Financial Review

Apple Bites

Sinclair Noe — October 25, 2016

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DOW – 53 = 18,169
SPX – 8 = 2143
NAS – 26 = 5283
10 Y un 1.75%
OIL – 1.22 = 49.30
GOLD + 8.70 = 1274.10

More than 90 companies delivered quarterly results today. Dow components 3M, Caterpillar and DuPont reported earnings before the bell. Caterpillar and 3M posted mixed results, as both beat estimates on the bottom line, while missing on revenues. Caterpillar also lowered its 2016 earnings per share guidance. DuPont posted better than expected quarterly earnings and raised its yearly profit forecast.

The largest S&P 500 stock by market capitalization – Apple – is the highlight of today’s earnings reports. After the closing bell, Apple reported net income per share of $1.67, down from $1.96 a share a year earlier. Revenue fell 9 percent to $46.9 billion. Analysts expected profit of $1.66 a share on sales of $46.9 billion.

Apple experienced its first annual sales decline since 2001. For the third consecutive quarter, iPhone sales were down from the year-ago period. Apple sold 45.5 million iPhones, down from last year’s sales of 48 million. But only a few weeks of iPhone 7 sales were included in this quarter. Next quarter is the holiday quarter, which is Apple’s biggest quarter, and it will be the first full period of iPhone 7 sales. Apple is projecting revenue of between $76 billion and $78 billion, which would be a slight return to growth for the company.

Apple spent much of the past year pushing services, such as the App Store, iCloud storage and Apple Music. That division has become the company’s fastest growing. Though those businesses represent a fraction of iPhone revenue, they foster customer loyalty by making it harder to trade in handsets for those made by rivals. Apple was trading down about 2% in after hours.

European earnings roundup: Syngenta’s third quarter revenue came in at $2.5 billion dollars, down 3%, dragged lower by weak Latin American sales. Orange’s core operating profit beat expectations as strong growth in Spain offset waning revenue in its home market of France. Novartis posted a 4% slump in third quarter profit as sales in its Alcon eye care division and cancer drug Gleevec continued to see declines.

Merck gained 1.9% after beating earnings and sales expectations. Whirlpool took an 11% hit after missing sales and earnings estimates, and lowering its outlook. Procter & Gamble reported better than expected earnings. Lockheed Martin posted higher than expected revenue as sales of Sikorsky helicopters rose nearly 15% and Lockheed announced it will hike its dividend.

Under Armour, the No. 2 U.S. sportswear maker, reported its slowest quarterly sales growth in six years. Although, net sales in North America grew 15% in the third quarter, it was below the 20 percent growth mark that the company normally. The stock dropped 14%.

FreePort McMoRan reported earnings of $217 million, or 13 cents a share on an adjusted basis – missing estimates. Revenue grew to $3.8 billion from $3.3 billion – missing estimates.

General Motors doubled its net income and notched record revenue in the third quarter with strong truck sales in the U.S. market and continued strength in China, but the auto maker signaled continued weakness in Europe because of Brexit fallout. Profit and revenue beat analysts’ estimates. Still, there is a nagging concern that the auto industry has seen 6 years of improving earnings and sales have plateaued. GM dropped about 4% today.

A federal judge has approved Volkswagen’s $14.7 billion settlement with regulators and owners of 475,000 polluting diesel vehicles that don’t meet emissions standard. Volkswagen admitted last year that the cars were programmed to cheat on emissions tests. The German automaker will spend up to $10 billion to either buy the cars back or fix them and compensate owners. The deal covers 475,000 VW models with 2-liter diesel engines dating to 2009. U.S. models include the 2009-2015 Jetta and Audi A3, the 2010-2015 Golf, and the 2012-2015 Beetle and Passat.

Most owners are expected to take the settlement. As of Sept. 16, which was the deadline opt out of the settlement, 3,298 owners said they wouldn’t participate. Those who don’t accept the settlement could sue VW, but it’s not guaranteed they would get better terms. Another 90,000 cars with 3-liter diesel engines also have cheating software, but they aren’t part of this settlement. Owners have a choice – VW will buy back the car or fix the car, although a fix has not yet been approved. The official settlement web site is vwcourtsettlement.com.

Reeling from the biggest and most costly car recall in history, Takata is now at the center of a messy takeover battle that could put the company on a path towards bankruptcy. Its fate will rest heavily on global automakers that will gather in New York today to discuss options for an outside investor to help the firm replace potentially defective airbags in more than 100 million vehicles.

Maybe we should call it driver-less beer. In a major milestone for autonomous trucking, some 45,000 cans of Budweiser beer arrived late last week to a Colorado warehouse after traveling over 120 highway miles in a self-driving semi with no driver at the wheel. Otto, the autonomous truck subsidiary of Uber, shipped the brew with a driver monitoring from the truck’s sleeper berth for the entire two-hour journey.

U.S. home prices rose slightly in August. The S&P/Case-Shiller U.S. National Home Price Index was up 5.3 percent on an annual basis in August from 5.0 percent in July. Top gainers in August were Portland, Oregon, with an 11.7 percent increase year to date, and Seattle, at 11.4 percent over the last year. Phoenix posted a gain of 0.6% from July to August, and prices advanced 5.2% over the past year.

While rising home prices point to a healthy housing market on the demand side, they also expose an affordability problem that has locked some potential buyers out. According to S&P/Case Shiller, the index of national house prices is within 0.1% of the record it set 10 years ago. Higher home prices are indicative of a shortage of homes for sale.

The Mortgage Bankers Association says lenders are expected to issue more than $1 trillion in mortgages for home purchases in 2017, marking the first year this would happen since the housing bust a decade ago. On the other hand, the MBA forecast a steep 40 percent drop in mortgage refinancing next year to $529 billion as the Federal Reserve raises interest rates gradually through 2018.

The Conference Board’s Consumer Confidence index dropped to 98.6 this month from 103.5 in September, a number that was revised lower. Consumer confidence is still near a post-recession peak despite the drop in October. The present situation index, a measure of current conditions, fell to 120.6 from 127.9. Fewer Americans said jobs are “plentiful.” The future expectations index declined to 83.9 from 87.2. That’s the lowest level since July.

The average premium for benchmark 2017 Affordable Care Act insurance plans sold on Healthcare.gov will jump 25% to $302 compared to this year, the biggest increase since the insurance first went on sale in 2013. Seeking to downplay the cost hikes, the administration said that including subsidies 77% of people would be able to find insurance plans with monthly premiums below $100, however, one in five consumers will only have one insurer from which to choose coverage.

The Federal Reserve is inclined to raise interest rates higher than would otherwise be the case if the next president pursues an expansionary fiscal policy. Speaking yesterday evening, Federal Reserve Bank of Chicago President Charles Evans said that the Fed should be more explicit about how policy makers would respond to new information on the economy. Market-implied odds of a rate increase by the central bank in 2016 were at 71 percent.

Renewable energy reached an important turning point last year with record new installations of emissions-free power surpassing sources that burn fossil fuel. According to a new report from the International Energy Agency new installations of renewable energy overtook conventional power for the first time in 2015. Global green power rose by a record 153 gigawatts, equivalent to 55 percent of newly installed capacity last year. Total installed capacity exceeded coal for the first time.

The report shows the acceleration toward clean-power generation was already picking up pace before governments agreed in Paris in December to reduce carbon dioxide emissions. The IEA raised its estimate of the amount of green energy on power grids by 13 percent, revising its forecast to 42 percent by 2021. About 500,000 solar panels were installed each day across the globe in 2015, according to the report.

Renewables will be the world’s fastest-growing source of electricity over the next five years. And the cost is coming down; solar panels are expected to be a quarter cheaper over the next 5 years.

Financial Review

Never the Twain Shall Meet

Sinclair Noe — September 22, 2015

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

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DOW – 179 = 16,330
SPX – 24 = 1942
NAS – 72 = 4756
10 YR YLD – .09 = 2.12%
OIL – .85 = 45.83
GOLD – 8.70 = 1125.70
SILV – .45 = 14.87

Pope Francis is in Washington. The Pope will visit Washington, New York City and Philadelphia as part of his first-ever trip to the U.S., a six-day, five-night trip which will feature a couple of masses that are expected to draw huge crowds. The Pope will address a joint session of Congress Thursday; he may make points that challenge both parties, particularly if he repeats his remarks against what he sees as the excesses of globalization and capitalism. And he may discomfort both the White House and Congress if he urges them to do more to help Syrian refugees flooding through Europe. Then he will address the United Nations General Assembly in New York, where he will also conduct mass at Madison Square Garden on Friday.

China’s President Xi Jinping touched down in Seattle today to meet American business leaders before heading to Washington on Thursday to speak with President Obama. The two will discuss several thorny issues, including cybersecurity, the South China Sea, North Korea’s nuclear threat, human rights and a widening trade deficit. President Xi will tour the Boeing aircraft plant near Seattle. Not much new to see really, China has stolen more data from Boeing than Xi will ever see on a hospitality tour. Meanwhile, in his first interview with foreign media since Chinese stocks skidded this summer, Xi told The Wall Street Journal that government intervention to arrest the plunge was necessary to “defuse systemic risks” and was akin to acts taken by governments in “some mature foreign markets.” Hmm, wonder who he’s thinking about?

The Asian Development Bank is forecasting the Chinese economy will grow less than 7% this year, and warning of widening fallout from the country’s economic slowdown.

Just two years after a government shutdown over the Affordable Care Act, lawmakers are again heading toward a funding impasse – this time over federal money for Planned Parenthood. In January 2014, the Bureau of Economic Analysis estimated the direct impact of the last closure lopped about three-tenths of a percent off real GDP growth in the 2013 fourth quarter, and experts now estimate a three-in-four chance the government shuts down at the end of September (up from 67% last week).

The dollar hit an almost two-week high against a basket of currencies this morning after comments from Fed officials revived expectations that rates could still be hiked later this year. Dennis Lockhart, a voting member of the Federal Open Market Committee, is scheduled to speak again later in the day. Fed Chair Janet Yellen speaks on Thursday; and this is the speech that matters most. She won’t take questions, so it’s up to Yellen to decide if she wants to guide market expectations by emphasizing the Fed remains on track to raise rates this year, or whether she is willing to wait until next year.

If she stays silent on the topic, that would point to a delayed liftoff. They don’t want to surprise the market, which means they have to lay out a course of action before they can be sure they are going to follow it. There are two remaining FOMC meetings this year. Investors see the chances of liftoff in October as only around 20 percent, while a hike by December is less than a 50-50 proposition, according to trading in federal funds futures.

Bond fund giant Pimco says the pace of Federal Reserve interest-rate increases is likely to be even more gradual than the firm expected in March and that the U.S. central bank may find it impossible to escape the effective lower bound of policy rates. Pimco said in its quarterly Cyclical Forum outlook report that: “In contrast to robust consumption and housing, business investment confronts the headwinds from low oil prices and cutbacks in drilling and exploration, while exports will be challenged by the delayed effects of a stronger dollar and slower growth in emerging economies.” Pimco cut its forecast for U.S. economic growth in the next 12 months to between 2.25 percent and 2.75 percent, from 2.5 percent and 3 percent in March.

The Federal Housing Finance Agency reports house prices rose a seasonally adjusted 0.6% in July. That takes the year-over-year gain to 5.8%. Over 12 months, every region was positive, led by the 9.4% rise in the Mountain region, which includes Arizona.

European Union ministers have approved a plan that compels member countries to take in 120,000 refugees, despite strong objections from four dissident nations in Central Europe. The Czech Republic, Hungary, Romania and Slovakia voted no. Finland abstained. As a legal matter, however, the plan is final and must be carried out even if those countries oppose it.

Problems at Volkswagen continue to grow. Over the weekend, VW said 482,000 vehicles equipped with diesel engines sold in the US were rigged with a sophisticated software algorithm that could detect when a car was undergoing an emissions test; the software would adjust the pollution emitted during the test, and then after that, it was back to spewing deadly nitrous oxide gases at up to 40 times the legal limit. Yesterday, VW announced they had set aside $7.3 billion to deal with the problem.

That’s bad, but it gets worse. Now the company admits that it cheated on the emissions controls for 11 million vehicles worldwide.  Regulators from Germany, France, South Korea and Italy have vowed to scrutinize Volkswagen’s vehicles. The U.S. Justice Department has also begun a criminal probe. The 11 million cars affected are more than VW sells in a year. To address the growing crisis, the executive committee of the carmaker’s supervisory board will meet tomorrow. VW shares have dropped 31% in the past 2 days.

The shock waves from the scandal enveloping Volkswagen were being felt across the sector as traders wondered who else might be affected. Germany’s Daimler, the maker of Mercedes-Benz cars, was down 6 percent, while BMW fell 5.3 percent. France’s Renault was 5.5 percent lower.

A former peanut company executive has been sentenced to 28 years in prison for his role in a deadly salmonella outbreak, the stiffest punishment ever handed out to a producer in a foodborne illness case. The outbreak in 2008 and 2009 was blamed for nine deaths and sickened hundreds more, and triggered one of the largest food recalls in U.S. history. Before he was sentenced, former Peanut Corporation of America owner Stewart Parnell listened as nine victims testified about the grief caused by tainted peanut butter traced to the company’s plant in southwest Georgia.

The Securities and Exchange Commission is voting on new rules that would force most mutual funds, outside of money market funds, to have sufficient liquid assets to meet the legal requirement for daily redemptions and access to funds within seven days. It would also allow “swing pricing,” which is the process of reflecting in a fund’s NAV the costs associated with shareholders’ trading activity in order to pass those costs on to the purchasing and redeeming shareholders.

Brian Moynihan will keep his dual role as Bank of America Corp.’s chairman and chief executive officer after shareholders voted to ratify governance changes made last year. Preliminary results showed the resolution passed with about 63 percent of the votes. Bank of America had called the special meeting after angering some investors by undoing a 2009 shareholder-backed bylaw requiring an independent chairman.

Lloyd Blankfein, CEO of Goldman Sachs, said he has been diagnosed with lymphoma and will undergo chemotherapy in New York over the next few months. In a memo published on the investment bank’s website, Blankfein said it is a “highly curable” form of lymphoma, and his doctors fully expect him to recover.

It may not seem like much; just an extra hundred dollars or so a year, but the steady upward creep in health insurance deductibles has easily outpaced the average increase in a worker’s wages over the last five years. According to a new study from the Kaiser Family Foundation deductibles have risen more than six times faster than workers’ earnings since 2010. Four of five workers who receive their insurance through an employer now pay a deductible, in which they must pay some of their medical bills before their coverage starts. Those workers’ deductibles have climbed from a yearly average of $900 in 2010 for an individual plan to above $1,300 this year, while employees working for small businesses have an even higher average of $1,800 a year. One in five workers has a deductible of $2,000 or more.

Is 100 percent renewable energy possible by 2050? Greenpeace says yes. In a new study, Greenpeace projects that complete global reliance on renewable energy is within our grasp, and suggests the switch will create millions of jobs. The prediction sounds idealistic, but in the past equally dramatic Greenpeace predictions have proven accurate. In fact, the US-based Meister Consultants Group concluded earlier this year that “the world’s biggest energy agencies, financial institutions and fossil fuel companies for the most part seriously under-estimated just how fast the clean power sector could and would grow.”

And the main finding of the report includes another positive projection: more renewables will mean more jobs. Solar PV is expected to provide 9.7 million jobs, and wind power is expected to provide 7.8 million. And the projected 20 million jobs coming from renewables are far more than the coal, gas, and oil industries today combined. So although the International Energy Agency predicts the number of jobs to fall after 2020, the Energy Revolution report expects the number of jobs to increase between now and then.

Financial Review

Rocket Science

Sinclair Noe — April 14, 2015

 

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

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DOW + 59 = 18,036
SPX + 3 = 2095
NAS – 10 = 4977
10 YR YLD – .04 = 1.90%
OIL + 1.38 = 53.29
GOLD – 6.10 = 1192.90
SILV – .13 = 16.23

For the past 3 months, retail sales have been down. There was some speculation that the harsh winter weather was to blame for declining sales; and that appears to be true. Retail sales rose in March for the first time since late last year as consumers stepped up purchases of automobiles and other goods. Retail sales increased 0.9 percent in March. That was the largest gain since March last year and snapped three straight months of declines.

In a separate report, the Labor Department said its producer price index for final demand increased 0.2 percent last month, with rising prices for goods accounting for more than half of the increase. The PPI, which measures prices at the wholesale level, had declined 0.5 percent in February.  In the 12 months through March, producer prices fell 0.8 percent, the biggest year-on-year decline since the revamped series started in 2009. Of course, the Federal Reserve has a 2 percent inflation target, so this data does not suggest the Fed needs to be in a hurry to raise rates.

The National Federation of Independent Business said its small-business optimism index fell 2.8 points to 95.2, the worst reading since June, with all 10 of its subcomponents declining. The biggest decline came in the percentage that say they expect better conditions in six months.

The U.S. ended the month of March with a budget deficit of $53 billion, up 43% from the same period last year, bringing the current fiscal year-to-date deficit to $439 billion at the end of last month. Meanwhile, Fitch has affirmed the U.S.’s long-term default ratings at “AAA,” citing the country’s “unparalleled” financing flexibility as the issuer of the world’s pre-eminent reserve currency and benchmark fixed-income asset. Fitch also expects the U.S. to grow 3% in 2015, before decelerating slightly in 2016.

The dollar’s strength almost perfectly tracks Fed statements about the coming end of easy money. The tightening of US monetary policy (or even the hint that policy will tighten at some point) has driven the dollar up (and oil down) even as Europe’s beginning of its own “QE” or quantitative easing program has driven the Euro down. None of it reflects the economic reality on the ground, but rather the fact that central bankers are, as investment guru Mohamed El-Erian frequently says, the “only game in town.”

A new study from the Berkeley Center for Labor Research and Education at the University of California finds nearly three-quarters of the people helped by public assistance programs actually goes to families headed by a worker; they just don’t make enough money to cover the basic expenses. Taxpayers pick up the difference between what employers pay and what is required to cover what most Americans consider essential living costs. The report estimates that state and federal governments spend more than $150 billion a year on four key antipoverty programs used by working families: Medicaid, Temporary Assistance for Needy Families, food stamps and the earned-income tax credit, which is specifically aimed at working families. As a result, taxpayers are providing not only support to the poor but also, in effect, a huge subsidy for employers of low-wage workers. A report issued last week by the Federal Reserve Bank of Cleveland said that labor’s share of overall income had fallen to record lows in recent years.

New research from the Federal Reserve Bank of St Louis shows nearly one in three Americans now paying down student debt are at least a month behind in their payments; that figure is far higher than official delinquency measures from the Education Department and the New York Fed. And it is probably more accurate because it looks at people who have started to pay and not all outstanding debt, which includes people who have not yet started repayment. It’s estimated there is now $1.3 trillion in student loan debt outstanding.

Greece is preparing to take the dramatic step of declaring a debt default unless it can reach a deal with its international creditors by the end of April. The Financial Times quotes a government official saying: “We have come to the end of the road…If the Europeans won’t release bailout cash, there is no alternative [to a default].” Athens has also decided to withhold €2.5 billion-euro of payments due to the IMF in May and June if an agreement is not struck.

The International Monetary Fund left its projection for global growth in 2015 unchanged from three months ago at 3.5 percent. According to the IMF’s World Economic Outlook, the global economy is being reshaped by swings in currency markets and the drop in oil prices. The strengthening dollar is boosting growth in the Eurozone and Japan while taking some steam out of the U.S. recovery. Both the euro and yen have declined against the dollar as the European Central Bank and Bank of Japan purchase assets to boost the supply of money in their economies. The IMF cut its US expansion forecast by 0.5 percentage point to 3.1 percent, still the fastest among major developed economies. The Japan growth outlook increased to 1 percent from 0.6 percent and the euro area is projected to expand 1.5 percent as weakening currencies provide a boost. The figures show India will grow more quickly this year than China for the first time since 1999. The IMF predicts India will expand at a 7.5 percent rate. China is expected to grow 6.8 percent this year. Brazil will contract 1 percent in 2015.

One of the more important points of the IMF report is that potential output is growing more slowly than before. So, the takeaway is that the global economy is characterized by weak investment, low real and nominal interest rates, credit bubbles and unsustainable debt. Any solution sounds a bit circular, and largely deals with tweaking interest rates one way or another, while avoiding the real questions of increasing sustainable growth and reducing instability. Thanks IMF.

The race for renewable energy has passed a turning point. The world is now adding more capacity for renewable power each year than coal, natural gas, and oil combined. And there’s no going back. The shift occurred in 2013, when the world added 143 gigawatts of renewable electricity capacity, compared with 141 gigawatts in new plants that burn fossil fuels. According to an analysis presented at the Bloomberg New Energy Finance annual summit in New York, the shift will continue to accelerate, and by 2030 more than four times as much renewable capacity will be added.

The price of wind and solar power continues to plummet, and is now on par or cheaper than grid electricity in many areas of the world. Solar, the newest major source of energy in the mix, makes up less than 1 percent of the electricity market today but will be the world’s biggest single source by 2050.

Earnings reporting season kicks into high gear. JPMorgan Chase posted stronger-than-expected earnings growth, helped by a rebound in fixed-income trading. Revenue rose 5 percent. Wells Fargo reported first-quarter earnings that topped expectations. Wells Fargo said low interest rates pushed first-quarter lending margins below 3 percent for the first time since the 1990s. Johnson & Johnson reported adjusted earnings that topped expectations, but the consumer products giant also cut its full-year forecast, citing the impact of a strong dollar. Late Monday, Norfolk Southern forecast a surprise drop in its first-quarter earnings and revenue. Intel reported a 3% growth in first-quarter earnings on flat revenue growth as the semiconductor giant was hurt by softer demand for personal computers and impacts from a stronger dollar. For 2015, Intel said it now expects revenue to be flat from a year ago.

Cyberattacks and cybercrime against large companies – those with over 2,500 employees – rose 40% globally in 2014, according to Symantec’s annual Internet Security Threat study published Tuesday. Attacks on small- and medium-sized companies, which accounted for 60% of targeted attacks, increased 26% and 30%, respectively. Despite the large hacks at Home Depot, JPMorgan, Staples and Sony, Symantec says the mining industry, which includes oil & gas, was the most-targeted sector last year.

Nokia is in talks to buy smaller telecom equipment maker Alcatel-Lucent in a deal that would combine the industry’s two weakest players. In a joint announcement, the Finnish and French companies said they were in “advanced discussions” on a “full combination, which would take the form of a public exchange offer by Nokia for Alcatel-Lucent.” The two, which have been seen as a possible combination for the last several years, cautioned that the discussions could still fall apart. The pair are a good fit in terms of products and geographies, and bulking up would help them cut costs as they try to compete with much larger competitors in the mobile market.

Amazon and HarperCollins have reached a new multi-year publishing deal – expected to go into effect this week – that covers both print and digital titles. The agreement calls for HarperCollins to set the retail prices of its digital books, with incentives for HarperCollins to provide lower prices to consumers. In November, Amazon ended its brutal battle with Hachette over print and e-books, following a six month stand-off that battered the French-owned publisher’s sales.

United Launch Alliance, a joint venture of Lockheed Martin and Boeing, has unveiled a reusable rocket named “Vulcan” that is slated to take off in 2019 and end US dependence on Russian-built rocket engines. Russian-made RD-180 engines currently power ULA’s Atlas rocket, but Congress has banned further imports as part of trade sanctions enacted after Russia invaded Ukraine last year. Vulcan’s reusable engines are likely to slash satellite-launch costs and provide a stepping-stone to various commercial space ventures.

Space X has been working on a reusable rocket, the Falcon 9. After bad weather yesterday forced a delay, the Falcon successfully launched today, and will delivered its cargo to the International Space Station; the reusable part of the rocket then landed on a floating platform in the Atlantic Ocean, but it came in a little hot and the 140 foot tall rocket tipped over and fell into the water. Turns out rocket science is difficult after all.

Wednesday, July 09, 2014 - Waiting for Liftoff

Financial Review with Sinclair Noe

DOW + 78 = 16,985

SPX + 9 = 1972
NAS + 27 = 4419
10 YR YLD - .02 = 2.54%
OIL – 1.46 = 101.94
GOLD + 7.00 = 1327.60
SILV + .08 = 21.10

 

The Federal Reserve released the minutes of the most recent FOMC policy meeting from June 17-18.

The Fed is going to take away the punchbowl. As of October, no more punchbowl. That’s it, QE is drying up. I think we all knew that was coming. And then after the Fed stops buying Treasuries and mortgage backed securities, they will get around to probably raising their target on interest rates, but rates would remain near zero for a “considerable time” (probably the spring of 2015) after the Fed halts its program of bond purchases.

According to the minutes, there continues to be division over when the Fed should stop reinvesting proceeds of the $4.2 trillion in assets it purchased to support financial markets. Ending reinvestment will put the central bank's balance sheet on a declining path, and some members argue that should not take place until interest rates have been increased. Fed officials also agreed that the rate of interest on excess reserves would play a “central role” in moving rates higher when the time comes.

And this is a fluid timeline for all this; it is partly dependent on “liftoff”; that’s the new word from the Fed – liftoff. At some point, the economy will slip the surly bonds of earth and wheel, soar, and swing high in the sunlit silence, and do a hundred things we haven’t dreamed of for such a long, long time. Someday, we’ll have liftoff.

The market players looked at the minutes and pulling away the punchbowl, while painful, was an indication of economic strength. Fed officials expressed overall confidence that moderate economic growth will continue and unemployment and inflation will gradually move towards the central bank's targets. A couple of participants noted that consumer spending had been supported importantly by gains in household net worth while income gains had been held back by only modest increases in wages. So, an important element in the economic outlook was a pickup in income, from higher wages as well as ongoing employment gains that would be expected to support a sustained rise in consumer spending. Which is correct in theory; we just haven’t seen the pickup in income.

At the press conference after the June meeting, Fed Chairwoman Janet Yellen said that recent inflation readings were “noisy.” According to the minutes, the Fed staff was not concerned with inflation despite some recent higher readings. Although the Fed staff revised its inflation forecast up “a little” in the near term, the medium term projection was revised down slightly.

Yesterday I talked about an anomaly in the jobs number from Thursday. How could we have negative 2.9% GDP in the first quarter while we were adding all those jobs? I concluded that the problem was that productivity was declining.

New data was released this morning showing US productivity growth was the worst since the recession. The data from the Labor Department looks at multifactor productivity, and it includes the impact of capital, new machines, investment in technology, and such. The measure of capital services input grew 1.9%, which is the best showing since 2008, but that is more a reflection of the bounce from the 1st quarter, and still far from the pre-recession levels that were consistently above 3%. So, the data in this morning’s report is consistent with an economy coming out of a recession but nowhere near its pre-recession rate of growth. Bottom line is that productivity needs to increase if the economy is going to get better.

One of the concerns for Fed monetary policy is inflation, which isn’t a problem right now and when we have seen a problem in the past 20 years of so, the Fed has been able to tamp it down. The problems with inflation right now are tied to energy and food prices. Food prices are largely tied to weather, and we have seen some nasty weather, and the Fed can’t control the weather. Extreme weather will be an ongoing problem, and rising food prices will be an ongoing challenge, but for now, it’s a short term inflation problem.

Energy prices are largely tied to geopolitical problems in the Middle East. Iraq, Israel, Syria, and other problems could explode out of control at any given moment, but we’ve seen crude oil prices dropping for 9 sessions. The problem in Iraq may very well result in the country splitting apart, but the southern regions, which produce and export the most oil, will likely continue exporting oil. So, the oil traders don’t seem concerned about Iraq divided in 3 parts. Meanwhile, Ukraine hasn’t unfolded as Putin planned. Kiev did not roll over. Sanctions are painful. Putin doesn’t look like he wants to escalate the fight; at least not today.

Meanwhile, the US is more or less on track to pass Russia and Saudi Arabia as the world’s largest producer of crude oil within the next 5 years. Domestic crude output is increasing but the increase is coming from shale and shale is notoriously tricky and expensive to extract. The US will continue to extract more shale oil but certain projects, even mega-projects, have been abandoned because of the expense. We know that there are huge reserves in the US, but it doesn’t always pay to pump it; so the increase in output may not be as strong as hoped. For now, prices are high and oil extraction is soaring at shale formations from Texas to North Dakota as companies split apart rocks using high-pressure liquid, or fracking. The result is that now Oklahoma has more earthquakes than California, and we are less dependent on foreign oil.

The United States has just become the world’s biggest oil producer, at least when you consider crude oil plus natural gas together. The US has been the top global nat gas producer for the past 4 years, but a new report from Bank of America says that in the first six months of this year the US overtook Saudi Arabia and Russia to become the top producer of petroleum product, that is oil and natural gas and the liquids that are separated from nat gas.

Annual investment in oil and gas in the US is at a record $200 billion, reaching 20% of the country’s total private fixed-structure spending for the first time, but it will take some time for that investment to work its way through the rest of the economy. We now produce about 11 million barrels a day of crude oil and we consume about 18.5 million barrels a day. So despite the boom, we still import oil and we are still dependent on OPEC. If we converted from oil and gasoline to nat gas, starting running more cars on compressed natural gas, we could become energy independent in short order.

The other side of the equation remains conservation and not just a switch to nat gas but a switch to renewable energy. You think green energy is too expensive? Tosh; tosh and falderal. Global energy markets are reaching a tipping point. For the first time, a large fraction of the world's fossil fuels could be replaced at a lower cost by clean energy, with today's renewable technologies and prices. And virtually no further investments in fossil fuels make long-term economic sense because higher fossil fuel prices over their useful life will be exorbitant.

Barclay's Bank recently downgraded the entire US utility sector in fear that it would not respond to the disruptive challenge of distributed solar. The Barclays credit team believes that, over the next few years, the “confluence of declining cost trends in distributed solar photovoltaic (PV) power generation and residential-scale power storage is likely to disrupt the status quo.” The new government in India is cutting fossil fuel subsidies and promising to provide rooftop solar for 400 million homes. Conservation is another important element. Profitable building retrofits would cut fossil fuel used for heating and cooling by 20%, and displace another 15% of fossil fuel electricity demand.

International oil companies are hitting the wall on the price they will pay for big new oil projects. There is plenty of oil in Ohio but BP, in its last quarterly report, announced it would halt development of the Utica shale fields. Along with BP, Chevron, Shell, Total, Statoil, and Exxon have all cancelled or delayed mega projects or even sold off major investments in US oil projects

The latest Bloomberg New Energy Finance projection suggests that 2/3 of incremental global power generation over the next fifteen years will come from renewables. Declines in coal use in developed economies will be sharp enough to cut the global share of fossil fuels from 64% today to only 44% in 2030.

Electricity currently provides only 1% of global transportation energy; EV's and rail could today replace the first 15% of the oil used by cars and trucks at with an internal rate of return higher than 15%. Fossil fuels generate 63% of the world's power, renewables less than 5%, but 1/3 of fossil electricity now costs more than competing wind and solar. And that doesn’t even begin to factor in the externalities associated with fossil fuels.

A couple of quick notes as we wrap up. Citigroup is reportedly close to paying about $7 billion to resolve a probe into whether it defrauded investors on billions of dollars’ worth of mortgage securities in the run-up to the financial crisis. A majority of the settlement is expected to be in cash, but the figure also includes several billion dollars in help to struggling borrowers. An announcement of the settlement between the bank and the Department of Justice could come as early as next week.

This bit of economic data came in late this afternoon. The Arizona Regional Multiple Listing Service shows the Phoenix market saw overall sales in June drop 11% year over year; now back to the lowest sales since 2008. Non-cash sales were up 6% year over year, but cash sales were down 40%; so it looks like investors are moving on. Active inventory is up 43% year over year and at the highest level for June since 2011. So, sales are down, inventory is very high, and cash is scarce.

When do we start QE4?

Tuesday, June 10, 2014 - Equity Party in the Wormhole

Financial Review with Sinclair Noe

DOW + 2 = 16,945
SPX – 0.48 = 1950
NAS + 1 = 4338
10 YR YLD + .02 = 2.63%
OIL - .22 = 104.19
GOLD + 7.90 = 1260.90
SILV + .13 = 19.29

The Dow Industrial Average hit another record high close; the fourth consecutive record. How did the Dow manage to move higher? Who knows? It wasn’t a big move but any positive results in a new record. How now Dow? Maybe it has something to do with the Federal Reserve and the other central bankers vacuuming up all the toxic detritus from the world of finance, pushing rates to sub-zero; leaving investors with little choice but a move to equities. Maybe global corporations have found a way to squeeze extra value out of a bone dry economy. Maybe the major indices have entered a cosmic wormhole devoid of common sense.

Today’s case in point is Uber, which is an app designed to connect riders with cars and drivers; which sounds a lot like hailing a taxi, but this is different because you can hail the taxi and pay the taxi with your smartphone; which means it’s software that eats taxis. Uber is different mainly because it is worth about $18 billion; which means it is worth more than most of the companies in the S&P 500 index. It’s an equity party, and for now at least, nobody is turning out the lights.

Friday’s jobs report was run of the mill; the economy added 218,000 jobs and the unemployment rate held steady at 6.3%. Today, we get a positive follow-up from the Labor Department, saying there were 4.7 million hires in April, the most since June 2008. By comparison, before the financial crisis, we averaged about 5.04 million hires per month. And workers’ opportunities look to be improving, too. There were 4.46 million job openings in April, the most since September 2007, up 17% from a year earlier.

OPEC is meeting in Vienna this week. The oil production cartel, which controls about 40% of global oil supplies, has imposed a 30 million barrel-per-day production ceiling for all 12 members’ output for the last two years. And the current price range of $100 to $110 a barrel seems to be the sweet spot; not too high to reduce demand; not too low to cover costs and national budgets. North American crude oil production is expected to be a major topic of discussion.

Estimates of North American oil supply have increased to 18.5 million barrels a day from 18.2 million six months ago, driven by US production at 11.4 million barrels a day. In 2012, the International Energy Agency (IEA) forecast that the US would outpace Saudi Arabia in oil production thanks to the shale boom by 2020, becoming a net exporter by 2030. The forecast was seen by many as decisive evidence of the renewal of the oil age and the end of peak oil. Not so fast.

This week, the IEA released its World Energy Investment Outlook which says that US oil production, drawing largely from the Bakken in North Dakota and the Eagle Ford in Texas, will peak around 2020 before declining. The US government’s Energy Information Agency recently downgraded its assessment of the Monterey Shale oil fields by 96%. The shortfall will make the US, and countries in Europe looking to import from America, increasingly dependent on Middle East supplies.

The report states: "… there is a risk that Middle East investment fails to pick up in time to avert a shortfall in supply, because of an uncertain investment climate in some countries and the priority often given to spending in other areas."

The IEA report reveals that over 80% of oil company investment is going into making up for exhausted fields where production is in decline. The agency also calls to ramp up investments in renewables and increasing efficiency, along with regulatory reform to incentivize investments, as part of the package. This is where we are headed.

Warren Buffet’s Berkshire Hathaway has been expanding its utility business in Nevada and Canada; and Buffet plans to increase the investment in renewable power. At the Edison Electric Institute’s convention in Las Vegas yesterday, Buffet said, “We’ve poured billions and billions and billions of dollars in retained earnings, and several billion of additional equity, and we’re going to keep doing that as far as the eye can see.”

Berkshire Hathaway Energy has $70 billion in assets and more than 8.4 million customers worldwide, according to its 2014 brochure. It has more than 34,000 megawatts of power generating capacity owned or under contract. Wind, solar, hydro, geothermal, and other renewable plants account for about a quarter of capacity, representing about $15 billion.

Yesterday Buffet said: “There’s another $15 billion ready to go, as far as I’m concerned.” Unlike other utility-holding companies, Berkshire Hathaway Energy retains all of its earnings. That probably will continue, Buffett said yesterday, estimating that the unit could reinvest about $30 billion into its business in the next decade.

Investments in renewable energy will be needed as the US seeks to reduce its reliance on fossil-fuel generation. Electric utilities face cuts of 30% in carbon dioxide emissions by 2030 compared with 2005, based on proposed regulations issued by the EPA on June 2.

Yesterday we talked about a Merger Monday. It has been a busy year for mergers and acquisitions. Some of the deals are all cash, as many corporations are sitting on piles of cash; but many deals are still done the old fashioned way, with leveraged lending. The Wall Street banks are more than happy to overload companies with too much debt for the simple reason that it is one of the most profitable forms of loans for the banks. Banks’ fees on US junk-rated loans stand at $4.9 billion so far this year, a year-to-date record and up 10% from the same period last year.

The Federal Reserve, the Office of the Comptroller of Currency, and the FDIC have issued guidelines to restrict banks making loans in deals like leveraged buyouts that would leave a company with debt levels that are more than 6 times its annual cash flow. Wall Street banks immediately started looking for loopholes, and the newest trick is to issue bonds that would split the overall debt load between a holding company and its operating subsidiary.

Companies typically borrow at the operating company level through loans. Since the loans can be secured against the company's assets, they are cheaper than other options. They can also borrow through the holding company by issuing bonds. Payments on those securities are made from the cash that remains after the liabilities of the operating company are met, making them riskier than operating company loans.

Many holding company bonds are structured as payment-in-kind (PIK) notes that pay interest by adding to the outstanding principal rather than returning cash to the bond's holder. Such bonds are expensive for the issuer and the risk involved makes the investor universe limited, but the market has been growing as investors chase yield.

We’ve seen this story before. You may recall the case of the $48 billion leveraged buyout of Texas power utility Energy Future Holdings in 2007, the biggest LBO in history. The deal's $40 billion debt was equal to 8.2 times adjusted EBITDA (earnings before interest, tax, debt and amortization). Energy Future filed for bankruptcy earlier this year, one of the largest bankruptcy cases ever.

For now, the banks are violating the 6 times annual cash flow limit, most of the time, but it’s a tactical decision. Three longtime banks for private equity firm KKR snubbed a request for a $725 million buyout loan for Brickman over concerns it was too risky to pass muster with US regulators, in spite of the firm’s strong track record of leveraging up and then reducing debt quickly. Others banks are trying to guess how big the fines could be, and weighing that up against the fees for underwriting such deals.

Welcome to the wormhole.