Financial Review

Computer Says

Sinclair Noe — June 13, 2017

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DOW + 92 = 21,328 (record)
SPX + 10 = 2440 (record)
NAS + 44 = 6220
RUT + 6 = 1425 (record)
10 Y un = 2.21%
OIL – .13 = 45.95
GOLD + .60 = 1267.10
BITCOIN + 1.48% = 2779.42
ETHEREUM – 1.97% = 387.89

The Dow Jones Industrial Average and the S&P 500 Index ended at all-time highs, while the Nasdaq 100 Index bounced back from its biggest two-day drop since September.

European and emerging-market equities advanced. Sterling rose for the first time since the U.K. election. Ten-year Treasury yields held near 2.21 percent and the dollar slipped versus major peers before the Fed is projected to raise rates Wednesday.

Tech stocks enjoyed a bit of a rebound but there are still concerns about valuations. A Bank of America Merrill Lynch report found a record 44 percent of fund managers polled in a monthly survey see equities as overvalued, up from 37 percent in May.

The technology-heavy Nasdaq Composite Index was named the most crowded trade, with 57 percent of investors saying Internet stocks are expensive and 18 percent calling them “bubble-like.’’ In the ninth year of a bull market, stocks are expensive.

So, what was behind the recent two-day sell-off in tech? Did investors just get nervous? Are tech stocks fundamentally overvalued? Computer says…. No. The quants were just rebalancing.

According to a new report from JPMorgan quantitative investing based on computer formulas and trading by machines directly are leaving the traditional stock picker in the dust and now dominating the equity markets. The report estimates “fundamental discretionary traders” account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double its share a decade ago.

Figures from market structure research firm TABB Group point to similar gains in machine-driven trade volume, while the overall number of shares traded has declined. A subset of quantitative trading known as high-frequency trading accounted for 52 percent of May’s average daily trading volume.

Crude tumbled in early trading on a report that at the same time as OPEC and its partners agreed last month on prolonging production cuts, the group’s output was climbing the most since November as members exempt from the deal restored lost supply. Oil then reversed and gained amid estimates that U.S. supplies declined.

The producer price index was flat last month following a sharp 0.5% increase in April. Still, inflation is more widespread after being largely invisible in 2016. The 12-month rate of wholesale inflation stood at a 2.4% in May, up from zero a year earlier and just a notch below a five-year high.

The flat reading in wholesale inflation in May, as expected, was tied to falling prices for gas and fuels used to heat and cool homes. The wholesale cost of gasoline sank 11.2%. The wholesale cost of food also fell for the first time in six months. Core wholesale costs slipped 0.1% in May, when stripping out the volatile categories of energy, food and retail trade margins.

The core rate of inflation was up 2.1% over the past 12 months.

The Corelogic Home Price Index shows home prices nationwide, including distressed sales, increased year over year by 6.9 percent in April 2017 compared with April 2016 and increased month over month by 1.6 percent in April 2017 compared with March 2017. Corelogic forecasts that home prices will increase by 5.1 percent on a year-over-year basis from April 2017 to April 2018.

Arizona posted 6% year-over-year growth in home prices, with 0.7% increase March to April. Corelogic forecasts Arizona home prices will increase 6.3% over the next 12 months.

The National Federation of Independent Business said its small-business optimism index held steady at a seasonally adjusted 104.5 in May from the prior month. In May, five of the 10 index components gained, four declined and one remained unchanged. A net 28% of owners reported plans to make capital outlays, well below historic levels.

Duke University/CFO Magazine conducted a survey of US chief financial officers. The share of CFOs who are more optimistic about the economy is the lowest since before the presidential election. A jump in sentiment about near-term fixes to tax and health-care policy has given way to increased doubt as Congress stays fixated on investigating Russia’s role in the U.S. election.

The Federal Reserve’s Federal Open Market Committee met today. Tomorrow they will conclude their meeting and issue a statement – almost certainly announcing a 25-basis point increase in the fed funds target rate. Fed officials have penciled in three rate hikes this year. A rate hike tomorrow would be the second rate hike of the year.

Fed officials have said they are not worried about the strength of the economy. They view weak first quarter growth as transitory and believe inflation will resume rising toward the central bank’s 2% target. The interest-rate decision is straightforward. Monetary policy works with a lag, so the Fed must think ahead.

The big question is whether the central bank will start to shrink its $4.5 trillion balance sheet in September or December, assuming the economy stays on course. The balance-sheet decision is slightly more complicated. It has three parts: The Fed must choose when to start shrinking its holdings, how quickly to shrink them once it has started, and how small the balance sheet should be when the holdings are back to normal.

When to start shrinking the balance sheet is partially dependent on the path of interest rate hikes. Once interest rates are at more normal levels, the Fed will likely begin to let its bond holdings mature and fall off the balance sheet based on a set timetable. This coming policy shift isn’t yet imminent, because interest rates need to rise a bit more first. But it’s fast approaching, and this week isn’t too soon for the Fed to start being clearer about its intentions.

Attorney General Jeff Sessions offered an aggressive defense of his conduct surrounding the Russia investigation, telling an open Senate hearing any allegations he had colluded with Moscow to undermine the election were an “appalling and detestable lie”. Sessions recused himself from the Russia investigation in March, citing his role as a key foreign-policy adviser in the Trump campaign.

His abstention came one day after The Washington Post reported Sessions, during his Senate confirmation process, had failed to disclose two meetings during the presidential campaign with the Russian ambassador to the United States.

Meanwhile Bloomberg is reporting Russia’s cyberattack on the U.S. electoral system before Donald Trump’s election was far more widespread than has been publicly revealed, including incursions into voter databases and software systems in almost twice as many states as previously reported.

In all, the Russian hackers hit systems in a total of 39 states. The new details, seem to confirm a classified National Security Agency document recently disclosed by the Intercept.

In November, Steven Mnuchin pledged the wealthy would not see “an absolute” tax cut under the administration’s developing tax plan. That is, whatever reduction in tax rates would be offset by fewer deductions, so the net result would be the same for the wealthy. During Mnuchin’s confirmation hearing to become Treasury Secretary, Mnuchin repeated his pledge, earning the nickname “The Mnuchin Rule”.

Today, during a Senate Budget Committee hearing Mnuchin walked back the rule, indicating tax reform might result in a windfall for the wealthy.

Verizon has completed its purchase of Yahoo’s internet business for $4.48 billion. The acquisition, which was first announced last July, aims to combine Yahoo’s operating business with AOL, which it purchased in 2015. The merger will form Oath, a division of Verizon that is expected to house more than 50 media and technology brands.

Verizon plans to layoff more than 2,000 people, or the equivalent of 15 percent of Oath’s new workforce. Tim Armstrong, AOL’s former chief executive, will lead Oath as its CEO. Marissa Mayer, Yahoo’s CEO, is out.

Uber CEO, Travis Kalanick, will step away from the company for an unspecified period. But that won’t likely change the day-to-day lives of the more than 5,000 Uber employees as much as the changes the company is committing to make to their recruiting, retention, and workplace-culture policies, detailed in a report known as the Holder Report.

Financial Review

Thus Spake Yellen

Sinclair Noe — October 14, 2016

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

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DOW + 39 = 18,138
SPX + 0.43 = 2132
NAS + 0.83 = 5214
10 Y + .03 = 1.77%
OIL – .11 = 50.33
GOLD – 7.30 = 1251.50

Sales at US retail stores rebounded in September, with auto dealers and gas stations racking up the biggest gains. Retail sales rose 0.6% last month to snap back from a small decline in August that was the first in five months.

In September, receipts at auto dealers increased 1.1%. Still, auto dealers relied on sharply higher discounts to lure buyers, as demand for new cars and trucks appears to be leveling off after a years-long boom in sales. Auto purchases account for about one-fifth of all retail spending.

Sales at gas stations climbed a seasonally adjusted 2.4%. We weren’t buying more gas, just paying more.

Department stores suffered a 0.7 percent sales decline in September, part of a long-term slowdown for the anchor tenants at many shopping malls that increasingly must compete with online outlets. But even online sales were soft. They rose a mere 0.3 percent in September, compared with recent monthly gains averaging nearly 1 percent.

The University of Michigan Consumer Sentiment Index dropped to 87.9 from 91.2 in early October. Blame the presidential election. The sub-index of consumer expectations fell to 76.6, its lowest level in two years, mostly from households with incomes lower than $75,000. The index of current economic conditions ticked up to 105.5 from 104.2 last month. In other words, people think things are pretty good now, but they will surely get worse.

By the way, this idea that consumer sentiment is down because of the presidential election – there may be something to it. The American Psychological Association, which is the largest psychological organization in the US, conducted their annual “Stress in America” survey and found that tension regarding the upcoming presidential election is exceedingly high. Fifty-two percent of over 3,500 adults surveyed said they felt stressed by all the politicking and campaigning leading up to the approaching election. It doesn’t matter if you are Democrat or Republican, the election is driving us crazy.

Producer prices rose again in September as wholesale inflation keeps creeping higher. The producer price index advanced 0.3% last month. Energy prices rose 2.5%. But even if you strip out volatile food and energy costs, the core rate also advanced 0.3%, indicating that food costs partly offset higher energy costs and inflation is creeping into the broader economy.

American businesses increased inventories by a modest 0.2% in August as they continue to work down an excessive build up last year. Business sales also increased by 0.2% in the same month. Companies have scaled back production in many areas such as manufacturing to bring inventories back in line, and that’s been a drag on the U.S. economy in the first half of 2016.

The U.S. Treasury has issued final inversion amendment rules in its effort to tackle “earnings stripping” – a tax-reduction technique employed by multinationals. In an inversion, a U.S. company moves its legal address abroad in order to pay lower taxes. Under earnings stripping, a foreign parent company lends money to its U.S. operation, and the interest is then deducted. The rules were initially proposed in April. The final regulations contain some exceptions to the initial proposal, including for certain entities where the risk of earnings stripping is low.

Earlier this week, the Fed released minutes of the September FOMC policy meeting; which we know was a split decision not to raise rates. Boston Fed President Eric Rosengren, one of the hawks, this morning said that he expects the unemployment rate to decline to 4.5% next year, an unsustainable level that may force the Fed to act. This afternoon, Fed chair Janet Yellen spoke at a Boston Fed conference. Yellen said she thinks it might be possible to temporarily run a “high-pressure economy, with robust aggregate demand and a tight labor market.”

Yellen made no mention of when the Fed might raise rates but she did question some of the most fundamental principles of economics, including the nature of inflation and the influence of financial markets. Among the questions raised were whether the severe downturn could erode the skills of the nation’s workforce, impeding future growth.

Yellen also suggested that changes in spending and behavior among some groups could have outsize effects on the health of the broader economy — a nuance that current mathematical models may not capture well.

Central bank officials are debating the best strategy for approaching such a slow recovery. Yellen said today, “If strong economic conditions can partially reverse supply-side damage after it has occurred, then policymakers may want to aim at being more accommodative during recoveries than would be called for under the traditional view that supply is largely independent of demand.”

It sounds like Yellen is a little confounded and annoyed by the sluggishness of the economy, and is willing to test the dovish boundaries of monetary policy and maybe even err on the side of overshooting the recovery.

Before the opening bell, we saw earnings reports from JPMorgan, Citigroup, and Wells Fargo. JPMorgan Chase reported a profit of $6.2 billion, or $1.58 a share. That compares with a profit of $6.8 billion, or $1.68 a share, in the same period of 2015. Revenue rose 8.4% to $25.5 billion. Analysts had expected $24 billion. Earnings and revenue beat estimates. The bank had record earnings in commercial banking and record loan balances in asset management.

JPMorgan is conducting a “deep dive” into the cross-selling of retail products; you know, the kind of stuff that landed Wells Fargo in hot water for opening bogus accounts. JPMorgan’s self-investigation has revealed a few instances; they say they can’t have “zero defects” but claim they do not have systemic problems. Quite a claim from a business that has paid more than $27 billion dollars in fines and legal costs over the past 5 years.

Citigroup said third-quarter profit and revenue were down, but results were still better than what analysts had predicted. Citi reported a profit of $3.8 billion, or $1.24 a share. That compares with the $4.2 billion, or $1.35 a share, it reported in the same period of 2015. Revenue was down to $17.7 billion from $18.6 billion a year ago. Trading revenue rose 16%. Investment banking revenue was up 15%.

Wells Fargo said its third-quarter profit fell to $5.6 billion, or $1.03 a share. That compares with $5.8 billion, or $1.05 a share, in the same period of 2015. Revenue rose to $22.3 billion. Both earnings and revenue topped estimates. The bank faces a raft of federal and state investigations. The earnings presentation addressed the fraudulent account openings in detail. Compared to August, consumers decided to apply for 30% fewer credit cards. And compared to last September, 25% fewer.

Consumer checking accounts also took a big fall. Year-over-year, the bank saw 25% fewer checking accounts opened and a whopping 30% fewer in comparison to August. And that’s just the beginning. We’ll probably learn more when fourth quarter earnings are announced in January. We did not learn how many customers have left the bank.

Wells Fargo said it is looking into how customers’ credit scores may have been affected by the 565,000 unwanted credit cards, and that it’s working with credit bureaus to expunge the fraudulent files and restore credit, or furnish the card connected to the account for the people who decided to keep their cards. In addition to that, the San Francisco-based bank will be looking into the indirect and more costly consequences of how the new accounts impacted consumers’ credit scores – for example, the effect it might have on a loan’s interest rate.

It will take more than the retirement of Wells Fargo CEO John Stumpf to make California State Treasurer John Chiang change his mind about doing business with the bank again. Chiang said, “We are beyond the point of tweaking. We want to see fundamental reform of Wells Fargo before we make a decision.” In September, the state suspended its relationship with the lender after it was accused of defrauding customers.

Today, Ohio jumped on the bandwagon, announcing that the Ohio state government will ban all business with Wells Fargo for 12 months. This will include using Wells Fargo to issue debt or bid for financial-services contracts. The decision applies to state agencies.

Verizon says Yahoo’s hack could have “material” impact on their planned acquisition. “If they believe that it’s not, then they’ll need to show us that,” so says Verizon general counsel Craig Silliman. Verizon agreed to buy Yahoo’s core assets for $4.8 billion in July, but the deal has yet to close.

Meanwhile, Twitter can’t find a bid. Salesforce will not put in an offer for the company. Salesforce was the last remaining bidder for Twitter after Disney and Google lost interest last week.

Tech giants including AMD, Dell/EMC, Google, Mellanox, Micron, Nvidia and Xilinx have joined forces to give Intel a good kick in the datacenters. The group has come up with an open specification, dubbed OpenCAPI, which can boost server performance by up to 10x. Effectively, they are moving away from PCIe – the current industry standard – to something that is both more open and vastly more powerful.

Financial Review

Sneaking Through the Backdoor

Sinclair Noe — February 17, 2016

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DOW + 257 = 16,453
SPX + 31 = 1926
NAS + 98 = 4534
10 Y + .04 = 1.82%
OIL + 2.35 = 31.39
GOLD + 8.10 = 1209.40

Three in a row; three up days, and good moves at that. If you believe the old adage that every stock market advance is short covering, you have some evidence to back your position. The most shorted stocks among Russell 3000 members gained 6.5% over just two trading days, Friday and Tuesday, while the least shorted issues trailed the Russell’s 4.6% advance over the same period. And while it looks like last Thursday’s lows provided some support in the short-term, it is too soon to see if that support will hold.

Anyone who is calling a bottom in the market is just making stuff up. I don’t know, you don’t know. What we know is the markets have been all over the map in the past 2 months, flitting from one crisis to the next. The good news is that nothing has blown up yet. The bad news is that everything is volatile.

Russia, Saudi Arabia, Qatar, and Venezuela announced an agreement Tuesday to freeze oil production in an effort to ease the oil glut. On Wednesday, Iran said it wouldn’t join the effort, as its production just came back online following years of sanctions, and then they changed their position, and said a production ceiling at January levels would stabilize the market; they didn’t say they would freeze their own production. Whatever. Oil bounced about 7% today. Of course any attempts to control output by oil producing countries does not have a track record of success.

Housing starts slowed in January. Groundbreaking fell 3.8 percent to a seasonally adjusted annual pace of just over 1 million units. Part of the decline in starts could be attributed to the snowstorms, which blanketed the Northeast last month. With building permits ahead of groundbreaking activity, home construction is likely to pick up in the months ahead. The report comes on the heels of a survey on Tuesday showing confidence among homebuilders fell in February amid concerns over “the high cost and lack of availability of lots and labor.”

Mortgage applications increased 8.2% last week. The average interest rate for a 30-year fixed conforming mortgage decreased to 3.83%, the lowest level since April 2015. Refinance activity was higher in 2015 than in 2014, but it was still the third lowest year since 2000.

Thanks in part to increased production of utilities and manufacturing, industrial production climbed 0.9% in January. This is the first increase since July and one of the biggest monthly gains of the expansion. The strength of the report was tempered somewhat by a downward revision of 3 percentage point to December, resulting in a revised decline of 0.7%. The rise in manufacturing production reflected gains in the output of long-lasting goods such as machinery, furniture and primary metals. Motor vehicle assembly accelerated. The production of food, textiles and chemicals also rose.

Producer prices, or prices at the wholesale level, rose in January as margins for wholesale machinery and equipment increased. The producer price index edged up 0.1 percent after slipping 0.2 percent in December. In the 12 months through January, the PPI decreased 0.2 percent. Lower oil prices and a strong dollar continue to pressure wholesale prices, which is contributing to holding inflation well below the Federal Reserve’s 2 percent target. The latest read on consumer prices is due for release on Friday.

The FOMC published the minutes from its meeting in January, where the Federal Reserve declared it still intended to raise interest rates gradually, but was “closely monitoring” market developments. Policymakers worried last month that tighter global financial conditions could hit the U.S. economy and considered changing their planned path of interest rate hikes in 2016. The word “uncertainty” was sprinkled throughout the minutes, and the Fed seemed afraid that a shock could make a mess of everything.

However, they agreed it would be premature to change their outlook for the U.S. economy, saying they would closely monitor global economic developments as well as oil and stock prices. That suggests the recent slowdown in global growth and steep stock market drops are leading the Fed to consider backing away from the signal it sent in December that it could raise rates four times this year.

Yesterday, Boston Fed President Eric Rosengren said the Fed can take its time to raise interest rates if headwinds from the global economy and financial markets persist. Wall Street is generally skeptical the Fed will raise rates at all this year. Prior to the release of the minutes, prices for fed funds futures implied investors saw a roughly 40 percent chance of a hike in December and less than that for prior meetings

Apple CEO Tim Cook said his company opposed a demand from a U.S. judge to help the FBI break into an iPhone recovered from one of the San Bernardino shooters. Cook said that the demand threatened the security of Apple’s customers and had “implications far beyond the legal case at hand.” In a letter to Apple’s customers, Cook said the FBI had asked the company to build “a backdoor to the iPhone,” and “The government is asking Apple to hack our own users and undermine decades of security advancements that protect our customers.”

In the letter Cook writes: “We have no sympathy for terrorists.” He goes on to add: “Compromising the security of our personal information can ultimately put our personal safety at risk. That is why encryption has become so important to all of us. For many years, we have used encryption to protect our customers’ personal data because we believe it’s the only way to keep their information safe. We have even put that data out of our own reach, because we believe the contents of your iPhone are none of our business.”

That may not be entirely accurate. The FBI can’t raid Apple’s data centers and read your text messages. If they did, they’d be reading a whole lot of encrypted gibberish. Here’s the problem: Apple built a backdoor into the iPhone just for itself, a way for the company to load up new software that could make it easier to gain access, and now the FBI wants to take that backdoor for a spin, too.

And one more thing. Apple appears to take a different tack in dealing with data security demands from China. In January 2015, the state-run Chinese newspaper People’s Daily claimed, in a tweet, that Apple had agreed to security checks by the Chinese government. This followed a piece in the Beijing News that claimed Apple acceded to audits after a meeting between Cook and China’s top internet official, Lu Wei. China’s State Internet Information Office would reportedly be allowed to perform “security checks” on all Apple products sold on the mainland.

According to the report, this was despite Cook’s assurances that the devices didn’t contain backdoors accessible by any government, including the US. We don’t know if Apple permitted a security audit, but if it did, it could have shared vital information with the Chinese government, such as its operating system’s source code, that could indirectly help government agents discover vulnerabilities on their own.

Apple is also in the news in the corporate debt market after the company sold $12 billion of bonds in the second-largest U.S. corporate debt offering so far this year. Yesterday alone, blue chip companies raised more than $23 billion in bonds.

The Hollywood Presbyterian Medical Center in Los Angeles has been operating without access to email or electronic health records for more than a week, after hackers took over its computer systems and demanded $3.6 million in Bitcoins in ransom to return it. Hospital staff are working with investigators from the Los Angeles Police Department and the FBI to find the intruders’ identities.

Meanwhile, without access to the hospital’s computer systems, doctors and nurses are communicating by fax or in person. Medical records that show patients’ treatment history are inaccessible. New patient records are being recorded on paper, and some patients have been transferred to other hospitals. While it’s unlikely that the facility will pay millions of dollars to restore its databases and systems, it’s in desperate straits without a backup of its patient files. Unless law enforcement can break the encryption keeping the data hostage, the hospital may be forced to start from scratch.

Fairchild Semiconductor has rejected a takeover offer worth about $2.5 billion led by Chinese state-backed buyers in favor of a bid from a U.S. rival because of concerns about regulatory approval. Fairchild had said in early January that it expected the Chinese bid to be a “superior proposal” – it amounted to $21.70 a share in cash, compared with the $20 a share that Phoenix-based ON Semiconductor was offering.

U.S. and Cuban officials have signed an agreement that provides for the reopening of scheduled air services between the two nations for the first time in more than 50 years. The move is expected to set off a scramble among American carriers to win route rights to serve Havana, which will be capped at 20 round trips a day from anywhere in the US.

You know that 2015 was the hottest year on record, by a wide margin; 2016 is on track to beat it. Last month was the hottest January in 137 years of record keeping, according to data released today by the National Oceanic and Atmospheric Administration. It’s the ninth consecutive month to set a new record.

To be sure, some of the recent extremes are the result of a monster El Niño weather pattern that still lingers in the Pacific Ocean. The heat that’s dispersed into the atmosphere during an El Niño can linger, which means there’s a decent chance 2016 will turn out to be the third straight year to set a new temperature record. That’s never happened before.

Financial Review

Bad Things in the Midwest

Sinclair Noe — May 14, 2015

 

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DOW + 191 = 18,252
SPX + 22 = 2121.10
NAS + 69 = 5050
10 YR YLD – .04 = 2.24%
OIL – .77 = 59.73
GOLD + 6.30 = 1222.40
SILV + .35 = 17.55

The Standard & Poor’s 500 Index closed at an all-time high, taking out the previous closing high of 2117.69. The Dow is still about 36 points shy of its record closing high. The dollar is on track for its longest weekly losing streak since October 2013. The bond market rallied, just a little, which is at least a change from the past couple of weeks. The earnings season is winding down, and it was ugly, but it looks like there will be positive earnings growth coming from the first quarter numbers. The economic data has been tepid.

The number of Americans who applied for unemployment benefits in the first full week of May fell by 1,000 to 264,000. New claims have registered less than 270,000 for three straight weeks, only the second instance in which that’s happened since 1975. Continuing jobless claims, people already collecting benefits, were unchanged at 2.23 million in the week ended May 2.

Producer prices, or prices at the wholesale level, fell a seasonally adjusted 0.4% in April to mark the seventh decline in the last nine months, mainly because of lower gasoline and food costs. Core producer prices that exclude the volatile categories of food, energy and trade rose 0.1% last month; the increase was mainly due to higher prices for drugs. Over the past year overall producer prices have fallen a record 1.3% on an unadjusted basis. Yet the core rate has risen 0.7% in the same span.

U.S. corporate spending on capital projects could fall this year to the lowest level since 2011, with steep reductions by the energy industry and companies in other sectors cutting spending amidst broad concerns about global growth. Among the S&P sectors, only the materials and financials sectors expect to spend more in 2015 than they did last year. They’re not spending at a pace that would suggest a global recovery. According to data from Thomson Reuters, estimates from analysts show that total S&P 500 capex spending could dip to $641 billion in 2015 from actual spending of $718 billion for 2014, marking the lowest level since 2011.

And it’s not just businesses that are holding on to the purse strings; yesterday we had a report showing retail sales were flat last month. It was widely believed that lower oil prices would put extra money in shoppers’ wallets and they would rush out to spend. Oil prices remain more than 40% below the highs reached in mid-2014, which equates to a roughly $150 billion ‘tax cut’ to consumers.

One reason for the lack of spending might be middle class debt. According to the Federal Reserve, as of 2013, the average debt of middle-class families, those that fall within the middle three-fifths of the population by earnings, amounted to an estimated 122 percent of annual income. That’s down from 2010, but still higher than 2001. Consumers have been trying to save more because they realized that gas prices could go higher, and it is happening; consumers also realize that interest rates could go higher, and for a typical household, higher rates could spell disaster.

Futures contracts imply that traders see the fed funds rate at about 0.3 percent rate by December. That’s the lowest estimate of the year, and about half the forecast for the overnight lending benchmark that the Fed gave in March. Fed policymakers have been saying that a rate hike will probably happen this year, with the caveat that any move will be data dependent. The economic data looks soft right now but the Fed has another motivation for a rate hike: financial stability. With interest rates near zero, the Fed is limited in their ability to deal with financial instability. They don’t have many tools in their tool belt.

So the Fed says rate hike, the futures traders say no; and this is setting up for another market-wide tantrum. Former Fed Chairman Alan Greenspan, speaking yesterday, said: “Just remember we had the ‘taper tantrum.’ And we’re going to get another one.”

If for no other reason than a blind pig can find an occasional acorn, Greenspan is probably right about this; traders are almost certain to complain about higher rates, even if rates have been abnormally low for a very long time; which will then give them an excuse to trade with higher volatility. Higher volatility equates to bigger profits, or losses if they get it wrong. The start of a tightening cycle typically causes some rise in volatility, but rarely a bear market, provided the Fed doesn’t surprise the markets. The extent of the impact is likely to be influenced by two other conditions: changes in equity valuations and the direction of inflation.

For now, inflation remains moderate but that can change; and one big factor will be energy prices. The fact that equity multiples have been rising suggests that markets are at greater risk for at least a modest correction; not a crash but enough to get your attention. And when we talk about rising multiples, we generally think of momentum stocks, and the usual suspects in this area would be biotech and social media stocks. The flip side to this line of thinking is that stocks climb a wall of worry. Momentum stocks typically represent areas of growth in an otherwise stagnant economy.

For now, volatility remains at low levels, the VIX, or volatility index is trading just under 13, almost half the level from back in December. It kind of feels like the calm before the storm.

Bad things are happening in the Midwest.

Deadly avian flu viruses have affected more than 33 million turkeys, chickens and ducks in more than a dozen states since December. On Tuesday, agriculture officials confirmed that the bird flu outbreak that has spread throughout the Midwest for months had reached Nebraska, making it the 16th state affected. Today, South Dakota reported its first possible infection on a chicken farm with 1.3 million birds in the eastern part of the state. The Iowa Poultry Association says there is no food safety risk for consumers. Chickens, turkeys and other poultry infected with bird flu will be destroyed and will not enter the food supply. Still, Iowa Governor Terry Branstad declared a state of emergency on May 1 due to the avian influenza outbreak. The virus may pose no risk to humans, but it is already having an impact on prices at the grocery store.

Iowa, where one in every five eggs consumed in the country is laid, has been the hardest hit: More than 40 percent of its egg-laying hens are dead or dying. For now at least, the biggest impact of the virus is on egg prices. It is estimated that prices will rise 1.6% for every million chickens destroyed. About 90 percent of the more than 25 million chickens that are being destroyed in Iowa produced liquid eggs, and already the wholesale price for those eggs nationwide has nearly doubled from late April. Liquid eggs are used in everything from mayonnaise to cake mix and are a major product of Iowa’s poultry industry.

According to the Associated Press, the price of a carton of eggs at supermarkets has increased 17% over the last month, hitting an average of $1.39. Bulk prices paid for eggs by cake mix and mayonnaise manufacturers, meanwhile, have spiked 63% over the past two-and-a-half weeks. Turkey prices are up as well, with breast meat at delis rising 10% since mid-April. So far, chicken prices appear to be unaffected.

Certainly the avian flu affects chicken farmers but from there it ripples through the Midwestern economy to the support businesses, ranging from bank lenders and insurers to trucking operations, feed mills and farmers. It hasn’t hit corn and soybean farmers yet, but it means a smaller market for part of their crops.

Next stop:
Chicago,
“Hog butcher for the world,
Tool maker, stacker of wheat,
Player with railroads and the nation’s freight handler;
Stormy, husky, brawling,
City of the big shoulders.
They tell me you are wicked and I believe them.”
City of Junk.

Moody’s Investors Service dropped two other hammers on Chicago taxpayers today, downgrading debt on both Chicago Public Schools and the Chicago Park District to junk levels. For the schools this will apply to $6.2 billion in general obligation debt.

The action won’t necessarily prevent CPS from borrowing more. But it will make that more costly, and comes at a particularly sensitive time, as the district seeks to renegotiate hundreds of millions of dollars in currently-losing swaps contracts. Beyond that, the district faces a deficit of well over $1 billion in its budget for the school year that begins on July 1, and is in negotiations with the Chicago Teachers Union, which says the current financial woes are “manufactured.”

At the parks, $616 million in outstanding general obligation debt is affected. Yesterday, Moody’s downgraded the city’s credit rating to junk status. Moody’s said Chicago’s options for curbing its $20 billion unfunded pension liability “have narrowed considerably” after last week’s Illinois Supreme Court ruling invalidated a state pension reform law. Moody’s said spending cuts and tax increases may be needed, regardless of how the court rules. The state could force the city to pay retirees directly, possibly leading to another rating cut. Moody’s on Tuesday also cut ratings on Chicago’s sales tax, motor fuel tax, and water and sewer revenue bonds.

Cities don’t get to play by regular bankruptcy rules. Cities don’t really have the choice of liquidating and going out of business. So when they can’t keep up with pensions, payrolls, services, and other obligations, they get temporary bankruptcy protection under Chapter 9. But they know that sooner or later they need to come up with a plausible matching-ends-with-means plan for coming out of bankruptcy. How will this all play out? I don’t know. But I’m guessing there might be a new nickname for Chi-town. City of big haircuts.

Financial Review

Patience For Now

Sinclair Noe — March 13, 2015

 

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

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DOW – 145 = 17,749
SPX – 12 = 2053
NAS –  21 =  4871
10 YR YLD + .01 = 2.11%
OIL – 2.05 = 45.00
GOLD + 6.50 = 1158.40
SILV + .12 = 15.64

At one point today, the Dow was down 250, so it could have been worse. For the week, the Dow was down 0.6% and the S&P 500 fell 0.9%. The Nasdaq was down 1.1% for the week. Today is Friday the 13^th. All I can say is pure coincidence. We looked at the market for 148 Friday the 13ths, going back to 1928, there is no particular trend.

 In the last week of January we saw oil prices drop to right around the $45 a barrel level, with intraday lows of $44.37, but the daily closing price hovering just a little above $45. And in February, prices popped up to touch $55.05; prices challenging $55 on 3 days, and could not break out. So, now we are back to challenging support at $45. And waiting to see if the trading range will break down.

The International Energy Agency says oil prices remain fragile due to unrelenting production by US shale-oil producers. There has been an expectation that oil producers would cut back production in response to lower oil prices, but the IEA  report shows oil production in the US has increased by 115,000 barrels, and now we’re running out of places to store the oil. The IEA says it doesn’t see cutbacks in production until the second half of the year; and for now at least, ballooning inventories combined with shrinking oil storage likely will drag prices lower.

Baker Hughes reported today that the oil rig count dropped by 67 last week to 1125, and that has been a trend in the oil patch, but it also means that existing wells continue to produce. At some point, the IEA says those discontinued wells could make a difference in the supply, and when it does it will make for some serious price disruption; but as of now, the cutbacks haven’t kicked in.

Meanwhile, Reuters reports a tentative deal has been reached between the United Steelworkers and oil companies to end the largest US refinery strike in 35 years. The reported deal would last four years and “wage increases would be 2.5% the first year, 3% each in years two and three, and 3.5% in the fourth year.” The strike affected 12 refineries representing a fifth of US refining capacity. The deal still needs approval from the rank and file, but it will likely lead to more refined products making the way to your local gas station, which should open up some of the storage facilities for crude oil.

Next week, European leaders meet to consider whether to prolong economic sanctions on Russia. The thinking is that they will allow most, or all of the sanctions to expire in July, and they will not be looking to add new sanctions.  And while Russia has continued to supply oil to the world markets, an easing of sanctions is likely to result in a fresh wave of Russian oil supply hitting the market; you know, to make up for lost revenue. Also, today Russia’s central bank cut its key interest rate one percent to try to stimulate its economy. That’s the trend these days; cut rates to give a jolt to the economy; it’s also a battle to devalue currencies.

Now, toss in a strong dollar. Over the past 14 sessions, the S&P has had a correlation of -0.96 to the dollar index, meaning that stocks consistently fall on days when the dollar gains. Perfect inverse correlation is -1.0.

Tokyo stocks surged through the 19,000 level today to record their highest close since April 2000. The Nikkei currently leads all major Asian markets with a 10.5% year-to-date gain. The Japanese stock market has been sparked by Bank of Japan stimulus, (known as Abenomics), which has pushed the yen down to the lowest levels against the dollar in 8 years.

And of course, the European Central Bank started its version of QE this week, and they will be buying about $66 billion dollars of bonds per month. In addition, concerns about Greece’s status in the euro bloc have weighed on the common currency. The dollar pushed to a new 12 year high today against the euro.

Also, investors are wagering that recent solid jobs data from February will persuade the Fed to send signals for a coming rate increase, perhaps as early as midyear, at its two-day Federal Open Market Committee meeting next week. The pace of the dollar’s rise against worldwide currencies suggests a number of undesirable outcomes for the US economy. First, there’s the loss in export competitiveness. In fact, the U.S. trade deficit just hit a record high (excluding oil). Secondly, corporations have to endure the disintegration of profits made in foreign currencies. Indeed, forward earnings estimates for the initial two quarters of 2015 have turned negative. But the Fed is looking at something different, and they are likely to hint at raising rates, even as it becomes harder to justify a rate hike. Still, no one wants to be short dollars going into FOMC. The Fed meets Tuesday and Wednesday, and until then we’ll just have to be patient.

One of the side effects of a strong dollar is disinflation, or maybe we could even call it deflation. Producer Prices dropped 0.5% in February. Despite the first rise in gasoline costs since last summer, US producer prices, or prices at the wholesale level, fell in February for the fourth straight month. Wholesale gas prices climbed 1.5% in February, the biggest increase since last June. Yet food prices retreated 1.6% to mark the biggest pullback in almost two years. Trade prices sank a record 1.5%. Excluding the volatile categories of trade, food and energy, core prices were flat on the month. Over the past year overall producer prices have fallen by 0.6%, the first 12-month decline on record.

The University of Michigan’s consumer sentiment index dropped to 91.2 in March from 95.4 in February. That’s the worst reading since November. We get cranky when we have to pay more for gas.

The Feds are looking into hedge fund manager Bill Ackman’s assault on Herbalife. Neither Ackman nor his fund, Pershing Square, has been served a subpoena. But The Wall Street Journal reports: “Prosecutors in the Manhattan US attorney’s office and New York field office of the FBI have conducted interviews and sent document requests in recent months in connection with the investigation, which is looking into whether people, including some hired by Mr. Ackman, made false statements about Herbalife’s business model to regulators and others in order to spur investigations into the company and lower its stock price.”

This week we learned that Wall Street bankers are struggling, and the bonus pool paid to security industry employees in New York City – that’s just in New York City – was $28.5 billion. It works out to an average bonus of $172,860. So somebody at the Institute for Policy Studies pulled out their calculator and figured that if you take 1.03 million full-time workers paid an hourly wage of $7.25 or less, the minimum wage, and multiplied by 50 hours of work per week; the total compensation would be about $15 billion dollars, more or less. A 40 hour work week would put the compensation at about $14 billion. So, the sum of Wall Street bonuses just for New York City is roughly twice the total amount paid to all the full-time workers paid minimum wage in the entire country.

It has been a busy week, which included news that most of the big banks had passed a stress test, and you might think that means the banks haven’t been getting into trouble. Not exactly. It’s time for today’s edition of “Banks Behaving Badly”. We start with Commerzbank, one of Germany’s largest lenders, which agreed to pay nearly $1.5 billion and dismiss some of its employees to resolve an array of charges in the United States. Commerzbank was accused of sending tainted money through the American financial system; siphoning funds to sanctioned Iranian corporations, facilitating accounting fraud at Olympus, the Japanese camera company; charged with Bank Secrecy Act criminal offense and institutional anti-money laundering. Eight regulatory agencies investigated the bank.

Leslie Caldwell, head of the Justice Department’s criminal division, which prosecuted the criminal part of the case said, “Financial institutions must heed this message: Banks that operate in the United States must comply with our laws, and banks that ignore the warnings of those charged with compliance will pay a very steep price.” And of course, we all know that means there were no indictments, just a fine; but in a rare breach of prosecutorial etiquette, the bank was not allowed to deny wrongdoing.

Meanwhile Bloomberg reports the Justice Department is about to get tough on banks that rigged the foreign exchange markets. Prosecutors are reportedly pressing Barclays, Citigroup, JPMorgan and the Royal Bank of Scotland to plead guilty, which would mean a fine, and the starting point for rigging the global currency markets is $1 billion, more or less. In keeping with prosecutorial etiquette, prosecutors are seeking a simultaneous settlement with the banks, which would enable the lenders to avoid being singled out for industrywide conduct.

Two weeks ago the FCC voted to approve rules on net neutrality and today they released the text on the actual rules. A couple of key points, the new rules will ban paid prioritization – so the internet cannot be divide into “haves” and “have nots”, or fast lanes and toll lanes; also the rules would ban blocking, meaning consumers must get what they pay for, unfettered access to any lawful content on the Internet.

The 400 pages of the FCC rule aren’t exactly beach reading, but if you are still trying to understand the importance of the ruling and the need for it, the first two sentences offer a nice summation: “The open Internet drives the American economy and serves, every day, as a critical tool for America’s citizens to conduct commerce, communicate, educate, entertain, and engage in the world around them. The benefits of an open Internet are undisputed.”

Financial Review

Justice Delayed is Par for the Course

Sinclair Noe — February 18, 2015

 

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

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DOW – 17 = 18,029 SPX – 0.66 = 2099 NAS + 7 = 4906 10 YR YLD – .08 = 2.06% OIL – 2.56 = 50.97

The S&P 500 closed above 2,100 for the first time ever on Tuesday, delivering year-end target goals to Goldman Sachs, Credit Suisse and Barclays nearly 11 months early.

Greece confirms that it plans to submit a request to the euro zone tomorrow to extend a “loan agreement” for up to six months, but EU paymaster Germany says Athens must stick to the terms of its existing international bailout. Greece wants to maintain a budget surplus before interest payments equal to 1.5 percent of gross domestic product; the current plan calls for a budget surplus equal to 4.5 percent of GDP. It’s still unclear what the terms of the extension will look like, as both Athens and its creditors seem determined not to compromise over the loan’s conditions.

The Federal Reserve released minutes from the January 27-28 Federal Open Market Committee meeting. The minutes reveal that “Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.” Allow me to translate; the Fed would like to put off raising interest rates because the economy is still a bit risky.

Well, that’s good news and bad news; good that the Fed isn’t going to raise rates; bad because the economy is still not recovered. The FOMC says the risks are “nearly balanced” but then they list the risks: a strengthening dollar, international flash points from Greece to Ukraine, slow wage growth, and even lower energy prices. Wait a minute; low energy prices are supposed to be a positive for the economy, and they are except some people in the energy industry are losing their jobs, and when people save money at the gas pump they aren’t spending it elsewhere. So, lower energy prices are good except maybe the energy market is telling us something.

Beyond that, low energy prices mean next to no inflation, so why raise rates when there are no inflationary pressures? Fed members who supported an early move said they were concerned that holding rates low for too long might lead to asset bubbles, but backers of waiting longer said an early move would result in the Fed’s having to cut rates back to zero afterward.

Speaking of asset bubbles; for the first three quarters of 2014, companies spent $420 billion on share buybacks, on track to set a record. As buybacks and dividends have risen, so has corporate debt. Since 2012, annual U.S. corporate bond issuance has topped $1 trillion a year. About $503 billion of corporate debt is set to mature this year, and each successive year will see higher amounts of debt maturing, with about $3.7 trillion is set to mature through 2019, according to Standard & Poor’s RatingsDirect.

So, the Fed is playing a delicate balancing act and we should not expect any sudden movements from the Fed; they will eventually raise rates but they will move at about the pace of an arthritic tortoise.

As widely expected, the Bank of Japan maintained its massive 80 trillion yen annual stimulus program today, its main tool to hit 2% inflation by next fiscal year. Data earlier this week confirmed that the country pulled out of recession in the fourth quarter of last year, although annualized growth of 2.2% was much weaker than expected. The Nikkei closed up 1.2% at 18,199 following the decision, its highest level since July 2007.

Bank of England officials voted unanimously to leave the central bank’s benchmark interest rate unchanged at 0.5% this month and the stock of assets purchased under its bond-buying program unchanged at £375 billion.

Construction on new U.S. homes dropped 2% in January to an annual rate of 1.07 million units, as heavy snowfall hindered builders in some regions such as the Midwest and Northeast.

Industrial production rose a seasonally adjusted 0.2% in January, well short of expectations. Another sign of weakness came in a slight downward revision to output in the past four months. Even with the revisions, industrial output advanced at a 4.3% annual rate in the fourth quarter.

Wholesale prices posted a record 0.8% decline in January. Low energy costs kept a lid on Producer Prices, but even when you strip out food and energy costs, the so-called core index dropped 0.3%. The price of goods fell sharply owing to a 10.3% decrease in energy costs. Gasoline prices in particular tumbled 24%, the biggest drop since 2008. Producer prices have shown zero change in the past 12 months because of plunging energy costs. The core PPI is up 0.9% in the same span, however.
 
So, what is the “Big Money” doing? SEC filings are showing us who has been buying or selling, and what:
Warren Buffett dumped Exxon Mobil. The billionaire’s Berkshire Hathaway holding company disclosed that it sold a $3.7 billion stake in the energy giant as oil prices have plunged. The company also purchased a 5% stake in agriculture equipment maker John Deere, plus shares of Twenty-First Century Fox and Restaurant Brands International, the owner of Burger King and Tim Hortons.
Soros Fund Management, the family office of billionaire hedge fund manager George Soros, cut holdings of U.S. stocks in the fourth quarter and shifted assets globally. Soros, which manages almost $30 billion, moved about $2 billion into companies in Asia and Europe. Warren Buffett and George Soros both boosted their stakes in General Motors.

Carl Icahn’s equity holdings declined by 5.2% during the fourth quarter to $31.9 billion as of Dec. 31, even as he bought more EBay and Hertz.

Daniel S. Loeb’s Third Point acquired five million shares of Phillips 66, a stake worth $384.5 million. And Leon G. Cooperman’s Omega Advisors acquired a 2.1 million-share position in Laredo Petroleum and a 652,500-share position in Sanchez Energy. At the same time, Omega sold about 29 percent of its big stake in Sandridge Energy, ending the quarter with 32.2 million shares. ValueAct Capital Management, an activist hedge fund, acquired big new positions in Halliburton and Baker Hughes, two oil field services companies that agreed to a $34.6 billion merger in November.
In the technology sector, David Einhorn of Greenlight Capital reduced his fund’s stake in Apple by about 6 percent, to 8.6 million shares, a stake worth more than $1 billion as of Tuesday. Another hedge fund, Coatue Management, which focuses on technology, reduced its Apple holdings by about 15 percent, to 8.9 million shares, as of the end of 2014. Appaloosa Management, David Tepper’s hedge fund, sold its entire 1.2 million-share stake in Apple, as well as its stakes in Facebook and the Chinese Internet giant Alibaba. Appaloosa Management had $2.74 billion less in U.S. stocks in the fourth quarter, a 40 percent drop from the previous quarter. Louis Bacon’s $14.8 billion Moore Capital Management had $2.3 billion in U.S. equities at the end of the year, about 25 percent less than the end of September.

Are you familiar with Snapchat? Let me explain how it works. Remember the old Mission Impossible shows? The team would get their mission and then the message would self-destruct in 10 seconds. That’s the idea behind Snapchat; it’s an app for your phone, and after you receive a message, the message will erase after a few seconds. Last month Snapchat received $485 million in funding, valuing the company at about $10 billion. Now Snapchat is looking to raise an additional $500 million, which would put the valuation “as high as $19 billion.” That would make the disappearing messaging platform the third-most-valuable VC-backed startup, behind Xiaomi and Uber, and give it a valuation nearly equal to the $22 billion paid by Facebook for WhatsApp.

Now for today edition of “Banks Behaving Badly”:
Switzerland raided HSBC. Police searched the bank’s Geneva offices for evidence of money laundering, in the wake of leaks that document HSBC’s attempts to help clients evade taxes through the use of private Swiss accounts. The story about leaked documents aired 10 days ago. The actual leaked documents were leaked 6 years ago. Justice delayed is par for the course.

BNY Mellon has restated its Q4 results it announced in January, taking a $598M litigation charge that suggests it is on course toward a settlement of cases, including a three-year-old forex lawsuit filed by the DOJ. The adjustment lowers net income for the year by about a fifth, to $2.5 billion. BNY Mellon (NYSE:BK) is one of the many banks under investigation for forex manipulation.

Next, let’s give credit where it is due: Citigroup says it will commit to spend $100 billion on initiatives to help combat climate change over the next ten years.

According to the company’s release the money will be used “to finance activities that reduce the impacts of climate change and create environmental solutions that benefit people and communities.” In 2007, Citi pledged $50 billion over ten years and met that goal three years early, hence the new, higher number.

Citi says it will use its $100 billion climate fund to finance infrastructure projects “that increase access to clean water and manage waste, while also supporting green, affordable housing for clients, including in low- and moderate-income communities”. Citi will also back “sustainable transportation” projects and help cities protect against climate extremes.

In 2012, Bank of America set a goal of $50 billion to provide loans and other financing for environmentally friendly energy projects over 10 years. The same year, Goldman Sachs set a 10-year target of $40 billion for investments in renewable energy projects. Clearly, Citigroup thinks they can make some money on Green Energy.

FINANCIAL REVIEW

Say Cheese

Sinclair Noe — January 15, 2015

Podcast: Play in new window | Download (Duration: 13:17 — 6.1MB)

DOW – 106 = 17,320
SPX – 18 = 1992
NAS – 68 = 4570
10 YR YLD – .06 = 1.77%
OIL – 2.28 = 46.20
GOLD + 33.50 = 1263.60
SILV + .11 = 17.06

After going through all of 2014 without a losing streak of more than three days, the S&P 500 today completed its second slide of five straight days. The benchmark gauge is down 3.4 percent over the past five days.

For the past 3 years the Swiss have kept their currency, the Swiss franc, from getting too strong; they imposed a cap to keep the euro from trading below 1.20 francs. In early 2010 one franc was less than 0.7 euro. By the middle of 2011 the franc was nearly at parity against the euro, a massive move in a very short period. As the Eurozone experienced economic strife, Switzerland was calm and offered a safe haven. As money poured in, the franc became more and more expensive; which means that things made in Switzerland became more expensive when the Swiss exported. So, they capped the franc. That basically involved printing more francs and buying more euros.

Fast forward to 2015, and the Eurozone is once again experiencing economic strife; money is once again pouring into Switzerland as a safe haven, and after 3 years the Swiss just threw up their hands and said they had enough; it didn’t make sense for the Swiss National Bank to keep on an endless path of buying more and more euros just to keep the currency down, and there was probably some concern that they had too many euros, which might be a liability. So, they removed the cap, without warning. It was quite the surprise.

What does it mean? Well the Swiss franc spiked a whopping 30 percent against the euro. So, it you were planning a vacation to Zurich, it just got more expensive; for many people in Europe who have mortgages with Swiss banks, their mortgage payments just went up; if you were planning to buy a Swiss watch it just got more expensive; same for Swiss chocolates; and if you need a corkscrew that can also work as a screwdriver, pliers, wrench, and knife – that will cost you more. The Swiss stock market fell about 11%. And if you were invested in a company such as Swatch, Nestle, Novartis, or Roche – you just got hammered. Sorry. And if you were trading in the currency markets and you were short the franc and long the euro – please step away from the ledge.

Thursday’s decision to call time on its efforts to keep the euro from trading below 1.20 francs came amid mounting speculation that the European Central Bank will next week back a big government bond-buying program that will put more euros in circulation, diluting their value. That expectation has seen the euro face intense selling pressure in currency markets, particularly against the dollar. The euro has fallen to nine-year lows against the dollar and below its launch rate in 1999. As a result, the cost for the Swiss central bank of constantly defending the peg by buying euros or selling francs has been rising.

The SNB clearly expected to see a huge surge of inflows in the week ahead and saw little reason to provide these buyers of francs with an artificially cheap rate. Switzerland’s immediate neighbors are countries in the Eurozone. The franc’s contiguous boundaries are with the euro. Switzerland’s central bank worried about inflows of hot money from Russia, either directly or via the euro. Think of it this way: yesterday a Moscow-based oligarch could move money from ruble to euro. Then he could move it from euro to Swiss franc, and the Swiss government and Swiss National Bank would maintain a 1.2 currency peg. That is now over.

In addition to making Swiss exports more expensive, a stronger currency makes imports into Switzerland cheaper, further dampening prices already-subdued by big drops in oil prices and other commodities.

In an effort to contain the franc’s appreciation and limit any damage to the Swiss economy, the central bank on Thursday also lowered a key interest rate — what it charges commercial banks to deposit at the bank — to minus 0.75 percent from minus 0.25 percent. That’s right, banks have to pay the Swiss central bank to park reserves. The hope is that it dissuades banks from parking their cash at the national bank and instead possibly invest it. That might not work; the Swiss franc is still considered a safe haven for investors. The franc’s value will remain sensitive to developments around the world, including the crisis in Russia and the oil market slump.

Switzerland is a small country. For most people, the Swiss surprise really is not a huge event, but today’s move confirms that deflation is a clear and present threat to the global economy.

If you were planning a trip to Davos Switzerland for the World Economic Forum, we can save you some money. The WEF 2015 Global Risks Report was published today; geopolitical issues are considered to be the biggest threat to global stability over the coming decade. According to the WEF’s lead economist, “Twenty-five years after the fall of the Berlin Wall, the world again faces the risk of major conflict between states,” and the means to wage such conflict are broader than ever, whether through cyberattack, competition for resources or sanctions and other economic tools. “Addressing all these possible triggers and seeking to return the world to a path of partnership, rather than competition, should be a priority for leaders as we enter 2015.” When asked to assess risks in terms of their potential impact, the nearly 900 experts surveyed by WEF found water crises as the greatest threat to the world.

US producer prices in December recorded their biggest fall in more than three years on tumbling energy costs while underlying inflation pressures were muted. The Labor Department said its producer price index for final demand declined 0.3 percent, the biggest drop since October 2011, after falling 0.2 percent in November. A sustained plunge in energy prices is keeping a lid on inflation throughout the pipeline, from bills for businesses to the consumer’s cost of living.

The number of Americans filing claims for unemployment benefits increased to a four-month high last week.

Consumer confidence increased last week to the highest level since mid-2007 as steady declines in gasoline prices and more hiring boosted Americans’ attitudes about the economy. The Bloomberg Consumer Comfort Index rose to 45.4 in the period ended January 11, from 43.6 the week before.

Bank of America, the second-largest US bank by assets, reported a 14 percent fall in quarterly profit as a decline in sales and trading revenue more than offset a big drop in operating expenses. Revenue from bond trading, which is part of the bank’s sales and trading business, plunged 30 percent to $1.46 billion.

Citigroup reported its fourth-quarter profit plunged as the bank was hit by large legal charges. The bank reported a profit of $350 million–which includes $3.5 billion in previously disclosed legal and repositioning charges–compared with a year-earlier profit of $2.46 billion. On a per-share basis, Citigroup reported a profit of six cents. Analysts had expected earnings of nine cents a share including the charges. On Wednesday, a provision — drafted by Citigroup — to repeal part of the Dodd-Frank financial reforms (Section 716) was added by House Republicans to their spending bill. On Thursday, Citigroup led the charge to persuade enough Democrats to vote for that bill. The repeal of Section 716 stayed in the spending bill only because Wall Street brought so much pressure and influence to bear. Apparently buying politicians is cheaper than paying fines and settlements for violating the law. Of course, I still maintain that not breaking the law is the best solution, but clearly that is not under consideration.

Bank of America slipped 5.2 percent to the lowest since August and Citigroup dropped 3.7 percent.

After the close, Intel reported fourth quarter net income rose to $3.66 billion, or 74 cents per share, for the quarter ended Dec. 27, from $2.6 billion, or 51 cents per share, a year earlier. Revenue rose to $14.7 billion from $13.8 billion. Intel forecast first-quarter sales that may fall short of analysts’ estimates because PC sales are down.
We’re starting to see some oil companies respond to lower oil prices. Schlumberger, the oilfield services provider, announced it will cut 9,000 jobs, even as they reported a 6 percent rise in quarterly revenue. Revenue rose to $12.64 billion from $11.91 billion. Net income attributable to the Houston, Texas-based company fell to $302 million, or 23 cents per share, in the fourth quarter ended Dec. 31, from $1.66 billion, or $1.26 per share, a year earlier.

Apache says it will also lay off several hundred employees, cutting 5% of its workforce this week. The move signals one of the first major workforce cuts at an American oil producer after the recent drop in crude prices. Apache had been profitable until the third quarter of last year, when it reported a $1.2 billion loss.

BP is planning to cut 300 jobs from its 4,000-strong North Sea business following a review of its operations. The U.K.-based oil major, which has been downsizing since the Deepwater Horizon oil spill in 2010, said it had long planned the cuts, but was speeding up the process due to falling oil prices.

This afternoon, there was more news on BP. A US District judge has ruled that the company dumped 3.19 million barrels of oil into the Gulf of Mexico in 2010. Today’s ruling on the spill’s size sets the stage for a trial next week at which the judge will determine the amount of the fines, based on the law’s provision for as much as $4,300 per barrel released and factors such as what BP did to minimize or mitigate the effects of the disaster. The court rejected the government’s 4.2 million barrel estimate of the spill size, decreasing the potential maximum fine from $18 billion to a maximum fine of $13.7 billion.

FINANCIAL REVIEW

Something is Rotten

Sinclair Noe — December 12, 2014

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

DOW – 315 = 17,280
SPX – 33 = 2002
NAS – 54 = 4653
10 YR YLD – .08 = 2.10%
OIL – 2.52 = 57.43
GOLD – 5.60 = 1222.80
SILV – .06 = 17.14

The fall in oil prices has been dramatic, now down almost 47% since June. Nobody was expecting it would fall that far that fast. Goldman was forecasting $85 oil for 2015 as recently as October 29. Crude-oil futures fell to their lowest since May 2009 on Friday, briefly dropping below $57 a barrel, after the International Energy Agency delivered the latest reduction in forecasts for global oil demand. On the week, oil futures have lost slightly more than 12%. So, oil is a bit oversold right here but it is never a good idea to try to catch a falling knife.

And the whole drop just tells us that something is rotten in the markets. The fundamentals of oil have not changed in concert with the price. We don’t have double the oil we had in June. So why is the price cut in half? I know that’s overly simplistic, but either the market is too negative on energy, or it is not diligent enough in thinking about broader implications. Low prices lead to oil being left in the ground. Low oil prices lead to debt defaults. Low oil prices can lead to collapses of exporters. Benefits to consumers likely smaller than expected. Hoped for renewables lose luster with low oil prices. The sharp decline in the price of oil has disoriented markets and changed the perception of the creditworthiness of companies and countries. And don’t forget, deflationary pressures, which is great when you go to the gas station to fill up but not so great in a number of other ways.

Bill Gross, who used to run the world’s largest bond fund before joining Janus Capital in September, said the Federal Reserve may become more “dovish” after oil prices plunged in recent weeks. Gross says the Federal Reserve would have to take lower oil prices “into consideration.” Why would they start to eliminate language that talked about an extensive period of time when the US itself is, not deflating but disinflating, and certainly not moving in the direction of its 2 percent inflation target?

The drop in oil prices likely reflective of world reaching debt expansion limit. The worry, as always, has nothing to do with the central banks’ concern for you, your job, your children, wealth equality, or the future, and everything to do with the simple fact that the stability of the banking system absolutely depends on a steady stream of new loans being created. The core of the problem is that we have a monetary system that is either expanding or collapsing. It has no steady state. Oil has been an engine of growth, resulting in global spending of nearly $3 trillion over the past decade, and that means a bunch of financing. We have never spent more money developing new oil supplies than we did last year, nearly $700 billion; and for all that spending, we did not double the current production. Something is very wrong with that equation, and that means something has to give. New oil drill programs are being scrapped left and right. New drill permits in the U.S. shale plays were down 40% in November compared to October and for good reason: most of the plays are uneconomical at current prices.

The shale miracle could easily turn into the shale collapse. This calls into question the sky-high valuations we currently see for stocks and bonds. Central banks have tried to prop up financial assets and financial markets, and one way was to finance the energy sector; after all, they already blew up the housing market. A decline in oil prices is not only due to supply issues but demand issues.

So, right now, the market players are having a hard time figuring out what all this means, and when they are clueless, they sell. The S&P 500 ended the week with the biggest loss in two-and-a-half years, while the Dow Jones Industrial Average recorded its biggest weekly decline since Sep 2011. The S&P 500 lost 3.5% for the week. Maybe it is just that we were due for a down week. The Dow was down 3.8% for the week, and the Nasdaq Comp lost 2.9% for the week.

A couple of economic reports today. Producer prices, or prices at the wholesale level, fell a seasonally adjusted 0.2% in November, the second decline in the last three months. The rate of wholesale inflation over the year fell to a nine-month low of 1.4%. The Federal Reserve policy committee will meet next week and this is another bit of data showing inflation should not be a concern.

The University of Michigan and Thomson Reuters consumer sentiment gauge rose to a preliminary reading of 93.8 from 88.8 in November; it’s the highest reading since January 2007. The global economy may be going to hell in a hand basket but if we can fill up the SUV and still have money to go to a movie, life is pretty sweet.

Sometime tonight or maybe Monday, the Senate will vote on whether to fund the government. Late last night, the House passed a spending bill and a two day extension to give the Senate time to vote. The idea of funding the government isn’t really controversial. We all know that the government will be funded, but the politicians use it as leverage to tack on poison pills, or provisions that probably would not pass on their own merit but they are accepted to avoid a shutdown. Perhaps the most controversial of these add-ons is a Wall Street-friendly provision which made its way into the bill at the last minute, the weakening of the so-called “swaps push-out rule” from the 2010 Dodd Frank financial reform law.

The push-out rule bans big banks from using taxpayer-insured depositor funds to back certain risky derivatives trading. It also requires financial institutions to move parts of their business involved in those trades to separate groups or affiliates, without FDIC insurance. The new provision would allow banks to gamble in the derivatives markets with FDIC insured depositor money. If their bets turn out to be losers, the taxpayers would bail them out, again. Imagine going to Las Vegas and gambling; if you win you get to keep all the money but if you lose the taxpayer has to pay for your losses.

If this sounds like a sweetheart deal for the big banks, well it is. The language in the bill appeared to come directly from the pens of lobbyists at Citigroup. Yes, this is the same Citigroup that was bailed out in 2008 because they were ready to implode under the weight of bad bets in derivatives. The Citi-drafted legislation will benefit five of the largest banks in the country: Citigroup, JPMorgan Chase, Goldman Sachs, Bank of America, and Wells Fargo. These financial institutions control more than 90 percent of the $700 trillion derivatives market.

The Washington Post is reporting that the provision was so important to the profits at the big banks that JPMorgan’s chief executive Jamie Dimon himself telephoned individual lawmakers to urge them to vote for it. You should try that, call your Senator; you’ll either get a recorded message or an aide who will write down your message and then throw it in the wastebasket. Jamie Dimon has a direct line. Why? Because money is more important than a vote.

Yes, this is the same JPMorgan that is the subject of an open criminal investigation by the Department of Justice for manipulating foreign exchange rates. Yes, this is the same JPMorgan that has paid billions of dollars in fines for a variety of transgressions and signed deferred prosecution agreements that if they ever broke the law again they would be criminally liable. Yes this is the same JPMorgan that gambled in the derivatives markets in the London Whale deal, and then lied about it.

And what they are likely to win is the repeal of the Dodd-Frank Act provision that requires them to separate their gambling from their banking; they fought against inclusion in the Act in 2010, and they’ve been fighting it ever since. So JPMorgan and Citigroup wrote new legislation and there is a good chance it will pass, without debate or amendment because they slapped it on the spending bill. But in finally getting what they wanted, big banks also thrust themselves back into the limelight in the worst possible way, simultaneously reminding the public of their role in causing the financial crisis and in their continuing influence over the various levers of the government. In one fell swoop, they undid whatever recovery to their battered reputation they’d made in the past four years and once again cast themselves as the sleazy casino gamblers and the bribers of politicians who offer a one-finger salute to taxpayers who bailed them out.

Sheila Bair, the former chairman of the Federal Deposit Insurance Corporation said in an interview yesterday that the bankers are trying to blackmail us by making sure government is not funded unless they get their way. Now consider that repealing the swaps provision, which was Section 716 of Dodd-Frank, is likely to only help banks on the margins, since they are allowed to continue engaging in the activity through affiliates. So, why are they fighting so hard to repeal it? Wall Street’s business model depends on the ability of large financial conglomerates to keep exploiting the cheap funding provided by their “too big to fail” subsidies.

Last year Bloomberg calculated that the top 10 US banks received a taxpayer subsidy worth $83 billion because the largest banks can borrow money at a lower rate because creditors assume the government, on behalf of taxpayers, will rescue them in an emergency. And so if this banker written legislation passes, we the taxpayers will be on the hook for the next bailout of the banksters, because the bankers’ money is more important than anything. And it will only be a matter of time.