Financial Review

Fed Day

Sinclair Noe — March 15, 2017

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DOW + 112 = 20,950
SPX + 19 = 2385
NAS + 43 = 5900
RUT + 20 = 1382
10 Y – .08 = 2.51%
OIL + 1.24 = 48.96
GOLD + 21.10 = 1220.70

Today is Fed Day.

Policymakers at the Federal Open Market Committee of the Federal Reserve raised interest rates, as expected. The decision to lift the target overnight interest rate by 25 basis points to a range of 0.75 percent to 1.00 percent marked one of the Fed’s most convincing steps yet in the effort to return monetary policy to a more normal footing.

This was the second interest rate hike in the past 3 months, and only the third rate hike in the past decade. The Fed indicated it is still looking at 2 more rate hikes in 2017, which matches the guidance they provided in December. The Federal Reserve under Janet Yellen has been very good at communicating any changes in policy; they do nothing that could shock the markets.

The Fed issued a statement confirming their view that the “labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace. Job gains remained solid and the unemployment rate was little changed in recent months.

Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat. Inflation has increased in recent quarters, moving close to the Committee’s 2 percent longer-run objective…”

The Fed added a fresh wrinkle by noting that inflation was little changed and still running below its long-term target if energy and food prices were excluded.

In a press conference following the statement, Yellen said the Fed isn’t trying to get inflation to run faster than 2% for a while to catch up from being below 2% for so long, but that doesn’t mean the Fed would stomp on the brakes as soon as the 2% target was breached. “Two percent is not a ceiling on inflation. It is a target.”

Yellen also said the Fed was not really considering any economic implications from President Trump’s proposals for tax cuts, deregulation, and infrastructure spending. Yellen said, “We haven’t tried to map out what our response would be to certain policies. We have plenty of time to see what happens.”

And Yellen added, “The simple message is, the economy is doing well.” It’s too early to react to Trump, Yellen said. Optimism is great, she said, but you have to show us actual changes in consumer or business spending, or actual changes in fiscal policies before we’re going to change our minds about the economy.

The Fed has a wait-and-see attitude about whether consumer or business optimism will translate into actual increased spending. Yellen said, “It’s uncertain just how much sentiment actually impacts spending decisions, and I wouldn’t say at this point that I have seen hard evidence of any change in spending decisions, based on expectations about the future.”

Yellen said the Fed does look at stock market valuations as part of its assessment of financial conditions, but there is no sign that the Fed is particularly worried about a dangerous bubble developing.

The lack of hawkishness from the Fed apparently caught some traders out of the money. Dollar-buyers exited the trade. Stocks shot higher as Yellen spoke. Financials were the weakest sector in the S&P. A rate hike tends to be a positive for banks, because it increases how much they can charge borrowers, compared with their own short-term borrowing costs. So, the banks wanted to hear that the Fed was going to be more aggressive in raising rates.

In theory, rising interest rates are supposed to hurt the stock market because it makes interest-rate instruments relatively more attractive and reduces liquidity in the marketplace. But interest rates and the stock market usually trend in the same direction over the long term.

That is because the conditions that lead to higher rates, such as an acceleration in economic growth, also fuel bull markets for stocks, while the drivers of rate cuts, like an impending economic recession, are often behind bear markets.

Eventually, rates could get high enough to choke off economic expansion and hurt stocks, but based on current market dynamics, the market appears to be safe for quite a while, maybe even years. So, the Fed has a long way to go before damaging the market or economy.

Of course, higher rates will hit people who have debt; everything from mortgage rates to car loans to credit card debt. That increase will cost consumers an additional $1.6 billion in credit card fees alone during 2017.

For savers, a rise in Federal Reserve interest rates is good news. Savings account rates will likely increase slightly, which should help consumers, especially since interest rates on savings accounts are at historic lows. Although consumers shouldn’t expect those rates to rise much. Banks will likely have to collect extra income from borrowers before being able to pass those funds onto the savers.

The International Energy Agency says global oil inventories rose for the first time in January as the market grappled with increased production last year, but if OPEC maintains its output cuts, demand should overtake supply in the first half of this year.

OPEC also flagged rising inventory levels, but raised its estimates for production outside the group and did not see a re-balancing between supply and demand until the second half of this year.

The IEA said crude stocks in the world’s richest nations rose in January for the first time since July by 48 million barrels to 3 billion barrels, more than 300 million barrels above the five-year average.

Investors cashed out of US-based high-yield junk bond funds.  Lipper data shows high-yield bond funds posted $2.1 billion in net withdrawals during the week ended March 8, the most since November 2016. Crude oil prices fell this week to 3-1/2 month lows. Energy producers are heavily represented in junk bond indexes.

Higher interest rates could shrink bond prices and hike borrowing costs for indebted companies. Still US-based stock funds attracted their sixth straight week of net inflows, $8.5 billion, while taxable bond funds netted $2.8 billion despite the high-yield outflows

American consumers paid slightly more in February for goods and services such as groceries and rent, reflecting upward pressure on inflation that’s intensified since last summer.

The consumer price index, or cost of living, rose by a seasonally adjusted 0.1% last month. The increase in inflation over the past 12 months advanced to 2.7% in February from 2.5% in January, putting it at the highest level since early 2012.

Excluding the volatile food and energy categories, so-called core consumer prices rose 0.2% in February. Core prices have advanced 2.2% in the past year. Inflation-adjusted wages rose just 0.1% per hour in February and worker wages are unchanged in the past year.

Retail sales recorded their smallest increase in six months in February. The Commerce Department said retail sales ticked up a seasonally adjusted 0.1% in February, after a much bigger gain of 0.6% the previous month. January’s gain was revised higher.

The figures suggest that strong job gains this year, near record-high stock prices and decent pay gains haven’t yet lifted spending. But last month’s sluggish pace could prove temporary, because spending was likely held back by delays in tax refund payments.

Business inventories in the U.S. rose 0.3% in January, largely because of more new vehicles sitting in auto dealer lots. Inventories at auto dealers rose 2%, reflecting a downturn in sales at the start of the new year. Sales were pumped up in December by holiday-season discounts and a slowdown was expected in January.

The value of auto inventories is 9.3% higher compared a year ago. Millions of Americans who held onto to aging cars in the wake of the Great Recession have upgraded to newer vehicles, but much of that pent-up demand has been met.

Twitter shares were lower in early trading after many high-profile Twitter accounts were hijacked. The hacker posted tweets that supported Turkish President Erdogan in his diplomatic spat with the Netherlands and Germany.

Dutch Prime Minister Mark Rutte’s party has taken the lead in an election widely seen as an indicator of populist sentiment in Europe. Anti-immigrant, anti-European Union figure Geert Wilders had run on a “de-Islamification” platform, calling for Islamic schools to be closed and the Quran and burqa to be banned. The latest polls show that no party will come close to winning an overall majority, so the post-election period will likely come down to forming a coalition government.

MIT has created an award for rule-breakers. The university’s Media Lab announced this week it will award $250,000 to a group or individual for disobedience. Per Joi Ito, the director of MIT’s Media Lab, “You don’t change the world by doing what you’re told.”

The eligibility requirements are simple: “The recipient must have taken a personal risk to affect positive change for greater society.” The winner will be announced in July.

Stocks off Lows, but Still Red on Close

Charles Schwab: On the Market

Posted: 3/6/2017 4:15 PM ET

Stocks off Lows, but Still Red on Close

U.S. equities finished the regular trading session off the day's lows, but in the red as investors seemingly focused on geopolitical concerns and the possibility that the Federal Reserve may move to raise its target rate as early as next week. Treasuries, crude oil prices and gold were lower, while the U.S. dollar advanced. In light economic news, factory orders exceeded estimates and durable goods orders for January were favorably revised.

The Dow Jones Industrial Average (DJIA) lost 51 points (0.2%) to 20,954, the S&P 500 Index lost 8 points (0.3%) to 2,375, and the Nasdaq Composite decreased 22 points (0.4%) to 5,849. In moderately-heavy volume, 796 million shares were traded on the NYSE and 1.8 billion shares changed hands on the Nasdaq. WTI crude oil ticked $0.13 lower to $53.33 per barrel and wholesale gasoline added $0.02 to $1.67 per gallon. Elsewhere, the Bloomberg gold spot price ticked $8.84 lower to $1,225.97 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was 0.1% higher at 101.67.

General Motors Co. (GM $38) announced an agreement with French automaker PSA Group Ltd. to sell its European operations, Opel and Vauxhall, to the parent of Peugeot SA(PUGOY $21) for about $2.2 billion. GM lost ground, though PUGOY advanced. 

TG Therapeutics Inc. (TGTX $10)surged to close over 90% higher after announcing positive results from a study of its leukemia treatment.

Factory orders report tops forecasts to kick off economic week

Factory orders (chart) rose 1.2% month-over-month (m/m) in January, versus the Bloomberg expectation of a 1.0% increase, while December's figure was unadjusted at a 1.3% gain. January durable goods orders—preliminarily reported a week ago—were adjusted higher to a 2.0% increase, from the preliminary reading of a 1.8% gain, and versus expectations of a downwardly revised 1.0% rise. Orders of nondefense capital goods excluding aircraft—a proxy for business spending—were revised slightly higher to a 0.1% dip from the first estimate of a 0.4% decline.

Treasuries were mostly lower, with the yield on the 2-year note flat at 1.30%, while the yield on the 10-year note rose 1 basis point (bp) to 2.49% and the 30-year bond rate gained 3 bps to 3.10%.

Tomorrow, the domestic docket will include the release of the trade balance, expected to have widened to a $48.5 billion shortfall in January after the prior month's $44.3 billion deficit. In the final hour of trading we will receive the January consumer credit report, forecasted to show consumer borrowing advanced $17.8 billion after increasing $14.2 billion in December.

With earnings season all but in the books and Fedspeak going quiet ahead of the March 14-15 meeting, all eyes will likely focus on this week's U.S. economic calendar, which will also deliver reads on the trade balance and 4Q nonfarm productivity and unit labor costs. However, the docket will be headlined by Friday's key nonfarm payroll report for February.

As noted in the latest Schwab Market Perspective: "Phenomenal" Expectations, U.S. stock indexes broke to the upside, on better economic data but also heightened expectations of tax and regulatory reform. The bar is now set higher for policy action to support the rhetoric, setting up the possibility for a market pullback and/or a pickup in volatility. The economic picture continues to look good, but inflation is heating up, which has put a March rate hike by the Federal Reserve firmly on the table. An earnings growth recovery has helped fuel a global rally, but there are risks that expectations and valuations have gotten a bit extended. Read more at www.schwab.com/marketinsight.

With last week's speech by Federal Reserve Chairwoman Janet Yellen solidifying March rate hike expectations and the markets highly-anticipating details of President Donald Trump's plans for tax, healthcare and regulatory reforms, along with infrastructure spending, see Schwab's Chief Fixed Income Strategist, Kathy Jones' article, What would a shake-up at the Fed mean for bond investors? at www.schwab.com/onbonds, and follow Kathy on Twitter: @kathyjones. In the wake of President Trump's first speech in front of Congress last week, Schwab's Vice President of Legislative and Regulatory Affairs, Michael T. Townsend offers his latest article, Presidential Reset: What Does Trump's Speech Mean for His Agenda?, at www.schwab.com/insights.

Finally, as the stock markets remain near all-time highs, Schwab’s Chief Investment Strategist Liz Ann Sonders delivers a look at investing strategies in the current bull market in her latest article, Radioactive: Is Passive's Dominance Over Active Set to Wane?, at www.schwab.com/marketinsight and follow Liz Ann on Twitter: @lizannsonders.

Europe dips, Asia mostly higher

European equities finished mostly lower in late-day action, with global caution setting in amid heightened geopolitical risks as U.S. political uncertainty remains and North Korea fired ballistic missiles off its east coast, while a key French Presidential election draws near. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, and Vice President of Trading and Derivatives, Randy Frederick discuss the French political front in the video, Why Should the French Presidential Election Be Important to Investors? at www.schwab.com/insights. Also, be sure to check out Jeff's article, Five Reasons to Stay Invested Despite Heightened Uncertaintyat www.schwab.com/oninternational. Follow Jeff and Randy on Twitter: @jeffreykleintop and @randyafrederick. M&A news ramped up, with Standard Life PLC. (SLFPY $19) and Aberdeen Asset Management PLC. In economic news, eurozone investor confidence improved much more than expected for March. The euro and British pound saw pressure versus the U.S. dollar, while bond yields in the region finished mixed.

Stocks in Asia finished mostly to the upside, shrugging off festering political risk in the U.S. and Europe, which was met with news that North Korea fired multiple ballistic missiles off its east coast, as well as heightened expectations of a rate hike in the U.S. later this month. However, a rise in the yen weighed on Japanese markets, while stocks trading in mainland China and Hong Kong advanced as the markets digested a cautious economic outlook by the government amid its annual legislative meeting. Australian securities rose and South Korean equities ticked higher. Indian listings advanced, extending its run as of late to a two-year high. Schwab's Director of International Research, Michelle Gibley, CFA, provides some timely analysis of global investing in her articles, Currency Hedging: 5 Things You Need to Knowand Emerging Markets: Why They Deserve a Place in Your Portfolioat www.schwab.com/oninternational, and be sure to check out our release, Why Your Portfolio Needs International Stocks—Despite 2017 Risks at www.schwab.com/insights.

Tomorrow, the international economic docket will yield the release of house prices from the U.K., factory orders from Germany, PPI from Italy and GDP from the Eurozone. Meanwhile, in central bank action, the Royal Bank of Australia will announce its monetary policy decision, with no changes to its current stance expected.

Financial Review

When Others Are Greedy

Sinclair Noe — February 16, 2017

Podcast: Play in new window | Download (Duration: 13:15 — 7.6MB)

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DOW + 7 = 20,619
SPX – 2 = 2347
NAS – 4 = 5814
RUT – 5 = 1399
10 Y – .05 = 2.45%
OIL + .19 = 53.79
GOLD + 5.40 = 1239.60

Asian markets moved higher this morning but European exchanges were slightly lower. World stocks hit an all-time high this morning, as the MSCI’s All Country World index, which spans 46 countries, notched a record. The Dow Jones industrial average, S&P 500 and Nasdaq have all closed at record highs for five consecutive days, something investors haven’t seen since 1992. And today the Dow, pulled out another record high close but couldn’t drag the other indices higher.

Yesterday, Fed Chair Janet Yellen was delivering her Humphrey-Hawkins testimony before the House Finance Committee and she answered a question about the market’s melt-up. She said: “I think market participants likely are anticipating shifts in fiscal policy that will stimulate growth and perhaps raise earnings.”

Federal Reserve Vice Chairman Stanley Fischer confirmed Fed chief Janet Yellen’s message to the markets this week that the central bank sees signs of strengthening in the economy and “is a little more confident about where we’re going and how soon we’ll get to full employment with stable prices.”

Yellen delivered 2 days of testimony before Congress this week and made the case for continued interest rate hikes this year. Stronger than expected inflation data combined with comments from Fed Chair Janet Yellen to Congress helped push the Fed funds futures market-implied chance of a rate hike in March to 44%, up from 34% the day before.

The odds, per overnight index swaps pricing, have jumped to 52% for March. The dollar hasn’t had a very good week despite the prospect of tighter US policy.

Promises of massive and phenomenal tax reforms have certainly been a driving force in the recent rally; the reality is that we don’t yet know the details, and so the cart seems a bit ahead of the horse. According to a new Bank of America Merrill Lynch Global Fund Manager Survey just 23 percent of respondents, for instance, expect tax cuts to happen before Congress takes its August recess, and 30 percent believe they won’t get enacted until 2018.

Another gauge of emotion, the Investors Intelligence Advisors Sentiment survey, shows bullishness on the stock market at 62.7 percent, the highest reading in more than 12 years. Bearish sentiment, or a belief that the market is heading lower, dropped to 16.2 percent, the lowest since August 2015. Of course, this is a contrarian indicator. You don’t want to buy when everyone is bullish. Or as Warren Buffett famously said, “be greedy when others are fearful and be fearful when others are greedy.”

Normally, the Fed taking a hawkish stance would wipe out giddy optimism but it hasn’t slowed this market hopped up on Trumponomics. What is especially peculiar, is that Trump is calling the economy a disaster.

At a press conference today, to announce his new nominee for Labor Secretary (Alexander Acosta, a former Justice Department official and current dean of Florida International University) Trump claimed: “It’s a mess. At home and abroad. A mess. Jobs are pouring out of the country. You see what’s going on with all the companies leaving our country. Going to Mexico and other places. Low pay, low wages… I inherited a mess.”

When it comes to the U.S economy, though, that “mess” isn’t borne out by most measures. The stock market is at all-time highs. Though growth in the gross domestic product is slow by historical standards, the economy is in the tenth year of one of the longest sustained expansions in history.

And the U.S. job market, which is creating jobs faster than employers can fill them, appears to be stronger than it’s been in nearly a decade; 227,000 new jobs last month and the unemployment rate at 4.8%, which is close to full employment.

The Philadelphia Fed said its manufacturing index soared in February to a reading of 43.3 from 23.6 in January. That’s the highest level since early 1984. Manufacturing activity in the Philadelphia region has been improving since the middle of last year. The new orders index rose 12 points to 39, and the shipments index rose 8.1 points to 28.6.

Initial claims for state unemployment benefits rose 5,000 to a seasonally adjusted 239,000 for the week ended Feb. 11. Claims have been below 300,000, a threshold associated with a strong labor market, for 102 consecutive weeks.

Construction on new houses fell 2.6% in January, but another increase in permits points to builders breaking ground on more units in the months ahead. Housing starts took place at an annual rate of 1.25 million last month. The decline in new construction last month was centered entirely on the category of multi-dwelling units that are usually rented.

Construction on apartment, condos and buildings with five or more units shrank nearly 8%. Yet work on new single-family homes rose almost 2%. Permits to build new homes, climbed 4.6% in January to a 1.29 million pace, and are up 8.2% in the past year.

On Monday, February 20, all US banks and financial markets will be closed in observance of the Presidents Day, perhaps giving investors a chance to catch their collective breath and contemplate the madness of the markets this year.

Cisco sees softness in its core business. The company beat on the top and bottom lines but said revenue from its key “NGN Routing, Switching and Data Center product revenue decreased by 10%, 5% and 4%, respectively.” Shares fell by more than 1% in after-hours trade.

Waste Management said revenue for the latest quarter climbed, driven by increased volumes and yield in the company’s collection and disposal business, though earnings on a per-share basis missed Wall Street expectations. Waste Management confirmed guidance for the current fiscal year.

Snapchat has reportedly set the value of its IPO. The company has set a valuation of $16.2 billion to $18.5 billion for its initial public offering, below the lower end of its range.

America’s largest banks are to propose a complete overhaul of how financial institutions investigate and report potential criminal activity, arguing that rules imposed in the years after the Sept. 11, 2001 attacks are onerous and ineffective. To keep drug traffickers and terrorists from laundering money through the US financial system, federal law mandates that bank employees file a Suspicious Activity Report (SAR) with authorities if they suspect transactions could be part of a crime.

Oil prices are moving higher after OPEC sources said the group could extend its oil supply-reduction pact with non-members and might even apply deeper cuts if global crude inventories failed to drop to a targeted level. OPEC and other exporters agreed last year to cut output by 1.8 million barrels per day to reduce a price-sapping glut. The deal took effect on Jan. 1 and lasts six months. Most producers appear to be sticking to the deal so far but it is unclear how much impact the supply reductions are having on world oil inventories that are close to record highs.

US oil producers sent a record 7 million barrels of crude out into the world market last week. The 1 million barrels a day is nearly double the week-earlier level. The Energy Information Administration’s weekly inventory data also showed that US oil stockpiles swelled to a record 518.2 million barrels last week, and gasoline inventories also hit a record 259.1 million barrels, gaining 2.8 million barrels.

At 2.25 gigawatts, Arizona’s Navajo Generating Station is the biggest coal-burning power plant in the Western US. The plant, and the nearby Kayenta coal mine that feeds it, are located on the Navajo Indian Reservation, and the Navajo and Hopi peoples have had a conflicted relationship with coal since the plant opened in the 1970s. Almost all the 900-plus jobs at the mine and plant are held by Native Americans, and the tribes receive royalties to account for large portions of their budget.

Negotiations were underway to improve the tribes’ lease terms, which expire in 2019. But on Monday, the four utilities that own most of the plant voted to close it at the end of 2019. They decided that the plant’s coal-powered electricity just can’t compete with plants burning natural gas.

Lease negotiations included consideration of a plan to close one of the plant’s three turbines and replace the generation with renewable energy. But the economically vulnerable tribes will be hard-pressed to immediately replace the critical jobs and revenue associated with coal should the plant close three years from now. The flip-side, of course, is that closing the plant (as well as the mine) would eliminate a significant amount of pollution and water use.

Staff at the Environmental Protection Agency have been told that President Trump is preparing a handful of executive orders to reshape the agency, to be signed once a new administrator is confirmed.

Oil Rally Helps Fuel Equity Gains

Charles Schwab: On the Market

Posted: 9/28/2016 4:15 PM ET

Oil Rally Helps Fuel Equity Gains

U.S. stocks finished with solid gains powered by the energy sector as crude oil prices rallied on the heels of a Reuters report that OPEC has reached a production cut deal, though a finalized plan may not come until November. Treasuries and gold ticked lower, while the U.S. dollar was nearly unchanged. Meanwhile, some rate hike uncertainty may have been revived as a plethora of Fed officials either have or will deliver remarks today, including Chairwoman Janet Yellen who gave financial regulation testimony to a House panel. In other developments, Dow member Nike offered a mixed earnings report and a preliminary read for durable goods orders in August was relatively upbeat.

The Dow Jones Industrial Average (DJIA) rose 111 points (0.6%) to 18,339, the S&P 500 Index gained 11 points (0.5%) to 2,171, and the Nasdaq Composite added 13 points (0.2%) to 5,319. In moderate volume, 910 million shares were traded on the NYSE and 1.8 billion shares changed hands on the Nasdaq. WTI crude oil surged $2.38 to $47.05 per barrel, wholesale gasoline was $0.08 higher at $1.44 per gallon and the Bloomberg gold spot price declined $4.50 to $1,322.82 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was nearly unchanged at 95.47.

Dow member Nike Inc. (NKE $53) reported fiscal 1Q earnings-per-share (EPS) of $0.73, above the $0.56 FactSet estimate, as revenues increased 8.0% year-over-year (y/y) to $9.1 billion, north of the projected $8.9 billion. The company said its global futures orders of athletic footwear and apparel were up 7.0% y/y, below the expected 8.3% increase as North American and Greater China orders were below forecasts, while Western European demand was slightly ahead of estimates. Shares traded lower. 

BlackBerry Ltd. (BBRY $8) posted flat 2Q EPS, compared to the $0.05 per share loss that was anticipated, as revenues declined 28.2% y/y to $352 million, below the projected $392 million. The company raised its full-year earnings outlook, reflecting improving margins and reduced interest expense, as well as planned investments in growth areas. BBRY also said it is focusing on software development, including security and applications, and plans to end all internal hardware development by outsourcing that function to partners. Shares finished nicely higher.

Durable goods orders relatively upbeat, mortgage applications dip

August preliminary durable goods orders (chart) came in flat month-over-month (m/m), compared to Bloomberg's estimate of a 1.5% decline and July's negatively revised 3.6% gain. Ex-transportation, orders declined 0.4% m/m, versus the 0.5% forecasted decrease, and July's downwardly revised 1.1% rise. Orders for non-defense capital goods excluding aircraft, considered a proxy for business spending, rose 0.6%, above projections of a 0.1% dip, and following the unfavorably revised 0.8% rise in the month prior.

Schwab's Chief Investment Strategist, Liz Ann Sonders notes in her article, Every Picture Tells a Story: Recession Risk Up, but Not High, that leading indicators weakened in August, but are not yet flashing a recession warning. Recession models show rising, but still low risk of a coming contraction in economic activity. Economic recoveries don’t tend to die of old age; they die of excess…of which there's little in this recovery. Read more at www.schwab.com/marketinsight and follow Liz Ann on Twitter: @lizannsonders.

The MBA Mortgage Application Index dipped 0.7% last week, after falling 7.3% in the previous week. The decrease came as a 1.6% drop for the Refinance Index more than offset a 0.8% increase for the Purchase Index. The average 30-year mortgage rate fell 4 basis points (bps) to 3.66%.

Treasuries ticked lower, with the yields on the 2-year and 10-year notes, as well as the 30-year bond all gaining 1 basis point to 0.75%, 1.57% and 2.29%, respectively. Schwab's Chief Fixed Income Strategist, Kathy Jones points out in her article, With a Whimper Instead of a Bang: Is the Great Bond Bull Market Over?, the end of the bull market doesn't mean a bear market is starting, as slow global growth, deflationary pressures abroad, a firm dollar and demographic trends are likely to keep yields low. Investors should focus less on short-term changes in the market and more on structuring a fixed income portfolio that can work for them over the long run. Read the whole article and other timely bond market commentary at www.schwab.com/onbonds. Follow Kathy on Twitter: @kathyjones.

Tomorrow, the U.S. economic calendar will yield the final look (of three) of 2Q GDP, projected to be adjusted slightly higher to a 1.3% quarter-over-quarter annualized rate of growth, after 1Q's 0.8% expansion. Additionally, we will receive weekly initial jobless claims, forecasted to increase by 8,000 to a level of 260,000, which will be followed by pending home sales, expected to come in flat m/m for August after increasing 1.3% in July.

Europe moves higher, Asia mixed 

European equities traded higher, with financials rebounding amid a recovery in shares of Deutsche Bank AG (DB $12). DB received a boost from the announcement that it agreed to sell its U.K. insurance business and its CEO eased concerns that the company will need to raise capital. Also, the German government denied a media report that it was preparing a contingency plan if the bank faces a capital shortfall. DB has sold off sharply as of late as capital concerns have ramped up, with the U.S. Department of Justice seeking a record $14.0 billion fine in relation to its alleged practices leading up to the 2008 mortgage crisis. Oil & gas and basic materials issues also gained ground to aid the markets, with crude oil prices rebounding in continued choppy action as headlines are sparking speculation regarding what this week's informal OPEC meeting may bring in terms of a production agreement. The euro and the British pound dipped versus the U.S. dollar, while bond yields in the region finished mostly lower.

With the volatility likely to remain as global market uncertainty heightens, Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, reminds investors, Three Reasons Why Now is Not the Time to Retreat from Global Diversification and why Your portfolio may be less diversified than you think. Read these articles, as well as Jeff's World Tour: An Around The World Look At the Economic Landscape, at www.schwab.com/oninternational. Follow Jeff on Twitter: @jeffreykleintop.

Stocks in Asia finished mixed on the heels of the advance in the U.S. yesterday on some upbeat consumer confidence and services sector data, while monetary policy uncertainty in Japan festered. Japanese equities fell as the yen pared yesterday's advance, while a large portion of stocks were adjusted lower to account for their dividend payments, per Bloomberg. Also, uncertainty surrounding the Bank of Japan's (BoJ) recently announced new monetary policy direction likely hamstrung equities with comments earlier in the week from BoJ Governor Kuroda that suggested a move further into negative interest rate territory weighed on the banking sector. For more on this topic, Schwab's Kathy Jones offers her article, Negative Interest Rate Policy: What Is It and Could It Happen Here at www.schwab.com/onbonds. Mainland Chinese stocks declined and Hong Kong shares rose in light volume posturing ahead of next week's golden week holiday break. Australian securities ticked higher, with strength in technology issues being met with weakness in oil & gas and basic materials stocks. Indian stocks advanced, while South Korean equities declined.

The international economic docket for tomorrow will include retail sales from Japan, CPI from Germany, business climate data from the Eurozone and consumer credit from the U.K.

Financial Review

Waiting on the Fed

Sinclair Noe — September 19, 2016

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

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DOW – 3 = 18,120
SPX – 0.04 = 2139
NAS – 9 = 5235
10 Y un – 1.70%
OIL + .16 = 43.19
GOLD + 2.80 = 1313.80

The Federal Reserve’s Federal Open Market Committee meets tomorrow and will issue a statement on Wednesday. A string of disappointing results on the U.S. economy in the past several weeks has all but ensured that interest rates will remain ultra-low for consumers and businesses for another few months.

That doesn’t mean the economy is in horrible shape, just more of the slow, consistent, sluggish, steady growth that we’ve seen for quite some time. Is it enough to move the Fed? Wall Street investors only see somewhere between a 9% to 15% chance that the Fed will hike rates. Still, the Fed could hike rates; they have certainly said a hike is on the table. Of course we won’t know for sure until the Fed makes its announcement.

The major stock indices started the day in positive territory. The Dow had an early gain of 100 points. Last week, the bulls and the bears faced off. As much as the bulls tried last week, they could never get the market back above a key hurdle. The threat of a September rate hike just continued to circulate, and never gave the buyers a chance to get traction. Then again, the bears didn’t make any progress either. As well as the S&P 500 held up last week, we’re still closer to a technical breakdown than a breakout.

Most likely, traders will not place big bets before Wednesday’s interest rate decision. After the Fed statement comes out, look for traders to trade, probably with enough commitment to break either support or resistance; a sizeable movement to finish out the week.

The Bank of Japan is also holding a meeting this week and they will issue their monetary policy a few hours before the Fed. The BOJ remains the most aggressive major central bank when it comes to quantitative easing—its program of bond and other asset purchases as well as negative interest rates that are designed to reflate Japan’s stubbornly sluggish economy.

Negative rates have failed to weaken the Japanese yen.  Year to date, the yen is up nearly 18% versus the dollar and 15% versus the euro. There is speculation the Bank of Japan may try to flatten the yield curve by buying long-term debt and selling short term debt. (Which sounds a lot like “Operation Twist”.)

Excessive credit growth in China is signaling an increasing risk of a banking crisis in the next three years, according to the Bank of International Settlements’ quarterly review. The central bank of central bankers also called the recent equity rally “more stick than carrot,” but stopped short of warning of a bubble, with policy makers questioning whether market prices fully reflect potential risks.

Global bond issuance is running at its fastest pace in nearly a decade as companies, countries and U.S. agencies such as Fannie Mae and Freddie Mac binge on debt. According to Dealogic, a total of $4.88 trillion of debt has been sold since the year began as issuers take advantage of rock-bottom borrowing costs. The figure is a hair below that of 2007, when $4.91 trillion of bonds were issued during the same period.

It seems more likely that London will lose its “passporting rights” with a hard Brexit. Some leading Conservative party members are currently pushing for a so-called hard Brexit option, which would end free movement between the U.K. and the EU and cut trading ties with the remaining 27 member states. But Jens Weidmann, the president of Germany’s central bank says if the U.K. exits the single market, the passport rights for London-based financial firms “would automatically cease to apply if Great Britain is no longer at least part of the European Economic Area.” Passporting allows British banks, including insurers and funds to sell their services seamlessly in any EU member state, without having to obtain a local license.

Losing the right means any financial institution using London as their EU headquarter would have to move to another country and “passport” their services into the rest of the union from there. They could also stay based in the U.K, and instead apply for regulatory approval in each country it wishes to continue to do business. In any case, the industry has warned it will cost billions of pounds in office relocations, staff transfers, added paperwork and new capital requirements. There are also concerns jobs will be lost to other European financial hot spots, such as Frankfurt, Paris, Dublin and Luxembourg.

Venezuelan President Nicolas Maduro said that OPEC and non-OPEC countries are close to an agreement to stabilize markets ahead of an informal meeting in Algiers next week. The uncertainty ahead of that meeting has seen oil investors head for the sidelines, cutting wagers on both falling and rising crude prices.

The National Association of Home Builders index on builder confidence regarding newly built, single-family homes climbed to 65 points in September from a downwardly revised 59 in August. As household incomes rise, builders in many markets across the nation are reporting they are seeing more serious buyers.

Contract negotiations between Canada’s Unifor union and General Motors are continuing around the clock, with the two sides divided over new investment, ahead of a looming strike deadline that could see 3,900 workers walk off the job by midnight tonight. A strike would halt powertrain and vehicle production in at least two Canadian plants and potentially start a ripple effect for GM production in the U.S. that relies on those parts.

Although approval had been expected by the end of August, Iran has been told the U.S. will issue export licenses for the purchase of more than 200 Boeing and Airbus aircraft by the end of September. The US Treasury can veto sales of modern aircraft to Iran, including non-U.S. aircraft, due to the high proportion of US parts.

Sarepta Therapeutics shares jumped up as much as 82% in early morning trade after the Food and Drug Administration granted its Duchenne muscular dystrophy drug accelerated approval. The drug – the first treatment for the degenerative disease – has had a long and controversial history with the FDA. The agency voted against approval, then delayed review.

Duchenne muscular dystrophy, which mostly affects boys, typically kills patients before the age of 30. Patients and their families were particularly outspoken advocates for the approval of the drug, pushing back against the agency’s concerns at meetings open to the public. Sarepta shares are up about 160% over the last three months.

Salesforce is embedding artificial intelligence into its software, making it the latest firm to enhance workplace tools with human-like abilities. Called Einstein, the new offering is a set of online A.I. services designed to automate tasks, predict behavior and spotlight relevant information. Salesforce will demonstrate the software at its annual user conference next month in San Francisco.

The announcement also allowed Salesforce to pre-empt an announcement from Oracle, which also is holding its annual customer event in San Francisco. High on Oracle’s list of new features: real-time analysis of enormous amounts of data. Oracle calls its product Oracle A.I. Elsewhere, General Electric is pushing its A.I. business, called Predix.

IBM has ads featuring its Watson computer talking to various celebrities. More than 30 private companies working to advance artificial intelligence have been acquired in the past five years, and Salesforce has been among the most active buyers along with Alphabet, Intel and Apple.

And it’s all kind of cool and exciting and maybe a little creepy. So, what’s really happening?

And the answer is that it is probably too soon to say for certain. For Salesforce the idea is to provide its customers sales tools. Who are the best prospects to call this week? Which leads are most likely to become prospective clients? Why am I getting outsold by my competitors in certain markets? How long will it take a deal to close?

We don’t know what value A.I. can provide because people are still trying to figure out how to use it. At its core, A.I. is just a series of advanced statistics-based exercises that review the past to indicate the likely future, or look at current customer choices to figure out where to put more or less energy. People are going to have to experiment, most likely first on pain points like security and product marketing.

Technology matures when we don’t pay much attention to it, or only notice when it fails; think of electricity in your house, or your phone (which has enough computing power to fly a rocket to the moon). Of course, by the time A.I. becomes ubiquitous and fades into the fabric of everyday life, we’ll have some new technology to worry about.

Nearly one-third of Hanjin Shipping container ships that have been waiting to dock at ports around the world have offloaded their cargo, raising hopes that the disruption in the global supply chain will ease ahead of the year-end holiday season. Meanwhile, a South Korean judge has ruled that all Hanjin vessels that have unloaded must cancel their charter agreements and return the ship to their owners.

After rolling out a similar hub in the US, UPS is expanding its 3D printing services to Asia with a new facility in Singapore run by its partner Fast Radius. The company sees 3D printing as a potential threat to its warehousing business – where it stores parts for manufacturers – so it has looked to incorporate the technology into its business model.

As it grapples with a massive global smartphone recall that is estimated to cost more than $1 billion, Samsung Electronics is moving swiftly to sell stakes in other tech companies to raise cash. The firm said Sunday it disposed of shares in ASML, Seagate, Rambus and Sharp. Total proceeds from the sales were nearly $900 million.

Financial Review

Decent August Jobs Report

Sinclair Noe — September 2, 2016

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

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DOW + 72 = 18,491
SPX + 9 = 2179
NAS + 22 = 5249
10 Y + .03 = 1.60%
OIL + 1.34 = 45.09
GOLD + 11.20 = 1325.80

The economy added 151,000 jobs last month. The unemployment rate was unchanged at 4.9%. Hiring was expected to taper off after strong gains in July and June in which more than a half-million new jobs were created. The results missed estimates of 180,000 new jobs.

Revisions subtracted a net 1,000 jobs from overall payrolls in the previous two months. The government said 275,000 new jobs were created in July instead of 255,000. But June’s gain was cut to 271,000 from 292,000.

The government’s underemployment rate, or U-6, held at 9.7 percent, as the number of people working part-time for economic reasons rose slightly. Some 6.05 million American employees were in part-time jobs but wanted full-time work, up from 5.94 million in the prior month.

The Labor Force Participation Rate was unchanged in August at 62.8%. This is the percentage of the working age population in the labor force.

Average hourly earnings rose 0.1 percent from a month earlier to $25.73, following a 0.3 percent increase in the prior month. The year-over-year increase was 2.4 percent, compared with 2.7 percent in the 12 months through July.

The average work week for all workers decreased by 6 minutes to 34.3 hours in July, the lowest since 2014 and the first drop in six months. If the jobs market were overheating, you would expect to see longer hours, not fewer.

When you combine the shorter workweek with the very small hourly wage gain, average weekly earnings actually fell in August, dropping 0.2 percent to $882.54.

We have now seen job growth for 71 consecutive months. Private employers have added 15.1 million jobs to their payrolls in the 78 months since February 2010, an average of 194,000 jobs a month. Total employment (private plus government) has averaged 191,000 a month over that period, as federal, state, and especially local government were net job losers.

That’s right, over the past 6 years, we have lost government jobs. In August, private employers added 126,000 jobs. Federal government employment increased by 1,000, state government employment was unchanged, and local government employment rose by 24,000.

Factories cut payrolls by 14,000, the most in three months. Mining and logging, which includes the oil patch, lost another 4,000 jobs. Employment at construction companies fell for the fourth time in the last five months; down 6,000 in August. Construction firms complain about a lack of skilled construction workers, but it may also portend a slowdown. If builders have orders, they tend to find the workers.

Employment slowed at private service providers, with payrolls in professional and business services adding 22,000 jobs, but that’s the smallest gain since a decrease in January. Retail jobs rose by 15,100. Leisure and Hospitality added 29,000. Education and health services added 39,000.

While equities advanced across the board, the S&P 500 Index remained squarely within the same 1.5 percent band it has now occupied for 37 straight days. That’s the tightest since 1964 for the gauge, with volatility hovering near a two-year low.

Things were no different in the currency and bond markets, where benchmark 10-year notes got stuck in the narrowest trading range in almost a decade in August. Yields on two-year notes, the coupon securities most sensitive to Fed policy, were little changed. The 10-year note dropped, pushing yields back above 1.6%; that selloff gave a boost to the banks, especially the regionals.

The dollar fell against the world’s major currencies; with a weaker dollar, gold was higher. And the gold miners (GDX) had a great day with a 1.9% pop.  GDX had dropped from $31.79 on August 12 to $25.17 yesterday, so maybe it was due for a bounce or maybe it’s just a dead cat bounce.

Oil rallied. In addition to a weaker dollar, oil halted four days of declines as Vladimir Putin said he would like Russia and OPEC to clinch a deal to freeze supply. The Russian president said he would likely give his backing to a plan to crimp production at the Group of 20 summit in China next week, ahead of OPEC talks in Algiers at the end of September. In the prior 4 sessions, oil lost just over 9%, so even with today’s gains, oil is down a little over 6% for the week.

So, the Jobs Report wasn’t great but not really bad. The economy only needs a little over 100,000 new jobs per month to maintain current levels. If we had seen a repeat of July’s report (275,000 new jobs), we would all be talking about how the job market was overheated. Instead, we have slow, steady growth.

The average growth over the past 3 months is still 232,000. In August, the year-over-year change was 2.45 million jobs; that is a very good, steady rate of growth, much better than expected at this point in the recovery.

Was it enough for the Federal Reserve to hike interest rates in September? The unemployment rate has been in a tight range between 4.7% and 5.1% for the past 12 months. No change last month. The economy is close to full employment but we aren’t seeing inflationary pressures as a result.

Fed rate hike odds are essentially unchanged. Fed funds futures imply a 30% chance of a September rate hike, down from 34% yesterday. But December is holding steady at 60%. We know that Fed Chair Janet Yellen said at Jackson Hole that 190,000 jobs would be a clear sign of a very strong labor market, and likely reason for a rate hike.

On Aug. 30, 2016, Fed Vice Chairman Stanley Fischer said the US is “very near full employment.” He added that an interest rate hike (or a series of them) would be made based on economic signs. FOMC members keep citing the current U.S. unemployment rate (U-3) of 4.9% as evidence that the US economy has recovered from the Great Recession. Fischer says the US is near full employment. Even though the U6 unemployment still seems to have some slack. As of August 2016, it was at 9.7%.

In December 2006, the U6 hit a low of approximately 7.9%. In October 2000, the U6 was at a much lower low of 6.8%. The U6 includes the U3 plus discouraged job seekers and those working less than full time because they have not been able to find full-time employment. It seems the data is not quite confirming the full employment argument – close, but not quite.

Richmond Federal Reserve Bank President Jeffrey Lacker said today, after the jobs report that the economy appears strong enough to warrant significantly higher interest rates. Lacker argued that a range of economic analysis suggests the Fed’s benchmark overnight interest rate is too low.

Meanwhile, the last time we saw the Fed hike interest rates in an election year was 2004, and that was part of an ongoing campaign of incremental, very widely anticipated quarter point moves. If the Fed hikes rates in September, it would be a surprise to the market, despite some recent, not-quite-convincing jawboning by policymakers. If the Fed wants to raise rates in September, they need to say it strong and loud – otherwise, we’ll wait for December, which is a long way away.

I read several headlines that called today’s report disappointing, or a “whiff”. Not at all. It just wasn’t as strong as June and July. August was still a good solid month of job growth. We’ve really only had one month this year that was really bad – that was in May, when we added just 24,000 jobs, which proved to be a blip.

The labor market still has problems.  More than 6 million Americans are working part-time because they can’t find full-time jobs, a number that has barely budged so far this year. Long-term unemployment remains a problem. Millions of Americans abandoned the labor force during the recession and are now returning at a trickle; the number of jobs increase, but the number of people coming off the sidelines and looking for jobs increased as well – that’s why the unemployment rate stayed steady at 4.9% instead of dropping.

The trend lines, however, are headed in the right direction – and one month of just decent job growth doesn’t change that.

We had some other economic data this morning:
The U.S. trade deficit slid almost 12% in July to $39.5 billion as a surge in soybean shipments pushed exports to a 10-month high. Exports rose 1.9% to $186.3 billion to mark the biggest advance in two and a half years. Soybean exports tripled to $5.2 billion, largely accounting for the increase. Imports, on the other hand, fell 0.8% in July to a seasonally adjusted $225.8 billion, even though the price of oil rose for the fifth straight month and hit the highest level per barrel since last September.

The Commerce Department says new orders for manufactured goods rebounded 1.9 percent in July after a downwardly revised 1.8 percent decrease in June. It was the biggest rise since October 2015 and followed two straight months of declines. Orders for non-defense capital goods excluding aircraft increased 1.5 percent in July. Manufacturing, which accounts for about 12 percent of the economy, remains constrained by the lingering effects of a strong dollar and weak global demand, which have crimped exports of factory goods.

Hurricane Hermine made landfall on Florida’s northwest coast early this morning, toppling trees and utility lines, cutting power to tens of thousands and leaving at least one person dead. The Category 1 hurricane moved ashore from the Gulf of Mexico near St. Marks, south of Tallahassee, with sustained winds of 80 miles per hour. It was downgraded to a tropical storm as it churned slowly toward the Carolinas.

Financial Review

The Case Has Strengthened

Sinclair Noe — August 26, 2016

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

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DOW – 53 = 18,395
SPX – 3 = 2169
NAS + 6 = 5218
10Y + .06 = 1.62%
OIL – .04 = 47.29
GOLD – .90 = 1321.70

Federal Reserve chair Janet Yellen delivered a speech at the Jackson Hole Economic Symposium this morning. Here’s what she said, the key point: “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.”

Yellen said the Fed expects “moderate growth” in gross domestic product, additional strengthening in the labor market and inflation rising to 2% over the next few years.  She said that any decision on interest rates “always depends on the degree to which incoming data continues to confirm the Fed policy committee’s outlook.” Yellen spent the bulk of her speech discussing the potential need to add new tools to the Fed’s toolkit to combat the next recession given that interest rates remain so low. Yellen said the “U.S. economy was nearing the Federal Reserve’s statutory goals of maximum employment and price stability.”

In the past, Yellen has been dovish; in no hurry to raise rates; and she wasn’t exactly pounding the table, and she didn’t give a specific date when the Fed might make a move. And even though Yellen was making a case for action, the markets kind of shrugged it off initially. So, vice-chair Stanley Fischer came along later and removed any ambiguity, saying: “Yellen’s comments are consistent with a possible September hike.”

That is not a guarantee of a rate hike but if the Fed takes action in about 3 weeks, you can’t say you weren’t warned. Stocks, bonds and commodities were all sporting nice gains following Yellen’s speech, then Fischer provided clarification and selling ensued, while at the same time the dollar moved higher and the VIX spike 4.5%.

U.S. economic growth was a bit more sluggish than initially thought in the second quarter as businesses aggressively ran down stocks of unsold goods, offsetting a spurt in consumer spending. Gross domestic product expanded at a 1.1 percent annual rate, down from the 1.2 percent rate reported last month. The revision also reflected more imports than previously estimated as well as weak spending by state and local governments. The economy grew at a 0.8 percent pace in the first quarter. It grew 1.0 percent in the first half of 2016.

The government also reported that after-tax corporate profits fell at a 2.4 percent rate last quarter after increasing at an 8.1 percent pace in the first quarter. Weak profits could limit an anticipated rebound in business spending. With profits declining, an alternative measure of growth, gross domestic income, or GDI, increased at only a 0.2 percent rate in the second quarter, the weakest since the first quarter of 2013.

Masked in the latest quarter is a very strong 4.4 percent annualized growth rate for consumer spending which is 0.2 percent higher than the first estimate. Inventory draw is the quarter’s culprit, pulling down GDP by a very steep 1.3 percentage points. But, in a counter-intuitive twist, lighter inventory in times of slow economic growth is a major positive for future production and employment and is a major plus for the ongoing quarter. The line of thinking is that there’s no pony in here now, but at some future point, there will be a pony, because ponies have always appeared in the past.

The Commerce Department reports the trade gap narrowed to a seasonally adjusted $59.3 billion in July from $64.5 billion in June. Exports rose by $2.9 billion during the month while imports shrank $2.4 billion. A surge in food exports helped cut the nation’s goods gap. Exports of foods, feeds & beverages rose 31 percent in the month though export prices of agricultural goods actually dipped slightly in the month. Other export readings are less favorable including a decline for capital goods, reflecting weak global investment in new equipment, and a small dip for consumer goods.

The University of Michigan’s consumer sentiment index for August slipped to 89.8 from 90.0 in July. The index is 2.3% lower than a year ago.

A very good article by Rex Nutting in Marketwatch asks a key question: Who’s preparing the United States for the 21st century? Nobody, really. Not the 22 million private businesses, not the 118 million households, and not the 90,000 state, local or federal government agencies.

Since the recession, investments have fallen sharply, and they haven’t gotten back up again. It seems that everyone is still scarred by the Great Recession, and by the collapse of asset bubbles in 2000 and 2006. Gross domestic investment totaled about $3.6 trillion in the second quarter of 2016, about 20% of gross domestic product.

That may seem a large sum, but it’s the lowest share of GDP, except during recessions, since 1947. But when you consider depreciation, the actual number is probably closer to $750 billion in the second quarter, or 4% of GDP, about half of the average over the post-war period. In fact, net investment has been running at the lowest rates since the Great Depression of the 1930s.

Business fixed investment has fallen for three quarters in a row, the first time that’s happened outside of a recession or its immediate aftermath since the mid-1980s. Net investment by state and local governments dropped to 0.6% of GDP in the second quarter, about half the average over the post-war period.

We have an economy that’s underperforming, but no one is willing or able to invest the sums needed to build the offices, factories, mines, computers, machinery, roads and airports we’ll need in the future. Business leaders don’t see a quick payoff in long-term investments, and public officials can’t fill the gap because the public thinks austerity now is better than growth tomorrow.

A U.K. sentiment index from YouGov and the Centre for Economics and Business jumped to 109.8 from 106.6 in July. The July print was a three-year low, and the rise in August was the largest in three years. It looks like the panic that gripped the public in the immediate aftermath of the Brexit vote has subsided, but the Centre warns it could all change though as details of the Brexit start to become reality.

If you have an Apple iPhone, you need to fix it. Apple issued a patch to repair a dangerous security flaw in iPhones and iPads after researchers discovered that a prominent United Arab Emirates dissident’s phone had been targeted with a previously unknown method of hacking. The hack is the first known case of software that can remotely take over a fully up-to-date iPhone 6. The researchers said they had alerted Apple a week and a half ago, and the company developed a fix and distributed it as an automatic update to iPhone 6 owners.

Adding another twist to the drama over Herbalife, investment bank Jefferies has been looking for the past month to find buyers for Carl Icahn’s 18% (roughly $1 billion) stake in the company. As if the idea of Herbalife’s largest shareholder exiting wasn’t enough of a story, the report also says Bill Ackman was among a possible group of buyers. Ackman has been shorting the stock for years. 

Icahn’s sale would come just weeks after he expressed renewed confidence in the company following the FTC settlement. Ackman kicked off the fight in 2012 with a widely watched presentation and a $1 billion bet that the stock would collapse. Icahn joined the battle a few months later and soon after got several Herbalife board seats.

Since then, the men have screamed at each other on live television and they and the company have traded legal accusations amid multiple investigations and a feature-length documentary. If Ackman really wanted to crush Herbalife, one way would be to get rid of the largest holder and then sell.

Apollo Global Management said it would buy cloud services provider Rackspace Hosting in a deal valued at $4.3 billion. The $32 per-share-offer represents a premium of 6 percent to Rackspace’s Thursday closing price. It’s also a 38% premium to Rackspace’s closing price on August 3. There was a very large short interest in Rackspace, more than $400 million. Ouch.

This exit from the public market can be laid squarely at the feet of Amazon Web Services. Amazon and Rackspace used to be such fierce competitors in cloud computing that Rackspace spearheaded a project called OpenStack to give itself and other IT vendors a chance to compete with Amazon. And OpenStack was successful, just not as successful as Amazon. It says something that the company went private instead of being bought by its partners, Amazon, Microsoft or any IT firms looking to jump start their cloud revenues; and what it probably says is that Amazon is crushing it in the cloud.

The Surgeon General of the United States, Vivek Murthy, has sent an electronic letter to 2.3 million doctors asking for their help to curb what’s being called an “unprecedented” epidemic of opioid painkiller overdose deaths. It’s the first time in history that a surgeon general has sent a letter directly to American physicians. Despite being home to 5% of the world’s population, America consumes 80% of its opioids. Between 2013 and 2014, deaths from synthetic opioids skyrocketed by 79%, according to a new Centers for Disease Control and Prevention report released Thursday.

A 2014 report from the American Academy of Neurology estimates that more than 100,000 Americans have died from prescribed opioids since the late 1990s. Those at highest risk include people between 35 and 54, the report found, and deaths from opioids in this age group have exceeded those from firearms and car crashes.

Financial Review

Pandora’s Box

Sinclair Noe — August 17, 2016

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

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DOW + 21 = 18,573
SPX + 4 = 2182
NAS + 1 = 5228
10 Y – .02 = 1.55%
OIL + .29 = 46.87
GOLD + 2.60 = 1349.40

The Federal Reserve released minutes from their July FOMC meeting. In July, with the Brexit vote over and market turmoil subsiding, the Fed seemed somewhat more open to the possibility of resuming rate hikes. Economic data has been mixed; we had a very weak report on second quarter gross domestic product and we had a very strong July jobs report. A key official, New York Fed President William Dudley,  said yesterday that a rate hike in September was possible – even if markets aren’t convinced that it’s probable.

Apparently the news of a possible rate hike in September was enough to spook the equity markets a little bit. Is a Rate Hike in September two months before an election, with this economic backdrop, possible? Doubtful. The bond market isn’t buying it. Ten-year yields have hardly budged. The currency market didn’t even shrug.

Here’s what the Fed said, quoted from the minutes: “Some other participants viewed recent economic developments as indicating that labor market conditions were at or close to those consistent with maximum employment and expected that the recent progress in reaching the Committee’s inflation objective would continue, even with further steps to gradually remove monetary policy accommodation. Given their economic outlook, they judged that another increase in the federal funds rate was or would soon be warranted, with a couple of them advocating an increase at this meeting.”

Sorry, but that is just a bit too vague to be taken seriously. If the Fed wants to raise rates in September, they need to pound the table and state very clearly that they intend to hike rates. Taken as a whole, then, Chair Janet Yellen is keeping the hawks at bay and the Fed on a course of loose monetary policy, including the current 0.25-0.5 percent range. That’s even despite some clamoring from those wanting to hike. And despite some initial chatter about “some” wanting a rate hike, following the release of the minutes the market quickly adjusted its sights.

Stocks closed higher; treasuries pared losses. Two-year Treasuries, the most sensitive to policy expectations, halted a back-to-back decline. The dollar was basically flat. The greenback has slumped more than 5 percent this year as Fed policy makers have yet to see signs that inflation is moving toward their 2 percent goal. That means the Fed is less likely to diverge from the paths of the Bank of Japan and European Central Bank, which are boosting monetary stimulus as they seek to spur flagging growth.

The minutes once again portray a Fed that can’t seem to find direction or purpose; not confident in holding steady but not ready to embrace new approaches. Fed chairwoman Janet Yellen is scheduled to speak at next week’s annual economic symposium in Jackson Hole, Wyoming. Let’s hope she actually says something.

Time now for a quick lesson in basic economics. Adverse selection is a phenomenon wherein the insurer is confronted with the probability of loss due to risk not factored in at the time of sale. This occurs in the event of an asymmetrical flow of information between the insurer and the insured. Asymmetrical information refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. Or another way of saying it; in any given deal, somebody has the upper hand.

In the case of insurance, adverse selection is the tendency of those in dangerous jobs or high-risk lifestyles to get life insurance. Or in the case of health insurance, it is a situation where “uninsured people with pre-existing conditions often face tens or even hundreds of thousands of dollars in out-of-pocket medical costs annually. If insurers charged everyone the same rate, buying coverage would be far more attractive financially for people with chronic illnesses than for healthy people.

And as healthy policyholders began dropping out of the insured pool, it would become increasingly composed of sick people, forcing insurers to raise their rates. …. But higher rates make insurance even less attractive for healthy people, causing even more of them to drop out. Before long, coverage would become too expensive for almost everyone.”

Yesterday, Aetna announced that it will withdraw from 11 of the 15 state Affordable Care Act exchanges where it sells marketplace plans; leaving some counties with only one option for healthcare, and in Pinal County – no options. Aetna cited mushrooming financial losses and structural problems with the exchange markets as causes for its retreat.

There might be more to the story. A few months ago, Aetna was looking to expand its presence in the ACA exchanges and Aetna also wanted to acquire Humana. In a letter to the US Department of Justice, Aetna CEO Mark Bertolini outlined the company’s plans to roll back much of its Obamacare business if the DOJ blocked a proposed merger with rival Humana. A company spokesman denied that participation in the exchanges was a bargaining chip in its negotiations with the DOJ, saying the decision was driven by losses.

So is this about losses or a merger battle? Is this a confessional, or extortion? It may in fact be true that Aetna can’t envision a way to make a profit in the exchanges without merging with Humana, even if it is true that its losses didn’t prevent it from seeing its earnings increase 20% in 2015.

Aetna executives and attorneys surely knew that government anti-trust lawyers would see the letter as thinly veiled extortion, even if their concerns were entirely sincere. At any rate, Aetna may have opened Pandora’s Box.

A recent report from the Kaiser Family Foundation shows that as many as two states and 650 counties are on track to have just one insurer on the Affordable Care Act exchanges next year. The entire states of Alaska and Alabama will be faced with just one choice in 2017, as well as large swaths of Kentucky, Tennessee, Mississippi, Arizona and Oklahoma. The effects of health insurance company pullouts will be to leave people uninsured.

That’s unfortunate, because it turns out that making health care available to people actually makes them healthier. A new study, published Monday in JAMA Internal Medicine, offers another way of looking at the issue. Low-income people in Arkansas and Kentucky, which expanded Medicaid insurance to everyone below a certain income threshold, appear to be healthier than their peers in Texas, which did not expand. One “solution” to health insurance behemoths threatening to pull out of the ACA exchanges would be to allow them to merge. A second “solution” is to let them hike premiums to ridiculous levels. The third solution is the Pandora’s Box, also known as the public option.

Britain’s job market is shrugging off Brexit, for now. Data from the Office for National Statistics showed that the number of people claiming jobless benefits in the UK unexpectedly fell in July. Additionally, the UK’s unemployment rate held at a record-low 4.9%. Analysts in the coming months will continue to watch the unemployment level as one of the key indicators of how the Brexit vote is affecting the U.K. economy.

Subprime credit-card lending is making a comeback. TransUnion’s Second Quarter 2016 Industry Insights Report shows that 11% of the 10 million new customers entering the credit-card marketplace in the past year were subprime borrowers. Additionally, the data suggests subprime borrowers are seeing the biggest increase in balances, up 14% versus a year ago. Still, TransUnion’s financial services business unit, says delinquency levels are not “alarming.”

Cisco Systems is readying for job cuts. The company is expected to eliminate 14,000 jobs, or about 20% of its labor force, beginning in the next few weeks. Microsoft, HP, and Intel have all announced big jobs cuts within the past year or so.

Target reported disappointing Q2 earnings and management placed part of the blame squarely on Apple. Comparable store sales at Target overall fell by 1.1%, but Target executives noted that electronic sales decreased by double digits and “accounted for 70 basis points [0.7%] of overall comp decline.”

Even more notably, Target specifically pointed out that Apple product sales were down by “more than 20%” year-over-year and were to blame for a third of the overall plunge of electronic sales at Target. Apple’s growth has been running into a bit of trouble recently, as the astounding success of the iPhone 6 has made for tough comparisons; and many customers are probably sitting on the sidelines before the launch of the iPhone 7.

The iPhone 7 might be coming soon. That’s according to a leaked photo spotted by 9to5Mac of “reset hours” at AT&T stores for September. The website speculates that the photo shows September 9 as the date AT&T will begin advertising the iPhone 7 and September 23 as the day when the phone will go on sale.

The Treasury Department issued rules this year that thwarted several tax inversions, but one large deal that managed to get through was the $16 billion acquisition of Tyco by Johnson Controls. The last hurdle for the transaction is a vote today by both sets of shareholders. Johnson Controls shareholders are set to vote in Dallas, while Tyco’s shareholders will do so in Dublin.