Financial Review

Don’t Fight the Fed

Sinclair Noe — May 18, 2016

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DOW – 3 = 17,526
SPX + 0.42 = 2047
NAS + 23 = 4739
10 Y + .12 = 1.88%
OIL – .12 = 48.19
GOLD – 20.80 = 1259.00

There’s an old saying “don’t fight the Fed.” The Fed has indicated that if the data points to a rate hike, they would be prepared to hike rates in June. The markets have not reflected the Fed’s position.

The CME’s Fed Watch tool, which uses fed fund futures trading levels to determine the likelihood of a hike at each meeting, indicates that a better than 50 percent chance of a move doesn’t happen until the December FOMC session. Within the past week, futures trading indicated almost zero chance of an increase in June.

Yesterday, Atlanta Fed President Dennis Lockhart and San Francisco Fed President John Williams agreed that up to three rate hikes this year “seemed reasonable,” while Dallas President Robert Kaplan said he would call for a rate rise in June or July.

Today, the Fed released minutes from the April FOMC meeting. June is definitely on the table. The minutes indicated that members of the Federal Open Market Committee were worried that markets were underestimating the possibility of an early rate hike. Fed officials sought to correct this misconception, by spelling out what they need to see to raise rates in June. They expect to see continued improvement in the labor market.

The April jobs report was weak, and it was published after the FOMC meeting, but it wasn’t like the labor pool has dried up; the economy is still creating jobs and the unemployment rate is still low. Inflation continues to show signs of life, as evidenced by yesterday’s CPI report, which was stronger than expected. The broader economy had a rough first quarter, but it is perking up in the spring.

The domestic outlook was further enhanced by significant improvements in US and international financial conditions. The global risks are still out there. Japan and Europe are still weakened economies. One question mark on the international stage is the June 23 referendum on the UK exit from the Euro Union. That is a very big question mark.

So, the Fed did not take an unequivocal hawkish stance in the minutes, but they have largely abandoned the dovish position. In anticipation of the release, traders had started to reprice the probability of a Fed hike. According to CME Group, prices for futures contracts on the Fed’s benchmark overnight lending rate implied that investors saw a 34 percent chance of a rate increase next month, up from 19 percent shortly before the release of the minutes.

This was reflected in the upward move in yields on 2-year Treasuries, the maturity most sensitive to Fed action, the probability rise indicated by the Fed funds futures, or the flattening of the yield curve, led by the front end and to an extent not seen since December 2007. This repricing accelerated into the afternoon, with large yield spikes, particularly for 2-year and 5-year Treasuries. And to punctuate the point, the Dollar Index closed up, just a whisker above 95, the biggest jump for the dollar in 6 months, which in turn put the brakes on the recent rally in oil.

It is clear that Fed monetary policy has been a major source of support for the markets. And as the Fed moves further away from its Zero Interest Rate Policy, you have to wonder what catalyst can push the markets higher from these levels.

Japan’s economy dodged a recession last quarter as gains in government and consumer spending compensated for a slide in business investment. Gross domestic product expanded by an annualized 1.7%, exceeding all forecasts and recording the nation’s fastest pace of growth in a year. Prime Minister Shinzo Abe is widely expected to announce new fiscal stimulus during the G7 Summit this month as part of his “Abenomics 2.0” program.

Iran’s oil exports are set to surge in May, climbing nearly 60% from a year ago, with European shipments recovering to about half of pre-sanction levels, according to Reuters. This shows that Tehran is regaining market share at a faster pace than analysts had projected as it battles with Saudi Arabia for customers by lowering its prices. April loadings at 2.3-million barrels per day were around 15% higher than the International Energy Agency estimated earlier this month.

Goldman Sachs has downgraded its outlook on equities to “neutral” over the next 12 months, saying there’s no particular reason to own them. In a research note to clients, Goldman analysts wrote: “Until we see sustained signals of growth recovery, we do not feel comfortable taking equity risk, particularly as valuations are near peak levels.”  Goldman also upgraded commodities to “neutral” on a three-month basis, stayed “overweight” on credit over both 3- and 12-month horizons, and remained “underweight” on bonds.

The Chair of the Securities and Exchange Commission says cyber-security is the biggest risk facing the financial system. Banks around the world have been rattled by an $81 million cyber theft from the Bangladesh central bank that was funneled through SWIFT, a member-owned industry cooperative that handles the bulk of cross-border payment instructions between banks.

SEC Chair Mary Jo White says some major exchanges, dark pools and clearing houses did not have cyber policies in place that matched the sort of risks they faced. Cyber security experts said her remarks represented the SEC’s strongest warning to date of the threat posed by hackers.

The U.S. Senate passed legislation that would allow families of Sept. 11 victims to sue Saudi Arabia’s government for damages. The “Justice Against Sponsors of Terrorism Act,” or JASTA, passed the Senate by unanimous voice vote. If it became law, JASTA would remove the sovereign immunity, preventing lawsuits against governments, for countries found to be involved in terrorist attacks on U.S. soil.

More than 4 million U.S. workers will become newly eligible for overtime pay under rules issued today. Under the new rules, the annual salary threshold at which companies can deny overtime pay will be doubled from $23,660 to nearly $47,500. That would make 4.2 million more salaried workers eligible for overtime pay. Hourly workers would continue to be mostly guaranteed overtime.

The United States has ramped up import duties on Chinese steel makers by 522%, accusing Beijing of anti-competitive behavior by selling steel below cost. Last year, U.S. Steel, AK Steel, ArcelorMittal, Nucor and Steel Dynamics, all filed a complaint to the International Trade Commission, alleging foreign companies were selling steel at unfairly low prices. The industry claims it has had to lay off 12,000 workers as a result of the unfair competition.

Google introduced its answer to Amazon’s Alexa virtual assistant along with new messaging and virtual reality products at its annual developer conference today, doubling down on artificial intelligence and machine learning as the keys to its future.

The new offerings include Google Assistant, a virtual personal assistant, along with the tabletop speaker appliance Google Home; plus, Allo, a new messaging service that will compete with Facebook’s WhatsApp and Messenger products and feature a chatbot powered by the Google Assistant; plus, a new virtual reality platform called Daydream designed to work with the Android mobile operating system.

Google Assistant can search the internet and adjust your schedule, and it can use images and other information to provide more intuitive results. For Google Home, the Google Assistant merges with Chromecast and smart home devices to control televisions, thermostats and other products. Google did not offer a specific release date or pricing for Google Home, saying only that it will be available later this year.

Target reported a lower-than-expected increase in quarterly sales at established stores and gave a cautious outlook for the current period, citing volatile weather and weaker demand for electronics and groceries. Shares of the company, which also reported slower digital sales growth, fell more than 9 percent in early trading.

Home improvement chain Lowe’s followed larger rival Home Depot in reporting better-than-expected quarterly sales as strength in the U.S. housing market and favorable weather led to strong demand for building and home renovation products. Results from the home improvement chains stand in stark contrast to grim quarterly sales reports from retailers such as Macy’s and Target, as consumer spending shifts away from apparel and accessories to big-ticket items including cars and homes.

San Francisco is set to become the first U.S. city to require health warnings on advertisements for soda and other sugar-added drinks after the beverage industry failed to get a court order to stop it. The law goes into effect July 25 and will require that billboards and other public advertisements include the language, “WARNING: Drinking beverages with added sugar(s) contributes to obesity, diabetes, and tooth decay.”

GrubHub shares hit a 2-month low yesterday, after Amazon announced it would expand restaurant delivery service into New York and Dallas. The offering is free with Prime membership and promises no markups from online menus. Where’s the profit? According to the NY Post, Amazon is reportedly charging restaurants 27.5% of each delivery order, compared to the 12-24% charged by GrubHub and Seamless, which merged in 2013.

Fedex has declared its recommended all-cash public offer for TNT Express unconditional, with all requirements having been satisfied or waived. Settlement will take place in one week.

Peabody Energy has won final bankruptcy-court approval for an $800M financing package after lenders made concessions to appease creditors. Peabody said final approval on the Chapter 11 financial arrangements ensures the company can continue operating as usual while it works through a load of debt that it can’t support given the declines in coal demand and prices.

Financial Review

Spend Your Time Wisely

Sinclair Noe — June 30, 2015

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

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DOW + 23 = 17,619
SPX + 5 = 2063
NAS + 28 = 4986
10 YR YLD un = 2.33%
OIL + 1.14 = 59.47
GOLD – 7.50 = 1173.60
SILV – .09 = 15.77

Today marks the end of the second quarter; we are halfway through the year. The stock market has been trading in an extremely tight range. After a weak January and a rebound in February, the major indices have moved sideways for 4 months. The Dow Industrials are down 204 points for the first half; the Nasdaq Composite is up 250 points for the first six months; the S&P 500 gained 5 points year to date. The S&P 500 is in the tightest trading range for the first half of a year in more than 2 decades. At some point it will break up or break down; as it is 2015 marks the worst first half of a year for the S&P 500 since 2010.

For the month of June, the Dow fell 2.2 percent, the S&P 500 fell 2.1 percent and the Nasdaq fell 1.6 percent. For the second quarter, the Dow fell 0.9 percent, the S&P 500 fell 0.2 percent. For the Dow and the S&P, that snaps a string of 9 consecutive quarters of gains. The Nasdaq rose 1.8 percent in its tenth straight quarterly advance. During the quarter, the Nasdaq hit its first records since the height of the tech bubble

Historically speaking, the ends of quarters tend to exhibit weakness, as portfolio managers tend to position themselves for the next quarter; it’s called portfolio pumping or window dressing.  The last day of the second quarter is a bit of a paradox as “portfolio pumping” has driven the Dow down 17 of the last 24 years while buoying the NASDAQ and Russell 2000 higher in 16 of those years.

Companies in the S&P 500 reported profit growth of just 0.8% in the first quarter, according to FactSet. In the second quarter, they are set to shrink 4.5%. Wall Street analysts often undershoot their profit forecast, so actual profits are likely to come in higher. But that is little comfort to investors staring at a stock market that has grown increasingly pricey. The S&P 500 trades at 17.9 times the past 12 months of earnings, up from 17.1 at the start of the year and close to a five-year high, according to FactSet. The average P/E for the last 10 years is 15.7.

U.S. government bonds have had their biggest quarterly selloff since December 2013. The yield on the benchmark 10-year Treasury note was 2.335% at the end of trade today. It has climbed from 1.93% at the end of March, marking the first quarterly loss since the final quarter of 2013. Bond yields rise as prices fall. Treasury debt overall has handed investors a total return of negative 1.56% between the end of March and Monday. For the year, the return was 0.05%, following a 5.05% return during 2014. Return includes price gains and interest payments. Other U.S. fixed-income markets have also lost ground amid higher Treasury bond yields. U.S. investment-grade corporate debt was the biggest loser this quarter, with a negative return of 3.22% through Monday. Treasury inflation-protected securities lost 1.1%, municipal bonds have lost 0.86% and U.S. corporate bonds sold by lower-rated companies, known as junk bonds, lost 0.04%.

Greek politicians spent the day talking with their creditors, but it was not enough to avoid a default on Greek debt. The deadline was midnight in Brussels, about one hour ago. Greece did not make the €1.5 billion-euro payment. Reports earlier suggested European Commission President Jean-Claude Juncker made Athens a last minute offer. That was followed by reports that Greece had requested a 2-year bailout program from the European Stability Mechanism. Then German Chancellor Merkel rejected more talks before the July 5 referendum in Greece. In reality, the conditions up for a vote were taken off the negotiating table, so the vote is over an offer that no longer exists. The Greek government says it will open 1000 bank branches tomorrow to allow pensioners to cash their pension checks, at least up to €120-euro per week. Beyond that, nobody really knows what will happen next.

Markets across Asia bounced back today, while European indexes remain mixed. You may have heard that the Greek situation will not be harmful to US stocks; and while there was not a chaotic crash yesterday, about $1.5 trillion was erased from the value of equities in the Wilshire 5000 index, while the Dow dropped 350 points, to slip below its 200-day moving average. In the S&P 500, the drop in market capitalization of just 86 companies equaled the entire GDP of Greece (about $242 billion.)

Meanwhile, a new crowdfunding campaign has been set up on Indiegogo.com. With a goal of raising $1.8 billion, the “Greek Bailout Fund” aims to do what the Hellenic Republic’s creditors apparently cannot. And supposedly, every donation gets a postcard from Greek Prime Minister Alexis Tsipras.

Puerto Rico will seek to delay payments on the island’s $72 billion debt load for “a number of years” as part of a plan to bolster the commonwealth’s finances and revive its economy. Governor Alejandro Garcia Padilla appealed to Washington to make unprecedented, “concrete” changes in bankruptcy rules to help rescue the island’s finances. Although U.S. cities and municipalities are eligible to file for bankruptcy, states and Puerto Rico are barred from seeking protection through bankruptcy. And just for comparison, US banks have about $14 billion in direct exposure to Greek default, but almost all of Puerto Rico’s $72 billion in debt is held by US financial institutions.

China is now taking an all-hands-on-deck approach to soothe the country’s plunging stock market, after an unexpected weekend interest rate cut failed to right the ship. Late on Monday the finance and social security ministries published draft rules that would permit the state pension fund to invest up to 30% of its net asset value in securities, potentially allowing $97 billion to enter the market. The Shanghai Composite Index closed up 5.6%.

The Export-Import Bank will expire today at midnight for the first time since the federal agency was created during the Depression. The bank, which guarantees commercial loans for overseas customers of American exporters, will not exactly go out of business. Employees will continue to service all outstanding loans, but new loans won’t be guaranteed. Supporters of the bank, however, are hoping to attach legislative language restarting the bank to a must-pass transportation funding bill in late July, then dare opponents in the House to kill it.

The Conference Board’s U.S. consumer confidence index jumped to 101.4 in June from a downwardly revised 94.6 in May. Both the present situation and expectations indexes advanced.

Chicago PMI rose in June but remained under the 50 level, indicating a slight contraction in conditions. That’s the fourth month below 50 this year.

 U.S. existing-house prices rose 1.1% in April, with gains in all the cities tracked by the Case-Shiller 20-city composite index released Tuesday. With seasonal adjustment, prices rose 0.3%. Home prices in April were up 4.9% from a year earlier, slightly slower than annual growth of 5% seen in March. Home prices in Phoenix rose 0.8% in April, with a 3.5% gain for the past 12 months.

Federal Reserve Vice Chairman Stanley Fischer says the US economy probably bounced back to an annual growth rate of around 2.5 percent in the second quarter, and the labor market is approaching full employment. I’m not sure the Fed knows what full employment is. Back in the 1950s the US saw the unemployment rate drop down to 2.9% before it sparked inflation, which was quickly tamped down. The big problem facing the economy is not inflation but unemployment, which then puts a drag on demand. And so far we have not seen enough tightness in the labor market to lift stagnant wages. Fisher said: “We should not wait until we have reached our objectives to begin adjusting policy.” Which sounds a lot like: quit before you cross the finish line. Fisher also said the global situation remained a “significant headwind” for the United States.

For the most part, financial weakness overseas (whether in China or Greece and the Eurozone) is not much concern for the Fed, unless it turns into a significantly stronger dollar or a big hit to US economic growth. Fed officials signaled after their mid-June policy meeting they expect to raise rates in 2015 after keeping them near zero for almost seven years. Several officials have said since their gathering that September could be the time for liftoff. That’s their story and they are sticking to it, at least for now.

President Obama has unveiled a proposal that would make nearly 5 million more workers eligible for overtime pay, a move that touches nearly every sector of the U.S. economy and could face legal challenges. The change would allow salaried workers who earn up to $50,400 per year to qualify for time-and-a-half pay when working more than 40 hours per week as soon as 2016. Under current rules, only those earning less than $23,660 are automatically eligible for the overtime wages.

At 5PM Pacific, time will be stopped in its tracks for one second; a minute will have 61 seconds. It’s a “leap second”, not to be confused with a Leap Year, which won’t happen until 2016. Since 1967, when clocks went atomic, human timekeeping has been independent of the earth’s rotation. The problem is, the moon’s gravitational pull slows down the rotation of the earth; a long, long time ago one day was only about 22 hours; the planet is slowing down and clocks are not. So every few years, to get everything back in sync, scientists add a second. They’ve done it 25 times since 1972. The last time was 2012, but that was on a weekend. June 30 will be the first leap second during regular business hours.

One of the concerns is that computerized time does not know how to handle something like a leap second. And not all computer operators have made the adjustment. There could be hiccups in your computer. Nobody anticipates serious problems from this, the internet will not break, just a few minor glitches. The good news is that you now have an extra second. Spend your time wisely.