Financial Review

Never Ending Pi

Sinclair Noe — March 14, 2017

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DOW – 44 = 20,837
SPX – 8 = 2365
NAS – 18 = 5865
RUT – 7 = 1362
10Y – .02 = 2.59%
OIL – .45 – 47.95
GOLD – 5.10 1199.60

The Federal Reserve Federal Open Market Committee is meeting today and tomorrow to determine monetary policy. Fed policymakers have clearly indicated they will raise the overnight benchmark interest rate by 25 basis points to a range of 0.75 percent and 1.00 percent,  and may signal there could be even more than the three rate rises they have forecast for this year.

While the Fed meeting is the focus for markets this week, investors also have to assess the impact of central bank meetings in Britain and Japan, a gathering of G20 finance chiefs, President Trump’s first budget and an election in the Netherlands.

The dollar index rose 0.3%. Yields on benchmark 10-year German government bonds briefly hit 14-month highs above 0.5%, before reversing. Oil fell to 3-1/2-month lows after Saudi Arabia announced it has reversed about one-third of its production cuts and the Organization of the Petroleum Exporting Countries (OPEC) reported oil stocks were still rising despite agreed output cuts.

US producer prices increased 0.3% in February after rising 0.6% in January; and the year-on-year gain was the largest in nearly five years. In the 12 months through February, the PPI jumped 2.2 percent, the biggest advance since March 2012. The core PPI, a key gauge of underlying producer price pressures that excludes food, energy and trade services increased 0.3 percent in February, the biggest gain since April 2016. Core PPI increased 1.8 percent in the 12 months through February.

Small-business owner optimism dipped in February but stayed near long-time highs. The sentiment gauge from the National Federation of Independent Business fell 0.6 points to 105.3. The stronger economy increasingly seems to come at a price for small-business owners. The NFIB wrote in its release: “This is one of the tightest labor markets in the 43-year history of the NFIB survey.”

FDIC Vice Chairman Thomas Hoenig rolled out what he called “a comprehensive plan for reforming bank oversight, calling on the biggest lenders to further separate investment banking activities and accept stricter capital requirements in exchange for fewer regulations. It would require large, complex, universal banks to separately capitalize and manage their traditional commercial banking activities and their nontraditional activities, such as investment banking.  In other words, a variation on the Glass-Steagall Act.

Wall Street seems largely unfazed by political turmoil and uncertainty. The major indices are still very close to record highs, and the VIX, the volatility index, is near long-time lows; closing today at 12.23. There are a couple of possible explanations: the global economy has been in recovery mode – a slow, sluggish and boring uptrend.

Per the World Bank, annual global growth since 2011 has hovered in a narrow 2.3 to 3 percent range. The International Monetary Fund’s measure pegs it in an even tighter 3.1 to 3.5 percent range since 2012. And if both institutions’ estimates are met, 2017 will be yet another year of growth being stuck within these narrow parameters. Global company earnings volatility has been low throughout the post-crisis recovery – consistently 5 percent or lower over the past five years.

In the past 20 years, there have been only two significant bouts of earnings volatility of 15 percent and higher, or global recessions. They coincided with the market crashes of 2000-02 and 2007-09. The other reason is that in a low interest rate environment investors don’t have much alternative. You ride out the risk. So, we have strong data but uncertain politics, and they seem to balance out, at least for now.

Luxury fashion retailer Neiman Marcus Group said it was exploring strategic alternatives, including a sale of the company. The move comes about two months after the company pulled its IPO. Neiman Marcus also reported a 6.1 percent drop in second-quarter revenue as issues in its new merchandising and distribution system forced the company to take additional markdowns. Hudson’s Bay has emerged as the most prominent suitor.

MoneyGram International has received a buyout bid from Euronet Worldwide that is 15% higher than MoneyGram’s current buyout deal with Ant Financial Services Group. Euronet’s bid of $15.20 a share in cash will value the company at over $1 billion. The Ant Financial bid MoneyGram agreed to in January was $13.25 a share. MoneyGram’s stock has doubled over the past 12 months through Monday.

Ruby Tuesday it was putting itself up for sale, as the casual dining industry’s slump shows no signs of ebbing. The Tennessee-based company said it’s considering “strategic alternatives,” including a potential sale or merger. The move was paired with an announcement that the company’s sales at restaurants open at least a year tumbled about 4% in the period ended Feb. 28. The chain’s quarterly revenue also fell nearly 17%, compared to a year earlier, to $225.7 million.

Networking software company Citrix Systems has been exploring strategic alternatives including a potential sale. Citrix, which gave activist hedge fund Elliott Management a board seat in 2015, has looked at selling itself in the past, before embarking on spin-offs and sales of smaller business units. It now has a market capitalization of $13.2 billion.

You might not be able to get there from here. A powerful nor’easter is hitting the mid-Atlantic and the Northeast with heavy snow, sleet and rain, prompting more than 6,000 flight cancellations today and more than 2,500 delayed flights, resulting in bad news for the airline stocks. The NYSE Arca Airline index lost about 2% today, dropping to a 4-month low. Plus, the storm resulted in school closures, power outages, and warnings from officials to stay off the roads – and that is bad news for trucking stocks

Brexit is coming. UK Prime Minister Theresa May has been granted the power to trigger Article 50; however, she’s not expected to begin the formal process of the UK’s exit from the European Union until the end of the month.

The New York attorney general accused Exxon Mobil of withholding documents from his office as it investigates whether the energy company misrepresented its understanding of climate change to investors and the public.

Lawyers for Attorney General Eric Schneiderman’s office said in court documents that Exxon hadn’t disclosed that Rex Tillerson, the former chairman and chief executive, used an alias email address to discuss risk-management issues related to climate change. Tillerson, now the U.S. secretary of state, used the pseudonym “Wayne Tracker” from at least 2008 to 2015.

The Trump administration is weighing even deeper cuts to the Environmental Protection Agency than previous versions of their budget outline suggested. In its first budget draft last month, the White House proposed a 25% cut to the EPA budget. But wait there’s more; officials are now considering cutting the agency’s $8.1 billion budget even further.

The ax looks set to fall hardest on EPA’s climate change programs, with the staff there expected to leave the agency. The EPA budget proposal is likely to run into opposition in Congress, and it is already running into opposition from mayors.

Los Angeles Mayor Eric Garcetti is coordinating the effort with dozens of other cities to purchase up to $10 billion worth of electric vehicles. Thirty cities including New York and Chicago jointly asked automakers for the cost and feasibility of providing 114,000 electric vehicles, including police cruisers, street sweepers and trash haulers. That would be comparable to about 72% of total US plug-in vehicle sales last year.

The auto makers have been fighting CAFÉ rules which set fuel efficiency standards and complaining that there is not enough demand to justify developing more efficient electric vehicles. The mayors say they would like to have more electric vehicles on the streets, including some that haven’t been developed yet, such as plug-in fire trucks and street sweepers. While the initiative would probably be spread out over several years, it would provide electric vehicle manufacturers reliable demand.

Alphabet’s Executive Chairman Eric Schmidt announced today via Twitter that “John Goodenough, inventor of the lithium battery, has developed the first all-solid-state battery cells.” And that is a pretty big deal. Goodenough’s batteries reportedly have three times as much energy density as today’s lithium-ion batteries. They store and transmit energy at temperatures lower than traditional lithium-ion packs and can be made using globally abundant supplies of sodium.

The research could result in “a safe, low-cost all-solid-state cell with a huge capacity giving a large energy density and a long cycle life suitable for powering an all-electric road vehicle or for storing electric power from wind or solar energy.” Goodenough and his team of researchers at the University of Texas have applied for patents on the solid-state battery technology and it may be a while till the batteries move to production.

Goodenough is a National Medal of Science laureate, and by the way, he is 94 years old.

Today, March 14, or 3-14, is Pi Day. Pi is the ratio of the circumference of a circle to its diameter and it is represented by the irrational number that never ends. Math enthusiasts know all about it, and the rest of the population is probably hoping for cherry pie, or maybe pizza.

Financial Review

Sheepish Algorithms

Sinclair Noe — July 14, 2015

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

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DOW + 75 = 18,053
SPX + 9 = 2108
NAS + 33 = 5104
10 YR YLD – .03 = 2.40%
OIL + .84 = 53.04
GOLD – 2.70 = 1155.80
SILV – .13 = 15.48

The stock market posted its first 4-day winning streak since January. The S&P 500 last week fell as much as 4 percent from its all-time high, and has since recovered to trade within 1 percent of its record set in May. The S&P 500 and the Dow are up 3 percent over four sessions, while the Nasdaq Composite has added 4 percent.

The United States and other world powers reached an agreement with Iran that calls for limits on Tehran’s nuclear program in return for lifting economic sanctions that have crippled Iran’s economy, enabling the oil-rich nation to ramp up its energy exports, access international finance and open the doors to global investors. Full implementation of the agreement will likely take months and is contingent on the pace at which Iran meets its obligations. The deal will keep Iran from producing enough material for an atomic weapon for at least 10 years and impose provisions for inspections of Iranian facilities, including military sites.

Oil prices initially dropped when the Iran deal was announced, but then prices climbed higher. The oil markets were not surprised by the news announcement, and a deal was clearly already priced in; and it will take some time before Iran has a big impact on supplies. Iran doesn’t have great reserves of crude oil supplies to throw on the market. Tehran has stored around 25 million barrels of oil mainly consisting of condensate.  Iran will have to invest heavily in infrastructure; they will need to attract investment, sign commercial contracts and figure out the other logistics needed with producing and exporting oil. If the deal holds, look for Iran to deliver more supplies by 2016, possibly pushing prices lower. Even so, this represents opportunities for the Big Oil firms like ExxonMobil, Total, Royal Dutch Shell; also, oilfield service companies like Schlumberger, Halliburton, and Weatherford; also tanker companies; also big banks should do well with financing deals, but only the biggest banks such as JPMorgan, Goldman Sachs, and Morgan Stanley.

The director of international affairs at National Iranian Oil Company, said, “We will try to maximize our crude export capacity to Europe and restore 42 to 43 percent share in the European market before the sanctions were imposed.” This is an interesting sidebar. Since the Russian invasion into eastern Ukraine, Europe has been dealing with the threat of Russia cutting oil and nat gas. Iran now steps up as an alternate energy source. Iran holds the world’s fourth-largest proved crude reserves and the second-largest natural gas reserves. So, Europe might be a winner in today’s announcement. The bottom line is that today’s announcement means the oil market will be over-supplied for a long time.

Prime Minister Alexis Tsipras appears to be facing open rebellion in his coalition as he attempts to push creditor reforms through Greece’s parliament ahead of Wednesday’s deadline. With dozens of MPs in Syriza threatening to defect, Tsipras will need the support of the opposition to pass the €86 billion-euro package, putting the future of his government in doubt. Meanwhile, Athens missed another payment due to the IMF late Monday. The Greek deal does not include debt relief, and this might be its fatal flaw. The other flaw is continued insistence on austerity, which has not worked. Austerity measures are primarily aimed at shrinking debt as a proportion of a country’s economic output, a measure known as the debt-to-GDP ratio. Even if total debt is reduced, the debt-to-GDP ratio can rise because gross domestic product shrinks in tandem. So, Greece still faces the same problems they faced a month ago – their debt burden is unsustainable.

In the first meeting with investors since calling its $72 billion debt pile “not payable”, Puerto Rico said it was still premature to discuss how creditors would be affected, but made the case for a restructuring. Puerto Rico bonds are held by many U.S. investors, who bought the securities because they’re tax-exempt nationwide and offered higher yields than comparable debt.

After a month-long rollercoaster ride, China’s stock market is showing some signs of stabilizing, suggesting Beijing’s bundle of support efforts are having the intended impact. Last week, Chinese officials allowed more than half of all listed companies to suspend their shares from trading and prohibited major stakeholders from selling at all, pushing the Shanghai market up 13% Thursday and Monday.  Chinese stocks are down 24% from their mid-June peak.

China accounted for 38 percent of the global growth last year, up from 23 percent in 2010. It’s the world’s largest importer of copper, aluminum and cotton, and the biggest trading partner for countries from Brazil to South Africa. If China slows down, the demand for industrial commodities goes down. That can have a huge impact on the global economy.

Retail sales fell an unexpected 0.3% in June as consumers pulled back on car, home and clothing purchases. It was the first drop in monthly retail sales since February and comes after an uptick in May initially pointed to a stronger spring. May retail sales were revised lower, however, to an increase of 1% from an initial 1.2% estimate.

Households cut spending on a variety of goods and services, including cars, clothes, home furnishings, and dining out. Americans also spent less online and shelled out less cash at do-it-yourself and building-materials suppliers. The decline in auto sales was expected because dealers had already posted lower sales after a huge month in May, but the rest of the report was disappointing. Only department stores, consumer-electronics outlets and gasoline stations posted sold sales gains; and the improvement at gas dealers owed mostly to higher fuel prices last month. If gas stations are stripped out, retail sales fell an even sharper 0.4%.

The prices the U.S. paid for imported goods fell a seasonally adjusted 0.1% in June, marking the 11th decline in the past 12 months. Excluding fuel, import prices declined by 0.2%.  In the past 12 months import prices have dropped 10%, mostly because of a lower oil costs. Import prices are down a smaller 2.3% excluding fuel in the same span.

U.S. homes are today less likely to be in the foreclosure process than at any time since the Great Recession started. According to Corelogic, about 1.3% of all mortgaged homes were in the foreclosure process in May — the smallest share since the end of 2007, when the downturn started.

Small-business owners weren’t cheerful about economic conditions in June. The National Federation of Independent Business’s monthly small-business optimism index dropped 4.2 points to 94.1, the lowest point of the year so far. Small-business owners said they planned to spend less and had weak expectations for sales and business conditions. Small-business owners were less optimistic about the prospect of making new hires, investing in their business or expecting growth in June. The report concludes that, “While this is not a recession signal, it is a clear sign that economic growth on Main Street is not set for a strong second half.”

Earnings reporting season kicks into high gear this week. This morning JPMorgan Chase reported earnings that beat estimates. Wells Fargo reported profits that matched estimates, but revenues that missed. Johnson & Johnson posted better-than-expected second quarter profit and adjusted its full year outlook higher. CSX reported profit rose 4.5% during its latest quarter, though falling coal volume weighed on revenue, which retreated 5.5%. Yum Brands posted better than expected results, mainly on the strength of international sales.

Also this week, look for reports from Intel, Google, Netflix, GE, Bank of America, Goldman Sachs, and Citigroup – just to name a few.

China’s Tsinghua Unigroup has submitted a $23 billion bid to buy out U.S. memory-chip maker Micron Technology; it works out to a 19% premium over Micron’s closing price on Monday. Tsinghua Unigroup, China’s largest state-owned chip-design company, already has several links to major U.S. companies. It acquired a controlling stake in Hewlett-Packard’s China networking-equipment unit in May. Intel bought a 20% stake in Tsinghua Unigroup last year for $1.5 billion. Micron, based in Boise, Idaho, is the last remaining U.S. maker of the widely used chips known as dynamic random access memory, or DRAMs. It is No. 2 behind Samsung Electronics in that market, and makes flash memory used to store data in mobile devices such as smartphones. Look for the Department of Justice to intervene in this deal.

Remember the flash crash in the Treasury market back on October 15^th? Actually, it was a melt-up in prices that sent the yield on the 10-year Treasury from 2.19% down to 1.86% in a matter of minutes. The US government released its report on the day’s dramatic swings. The main culprit – algorithms. Primary trading firms accounted for more than 50 percent of the total trading volume in both cash and futures markets for US Treasuries on Oct. 15. That proportion is not unusual, according to the report, but what is remarkable is their level of activity on the day. Most of their trading is done almost automatically by computers running algorithms. As trading began to heat up, these algorithms essentially fed on each other, causing the amount of “self-trading” undertaken between different arms of the same PTF firms to increase. The computers performed like so many sheep, just following the herd. The problem might have been worse, if humans hadn’t stepped in, some simply pulled the plugs on their trading machines and order was restored.

Financial Review

Magnitude of Falsity is Enormous

Sinclair Noe — May 12, 2015

 

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

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DOW – 36 = 18,068
SPX – 6 = 2099
NAS – 17 = 4976
10 YR YLD – .03 = 2.25%
OIL + 1.50 = 60.75
GOLD + 9.50 = 1194.00
SILV + .21 = 16.58

The Treasury market continued to sell-off this  morning, pushing the yield on the benchmark 10-year Treasury up to 2.35% intraday, the highest point since Nov. 21. The selling eased by the afternoon, sending the yield down to 2.25 percent. The intense selling in the Treasury market was fueled by a similar meltdown in the Eurozone’s government bond market which has been going on for more than two weeks. Germany’s 10-year bund yield is 14 times higher than a month ago.  The yield on the 10-year benchmark German bond known as the bund increased 12 basis points to 0.71% intraday and European peripherals, such as Spain, Italy and Portugal, also saw their yields jump between 10 and 13 basis points.

At a panel discussion in Zurich this morning, NY Fed President William Dudley outlined that he does not know when interest rates will rise but repeated recent comments that the policy tightening will depend on the US economy. In other words, the Fed won’t send out engraved invitations and you will need to stay alert but the markets shouldn’t be surprised when the Fed raises rates. Dudley said the conditions that will determine the timing of the Fed raising rates from their current near-zero levels are “well specified” and “market participants should be able to think right along with policymakers, adjusting their views about the prospects for normalization in response to the incoming data.” Dudley went on to say that when the Fed raises rates it “will have implications for global capital flows, foreign exchange valuation and financial asset prices even if it is mostly anticipated when it occurs.”

The National Federation of Independent Business said its small-business optimism index rose 1.7 points to 96.9. It’s the second-worst reading since October. Overall business investment has sagged, with energy companies slashing capital expenditure budgets and laying off thousands of workers as lower energy prices undermine exploration and drilling activity. Nine of the NFIB index’s 10 components rose last month, with the exception of sales. The NFIB said despite the turmoil in the energy sector, “the shale states exhibited stronger capital spending and hiring than the rest.”

Oil production from seven major U.S. shale plays is expected to fall by 86,000 barrels per day in June. According to the latest report from the Energy Information Administration Oil output at the Eagle Ford shale play in South Texas is forecast to see the biggest decline, down 47,000 barrels per day, while production at the Bakken shale play, centered in North Dakota, is expected to drop by 31,000 barrels per day.

Job openings at US workplaces declined to 4.9 million in March from 5.1 million in February. The Labor Department’s JOLT survey measures the number of job openings in the economy, a measure of how aggressively employers are looking to hire, and more job openings indicates a labor market turning in favor of employees over employers. The number of hires in March, however, rose to 5.07 million from 5.01 million in February, while total separations also rose to 4.98 million from 4.79 million in February. The numbers of people quitting their job ticked up slightly in March, to 2.78 million from 2.72 million in February. Quits are seen as a sign of strength in the labor market, as workers wouldn’t be quitting their jobs unless they were reasonably confident they could find another one. It might also signal the possibility of higher wages in the not so distant future.

The US budget surplus in April rose to the highest level since 2008 on record revenue as hiring improved during a month when Americans file tax returns. The Treasury Department reports revenue exceeded spending by $156 billion last month, compared with a $106 billion surplus a year earlier. The April surplus was the fifth-highest on record for any month. So far this fiscal year, which began Oct. 1, the deficit declined to $282 billion compared with $306 billion in the same seven-month period a year earlier. Even though spending increased 6%, more people had jobs (the unemployment rate dropped to 5.4% in April) and that added to the Treasury’s coffers. So, it looks like one of the best ways to cut the deficit is to grow the economy. Who knew?

The Trans-Pacific Partnership faced its first test with a critical vote in the U.S. Senate today. Senate Democrats staged a last-minute rebellion against one of President Barack Obama’s top legislative priorities by blocking a test vote on a trade measure that didn’t include companion measures they sought. The vote, 52-45, effectively delays fast-track legislation Obama wants to expedite approval of trade accords. Supporters needed 60 votes to advance the bill to a final vote. Senate Majority Leader Mitch McConnell said the Democrats’ opposition was “pretty shocking” and vowed to keep working to reach an agreement he could bring back for a vote later. TPP would create a free trade zone covering 40% of the world economy – making it the biggest trade deal since NAFTA.

Verizon is buying AOL for $4.4 billion. The biggest U.S. wireless carrier will gain access to AOL’s mobile video platform and content. AOL bought Time Warner for more than $160 billion in 2000 in what turned out to be one of the most disastrous corporate mergers in history. AOL was spun off from Time Warner in 2009 at a value of about $3.4 billion. It’s easy to think of AOL in terms of an epic acquisition failure, or for the catch phrase “you’ve got mail”, or not at all. Actually, AOL has built up a decent infrastructure for the online ad marketplace, particularly for video and mobile platforms. And they have been making money; and they are growing; revenue is up 39% in the past year; profit is up 19%. It even brought in $600 million in revenue last year from 2 million customers dialing in for internet access.

In a separate matter, Sprint and Verizon will pay a total of $158 million to resolve nationwide allegations that they engaged in mobile cramming, a practice in which cell phone providers place unauthorized third-party charges on customers’ bills. Sprint will pay $68 million and Verizon will pay $90 million. Of those amounts, $50 million will be refunded to Sprint customers and $70 million will be refunded to Verizon customers. The rest will go to the 50 states that brought suit against the mobile phone carriers. The carriers also agreed to take steps to ensure that they only bill customers for third-party charges that have been authorized by the customers. The carriers have set up phone lines for customer questions about refunds.

Many on Wall Street have long argued that the banks did not generally break the law when they packaged shoddy mortgages and sold them to investors in the lead-up to the financial crisis of 2008. But yesterday a federal judge dealt a strong blow to that version of history. She ruled that two banks misled Fannie Mae and Freddie Mac in selling them mortgage bonds that contained numerous errors and misrepresentations. “The magnitude of falsity…is enormous,” declared U.S. Judge Denise Cote, adding, “The origination and securitization of these defective loans not only contributed to the collapse of the housing market, the very macroeconomic factor that defendants say caused the losses, but once that collapse started, improperly underwritten loans were hit hardest and drove the collapse even further.”

The two banks, Nomura and RBS, have been the only ones out of 18 financial firms that took their case to trial, arguing that it was the housing crash, and not deceptive loan documents, that caused the bonds to collapse. The other firms – including Goldman Sachs and Bank of America – settled, together paying nearly $18 billion in penalties.

More than seven years after the financial crisis, Congress is still fretting that some megabanks might be “too big to fail.” Yesterday, the House Financial Services Committee subpoenaed three federal agencies (the Department of Justice, the NY Fed, and the Treasury) citing “extraordinary stonewalling” from the agencies and lingering questions as to whether regulators went easy on banks deemed to be too large to prosecute. One case in particular got the attention of lawmakers; when the DOJ settled with HSBC despite overwhelming evidence the bank laundered money for terrorists and Mexican drug cartels.

Another for-profit college is in trouble. ITT Educational Services was charged with fraud today. The Securities & Exchange Commission said the company’s chief executive and chief financial officer misled investors and auditors with “outright misstatements” and “half-truths” about its student loan program. ITT Educational Services allegedly created a fraudulent scheme to show that it was doing better financially than it really was. Students had been defaulting on their loans in droves, but the SEC claims that CEO Kevin Modany and CFO Daniel Fitzpatrick hid the real cost from investors. More than 51,000 students take online courses or attend the 135 ITT Technical Institute campuses located in 39 states. ITT also runs the Daniel Webster College in New Hampshire.

After the financial crisis, student loans started to dry up.To entice lenders, ITT offered to back the loans if student loan defaults rose over a certain threshold. When defaults started rising in 2012, the company had to pay third party lenders to make good on its guarantees. ITT also started making student loan payments on its own to mask the default rate. Shareholders were kept in the dark about all these payments. The company is also being sued by the Consumer Financial Protection Bureau over alleged predatory student lending. The CFPB has also taken Corinthian College to court for the same issue. Corinthian filed for bankruptcy last week and abruptly closed all of its remaining campuses.