Financial Review

Ban Blowback

Sinclair Noe — January 30, 2017

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DOW – 122 = 19,971
SPX – 13 = 2280
NAS – 47 = 5613
RUT – 18 = 1352
10 Y un = 2.48%
OIL – .50 = 52.67
GOLD + 3.70 = 1196.00

On Saturday, a federal judge in New York temporarily barred the US from deporting detainees from the countries covered in an executive order restricting travel to the US from 7 countries. The White House also clarified its policy regarding green card holders, stating the travel ban would not apply to those with legal permanent residence in the United States.

Several businesses and trade organizations responded to the travel ban over the weekend. Many airlines, caught off-guard by the sudden policy change, scrambled to follow the new directive while attending to their customers. Shares of airline companies were knocked lower. American – 4.3%, Delta – 4%, United – 3.6%

Delta Air Lines suffered a systems failure. The airline grounded US domestic flights on Sunday evening as it dealt with a systems failure. Early this morning, Delta tweeted: “UPDATE: Systems return to normal; some flight cancellations linger.” Delta said it canceled about 170 flights on Sunday, and approximately 110 flights have been cancelled today. The airline also warned that a few additional cancellations are possible.

Starbucks CEO Howard Schultz said the company planned to hire 10,000 refugees in 75 countries. Brian Chesky, a founder of Airbnb, wrote on Twitter that his company, would provide “free housing to refugees and anyone not allowed in the U.S.” The New York taxi drivers’ union joined a protest at Kennedy International Airport on Friday night. Drivers temporarily halted pickups at the airport.

Google has created a $4 million crisis fund and recalled staff to the US, UBER will establish a $3 million defense fund and LYFT said it would donate $1 million. And while the ban met with opposition from most Silicon Valley tech companies, it was also opposed by the likes of General Electric and Ford Motor.

Also, Morgan Stanley, JPMorgan Chase, Citigroup and Goldman Sachs all came out in opposition to the ban and told their employees they will provide support to individuals and families affected by immigration restrictions.

President Trump also made  phone calls to world leaders on Saturday as he began shaping his new administration’s foreign policy. A conversation with Vladimir Putin discussed combating terrorism, confronting ISIS, the Ukraine crisis and the Iran nuclear deal, but the topic of easing U.S. sanctions against Russia over its 2014 annexation of Crimea didn’t come up. Trump is expected to announce his Supreme Court nominee tomorrow.

This morning Trump signed an executive order to cut regulations. The measure will expand regulatory review with the goal of revoking two regulations for every new one put forward. Under the order, federal agencies will propose rules they want to drop and the White House will review them.

It sets a budget each year for what new regulations would cost the economy, companies and employers. For fiscal 2017, it gives a budget of $0 for new regulations. The Office of Management and Budget will have discretion to give the agencies guidance. There are some 80,000 pages in the Federal Register, where all federal rules are published; but to repeal a regulation, a federal agency must go through the same notice and comment rule making process used to formulate new regulations. And that generally takes at least a year.

This week’s economic calendar includes the December Jobs Report on Friday. Consensus estimates call for 170,000 new jobs last month, with the unemployment rate holding below 5%. The Federal Reserve is almost certain to stand pat and leave U.S. interest rates unchanged when FOMC policymakers meet Tuesday and Wednesday.

The central bank wants to see more evidence of faster growth, and perhaps get a more detailed look at some of Trump’s plans, before committing to another increase in borrowing costs for consumers and small businesses. What we know is that the economy is solid but growth is slowing. Friday’s first assessment of fourth quarter GDP came in at 1.9% for the quarter, with the economy rolling along at 1.6% growth for calendar year 2016.

Remember that the Fed has been unusually accommodative over the past 8 years, with near zero interest rates and QE 1,2,3 and Operation Twist; and all this helped Wall Street, even if it didn’t offer much relief to Main Street. And now the Fed and other central banks are tightening at the same time the economy is losing steam.

So, just as stocks have been hitting record highs, we are now faced with headwinds in the form of less Fed stimulus, higher borrowing costs and an economy that is slowing. The aggregate revenue for the 30 companies in the Dow is $2.69 trillion. Revenues are lower than they were in 2011. Yet investors push the price of the Dow north of 20,000? Why are so many content to pay 2016 prices for 4.4 % less revenue than occurred in 2011?

Consumer spending rose 0.5% last month; that’s the biggest increase in spending in December since the last month of 2009. The increase in spending outpaced the 0.3% gain in individual incomes. As a result, the U.S. savings rate fell 0.2 percentage points to 5.4%, marking the lowest level since early 2014.

Overall, consumer spending rose a solid 3.8% in 2016 after a 3.5% advance in 2015.  The PCE inflation index has climbed 1.6% in the past year, the fastest 12-month gain since September 2014.

The PCE index rose 0.2% in December. The core rate that strips out food and energy edged 0.1%. The core rate was flat at 1.7% over the past 12 months.

The National Association of Realtors’ index of pending home sales jumped 1.6% to 109. That’s 0.3% higher than a year ago. The index forecasts future sales by tracking real estate transactions in which a contract has been signed, but the deal has not yet closed. Supply is the big question for 2017, NAR noted in a release. The group is concerned that tighter inventory will continue to push home prices higher even as borrowing costs rise. In December, there was more inventory of higher-priced homes than in other price ranges, a sign that more affordable properties are being snatched up quickly.

The number of active US rigs drilling for oil climbed for a second consecutive week, feeding expectations that growth in domestic output may outweigh efforts by other major crude producers to ease global supplies. Baker Hughes reported on Friday a weekly rise of 15 in U.S. oil drilling rigs to total 566 and government data released last week showed a rise of 17,000 barrels a day in total domestic crude production for the week ended Jan. 20.

After selecting Citigroup as its financial adviser, Puerto Rico’s federal oversight board has voted to give the commonwealth more time to submit a fiscal turnaround plan and restructure $70 billion in debt without fear of lawsuits. A stay on litigation over missed payments will be moved to May 1 from Feb. 15, while a deadline for a fiscal blueprint will be extended to Feb. 28 from Jan. 31.

Volkswagen is the world’s biggest automaker. Despite a scandal involving tampering with diesel emission software, VW sold 10.31 million vehicles worldwide in 2016, surpassing Toyota, which had held the title for four straight years.

Japanese trust banks are preparing to sue Toshiba Corp over its 2015 accounting scandal. The news follows an announcement by the struggling conglomerate on Friday that it will sell a minority stake in its memory chip business to raise funds and that its overseas nuclear division – the cause of its current woes – was now under review.

Fitbit said it expects an adjusted loss per share of 51 cents to a loss of 56 cents, after previously announcing guidance of a profit of 14 cents to 18 cents. To reduce expenses, the company said it plans to cut about 110 employees or 6% of its workforce, which is expected to cost the company $4 million in the first quarter of 2017.  FIT down 16%.

Shares of Tempur Sealy dropped 28% and hit a three-year low in very-active trade, after the mattress seller said it terminated all contracts with key customer Mattress Firm.

Walgreens Boots Alliance and Rite Aid’s giant drugstore merger got smaller today after the companies said they would cut the value of the deal, may divest more stores to satisfy antitrust regulators and will extend the deadline by which the takeover will be completed. Walgreens will now pay $6.50 to $7 a share for Rite Aid (depending on how many stores Walgreens must divest), that’s down from the $9 a share. The new agreement also includes a six-month extension to July 31. Rite Aid down 17%.

If you haven’t signed up for health insurance through the Affordable Care Act, you are running out of time. You have until Tuesday, Jan. 31, to apply for 2017 coverage through state and federal marketplaces. More than 11.5 million people have signed up for insurance through the exchanges as of Jan. 10. And even though President Trump has talked about repealing the ACA, it is still the law for 2017, and whatever happens in 2018 is still a mystery.

It’s the Year of the Fire Rooster! Chinese markets will remain closed for most of the week as Lunar New Year celebrations kick off for much of Asia. The People’s Bank of China pumped roughly $165 billion into domestic money markets last week via its routine operations as consumers prepared for shopping sprees and to hand out red packets filled with fresh notes to friends and relatives. Markets will reopen on Friday.

FINANCIAL REVIEW

One Foot on the Gas, One Foot on the Brake

Sinclair Noe — January 30, 2015

 

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

DOW – 251 = 17,164
SPX – 26 = 1994
NAS – 48 = 4635
10 YR YLD – .08 = 1.67%
OIL + 3.25 = 47.78
GOLD + 25.00 = 1284.10
SILV + .31 = 17.33

GDP growth slows. The Commerce Department reports fourth quarter gross domestic product grew by 2.6%, down from a very strong 5% growth rate in the third quarter. The results were below consensus estimates of 3% growth. For all of 2014, the economy grew 2.4% compared to 2.2% in 2013.

Consumer spending advanced at a 4.3% pace in the fourth quarter – the fastest since the first quarter of 2006 and an acceleration from the third quarter’s 3.2% pace. The final read on the University of Michigan’s consumer sentiment index was 98.1, down a tick from the 98.2 in the preliminary estimate. That’s still above the 93.6 mark in December and the best reading in 11 years.

Just as consumers were stepping on the gas, businesses were tapping the brakes. Business spending on equipment fell at a 1.9% rate. It was the largest contraction since the second quarter of 2009. The fourth-quarter weakness could reflect cuts or delays to investment projects in the oil industry. But it could also be payback after two back-to-back quarters of robust gains.

A wider trade deficit, as slower global growth curbed exports and solid domestic demand sucked in imports, subtracted 1.02 percentage point from GDP growth in the fourth quarter.

That’s how it works when the rest of the world is moving to QE. Worldwide central bank stimulus now totals over $10 trillion dollars. The new buzz phrase is currency wars, or you could just call it competitive devaluation. Countries are competing against each other to achieve a relatively low exchange rate for their own currency. As the price to buy a currency declines, so too does the price of exports from the country and imports become more expensive. This allows domestic industry and employment to expand.

The downside of this is that price increases for imports can harm citizens’ purchasing power. A policy of competitive devaluation can also result in retaliatory action by other countries, which in turn, can lead to a general decline in international trade. For the US, the problem is that a stronger dollar is slowing GDP growth even as we see the benefits of lower oil prices to counter tougher export markets.

Inflation remains muted in the fourth quarter. In a separate report the Labor Department reports the personal consumption expenditures (PCE) price index fell at a 0.5% rate, the weakest reading since the first quarter of 2009. Excluding food and energy, prices rose at a 1.1% pace, the slowest since the second quarter of 2013. The strong pace of consumer spending in the fourth quarter was overshadowed by a drop in capital expenditure. The PCE is the inflation gauge used by the Federal Reserve, and it is telling the Fed not to rush into raising rates.

In Europe – Deflation. Eurostat today reported the largest decline in consumer prices in the eurozone since July 2009. Consumer prices were 0.6% lower than in January 2014, having fallen 0.2% on an annual basis in December.

European stocks slipped today on the deflation report, but the region’s equity benchmark was still on track for its best monthly performance in more than three years. The Stoxx Europe 600 is up 7.2% for the month of January, which would be its best since October 2011.

Russia’s central bank cut its key interest rate to 15% this morning, after announcing a surprise hike from 10.5% to 17% in December to shore up the weakening ruble.

European Union foreign ministers have extended existing sanctions against Russia, but held off on tighter economic measures for now. Last year’s travel bans and asset freezes will now continue until September. Any sanction require a unanimous vote by all the EU countries. There was some question about whether Greece would approve sanctions, but much of that was misreported. Greece did not oppose sanctions; the EU just never asked the Greeks, and the Greeks did not appreciate being neglected in that manner. It was really symptomatic of how the EU has dealt with Greece for several years now.

Meanwhile, Greece’s new, leftist government opened talks on its bailout with European partners today by flatly refusing to extend the program or to cooperate with the international inspectors overseeing it. Prime Minister Alexis Tsipras has repeatedly said he wants to keep Greece in the euro but he has also made clear he will not back away from election campaign pledges to roll back the terms of the bailout.

A funny thing happened today in the oil market, prices went up, and it was a fast move. There was a big drop in the number of US oil rigs. Baker Hughes reports petroleum producers took 94 oil-drilling rigs off the market in the United States this week as sub-$50 oil continued to wreak havoc on the oil industry. Prices jumped and then many traders probably decided to cover short positions on the last trading day of the month. This week’s drop left 1,223 oil units up, the lowest number in three years. It was the biggest one-week decline for oil rigs since 1987. That year, the oil industry had faced another oil bust that left hundreds of rigs idle or repossessed by banks, which sold them for scrap.

Earlier today, the Commerce Department reported investment in drilling rigs and wells climbed at an 8.9% pace in the fourth quarter after an 8.3% increase from July through September. Prices were going down in the fourth quarter and domestic oil producers were shrugging and pumping more. At least until just recently.

By the way, if you were wondering what lower oil prices mean for renewables, the quick answer is not much. Oil is for cars; renewables are for electricity. The two don’t really compete. The biggest limit to solar installations is the availability of panels. And even as gas prices have dropped, the price for electricity continues to go up. And that is the advantage of solar; as time passes, the efficiency of solar power increases and prices fall. It’s a technology, not a fuel.

And it would be crazy to believe oil prices will stay this low forever. The history of oil prices follows a golden rule: What goes down must come up. Goldman Sachs identified almost $1 trillion in investments in future oil projects that are no longer profitable with oil under $70 a barrel. American drillers are idling rigs faster than they have since 1991. Eventually, supply will shrink and prices will rise again.
Shares of solar and wind companies have been pulled down with oil prices. Still, global investment in clean energy increased 16% last year, to $310 billion. Fossil-fuel subsidies outpace renewable-energy subsidies by a factor of 6 to 1, and this represents a strain on government budgets, and not just here in the US. Reducing the subsidy gap is one of the cheapest ways to increase fuel efficiency and speed up the switch to cleaner energy.

And then that pesky problem of climate change isn’t going away. The U.S. and China reached a historic deal in November to rein in greenhouse gases. Pope Francis is preparing a papal encyclical on climate change, a letter to the world’s bishops that will formalize the church’s moral position on the issue for 1.2 billion Catholics.

With today’s move, oil prices are up 5.8% for the week, but still down 9.4% for the month.

For the week, the Dow was down 2.8%, the S&P was down 2.8% and the Nasdaq down 2.6%. For the month, the Dow was down 3.6%, the S&P fell 3.1% and the Nasdaq was off 2.1%. January marked the worst monthly performance for both the Dow and S&P since January 2014.The Dow has now dropped under support at 17,200 and the S&P has dropped under 2000.

Do you want to know how stocks might perform this year? A widely followed market theory, the January barometer, claims that as January goes, so goes the year. It worked two years ago; January 2013 was a positive month for stock prices, up 7%, and the market went higher for the year by 30%. January 2014, saw stock prices drop by 4%, and it didn’t work – prices were up last year by a little over 11%.

Interestingly enough, while an up January is generally bullish for stocks, a down January is not a reliable predictor of a weak year overall. In ten out of twenty-four weak January years, the stock market actually ended higher, often by a very substantial amount. Indeed, this has happened four times in the last decade alone.

Visa announced an 11.5% increase in profit during the quarter, as a strengthening U.S. job market and cheaper gasoline prices encouraged people to spend. Beating both top and bottom line estimates, net income rose to $1.57B from $1.41B, a year earlier. Visa also announced a four-for-one stock split, cutting its weight in the Dow from 9% to 2.5%.
(Here’s a little quiz. Q: Now that the weighting for Visa is dropping, which Dow Industrial stock has the highest price weighting? A: Goldman Sachs.) (Goldman Sachs and Visa both entered the Dow in September 2013, when the average was last reshuffled. Visa rallied 25% since it joined the gauge on Sept. 20, 2013, while Goldman Sachs gained 3.7%, compared with Dow’s 13% advance. So, Goldman has the highest weighting, due largely to underperformance.)

Shake Shack’s initial public offering priced well above expectations at $21 apiece, and in its first day of trading, the burger chain more than doubled to $48. Underwriters had set an expected price range of $17-$19 per share, up from an initial $14-$16 due to strong demand. At the IPO price, Shake Shack boasted a valuation of about $746 million. Following today’s gain, the market value is more than $1.7 billion. Shake Shack’s debut comes two days after a CEO change at McDonald’s Corp., which is mired in its worst US sales slump in more than a decade.
Next week brings more earnings reports including a slew of energy companies. Monday, we’ll get a report from the Institute for Supply Management. Auto sales are coming out on Tuesday. Next Friday we have the monthly jobs report.