moving earnings out of the United States and into a Swiss subsidiary, despite internal company warnings that the strategy lacked a business purpose, other than tax avoidance.

The CIA faces what could potentially be the biggest ever leak of its secrets, after Wikileaks published thousands of documents claiming to show how the agency uses cyber espionage tactics to hack into smartphones and other devices. The leak, named “Vault 7” by WikiLeaks, will once again raise questions about the inability of US spy agencies to protect secret documents in the digital age.

The methods could reportedly capture text and voice messages on iOS, Android and Whatsapp before they were encrypted, and could hack Microsoft software and Samsung TVs. Apple released a statement saying they have already dealt with some of the issues raised in the leaks. Microsoft is reportedly considering the issue.

Microsoft says it is committing to use chips based on ARM Holdings technology in the machines that run its cloud services, potentially imperiling Intel’s longtime dominance in the profitable market for data-center processors. Microsoft has developed a version of its Windows operating system for servers using ARM processors, working with Qualcomm and Cavium.

In Hawaii, the Kauai Island Utility Cooperative is now drawing energy from 272 Tesla power packs to provide electricity after dark. While the island previously relied on solar and other renewable energy during the day, it had no way to store the sun’s power after it went down.

Using stored energy from Tesla’s power packs is expected to save KIUC 1.6 million gallons of diesel fuel annually, which has traditionally been the way the utility generates power after dark. Tesla says the power packs will cut KIUC costs per kilowatt hour from 15.5 cents down to 13.9 cents. The 13.9 cents is a fixed price for the next 20 years.

The West Virginia Gazette-Mail obtained previously confidential drug shipping sales records sent by the US Drug Enforcement Administration to West Virginia Attorney General’s office. The records disclose the number of pills sold to every pharmacy in the state and the drug companies’ shipments to all 55 counties in West Virginia between 2007 and 2012.

In six years, drug wholesalers showered the state with 780 million hydrocodone and oxycodone pills, while 1,728 West Virginians fatally overdosed on those two painkillers. The unfettered shipments amount to 433 pain pills for every man, woman and child in West Virginia.

The nation’s three largest prescription drug wholesalers -McKesson, Cardinal Health and AmerisourceBergen – supplied more than half of all pain pills statewide.

Urban Outfitters CEO Richard Hayne does not have comforting words for the retail industry. Hayne said on the company’s earnings conference call on Tuesday: “Our industry, not unlike the housing industry, saw too much square footage capacity added in the 1990s and early 2000s,” “Thousands of new doors opened and rents soared. This created a bubble, and like housing, that bubble has now burst. We are seeing the results, doors shuttering and rents retreating. This trend will continue for the foreseeable future, and may even accelerate.”

Shares in H&R Block were higher after the company reported results that beat Wall Street expectations.

German sportswear giant Adidas reported its 2016 full-year earnings on Tuesday, and its revenue of 19.3 billion euros was slightly below analyst expectations, but they raised guidance for 2017 and beyond. Adidas’s overall sneaker sales jumped 80% in 2016; a substantially larger spike than any major competitor saw.

Wall Street firm, State Street Corp., has put up a statue of a girl in front of Lower Manhattan’s well-known bronze charging bull, as if to fearlessly stare it down. Placing the diminutive, grade school-aged girl in front of the massive bull on the eve of International Women’s Day was a way of calling attention to the lack of gender diversity on corporate boards and the pay gap of women working in financial services.

State Street said one out of four of the companies that make up the Russell 3000 Index still have no female representation on their boards.

Stocks Manage Decent Gains

Charles Schwab: On the Market

Posted: 10/19/2016 4:15 PM ET

Stocks Manage Decent Gains

With the Nasdaq able to hold positive territory, U.S. stocks finished the regular trading session higher amid some upbeat earnings reports and as Fed rate hike expectations remained elevated. Financials and energy issues were among the top performers and crude oil prices rallied following a bullish government oil inventory report. Treasuries and the U.S. dollar were little changed and gold moved higher. In other developments, domestic housing construction data was mixed and the Fed's Beige Book report showed economic activity continued to expand at a moderate to modest pace.

The Dow Jones Industrial Average (DJIA) rose 41 points (0.2%) to 18,203, the S&P 500 Index added 5 points (0.2%) to 2,144 and the Nasdaq Composite ticked 3 points higher to 5,246. In moderate volume, 781 million shares were traded on the NYSE and 1.5 billion shares changed hands on the Nasdaq. WTI crude oil increased $1.20 to $51.82 per barrel, wholesale gasoline was unchanged at $1.51 per gallon and the Bloomberg gold spot price gained $6.97 to $1,269.47 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was nearly flat at 97.92.

Dow member Intel Corp. (INTC $36) reported 3Q earnings-per-share (EPS) ex-items of $0.80, above the $0.73 FactSet estimate, as revenues rose 9.0% year-over-year (y/y) to $15.8 billion, compared to the expected $15.6 billion. INTC issued 4Q revenue guidance that came in a bit shy of estimates. Shares finished solidly lower.

Morgan Stanley(MS $33) posted 3Q profits of $0.81 per share, north of the $0.63 expectation, as revenues grew 14.1% y/y to $8.9 billion, topping the forecasted $8.1 billion. MS said it saw record revenue in its wealth management segment and a strong performance in its sales and trading business. Shares closed higher.

Yahoo Inc. (YHOO $43) announced 3Q EPS ex-items of $0.20, exceeding the estimated $0.14, with revenues excluding traffic acquisition costs (TAC) declining 14.6% y/y to $857 million, below the projected $861 million. The company noted that in addition to its continued efforts to strengthen its business, it is busy preparing for integration with Verizon. YHOO gained solid ground.

For analysis of earnings and the stock markets, Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, offers his latest article, Three Reasons Stocks May Avoid Another Lost Decade, at www.schwab.com/marketinsight, and follow Jeff on Twitter: @jeffreykleintop.

Housing construction activity mixed

Housing starts (chart) for September fell 9.0% month-over-month (m/m) to an annual pace of 1,047,000 units, below the Bloomberg forecast of a 1,175,000 unit rate. August starts were upwardly revised to an annual pace of 1,150,000. Building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, rose 6.3% m/m in September to an annual rate of 1,225,000 units, after August's unrevised 1,139,000 rate, and well above the expected annual pace of 1,165,000 units.

Housing data will continue to dominate the economic front tomorrow in the form of the key release of existing home sales, with contract closings expected to rise 0.4% m/m to an annual rate of 5.35 million units in September. For analysis of investing in real estate, see Schwab's Director of Market and Sector Analysis, Brad Sorensen's, CFA, article Real Estate Sector: Marketperformat www.schwab.com/marketinsight.

At 2:00 p.m. ET, the Federal Reserve released its Beige Book report—an anecdotal report on national economic activity used by the Central Bank to prepare for the next two-day monetary policy meeting which concludes on November 2. The report showed that U.S. economic activity continued to expand at a modest or moderate pace in most reporting districts from late August to early October and outlooks were mostly positive. Employment and wage growth were modest and labor market conditions remained tight in most areas. Consumer spending was mixed for the period, while demand for nonfinancial services generally expanded compared to the previous report. Manufacturing activity widely diverged amid the regional landscapes and the strong U.S. dollar continued to weigh on exports according to a few districts.

As noted in the recent Schwab Market Perspective: Spinning Our Wheels, after a temporary soft patch in August, economic data has improved. The next couple of weeks will be data heavy and we'll be watching closely to gauge likely Fed policy. Read more at www.schwab.com/marketinsight, and follow Schwab on Twitter: @schwabresearch.

The MBA Mortgage Application Index rose 0.6% last week, after dropping 6.0% in the previous week. The increase came as a 0.8% decline for the Refinance Index was more than offset by a 3.0% rise for the Purchase Index. The average 30-year mortgage rate rose 5 basis points (bps) to 3.73%.

Treasuries were little changed, with the yields on the 2-year and 10-year notes flat at 0.80% and 1.74%, respectively and the 30-year bond rate ticked nearly 1 bp lower to 2.50%. Schwab's Chief Fixed Income Strategist, Kathy Jones discusses the interest rate environment in her latest article, Are Bond Yields About to Rise?, at www.schwab.com/onbonds and follow Kathy on Twitter: @kathyjones.

Ahead of tomorrow's existing home sales release, the U.S. economic calendar will also deliver the Philly Fed Manufacturing Index, forecasted to have declined to 5.0 for October from 12.8 in September, along with the weekly initial jobless claims report, expected to show an increase to 250,000 from last week's 246,000 level. Finally, we will also receive the Leading Index, with economists expecting a 0.2% m/m increase for September after the 0.2% decline experienced in August.

The markets continue to grapple with the uncertain U.S. political landscape as the November election looms and ahead of tonight's third and final Presidential debate. Schwab's Vice President of Legislative and Regulatory Affairs, Michael T. Townsend offers his latest article, Where Do the Candidates Stand? Key Issues for Investors, as part of our election 2016 commentary at www.schwab.com/insights/category/election-2016, where you can also find timely analysis of The Stock Market and Election Cycles. Also, for a look at the election and the potential impact on sectors, see Schwab's Brad Sorensen's, CFA, latest Schwab Sector Views: Election Specialat www.schwab.com/marketinsight.

Europe ticks higher, Asia mixed following China data

European equities turned modestly higher, though caution likely persisted ahead of tomorrow's monetary policy decision from the European Central Bank (ECB), which will be preceded by tonight's final U.S. Presidential debate. Also, the global markets digested a plethora of mixed Chinese economic data, as an in line 3Q GDP report was met with a disappointing read on industrial production. Crude oil prices rose to lift the energy sector on the heels of a bullish U.S. oil inventory report, while financials modestly extended a recent rally that has come from upbeat earnings from the sector in the U.S. and a reprieve from elevated concerns toward European banks. For analysis of the potential impacts of flare-up in the European banking sector uneasiness, see Schwab's Fixed Income Director Collin Martin's, CFA, article titled, European Bank Stress: What Does It Mean for the Preferred Securities Market? at www.schwab.com/marketinsight. In economic news in the region, eurozone construction output declined m/m in August, while the U.K. August employment change rose more than expected. The euro dipped and the British pound ticked higher versus the U.S. dollar, while bond yields in the region finished mixed.

With the global markets choppy amid a plethora of uncertainty/volatility, Schwab's Jeffrey Kleintop, CFA, reminds investors, Three Reasons Why Now is Not the Time to Retreat from Global Diversification and why Your portfolio may be less diversified than you think. Read these articles, at www.schwab.com/oninternational.

Stocks in Asia finished mixed as the markets digested a divergent bag of Chinese economic data, while the yen gained some ground and attention remains on earnings, politics and Fed rate hike expectations in the U.S. China's 3Q GDP grew 6.7% y/y, matching forecasts and 2Q's expansion, helping ease concerns about slowing growth in the world's second largest economy. However, some of the enthusiasm may have been tempered by a separate release showing the nation's industrial production rose at a smaller-than-expected amount in September. China also showed September retail sales and fixed asset investment both rose in line with forecasts. The data follows yesterday's stronger-than-expected lending figures for last month. Mainland Chinese equities finished flat and those traded in Hong Kong declined. For more on China, see Schwab's Director of International Research Michelle Gibley's, CFA, article, 5 Big Risks Posed by China (And Why They Shouldn't Crash Global Markets in 2017) at www.schwab.com/oninternational.

Japanese stocks rose amid the slight gain in the yen, and Australian securities advanced with weakness in oil & gas issues being more than offset by strength in basic materials issues. South Korean equities finished flat and Indian stocks gave back some of yesterday's rally.

In addition to the aforementioned ECB monetary policy meeting, tomorrow's international economic docket will yield machine tool orders from Japan, business confidence and employment data from Australia, retail sales from the U.K., PPI from Germany and the current account for the Eurozone.

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.