Financial Review

The Last Century of Fossil Fuels

Sinclair Noe — June 8, 2015

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DOW – 82 = 17,766
SPX – 13 = 2079
NAS – 46 = 5021
10 YR YLD – .02 = 2.38%
OIL + .14 = 58.28
GOLD + 1.40 = 1174.70
SILV – .17 = 16.06

The Standard & Poor’s 500 closed out 2014 at 2,058, and since then it has been trading in a fairly tight range, from about 2050 to 2130. It’s been 3 1/2 years since the broad stock market suffered a 10% drop. At some point the market will either break out or breakdown, but we didn’t see any real indications today. Even though the major market indices have hit record highs this year, the Dow, with today’s loss, is in negative territory year to date.

In contrast, international markets have been anything but boring. Germany’s DAX entered correction territory, down 10%, as European stocks declined on continuation of Greek debt negotiations. And Wednesday could be a very interesting day for Chinese stock exchanges, where the Shenzen has been on a run; up 50% year to date. Index provider MSCI will announce tomorrow whether to include China’s domestic markets in its widely followed emerging-market and global indexes. Rival index provider FTSE Group has already inaugurated transitional indexes for emerging markets to include Chinese A-shares, while S&P Dow Jones Indices said it would likely add the shares to its indexes in September. The new step will add a piece of a market that has some of the world’s highest valuations and volatility to millions of foreign investors.

If you thought the bull market would fix pensions by now, you’d be wrong. Half a trillion dollars wrong. Pensions and other post-employment benefits of the giant companies in the Standard & Poor’s 500 are underfunded to the tune of $584 billion; that’s 44% worse than the $405 billion underfunding in 2013. According to a report released by S&P, just 75% of the total obligations are covered, down from 81% in 2013. And just 4.5% of pension and post-employment benefit plans are fully funded, down from the 8.4% that were in 2013.

Total assets set aside for pensions and post-employment benefits plans grew just 3.5% in 2014. The trouble is that obligations shot up 11.3% to a record $2.34 trillion. That’s a mess. Pensions are still reeling from the 37% hit they took amid the 2008 market meltdown. Most of the mess centers around the low growth of pension investment asset values compared to the skyrocketing of the obligations. The underfunding of corporate pensions hit $389 billion in 2014 – which is 9.7% worse than the shortfall in 2011 – even though the market has shot up by 10% those years. S&P says pensions are the most underfunded since the record high in 2012 at $452 billion.

Leaders from the G7 industrial nations met in the Bavarian Alps for a second day of a summit overshadowed by Greece’s debt crisis and ongoing violence in Ukraine. On Sunday, leaders focused on global growth. Today, German Chancellor Angela Merkel urged G7 leaders to commit to tough goals to cut greenhouse gases. The G-7 nations agreed to cut greenhouse gases by phasing out the use of fossil fuels by the end of the century. Merkel said the leaders had committed themselves to the need to “decarbonize the global economy in the course of this century”. They also agreed on a global target for limiting the rise in average global temperatures to a maximum of 2C over pre-industrial levels, but they did not actually sign off on immediate or binding agreements on emission targets.

In a 17-page communique, the G7 leaders agreed to back the recommendations of the IPCC, the United Nations’ climate change panel, to reduce global greenhouse gas emissions at the upper end of a range of 40% to 70% by 2050, using 2010 as the baseline. Reacting to the summit’s final declaration, the European Climate Foundation described the G7 leaders’ announcement as historic, saying it signaled “the end of the fossil fuel age” and was an “important milestone on the road to a new climate deal in Paris”. That may be a bit of an overstatement, but we are seeing a shift in thinking about fossil fuels, and there are some important implications.

The G-7 meeting is a small step with no binding agreements, it will be followed in a month or two by an encyclical published by Pope Francis dealing with climate change, and then the IPCC summit in Paris later this year, which might actually result in binding agreements.

There were other issues at the G-7 summit. Merkel warned that time is running out for a deal to keep Greece in the Eurozone; she said Europe would show solidarity but only if Greece “makes proposals and implements reforms”. The European Commission is asking for tax increases and cuts in civil servants’ salaries and pensions, before the next €7.2 billion-euro tranche of bailout money can be released. But Greece has robustly rejected these proposals without some form of debt restructuring agreement in return.

President Obama reportedly said that “the strong dollar posed a problem”. A senior White House official denied the report, saying the president was just reiterating his belief that global demand needs to strengthen and G-7 members need to step up use of policy to drive growth. Obama said at a news conference following the G-7 meeting in southern Germany. “Don’t believe unnamed quotes, I did not say that. I make a practice on not commenting on the daily fluctuations of the dollar or any other currency. ”

Apple is hosting its annual developers’ conference today. Apple introduced a streaming music service it developed with Beats Electronics, the company it acquired for $3 billion last year. The service, called Apple Music, allows users to search for songs and stream them over the Internet, similar to Spotify. It also makes recommendations for other playlists and albums for people to listen to. The service costs $10 a month or $15 a month for up to six family members. The new Apple Music service will be offered alongside an overhauled version of iTunes Radio, the Pandora-like radio service it introduced in 2013. The service will now include live stations.

The Apple developers’ conference is a big event but the streaming music service seemed to miss the “wow” factor. The conference also dealt with upgrades to the operating system, upgrades to the Apple watch and Apple pay, plus improvements to the mapping system. Apple is known for the next big thing, but it didn’t seem to happen today.

Google’s new mobile phone payment service, Android Pay, will not collect any transaction fees from credit card companies, possibly putting pressure on Apple to drop or lower its charges for Apple Pay. Visa  and MasterCard recently standardized their “tokenization” card-security service and made it free, preventing payment services, such as Google, from charging fees to issuers.

Samsung Electronics plans to offer a mobile payments function in a smartwatch to be launched in the second half of the year. Samsung Pay mobile payments service, which supports NFC technology, will become available for “select partners” in July.

Panasonic plans to send hundreds of its employees to Tesla’s Gigafactory in Nevada to prepare for production of lithium-ion batteries for electric cars, which it confirmed will start sometime next year. Panasonic also said it expects to invest nearly $500 million in the current fiscal year through March in its automotive business, which includes the Gigafactory and a joint development project with Spanish auto parts maker Ficosa International.

Deutsche Bank purged its leadership on Sunday, appointing John Cryan as chief executive to replace co-CEOs Jürgen Fitschen and Anshu Jain. Cryan has been on the bank’s supervisory board since 2013 and was a former chief financial officer of UBS. Deutsche Bank failed a U.S. stress test of large financial institutions in March and has been the subject of hefty penalties in recent months. Back in April, Deutsche Bank settled charges leveled by U.S. and British federal authorities, agreeing to pay $2.5 billion in fines and pleading guilty to U.S. charges that it manipulated a key interest rate. Deutsche Bank, which also is ensnared in a currency-rigging scandal, is awaiting penalties for its role in fixing prices in currency markets too.

General Electric is close to an agreement to sell its private-equity-lending unit to Canada’s largest pension fund, marking a major step in the industrial giant’s retreat from banking, in one of the biggest finance takeovers since the credit crisis. The deal, which would include assets of more than $10B, may be announced by GE and the Canada Pension Plan Investment Board as soon as today.

McDonald’s posted a smaller-than-expected decline in worldwide sales at established restaurants in May. Worldwide sales fell 0.3%, the 12th consecutive month of declines. Sales in the U.S. fell more than 2% as fewer customers and increased competition ate into demand.

Sears Holdings’ reported a narrower-than-expected adjusted loss of $2 per share in its first quarter. Revenue continued to disappoint with sales falling more than 25% from a year earlier. The big problem is that Sears is burning through cash; holding $286 million in cash at the end of the quarter, down from $4.4 billion at the start of 2006. The company has suffered more than $7 billion in net losses since 2012.

Tuesday, July 22, 2014 - Curb Your Enthusiasm

Financial Review with Sinclair Noe

DOW + 61 = 17,113
SPX + 9 = 1983
NAS + 31 = 4456
10 YR YLD - .01 = 2.46%
OIL - .17 = 104.42
GOLD – 4.70 = 1308.50
SILV + .04 = 21.07

We start with a couple of economic reports. The National Association of Realtors reports existing home sales were up 2.6% in June to a seasonally adjusted rate of 5.04 million, compared to 4.91 million in May. Sales in June were 2.6% higher than last month, but were 2.3% below the June 2013 rate. Total inventory rose 2.2% in June to 2.3 million existing homes for sale; unsold inventory is up 6.5% from a year ago.

At June’s pace of sales, there was a 5.5-month supply of homes for sale. The Realtors’ group considers a 6-month supply to be a balanced market. Higher supplies favor buyers and lower supplies favor sellers. The Federal Housing Finance Agency says home prices in May rose 0.4% from the prior month and were 5.5% above their level of May 2013. Distressed sales accounted for just 11% of sales in June, down from 15% last year, 25% in 2012, and 30% in 2011. Fewer distressed sales probably explain why there were fewer sales than June of last year.

The Consumer Price Index, or CPI, measures inflation at the retail level; the CPI increased 0.3% in June. The core CPI looks at prices excluding food and energy, which is important for people who don’t eat food or drive cars or use electricity; core CPI was up 0.1% in June. On a year over year basis, CPI is up 2.1%, and the core CPI is up 1.9%. The big driver for the increase in June was higher prices for gasoline.

In earnings reports:

Quarterly profit at McDonald's fell more than expected. Second quarter net income fell almost 1% to $1.3 billion, or $1.40 per share. Sales at McDonald’s restaurants in the US dropped for a third straight quarter.

Coca Cola’s 2Q net income dropped to $2.6 billion from $2.68 billion a year earlier.

Verizon reported second quarter earnings nearly doubled, but it was a confusing report because Verizon paid for Vodaphone shareholders in the quarter, plus they sold some of their wireless spectrum to T-Mobile; cutting through the clutter, Verizon added 1.4 million devices; Verizon added three tablets for every new smartphone. Earnings were just a smidge above expectations.

Comcast reported net income of almost $2 billion for the second quarter, with total revenue of $16.8 billion, up 3.5% from the same period last year. The revenue increase came from high-speed internet service. Comcast lost cable video customers, as more people bypass cable and satellite subscriptions in favor of cheaper streaming alternatives.

Credit Suisse reported a second quarter loss of $779 million, the largest loss since 2008; reflecting the charge of $2.6 billion related to the settlement with US law enforcement for a guilty plea to conspiring to aid tax evasion in helping American customers hide money in Swiss accounts. On the other hand, another way to look at it, they were one criminal conviction away from a $1 billion quarterly profit. Credit Suisse also announced it would exit the commodities trading business.

Meanwhile, it looks like bond traders are exiting the bond trading business. Trading in US government bonds has dropped 25% in the past few weeks compared to the same period a year ago. Since the end of the second quarter, trading in investment grade bonds has dropped 17% and trading in junk bonds has dropped 8%.

Last week, Fed Chair Janet Yellen talked about overvaluation in the biotech and social media sectors. One of the most common measures of value is the P/E, or price to earnings ratio; there are certainly other measures of value, but PE is common. Generally, a low PE can point toward value, while a high PE might indicate overvaluation, or even an unprofitable company. Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share. Therefore, you might think a PE of 165 would mean a stock was extremely overvalued, ready to crash; or not. In September 2003, Apple had a PE of 165; since then it has gained about 6,000%.

After the close of trade today, Apple posted fiscal third quarter results. Revenue came in at $37.4 billion versus $38 billion expected; EPS was $1.28 versus $1.23 expected; iPhone sales were on track; iPad sales were a little weak; Mac sales were a little better than expected. Apple posted profit of $7.75 billion, up from $6.9 billion in the year-ago period. Apple announced a new iPhone 6, not yet available, but ready to swamp stores before the end of the year; it will have a bigger screen. Curb your enthusiasm.

Also after the close, Microsoft posted profit of $4.6 billion, or 55 cents a share, on revenue of $23.4 billion. During the year-ago period, the world's largest software company earned $4.97 billion, or 59 cents a share, on $19.9 billion in sales. So, sales were up, profit was a slight miss, due to the Nokia acquisition. Bing search ad revenue is up 40%, and Bing now has about 20% of the market share for search engines. Microsoft is big in the cloud, where revenue is up almost 150%, topping 4 billion.

Hedge fund manager Bill Ackman went on CNBC yesterday and promised he would deliver the deathblow against Herbalife. Ackman has been shorting the stock for about a year; a $1 billion bet the company would crash. Then he delivered a 3-hour diatribe with 250 slides in his PowerPoint presentation, alleging that Herbalife is not just a multi-level marketing nutritional club, it is a pyramid scheme preying on minorities, and the biggest fraud since Enron. Ackman did not present a great deal of evidence. Today the stock was up 15%, for no apparent reason, other than surviving an Ackman deathblow.

There were two rulings from two federal appeals court panels on Obamacare today. The question was whether the government could subsidize health insurance premiums for people in states that use the federal insurance exchange; 36 states use the federal exchange, while the other states set up their own state exchanges. This goes back to wording in the original law that says subsidies can be applied to state exchanges.

 The United States Court of Appeals for the District of Columbia Circuit said that the government could not subsidize insurance for people in states that use the federal exchange. That decision could potentially cut off financial assistance for more than 4.5 million people who were found eligible for subsidized insurance in the federal exchange, or marketplace.

A couple of hours later, the United States Court of Appeals for the Fourth Circuit, in Richmond, upheld the subsidies, saying that a rule issued by the Internal Revenue Service was “a permissible exercise of the agency’s discretion.”

For now, nothing changes, with the exception that there will be many more billable hours for the attorneys.

Bloomberg reports that regulators are ready to label MetLife a potential threat to the financial system, subjecting the insurer to oversight by the Federal Reserve. MetLife, the biggest US life insurer, could be subjected to stricter capital, leverage and liquidity requirements as a result of Fed supervision. A decision by the Financial Stability Oversight Council may come as early as July 31, and MetLife would have 30 days to request a hearing before the FSOC to contest the decision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now 4 years old, even though it isn’t really in effect; just 52% of the rules mandated under Dodd-Frank have been finalized by regulators; Another 23% have been proposed but they’re still working out details, and regulators haven’t even gotten around to 24% of the rules. A recent report by consumer watchdog Public Citizen called out the Securities and Exchange Commission as a particularly egregious delayer, noting that it had pushed back the deadlines for 13 of the 23 rules it was supposed to finalize this year.

City workers and retired city workers in Detroit have agreed to pension cuts to help bailout the city from bankruptcy. General retirees would get a 4.5% pension cut and lose annual inflation adjustments. They accepted the changes with 73% of ballots in favor. Support for the pension changes triggers an extraordinary $816 million bailout from the state of Michigan, foundations and the Detroit Institute of Arts. The money would prevent the sale of city-owned art and avoid deeper pension cuts.

Most people travel to or from Israel by air, and the major airport, really the only airport is Ben Gurion in Tel Aviv; last year, 14 million people went through Ben Gurion Airport, in a country with a population of 8 million.  Yesterday a rocket from Gaza landed about one mile from the airport; we don’t have further details on that rocket; it did not hit the airport; it was a mile away. When news spread, Delta diverted a flight to Paris. United airlines cancelled flights. The Federal Aviation Administration banned all US passenger and cargo flights to and from Tel Aviv for at least the next 24 hours. European airlines cancelled flight to Israel. The possibility of a passenger jet being shot down over a war zone is a very realistic and fresh memory.

US and United Nations diplomats are in Israel, trying to broker a ceasefire of some sort. Israel continues to pound targets across the Gaza Strip. It does not appear a ceasefire is near. If there is any light at the end of the tunnel, the tunnel will be destroyed.

The European Union today threatened Russia with harsher sanctions if Russia does not cooperate in the investigation of the downing of the Malaysian flight 17 and if Russia does not stop sending weapons to Russian backed separatists in Ukraine. However, it was just a threat, and they will get together later in the week to draft proposals for sanctions.