Financial Review

Live Long and Prosper

Sinclair Noe — February 27, 2015

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DOW – 81 = 18,132
SPX – 6 = 2104
NAS – 24 = 4963
10 YR YLD – .01 = 2.00%
OIL + 1.03 = 49.20
GOLD + 4.50 = 1214.70
SILV + .04 = 16.67

We are wrapping up the first 2 months of trading. January was a down month for stocks, but February turned positive, with record high closes posted for the Dow, the S&P 500 and the Russell 2000. The Nasdaq went almost entirely green for the month, closing in on 5000, and actually setting a new monthly closing high, taking out the March 2000 monthly close of 4572.

For the month, the Dow Industrial Average gained 5.6%, the S&P 500 gained 5.5% and the Nasdaq added 7.1%, and the Russell 2000 added 5.8%. Year to date, , Dow Jones Industrial Average +1.7% YTD, S&P 500 +2.2% YTD, Nasdaq Composite +4.8% YTD,  and the Russell 2000 +2.4% YTD.

Junk bonds are poised to deliver gains of 2.3% for February, the best monthly result since 2013, while investment-grade debt has registered losses. Investors are also returning to the equity markets, with the MSCI All-Country World Index touching a record Thursday after two losing months. Markets in Germany, the United Kingdom and Sweden hit all-time highs. Japan, the poster child of deflation, saw its stock index reach its highest point in 15 years. This should confirm that markets love it when central banks crank up the printing press. Even Greece saw its stock market tick up.

Part of the risk-on sentiment is because oil dropped, fast and hard, and nobody was quite certain where prices would go. Nobody likes to try and catch a falling knife. Oil started the year at $54.26 a barrel, dipped down to $44.37, which now provides support, and is basically back where it was at the start of February hovering right around $49 to $50. Gold is up about 2.5% year to date but down from the highs of 1308 in late January. And the CRB Commodity index is down 2.5% year to date.

Wall Street has traded in a tight range of late, with both volatility and trading volumes drying up as the earnings season winds down and Federal Reserve Chair Janet Yellen’s recent Congressional testimony delivered no surprises. While markets have held near record levels, whenever we hit records traders worry equities have gotten stretched and could be vulnerable. Yale professor and Nobel prize winner Robert Shiller’s measure for stock values, the Shiller P/E, is at levels last seen before the financial crisis. Consider also that 71% of IPOs had no earnings the day the company went public, a level last seen in the Dot-com bubble. That’s a lot of investing in stocks that only have promises and projections.

The most important economic data next week will be the monthly jobs report. Best guesstimate is that the economy added about 235,000 to 240,000 jobs in February. Of course, we still have to get past Friday, and in Washington the politicians are still trying to figure out how to keep the Department of Homeland Security open for business. On a 68-31 bipartisan vote, the Senate cleared a so-called “clean” DHS bill, after stripping out provisions that would have blocked President Obama’s recent executive orders on immigration. Now, it is up to the House to take action, and the best that might happen is a 3 week extension.

The U.S. economy grew a revised 2.2% in the fourth quarter of 2014, mostly because companies restocked warehouse shelves at a slower pace than the government originally reported. Gross domestic product was marked down from an original estimate of 2.6%; still, it was better than estimates of a mark-down to 2%. But the slower pace of growth actually might be good news: One of the key reasons growth was revised lower was company inventories were smaller than first thought in the fourth quarter. That could signal slightly stronger growth at the start of 2015, as companies stocked up for the American consuming public.

Moreover, imports rose more than first expected, resulting in a larger trade deficit, which in the calculus of GDP actually subtracts from growth. But that also suggests that American consumers are gaining strength. Consumer spending continued to rise at a 4.2% clip in the fourth quarter, the most since the last three months of 2010. Demand for services climbed 4.1 percent, the most since 2000.

Revisions to third-quarter personal income also showed the picture brightening. Wages and salaries rose by $87.2 billion, a $20.5 billion improvement from the prior estimate. Preliminary data for the fourth quarter showed a $94.4 billion advance. Job growth has strengthened over the past year, with payrolls rising 257,000 in January to cap their strongest three-month run in 17 years.

For all of 2014, the U.S. economy grew at a 2.4% clip, compared to 2.2% in 2013. You will recall that the first quarter of 2014 was negative, with bad weather taking the blame; today we see that the fourth quarter was pretty tame, but the summer was sizzling with economic growth around 5%. The hope is that the summer of 2015 might be just as strong.

One area of weakness might be in manufacturing. The Institute for Supply Management-Chicago Inc.’s business barometer slumped to 45.8 in January from 59.4 the prior month. It was the first time the measure dropped below 50, signaling contraction, since April 2013. The 13.6 point plunge was the second-biggest in data going back to 1979, only behind a 19.2 point plunge at the height of the meltdown in financial markets in October 2008. The magnitude of the drop suggests special circumstances, such as the work stoppage at West Coast ports or bad weather, were at play, although we won’t know if this was a one-off report until next month.

A report showing more Americans signed contracts to purchase previously owned homes in January rounded out a week of housing data that depicted an uneven recovery. The index of pending sales climbed 1.7 percent after a 1.5 percent drop the prior month that was smaller than initially estimated, according to data from the National Association of Realtors. Pending sales are a leading indicator because it tracks contract signings, as opposed to purchases of existing homes, which are tabulated when a deal closes, typically a month or two later.

Germany’s parliament approved an extension of Greece’s bailout today. Other EU countries are expected to vote in favor of the deal. The terms of deal aren’t going over well in Athens; protesters were angry at a pending deal to extend Greece’s financial bailout package with international creditors. The Syriza party, which came to power in Greece on a promise to roll back Troika imposed austerity, does not accept a strict, minimalist reading of the Eurogroup text. Look for Syriza to cancel privatization of ports and airports. Look for Germany to get upset.

Earlier this week, International Monetary Fund Director Christin Lagarde threw cold water on the tentative agreement between Greece and the EU warning that many of Athens’s pledges were vague and “not conveying clear assurances that the government intends to undertake the reforms envisioned.” Lagarde may want to moderate her insistence that everyone follow rules as if they were set in concrete, considering that the IMF itself has been so flexible with its own rules when it suited its managing directors. As the fight has unfolded, some of the IMF’s skeletons have been exposed, including the fact that the IMF bent rules to stick Greece with unpayable debts in the first 2010 bailout, and then imposed austerity measures that knowingly plunged the country into depression.

It is clear that Syriza aims to test how much freedom of action it has. This guarantees a fresh fight at the end of April, when EMU inspectors will demand proof that reform legislation is being enacted and enforced, and an almost certain showdown in June when Syriza’s four-month reprieve expires. It must then negotiate a third bail-out or face hostile markets alone. It could hardly be worse than what the IMF has already done to Greece.

Tomorrow, Warren Buffett will release his annual letter to shareholders, and this year’s letter is special because it marks the 50th anniversary of Buffett’s purchase of a struggling New England textile maker known as Berkshire Hathaway.  Buffett appears to be in a particularly reflective mood. In December, he said he had already composed around 20,000 words, or around 30 pages, roughly twice the typical length.

Of course investors love to follow the Buffett letters; you can learn a lot. In 2008, when Buffett famously “bet on America” by investing $5 billion in Goldman Sachs he left out the part where he bought preferred shares priced at a discount, paying a 10% dividend and offered only to him. Because of those provisions Buffett’s stake in Goldman is up about 200% more than anyone who thought they were buying alongside him. Maybe the most important thing we can learn from Warren is that we can’t really invest like Warren.

Leonard Nimoy passed away today. Of course he played the role of Spock on Star Trek. In 1973, Martin Cooper made the first cell phone call; Cooper said he was inspired by Star Trek and Captain Kirk’s gold flip top communicator. One of the first pieces of technology to come out of Star Trek was the automatic door. Today, you can find that once futuristic technology at any corner store. Spock and Kirk and the crew of the Starship Enterprise had technology that allowed them to understand any alien language thanks to a universal translator; today we have Google translate.

Those giant view screens on the bridge of the starship; today we have skype and GoToMeeting. The tricorder now goes by the brand name Scanadu. Transparent aluminum is now called ALON and it is made by a company called Surmet. Remember when Kirk or Spock would talk commands to the computer; today we have Siri, Cortana, and OK Google. We can’t send people through a transporter, but we can lock in on a location with GPS. And we don’t have a holodeck but that should change next year with the release of Windows 10.

Live long and prosper.

Thursday, August 21, 2014 - Rarefied Air

Financial Review with Sinclair Noe

DOW + 60 = 17,039
SPX + 5 = 1992
NAS + 5 = 4532
10 YR YLD - .02 = 2.40%
OIL + .45 = 93.90
GOLD – 15.10 = 1277.30
SILV - .04 = 19.52
 

The S&P 500 broke two records during today's session, climbing past its previous intraday all-time high of 1,991.39 and ending above its previous record close of 1,987.98. Both had been set on July 24.

Family Dollar has rejected a $9 billion dollar buyout offer from Dollar General, opting instead for a smaller $8.5 billion dollar offer from Dollar Tree. The thinking is that a combination of the largest dollar store – Dollar General with the #2 Family Dollar, would be unlikely to win antitrust approval.

Once upon a time, Sears was the largest retailer in the nation. Today, Sears Holdings announce it lost $975 million in the first half of the year; $573 million in the second quarter. This was the 9^th consecutive quarter of losses, and the past quarter also marked the heaviest losses. Quarterly revenue dropped about 10%. The plan now is to close underperforming stores, or, in a classic example of corporate-speak “rationalizing our physical footprint.” The company successfully spun off Lands End earlier this year, to the benefit of shareholders. But its Sears Canada and Sears Automotive stores have been on the block for some time, indicating either a lack of interest on the part of buyers or an unwillingness by Sears to bend on its asking price.

Gap shares moved higher in after-hours trade after earnings topped expectations. With a few exceptions, retail earnings this quarter have been disappointing. Last week, Walmart cut its full-year earnings guidance, and a few days later, Target reported a disappointing quarter. It’s hard to get consumers to loosen their grip on the purse strings.

The National Association of Realtors said sales of existing homes rose 2.4% in July to a seasonally adjusted annual rate of 5.15 million, the fourth consecutive month of gains and the fastest rate of gain in 10 months. More people are buying homes compared to earlier in the year, but the sales pace is still down 4.3% from one year ago. The median existing-home price for all housing types in July was $222,900, which is 4.9% above July 2013. This marks the 29th consecutive month of year-over-year price gains.

In a separate report, the Labor Department said initial claims for state unemployment benefits fell 14,000 to a seasonally adjusted 298,000 for the week ended Aug. 16.

The Conference Board’s Leading Economic Index increased 0.9% last month after an upwardly revised 0.6% rise in June.

The Bureau of Economic Analysis, the BEA, has released its state by state analysis of quarterly gross domestic product. California has the biggest economy among the states, with about $2.1 trillion in GDP, followed by Texas at $1.4 trillion, and New York at $1.2 trillion. Vermont has state GDP of about $28 billion. Arizona comes in at almost $265 billion.

The latest numbers from the Census Bureau show the gap between Americans at the top of the economic ladder and those at the bottom is as wide as ever. Between 2000 and 2011, the gap expanded considerably. The net worth of the poorest 20% of US households fell by $5,124. At the same time, the wealthiest 20% posted a $61,379 increase in net worth. Looked at another way, the net worth of the richest 20% of families totaled $630,754 in 2011. The poorest had a negative net worth of $6,029. Altogether, the top 40% of households increased their net worth from 2000 to 2011. The bottom 60% lost ground.

Sentier Research has analyzed Census data on incomes. In June 2014, the median household income was $53,891, down from $55,589 in inflation-adjusted dollars when the economic expansion began in June 2009; that is a 3.1% drop in median income. Now, let’s clarify this report because you may have seen that the average inflation adjusted per-person disposable personal income is up 4.2% over the past 5 years. There is a difference between median and average; Bill Gates walks into a room with 80 other people and the average net worth of everyone in the room is about one billion dollars; while the median net worth is barely changed. The averages can be distorted by the strong income gains among the wealthiest; the median income numbers give a better sense of the majority of Americans.

And it’s not just the past 5 years; median income remains lower than back in January 2000; the middle income family is worse off than they were 14 years ago. The good news is that there has been some improvement in the past 3 years; since 2011, inflation adjusted household incomes are up 3.8%. We are starting to dig out of a hole, but we’re still digging.

The point is that the economic recovery has been pretty miserable for most Americans. Meanwhile, the Federal Reserve is holding its annual confab for the world’s most powerful financial players at Jackson Hole, Wyoming. The invitation only soiree includes central bankers, investment bankers, economists, and a various assortment of other bigwigs. Tomorrow morning, Fed Chair Janet Yellen will deliver the customary opening speech. ECB President Mario Draghi will speak at lunch. This year’s theme is “Re-Evaluating Labor Market Dynamics”.

In the mountains of Wyoming, the air is thin, and around Jackson Hole, it is rarefied: One banker was quoted as saying: "It seems that conditions reflect the best of all worlds - US economic growth that is neither too slow, which would put pressure on earnings - nor too fast, implying inflationary pressures which could lead to (price-to-earnings ratio) contraction and possibly accelerate the Fed's move towards higher interest rates."

Kansas City Federal Reserve Bank President Esther George says the time has come for the Fed to raise rates, citing improvement in the labor markets. George said: "I don't want us to be behind the curve in beginning to normalize interest rates… When you see the economy getting as close as we are to full employment, to stable inflation, it would suggest to me that the time has come to do that… I think a very natural response when you get to this point is worrying that you might derail the recovery, but then again we've seen data come in stronger than we expected."

Fed officials are convinced that the economy is gaining strength after the years of false starts, but a majority of policy makers, led by Janet Yellen, favors a slow retreat from the Fed’s efforts to encourage job creation. They note that millions of people still cannot find jobs, while inflation remains relatively weak.

The theme is the labor market, and the Fed tracks wage trends closely because they're an important inflation indicator, and they're also a reflection of how close the economy is to full capacity. Also, in a well-functioning economy, wages should be rising particularly when productivity is going up. The Fed can't really do anything to get wages up; what it can do is wait to raise interest rates until the job market is healthier and that's what they're debating now - should they wait a while longer?

The latest government data show average hourly earnings adjusted for inflation have not increased at all in the last year, even though we're told the economy is getting better and other wage measures show similar trends. The problem with Jackson Hole is somebody like Bill Gates walks into a restaurant, and all the economist believe they are billionaires.

It is shaping up to be another good year in the equity markets, not as good as last year, but not a letdown; investors have ignored the calls for a correction, and this is still a risk-on market. Typically, when risk is not given much weight, this would be a good time to hedge one’s portfolio. And the reason for “risk-on” is a Federal Reserve that keeps interest rates at historic low levels; add in the demographics of most investors who have no choice but to stick what they have into higher risk assets such as stocks; plus the corporate world that is sitting on cash and the closest idea to innovation is to buy back their own stock, thus pushing prices even higher.

In this environment, weakness in the economy and even geopolitical events are being disregarded, with both being seen as buying opportunities. Investors might not have much choice but to hang onto the bandwagon, but you also should be keenly aware of when you need to get off because the markets could switch to risk-off in the blink of an eye.

The Bank of America settlement deal was announced today. BofA agreed to pay $16.65 billion to end federal and state investigations into the sale of toxic mortgage securities during the subprime housing boom; actually, it works out to $9.65 billion that will actually be paid, plus $7 billion in soft-consumer relief; minus about $600 million in tax deductions. About $5 billion of the cash portion of the settlement is paid as a penalty to the US Treasury. Other portions will go toward compensating investors, including state pension funds. Just under $1 billion will be split among six states.

Under the out-of-court settlement, Bank of America acknowledged that Merrill Lynch told investors in subprime mortgage bonds in 2006 and 2007 that the loans generally complied with underwriting guidelines, though reviews suggested as many as 50% did not. Bank of America also acknowledged that Countrywide did not generally tell investors the extent to which it made exceptions to its own internal guidelines. The settlement also covered some post-crisis conduct, including Bank of America's admission that from 2009 to 2012 it submitted loans for government insurance under the Federal Housing Administration that did not qualify.

The statement of facts failed to identify the amount of profit the bank gained, or show how the penalty will restore losses to investor victims. No individuals were charged. Maybe we can blame robots.

Bank of America shares jumped 4.1% to $16.16; the thinking is that the worst is behind them. The bank had already set aside reserves to handle the legal problems and the thinking is that this settlement is the settlement to end all settlements. Ultimately it works out to about a half year’s profit, give or take; you know, the cost of doing business.