Financial Review

Spend Your Time Wisely

Sinclair Noe — June 30, 2015

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DOW + 23 = 17,619
SPX + 5 = 2063
NAS + 28 = 4986
10 YR YLD un = 2.33%
OIL + 1.14 = 59.47
GOLD – 7.50 = 1173.60
SILV – .09 = 15.77

Today marks the end of the second quarter; we are halfway through the year. The stock market has been trading in an extremely tight range. After a weak January and a rebound in February, the major indices have moved sideways for 4 months. The Dow Industrials are down 204 points for the first half; the Nasdaq Composite is up 250 points for the first six months; the S&P 500 gained 5 points year to date. The S&P 500 is in the tightest trading range for the first half of a year in more than 2 decades. At some point it will break up or break down; as it is 2015 marks the worst first half of a year for the S&P 500 since 2010.

For the month of June, the Dow fell 2.2 percent, the S&P 500 fell 2.1 percent and the Nasdaq fell 1.6 percent. For the second quarter, the Dow fell 0.9 percent, the S&P 500 fell 0.2 percent. For the Dow and the S&P, that snaps a string of 9 consecutive quarters of gains. The Nasdaq rose 1.8 percent in its tenth straight quarterly advance. During the quarter, the Nasdaq hit its first records since the height of the tech bubble

Historically speaking, the ends of quarters tend to exhibit weakness, as portfolio managers tend to position themselves for the next quarter; it’s called portfolio pumping or window dressing.  The last day of the second quarter is a bit of a paradox as “portfolio pumping” has driven the Dow down 17 of the last 24 years while buoying the NASDAQ and Russell 2000 higher in 16 of those years.

Companies in the S&P 500 reported profit growth of just 0.8% in the first quarter, according to FactSet. In the second quarter, they are set to shrink 4.5%. Wall Street analysts often undershoot their profit forecast, so actual profits are likely to come in higher. But that is little comfort to investors staring at a stock market that has grown increasingly pricey. The S&P 500 trades at 17.9 times the past 12 months of earnings, up from 17.1 at the start of the year and close to a five-year high, according to FactSet. The average P/E for the last 10 years is 15.7.

U.S. government bonds have had their biggest quarterly selloff since December 2013. The yield on the benchmark 10-year Treasury note was 2.335% at the end of trade today. It has climbed from 1.93% at the end of March, marking the first quarterly loss since the final quarter of 2013. Bond yields rise as prices fall. Treasury debt overall has handed investors a total return of negative 1.56% between the end of March and Monday. For the year, the return was 0.05%, following a 5.05% return during 2014. Return includes price gains and interest payments. Other U.S. fixed-income markets have also lost ground amid higher Treasury bond yields. U.S. investment-grade corporate debt was the biggest loser this quarter, with a negative return of 3.22% through Monday. Treasury inflation-protected securities lost 1.1%, municipal bonds have lost 0.86% and U.S. corporate bonds sold by lower-rated companies, known as junk bonds, lost 0.04%.

Greek politicians spent the day talking with their creditors, but it was not enough to avoid a default on Greek debt. The deadline was midnight in Brussels, about one hour ago. Greece did not make the €1.5 billion-euro payment. Reports earlier suggested European Commission President Jean-Claude Juncker made Athens a last minute offer. That was followed by reports that Greece had requested a 2-year bailout program from the European Stability Mechanism. Then German Chancellor Merkel rejected more talks before the July 5 referendum in Greece. In reality, the conditions up for a vote were taken off the negotiating table, so the vote is over an offer that no longer exists. The Greek government says it will open 1000 bank branches tomorrow to allow pensioners to cash their pension checks, at least up to €120-euro per week. Beyond that, nobody really knows what will happen next.

Markets across Asia bounced back today, while European indexes remain mixed. You may have heard that the Greek situation will not be harmful to US stocks; and while there was not a chaotic crash yesterday, about $1.5 trillion was erased from the value of equities in the Wilshire 5000 index, while the Dow dropped 350 points, to slip below its 200-day moving average. In the S&P 500, the drop in market capitalization of just 86 companies equaled the entire GDP of Greece (about $242 billion.)

Meanwhile, a new crowdfunding campaign has been set up on Indiegogo.com. With a goal of raising $1.8 billion, the “Greek Bailout Fund” aims to do what the Hellenic Republic’s creditors apparently cannot. And supposedly, every donation gets a postcard from Greek Prime Minister Alexis Tsipras.

Puerto Rico will seek to delay payments on the island’s $72 billion debt load for “a number of years” as part of a plan to bolster the commonwealth’s finances and revive its economy. Governor Alejandro Garcia Padilla appealed to Washington to make unprecedented, “concrete” changes in bankruptcy rules to help rescue the island’s finances. Although U.S. cities and municipalities are eligible to file for bankruptcy, states and Puerto Rico are barred from seeking protection through bankruptcy. And just for comparison, US banks have about $14 billion in direct exposure to Greek default, but almost all of Puerto Rico’s $72 billion in debt is held by US financial institutions.

China is now taking an all-hands-on-deck approach to soothe the country’s plunging stock market, after an unexpected weekend interest rate cut failed to right the ship. Late on Monday the finance and social security ministries published draft rules that would permit the state pension fund to invest up to 30% of its net asset value in securities, potentially allowing $97 billion to enter the market. The Shanghai Composite Index closed up 5.6%.

The Export-Import Bank will expire today at midnight for the first time since the federal agency was created during the Depression. The bank, which guarantees commercial loans for overseas customers of American exporters, will not exactly go out of business. Employees will continue to service all outstanding loans, but new loans won’t be guaranteed. Supporters of the bank, however, are hoping to attach legislative language restarting the bank to a must-pass transportation funding bill in late July, then dare opponents in the House to kill it.

The Conference Board’s U.S. consumer confidence index jumped to 101.4 in June from a downwardly revised 94.6 in May. Both the present situation and expectations indexes advanced.

Chicago PMI rose in June but remained under the 50 level, indicating a slight contraction in conditions. That’s the fourth month below 50 this year.

 U.S. existing-house prices rose 1.1% in April, with gains in all the cities tracked by the Case-Shiller 20-city composite index released Tuesday. With seasonal adjustment, prices rose 0.3%. Home prices in April were up 4.9% from a year earlier, slightly slower than annual growth of 5% seen in March. Home prices in Phoenix rose 0.8% in April, with a 3.5% gain for the past 12 months.

Federal Reserve Vice Chairman Stanley Fischer says the US economy probably bounced back to an annual growth rate of around 2.5 percent in the second quarter, and the labor market is approaching full employment. I’m not sure the Fed knows what full employment is. Back in the 1950s the US saw the unemployment rate drop down to 2.9% before it sparked inflation, which was quickly tamped down. The big problem facing the economy is not inflation but unemployment, which then puts a drag on demand. And so far we have not seen enough tightness in the labor market to lift stagnant wages. Fisher said: “We should not wait until we have reached our objectives to begin adjusting policy.” Which sounds a lot like: quit before you cross the finish line. Fisher also said the global situation remained a “significant headwind” for the United States.

For the most part, financial weakness overseas (whether in China or Greece and the Eurozone) is not much concern for the Fed, unless it turns into a significantly stronger dollar or a big hit to US economic growth. Fed officials signaled after their mid-June policy meeting they expect to raise rates in 2015 after keeping them near zero for almost seven years. Several officials have said since their gathering that September could be the time for liftoff. That’s their story and they are sticking to it, at least for now.

President Obama has unveiled a proposal that would make nearly 5 million more workers eligible for overtime pay, a move that touches nearly every sector of the U.S. economy and could face legal challenges. The change would allow salaried workers who earn up to $50,400 per year to qualify for time-and-a-half pay when working more than 40 hours per week as soon as 2016. Under current rules, only those earning less than $23,660 are automatically eligible for the overtime wages.

At 5PM Pacific, time will be stopped in its tracks for one second; a minute will have 61 seconds. It’s a “leap second”, not to be confused with a Leap Year, which won’t happen until 2016. Since 1967, when clocks went atomic, human timekeeping has been independent of the earth’s rotation. The problem is, the moon’s gravitational pull slows down the rotation of the earth; a long, long time ago one day was only about 22 hours; the planet is slowing down and clocks are not. So every few years, to get everything back in sync, scientists add a second. They’ve done it 25 times since 1972. The last time was 2012, but that was on a weekend. June 30 will be the first leap second during regular business hours.

One of the concerns is that computerized time does not know how to handle something like a leap second. And not all computer operators have made the adjustment. There could be hiccups in your computer. Nobody anticipates serious problems from this, the internet will not break, just a few minor glitches. The good news is that you now have an extra second. Spend your time wisely.

Wednesday, July 30, 2014 - GDP, Fed, Vultures, and Banksters

Financial Review with Sinclair Noe

DOW – 31 = 16,880
SPX + 0.12 = 1970
NAS + 20 = 4462
10 YR YLD + .09 = 2.55%
OIL - .72 = 100.25
GOLD – 4.30 = 1295.50
SILV + .06 = 20.72

Last week we told you that this week would be very busy. Well, here we are; today we had a big report on second quarter GDP and the Fed wrapped up a policy session, and that’s just the beginning. 

This morning, the Commerce Department reported the gross domestic product grew at a 4% pace in the second quarter. Boom. First quarter GDP was revised from negative 2.9% to negative 2.1%; but any way you look at it, this was a massive turnaround.

The government also published revisions to prior GDP data going back to 1999, which showed the economy performing much stronger in the second half of 2013, growing at a 4% pace, the strongest 6 months since late 2003. This was the first estimate of second quarter GDP, and the first revision will be released August 28.

Inventories added 1.66 percentage points to this GDP report. Stockpiles were rebuilt at a $93.4 billion annualized pace after a $35.2 billion gain in the first three months of the year. That could mean companies will keep tighter control on the number of goods on hand this quarter, which could cut into economic growth. Or it might mean companies are optimistic about sales.

Consumer spending rose at a 2.5% pace last quarter, which also topped expectations, and more than double the 1.2% advance in the first quarter of 2014, in part due to less spending on healthcare. Purchases of durable goods, including autos, furniture and appliances and recreational vehicles, jumped at a 14% annualized rate, the fastest since the third quarter of 2009. Despite the pick-up in consumer spending, Americans saved more in the second quarter. The saving rate increased to 5.3% from 4.9% in the first quarter as incomes rose, which bodes well for future spending.

Corporate spending on structures, equipment and intellectual property such as software increased at a 5.5% annualized rate after rising at a 1.6% pace in the prior three months. In addition to consumer spending and business investment, growth got a boost from the biggest gain in state and local government expenditures in five years. Congress is still debating spending for infrastructure improvements such as roads and bridges, and if they can’t work out differences that could prove a stumbling block later in the year. A widening trade gap subtracted 0.6% from growth. Excluding inventories and trade, so-called final sales to domestic purchasers climbed at a 2.8% rate, the biggest increase since the third quarter of 2011.

Still, the big swing from negative 2.1% contraction to positive 4% growth seems like a very big swing, almost freakish. We know that the first quarter was hit by bad weather and the polar vortex …, still. So, we can smooth out the numbers by looking at the full year growth rate; over the past 12 months the economy expanded at a 2.4% rate, pretty much in line with the past 3 years; in fact, 2.4% growth would be decent in normal times, but the economy is still in recovery mode, and 2.4% is not enough to achieve “liftoff”. The economy is headed in the right direction, it is gathering momentum, but it is still operating below potential. By the Congressional Budget Office’s estimates, the level of output reported for the second quarter is still $770 billion below the nation’s current economic potential, or 4.2% below. That implies that the nation still has plenty of room to grow if a faster expansion ever kicks in.

The economy is far from perfect, we have a long way to go, but today’s report indicates progress, real, honest to goodness progress.

A price index in the GDP report rose at a 2.3% rate in the second quarter, the quickest in three years, after advancing at a 1.4% pace in the prior period. A core price measure that strips out food and energy costs increased at a 2.0% pace, the fastest since the first quarter of 2012. The inflation picture should lend support to the Fed hawks who want to hike interest rates sooner rather than later, but for now the Fed is standing pat.

The Federal Reserve Federal Open Market Committee reaffirmed it was in  no rush to raise interest rates, even as it upgraded its assessment of the economy and expressed a level of comfort that inflation was moving up closer to its target, and the taper is  still on track. The Fed has kept overnight rates near zero since December 2008 and has more than quadrupled its balance sheet to $4.4 trillion through a series of bond purchase programs. The Fed announced, as expected, that it would reduce its monthly bond purchases to $25 billion per month, but it gave no indication that recent signs of stronger economic growth had changed its previously announced plan to hold short-term interest rates near zero well into 2015.

The Fed acknowledged both faster economic growth and a decline in the unemployment rate, but expressed concern about remaining slack in the labor market. The Fed’s statement said: "Labor market conditions improved, with the unemployment rate declining further… However, a range of labor market indicators suggests that there remains significant underutilization of labor resources."

Some Fed officials see evidence that the economy is settling into a pattern of slower growth, and that monetary policy has substantially exhausted its power to improve the situation. They want the Fed to retreat more quickly from its stimulus campaign, fearing higher inflation, or that it will encourage bubbles in financial assets. Fed chairperson, Janet Yellen, and her allies have taken a more cautious view, arguing that the decline in the unemployment rate appears to overstate the improvement in the labor market, because it counts only people who are looking for work. Yellen expects some people who had been discouraged about their job prospects will return to the labor force as the economy continues to improve, and she has pointed to weak wage growth as evidence that it remains easy to find workers.

More optimism for the economy came in a report from ADP, the payroll processing company; private employers added 218,000 jobs last month, which was down from 281,000 in June. It was the fourth straight month of job gains above 200,000. While ADP’s numbers offered reason to be hopeful, the company’s figures cover only private businesses and often do not track with the government’s jobs report, which will be released Friday.

The ratings agency Standard & Poor’s says Argentina has defaulted after it failed to make a $539 million interest payment due on its discount bonds. The downgrade came late this afternoon as representatives for Argentina and New York hedge funds sought to reach a last-minute agreement on Argentina’s debt. Yet after more than five hours of mediated talks, neither side appeared closer to a deal. Standard & Poor’s lowered its rating on the country’s debt to “selective default”, noting that Argentina had a 30-day grace period following the June 30 scheduled interest payment date to make payment.

This story goes back to 2001, when Argentina defaulted on tens of billions of dollars of sovereign bonds. It later exchanged those bonds for discounted ones with most of its bondholders, but a small group of traders, mainly hedge funds, led by Paul Singer’s Elliott Management refused to take the new bonds, even though they had purchased the discounted bonds after the default, at pennies on the dollar, they demanded full payment, and they have not backed down, and they took it to court in the US.

In 2012 a US federal judge ruled that Argentina could not make payments to bondholders who had agreed to discounted bonds, without paying the holdouts. Argentina appealed and took its case to the United States Supreme Court, which rejected the appeal last month. Argentina had until the end of the day to pay the holdouts or risk defaulting for a second time in 13 years.

A federal judge has ordered Bank of America’s Countrywide unit to pay $1.27 billion in penalties for defective mortgage loans sold to Fannie Mae and Freddie Mac in 2008. US District Judge Jed Rakoff in Manhattan issued the civil penalty against BofA in the first mortgage-fraud case brought by the federal government to go to trial. A jury in Manhattan found Countrywide liable. The judge determined that Fannie and Freddie had paid Countrywide nearly $3 billion for HSSL loans, but determined that 57% of the loans were of acceptable quality. HSSL refers to a Countrywide loan program called the High Speed Swim Lane, which fast-tracked almost any loan; it was also known as a “Hustle” loan.

In today’s decision, Judge Rakoff wrote: “While the HSSL process lasted only nine months, it was from start to finish the vehicle for a brazen fraud by the defendants, driven by hunger for profits and oblivious to the harms thereby visited, not just on the immediate victims but also on the financial system as a whole.”

Separately, Bank of America is reportedly nearing a settlement with the Justice Department to resolve an investigation into its sale of mortgage backed bonds centered on faulty loans the company inherited from Countrywide and Merrill Lynch, which it purchased in 2008. The discussions include how much money will be paid in cash and how much in consumer relief. Potential terms have ranged from $13 billion to $17 billion. The DOJ has been trying to work out a settlement for some time, and was reportedly dissatisfied with a $13 billion deal that included $5 billion in consumer relief. The consumer relief portion of these settlements has typically been an easy out for the banks. The amount of any settlement would come on top of the $9.5 billion the bank agreed to pay in March to resolve Federal Housing Finance Agency claims.