Financial Review

Not Patient But No Hurry

Sinclair Noe — March 18, 2015

 

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DOW + 227 = 18,076
SPX + 25 = 2099
NAS + 45 = 4982
10 YR YLD – .11 = 1.95%
OIL + 1.25 = 44.71
GOLD + 18.30 = 1166.90
SILV + .36 = 15.99

Today is Fed decision day. The Federal Reserve released a policy statement along with quarterly economic projections followed by a Janet Yellen news conference. In the statement, the Fed removed the phrase about being “patient” regarding an interest rate increase, which might seem like bad news for Wall Street; except, they came up with new language which sounds like they will be …, well, patient about increasing interest rates.

Here is the new language: The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. 
 
So, now we are looking for “further improvement in the labor market” and reasonable confidence” about inflation.

If this sounds like so much word play, well it is; but the bottom line is that they did not make a firm commitment to raising rates in June, and it could be quite some time until we see interest rates rise. Wall Street liked it and went from a triple digit loss to a triple digit gain.

Maybe Wall Street shouldn’t be so happy. The flip side of the interpretation is that there is still way too much slack in the labor force and we are dealing with disinflation and maybe even deflation. Throw in weak economic data and add a dash of a very strong dollar and aggressive monetary policy from the Bank of Japan and the European Central Bank which may already be having an effect similar to a rate increase by cutting into US exports. And you are looking at Fed monetary policy that has painted itself into a dovish corner. Or maybe we can just chalk it up to bad winter weather and a temporary drop in oil prices; whatever, Wall Street seems to love uncertainty when it comes to raising rates.

The Fed’s economic forecasts see the economy growing 2.3% to 2.7% in 2015, below its prior target of 2.5% to 3%. Nor does the Fed see the U.S. growing more than 2.7% in 2016 or 2017, even with the unemployment expected to fall to as low as 4.8% from its current 5.5% level. And then converting that economic forecast into a dot plot chart, shows interest rates going from zero to  0.625% by the end of the year, down from an earlier projection of 1.125% by the end of 2015.

After the Fed issued the statement, Janet Yellen held a news conference. She said that even though the Fed removed the word patience, they will be patient. Other highlights of the news conference: Yellen says productivity has been “disappointingly low.” She said that equity valuations “appear on the high side but not outside of historical ranges,” and she had no comment of specific sectors, such as biotech. She said the Fed hasn’t made a decision about when to reduce its balance sheet. She also said the Fed can’t change the “brazen” behavior at some of the banks it supervises; which seems like a strange thing for a regulator to admit. And regarding the specifics about just how much improvement the Fed would need to see in the labor market and how confident they would need to be about inflation, well, that was all a little vague but Yellen says the Fed will know it when they see it.

For now, the Fed has opened the door for a rate hike but they don’t appear to be in a hurry to cross the threshold.

Oil extended losses earlier today, and then turned higher following the Fed announcement. Late yesterday the American Petroleum Institute said its data showed U.S. crude stockpiles rose by a massive 10.5 million barrels in the week ended March 13. That was more than double market expectations. This morning the EIA reported that stockpiles rose by 9.6 million barrels to 458 million barrels last week; that’s a new record, and storage has been surging for 10 consecutive weeks. Oil prices have been falling since mid-2014, but the decline stalled in February, raising expectations that prices had bottomed out. But Nymex oil has lost roughly 15% month to date as production has surged despite lower prices; even if we haven’t seen a corresponding drop in retail prices yet; always a little lag in lowering prices at the pump.

Prices are low, storage is filling up, and oil-drilling rigs are being idled at an unprecedented rate. But the U.S. oil boom hasn’t slowed yet.  Global oil demand marches higher each and every year by nearly a million barrels per day. Inventories aren’t likely to max out, there is still room in the storage tanks; but even the possibility of that happening is adding pressure to an oversupplied oil market.

Supply and demand have both been freakishly in tandem for the last 15 years; each up by the same million barrels. Global demand is right around 93 million barrels a day; so just a swing of a few million barrels per day can swing the price from $40 a barrel to $120 a barrel. So, we will see domestic production growth slow, probably sooner rather than later. OPEC is expected to cut production in June. So, the thinking, including Fed forecasts, is that oil prices will rise again, with all the attendant implications for the economy.

There is something that could change the equation for oil price volatility – renewable energy. The cost of solar cells has fallen 75% over the last six years. Meanwhile, fuel efficiency has been improving. Renewable energy doesn’t have to replace oil in order to put a thumb down on global energy prices. It merely needs to become the “swing producer,” what the US became in the past half-decade thanks to the fracking boom, the additional source of supply that tips the balance.

Oil prices may go lower, but at some point the price movement will swing and probably move higher, which would encourage some oil producers to tap wells that are being idled today, but higher oil prices will also encourage more renewable supplies. Eventually, all these wild swings in energy prices will give way to stable, predictable energy, but not just yet.

Greece frustrated its main creditors yesterday by refusing to update euro zone peers on its reform progress at a scheduled teleconference, insisting that the discussions should be escalated to tomorrow’s EU summit. Prime Minister Alex Tsipras hopes to unlock funds from the country’s $254 billion bailout package. Greece faces about $2.1 billion in debt payments on Friday. Athens is likely to run out of cash by the end of the month. The IMF says Greece is its most “unhelpful client ever.” This is all pointing to a possible Greek exit from the Eurozone.

And it is a safe bet that the ECB has been calculating the possibility of a Greek Exit. Greece has about € 320 billion in debt. You would have to think an exit would mean default. And you might wonder why Greece would default when there was already a bailout, two bailouts actually. In the first bailout, the ECB allowed European nations and banks to dump sovereign bonds onto the ECB balance sheet in exchange for cash. In the second bailout, the ECB dumped Greek bonds onto banks, mainly French and German banks. About 80% of the bailout money went to Greek bondholders, not to the Greek economy. So, the earlier bailouts were about giving money to banks that were using Greek bonds as collateral to meet capital reserve requirements. It had almost nothing to do with helping Greece.

So, if Greece defaults, what are the implications? Well Greek debt amounts to about 2% of Europe’s GDP. Why not take a hit and give Greece a fresh start with a square deal that has them make much smaller payments with a haircut for the bondholders? And the most likely answer is that the Troika – the ECB, and the IMF, and the Euro Monetary Union – don’t care a flip about Greece. The fear is that if Greece gets a deal, then Spain and Italy and Portugal and maybe even France will want a deal; and then you are talking about € 3 trillion in sovereign debt, which in turn has been used as collateral for something like € 100 trillion in various derivatives deals. So, the Troika can’t afford a Greek default and they can’t afford a precedent of leniency; which means the preferred approach is to take a hard line to force the Greeks into a bad deal, again.

Just one little problem, now, it is obvious that it is a bad deal. The Greek voters voted against more austerity and more bad deal. Other Europeans see what is happening to Greece and they don’t’ want the same deal. Violent protests hit the streets of the German city of Frankfurt today, as anti-austerity protesters rallied against the opening of a new $1.4 billion building for the European Central Bank.

Premera Blue Cross, which sells health insurance in the northwestern US, said information on 11 million people may have been exposed in a cyberattack uncovered six weeks ago. Hackers may have accessed information including names, Social Security numbers, bank accounts and medical information. The company says it discovered the breach on Jan. 29, said notified the FBI, and is sending letters to affected individuals.

Facebook is updating its PC and mobile Messenger apps to allow users to send cash to each other. Once users link a Visa or MasterCard debit card to their Messenger account, they will be able to send their friends money for free by tapping a dollar sign in the chat box. Some are now speculating that WhatsApp will also join rival messaging platforms to support payments.

FINANCIAL REVIEW

Proportional Response

Sinclair Noe — December 18, 2014

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

DOW + 421 = 17,778
SPX + 48 = 2061
NAS + 104 = 4748
10 YR YLD + .05 = 2.20%
OIL – 1.88 = 54.59
GOLD + 9.00 = 1198.90
SILV + .13 = 15.98

If you were waiting for confirmation, you got it. The major indices went through about 7 days of doom and gloom. Maybe this has something to do with the Federal Reserve’s FOMC statement yesterday. The central bank said in its official statement Wednesday it would “be patient” in deciding when to start raising interest rates from near zero. But then it added that it sees “this guidance as consistent with its previous statement” pledging to keep rates very low for “considerable time.” When asked what “patient” meant, Chairwoman Yellen said the Fed would not begin hiking rates for “a couple” of meetings. Pressed further, she confirmed “a couple” means two. But I’m not sure whether it was hawkish or dovish; more likely it was just a continuation.

Here’s my guess and it is only a guess because I don’t know and probably nobody knows. My guess is that a lot of money has come out of oil lately and now that money is moving back into stocks. It’s the buy on the dip mentality, with a little sector rotation on the side. Whatever it was, it was the best day for the S&P 500 this year. The Dow had its biggest gain in 3 years. Not enough to take out the old highs but back within striking distance.

The MSCI All-Country World Index gained 2.18% and emerging-market stocks surged 1.8%. The STOXX Europe 600 Index advanced 3%, the most in three years. Treasuries moved lower, pushing yields higher. Oil slumped 3.2% after wiping out a 4% rally.

Goldman Sachs released a report showing almost $1 trillion in investments in future oil projects at risk. They looked at 400 of the world’s largest new oil and gas fields, excluding US shale, and found projects representing $930 billion of future investment that are no longer profitable with Brent crude at $70. In the US, the shale-oil party isn’t over yet, but there are bound to be some oil projects planned for next year that have little hope of a productive future. If the unprofitable projects were scuttled, it would mean a loss of 7.5 million barrels per day of production in 2025, equivalent to 8% of current global demand.

Meanwhile, today the chief economist for JPMorgan said the drop in oil prices could be painful for Texas and could throw the state into recession, citing the similarities to 1986 when oil prices were cut in half. The economist says there are some reasons to believe this time may be different, such as “rapid technological gains” in the energy sector that have reduced extraction costs. But he concluded that those arguments “are not so strong as to signal smooth sailing for the Texas economy.”

The Goldman tally takes the long view of project finance as it plays out over the next decade or more. But the initial impact of low prices may be swift. Next year alone, oil and gas companies will make final investment decisions on 800 projects worth $500 billion. If the price of oil averages $70 in 2015, $150 billion will be pulled from oil and gas exploration around the world. With oil prices at $65 it could trigger the biggest drop in project finance in decades.

And then the question is where will all that money go? Will it eventually be poured back into oil rigs, or will it end up financing some other, less volatile, less polluting energy source? Or maybe the money will just shift to some other place.

And the flip side is that while lower oil prices may be hard for Texas and global oil producers, it is great for consumers who keep a few extra dollars in their purse with each fill-up. The consumer drives the US economy, which drives the global economy, so that’s good news.

In economic news: Initial jobless claims fell by 6,000 to a seasonally adjusted 289,000 in the seven days ended Dec. 13, and for 13 of the past 14 weeks new claims are under 300,000.

The Federal Reserve Bank of Philadelphia’s monthly index on regional manufacturers fell to 24.5 in December from 40.8 in November.

The Conference Board’s leading economic index rose 0.6% in November, indicating the US is likely to expand at a fairly robust pace in the next few months. The coincident index, which measures current conditions, rose 0.4% in November, while the lagging index gained 0.3%.

Russian President Vlad Putin delivered a 3 hour press conference today. Putin said the problems in Russia will pass, the ruble will come back in time, about 2 years; he said Russia was facing a perfect storm of low oil prices combined with economic sanctions from the West over Ukraine. He did not say how he would fix it. The ruble continued to weaken against the dollar and the euro following the speech. For the typical Russian these are going to be a difficult times but it is tough to sympathize with Putin. Russia should not be a debtor country. It has managed this nonetheless, presumably because corporations and banks have borrowed abroad, and somehow that money has ended up invested in luxury London real estate and other things. Oligarchy is not an optimal economic model.

Sony Pictures canceled the December 25 premier of “The Interview.” The studio pulled the North Korea-themed comedy’s planned release following terrorist threats against theaters and a devastating hacker attack that leaked reams of sensitive company data. US security officials told news outlets that North Korea directly ordered the hacks, but some say the evidence is thin. The United States said the cyber-attack on Sony Pictures was a serious national security matter and the Obama administration was considering a proportional response.

I don’t know what that means. Maybe we’ll cancel the premier of a North Korean film, or maybe we can get James Franco and Seth Rogen to make more films and we’ll just swamp North Korea with mindless comedies. Or better yet, maybe we can send some Sony executives to North Korea, to motivate the workers.

One of the most shocking revelations to come out of the Sony hack is that people are still saying stupid things in email. You have to assume that everything you write in an email, instant message, or text, or any digital form of written communication, will be read by your boss and co-workers and your spouse; and if you write something incredibly stupid it might even go viral. Seriously.

The Sony hack raises a whole bunch of issues, including whether insurance would pay a claim for someone injured in an attack on a theater. And then there are first amendment questions. And then there is the whole question of cyber security, and why it was clearly lacking at Sony, and just how bad it is at other major companies, and who is liable for hacks. Some Sony employees have already filed lawsuits accusing Sony of negligence for failing to secure its network, and not taking adequate steps to protect employees once the company knew the information was compromised. In the past, companies have tried to cut costs on cyber security, because they felt the liability should fall on the hackers, even if nobody was actually tracking down the hackers. Now, the liability might fall on the company because they knowingly left the keys in the car.

Here’s a quiz for you: Have you ever heard of Kabam, Instacart, WeWork, and Stripe? Probably not. These are the names of companies that did not exist a couple of years ago and now they are worth between $1 billion and $5 billion. Instacart is a same day grocery delivery company; WeWork provides shared office space; Stripe is an online payment company; Kabam makes games for mobile devices. Companies are going from zero to billion-dollar valuations faster than ever before, despite a lack of revenue and, perhaps, even a market plan. In the frenzy, ideas that once were discarded as failures are being recycled into billion-dollar start-ups.

Have your heard about Cuba? Not the island country, but the energy drink. Shares of Cuba Beverage Company were up 140% yesterday. The jump comes on a day when President Barack Obama said the United States will begin to normalize relations and establish diplomatic ties with Cuba–the country, not the company. The company is an energy-drink purveyor with less than $10,000 in sales last quarter that was trading for 1.59 cents on Tuesday afternoon, and absolutely no link whatsoever to certain islands 90 miles off the coast of Florida but which contains the magic four letters, in the correct order? Actually, the ticker symbol is CUBV. If the ticker had been CUBA, I’m guessing it would have been a ten-bagger. Well, why haven’t you placed that buy order yet?

Food startup Hampton Creek Foods, whose goal is to replace egg products in food with plant-based alternatives, just scored $90 million in funding at a reported $500 million valuation; this for a company that wants to make fake mayonnaise. Vox Media just went through a round of funding that valued the online media company at $380 million; compare that to the $250 million sale price for the Washington Post. The big start up story this year is Uber. Actually Uber started 5 years ago, but in the past 6 months the valuation went from $18 billion to $41 billion. If it all sounds a little bubblicious, well it probably is.

FINANCIAL REVIEW

Have a Cigar

Sinclair Noe — December 17, 2014

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

DOW + 288 = 17,356
SPX + 40 = 2012
NAS + 96 = 4644
10 YR YLD + .08 = 2.15%
OIL + .06 = 55.94
GOLD – 6.10 = 1189.90
SILV + .03 = 15.85

I have been telling you for a few years now that the Fed is a vital force in the stock market. I have talked about how the stock market has advanced along with the Fed’s balance sheet. Today absolutely confirms what I’ve been telling you.

Most major indices started the day a little higher, and then jumped following the Fed’s FOMC statement and again during Chairwoman Janet Yellen’s press conference. At one point the Dow Industrial Average was up about 300 points; and then people started to digest what was being said; which is what we will do right now.

The Federal Reserve indicated it was moving closer to raising interest rates from record-low levels because the economy and job market are getting stronger. The Fed also promised to take a “patient” approach in doing so, which sounded very reassuring investors; it sounded like the Fed wouldn’t tighten credit too soon and endanger the economic recovery; they won’t surprise us or rush to tighten next year. The Fed kept the phrase “considerable time” and then they added that they will be “patient”, which really did not help to provide clarity or precision.

Yellen’s press conference covered a range of topics. She said a short period of very low unemployment will help get inflation back to target. And we may be closer to the inflation target than we think because market-based expectations for inflation can’t be entirely trusted to give clear signals. The drop in the market’s expectations for inflation could also reflect other factors, such as the flight to safety into Treasuries. The Fed puts more weight on survey-based measures derived from consumers’ expectations and economists’ forecasts.

This morning before the Fed statement we had a report on inflation. The consumer price index fell by a seasonally adjusted 0.3% last month to mark the largest drop since December 2008. Energy costs fell for the fifth straight month, led by a 6.6% decline in the price of gasoline. The cost of food rose just 0.2% in November. And for people who don’t drive or eat food they strip out volatile food and energy costs, so-called core inflation edged up 0.1% last month. The pace of inflation over the past 12 months fell to 1.3% in November and is down sharply from 2.1% just five months ago. Real hourly wages are up just 0.8% in the past 12 months, so there is really no inflationary pressure from wages.

But the Fed doesn’t seem concerned about low-flation. The plunge in oil prices is a plus for the economy and will have only a transitory impact on inflation. Their thinking is that they are on track for their inflation target of 2%, more or less, give or take. Maybe. Except it isn’t happening now. In fact, 2014 will mark the first time in at least 55 years, not one advanced economy will see consumer prices growing more than 4% this year. But the Fed isn’t particularly worried about weakness in the global economy or low oil prices or the meltdown in Russia; they are aware and monitoring but not very concerned.

The Fed will raise rates at some point, probably. Keep in mind that Ben Bernanke talked about raising rates, but he never quite got around to it. But Yellen’s Fed will be raising rates, but they will be patient. The first rate hike won’t come for at least “a couple of meetings.” And “a couple means two.” So, that sounds like a rate hike in March, but Yellen says more likely before the summertime, but that’s not a promise or commitment; more like a qualified maybe.

Raising rates too quickly could increase lowflationary pressures. And it could doom millions of workers to subpar incomes, unemployment or underemployment. Raising rates too slowly could theoretically increase inflationary pressures, but the real danger in the mind of the Fed is that low rates encourage risky financial behavior, the kind of risky behavior that led to the last couple boom-and-bust cycles. It’s not just the departure date that matters, Yellen says. The pace of subsequent rate hikes is what is important. And that will depend on the data.

And after all the tap dancing was over we were back where we started, which is the idea that the Fed will start to raise rates around June as long as the economy continues to improve pretty much as expected and nothing collapses unexpectedly. More or less.

Now, since the press conference I’ve been reading about Yellen’s performance and it is easy proclaim the Fed is wishy washy or uncertain or guessing. But if you have been following the Fed for a long time, and I have, this is just standard operating procedure. When Yellen says a hike could happen in a “couple of meetings” it is a trial balloon. When they add language about being “patient” they are testing the markets while trying to be reassuring. One thing the Fed has learned is not to make sudden movements; it did not work well in 2008; it did not work well in 1987. And it does not look like there will be any sudden movements in the foreseeable future.

Maybe.

Treasuries declined after the Fed statement. The stock market moved higher. Enjoy. Have a cigar. Not some beat up old stogie but a real cigar, a Cuban. Actually, you can’t do that today, but maybe soon. President Obama and Cuban President Raul Castro announced today they would begin normalizing relations between the two nations, as art of a deal brokered by Pope Francis. The pope played a key role in the talks, sending a letter to Castro and Obama urging them to resolve the dispute over Gross and pursue closer relations. The request from the Pope was rare and came shortly after a meeting Obama had with Francis at the Vatican earlier this year.

The action means not simply the opening of a US embassy in Havana but the lifting of some of the restrictions that have limited travel and commerce and kept aficionados from legally bringing Cuban cigars to US soil.

The announcement was wrapped into the release of American aid worker Alan Gross and the exchange of a US spy for three Cuban intelligence agents. Obama and Castro made simultaneous announcements in Washington and Havana to outline the rapprochement. The US will issue regulations within weeks and will open an embassy as soon as logistically possible. Obama said he would engage Congress “in an honest and serious debate” about changing legislation to fully end the US embargo of Cuba. Some legislators have already vowed to block any change in legislation.

If it goes through, US companies will be permitted to export to Cuba telecommunications equipment, agricultural commodities, construction supplies and materials for small businesses. US financial institutions will be allowed to open accounts with Cuban banks. Exports will mainly be permitted to Cuba’s emerging private sector, including residential goods and equipment for small businesses and agriculture; and there will be some travel permitted for US citizens, but not for tourism. Limits on Cuban-Americans’ remittances to relatives in their homeland will jump to $8,000 from $2,000 annually.

Why, after more than 50 years, did a breakthrough in Cuban-American relations happen now? There are many reasons, but one factor is oil. Cuba has been getting about 100,000 barrels of oil per day from Venezuela in exchange for medical personnel. The collapse in oil prices now leaves Venezuela’s economy in terrible shape with the world’s fastest inflation and the country’s bonds on the verge of default. The country faces a 60 percent chance of defaulting on its foreign debt in the second half of next year if oil prices do not recover. Cuba recognized that it was very risky to be overly dependent on Venezuela. Cuba was well aware of the risks of dependency after the economy collapsed in the early 1990s when the Soviet Union collapsed.

Cuba and Venezuela are not the only countries facing problems from low oil prices. Russia of course – we talked about that yesterday. Tomorrow Putin will talk about it. The Russian president will face questions from the media at his annual press conference. Whether a few words from Putin will restore the status of Russian stocks and the ruble remains to be seen.

On December 8th Moody’s gave 6 Middle Eastern countries a thumbs up based on the assumption that oil prices will average $80 to $85 a barrel in 2015. That assumption now seems suspect. Yesterday, oil prices briefly dipped down around $53 a barrel; today crude for January delivery was down as low as $54.21. While Gulf states can make some spending cuts, they’ll need to do more to cover likely shortfalls. The states with bigger sovereign wealth funds will tap them as needed. The ones with weaker positions will borrow. Many of these oil producing countries run sovereign wealth funds which are largely funded by oil. They are pretty certain not to be making new investments and are likely to be making some sales. Not only will their sales have some impact at the margin, but their absence as deep pocket opportunists could be more important than one might imagine. Recall that in the early stages of the financial crisis, sovereign wealth funds stepped up to provide capital to quite a few wobbly banks. There will be fewer to act as rescuers this time around. And sovereign wealth funds are also big investors in private equity.

Greece moved a step closer to early elections after Prime Minister Antonis Samaras failed to gather enough support for his nominee in a parliamentary vote for a new head of state. Samaras got 160 of the 300 votes but needed a two-thirds majority. There will be another vote December 23rd, and if that fails, a third vote on December 29 with a 180 vote threshold, and if that fails the parliament will be dissolved and early elections will be called.