FINANCIAL REVIEW

At Least it Wasn’t a 100 Point Drop

Sinclair Noe — December 15, 2014

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

DOW -99.99 = 17,180
SPX – 12 = 1989
NAS – 48 = 4605
10 YR YLD + .01 = 2.11%
OIL – 2.53 = 55.28
GOLD – 28.30 = 1194.50
SILV – .85 = 16.29

The S&P 500 index traded below its 50 day moving average for the first time since the end of October. At its session low, the S&P 500 was down about 5 percent from its record intraday high hit earlier this month but up more than 8 percent from a low hit in October. Oil continues to be a drag on the stock market, and West Texas Intermediate hit a 5 ½ year low; now down right at 50% from the highs of June. OPEC’s Secretary General reiterated the oil producing organization will not cut production despite the current low prices and glut of supply coming out of the US and elsewhere. That’s leaving supply plentiful and prices low even as demand has been waning.

We have seen the lower prices at the pump and that basically means everybody gets a break, a few extra dollars in your pocket. That’s a good thing. So, why is the stock market reacting badly to lower oil prices? Quite simply there are a lot of companies involved in the energy sector, and that is where we get the drag. Also, the decline in oil prices alongside other economically sensitive commodities, including copper, might signal trouble in the global economy. A sputtering recovery in Europe and concerns about Asia have undercut oil demand even as robust production adds to a global oil glut. The fear is that the drop in oil prices might be a warning of something more sinister in the global economy. And if there are really global economic problems, it could spell trouble for the debt accumulated by energy companies, especially in the high yield market.

In economic news today, the National Association of Home Builders/Wells Fargo released the homebuilders’ confidence index today; it dropped one point to 57. A reading above 50 indicates optimism about new home sales trends. December marks the sixth consecutive month of above-50 readings.

Industrial production rose a seasonally adjusted 1.3% in November. This is the biggest increase since May 2010. The Federal Reserve also made upward revisions to output in the past three months. In November, manufacturing output rose 1.1% with broad-based gains. Output of consumer goods rose 2.5%, the largest increase since August 1998. Utilities output jumped 5.1% on cold weather in the month. Mining output dropped 0.1%.

The Great Recession is officially over, but Americans are still 40% poorer today than they were in 2007, the year before the global financial crisis. According to a new report by the nonprofit think-tank Pew Research Center, the net worth of American families — the difference between the values of their assets, including homes and investments, and liabilities — fell to $81,400 in 2013, down slightly from $82,300 in 2010, but a long way off the $135,700 in 2007. There is also a dramatic disparity in net worth between races. The median net worth of white households was $141,900 in 2013, down 26% since 2007. It declined by 42% to $13,700 over the same period for Hispanic households and fell by 43% to $11,000 for African-American households. One theory for the wealth gap: White households are more likely than other ethnicities to own stocks directly or indirectly through retirement accounts.

The wealth of most Americans has stood still. According to the Bureau of Labor Statistics, in November 2014, the average weekly wage was $853 versus $833 for November 2013. But things are improving somewhat when it comes to housing. According to Black Knight Financial Services, which tracks mortgage performance, nationwide, only 8% of borrowers have homes that are underwater as of October 2014, down from a peak of 35%, or 18 million homes, in February 2011; but 8% still impacts 4 million homes.

Bigger economic news this week will come from Europe, where there will be a presidential election in Greece, which will likely lead to snap elections, which will likely lead to talk of Greece defaulting or making a general commotion in the Eurozone.

Greek Prime Minister Antonis Samaras has brought forward the presidential election to this Wednesday, two months earlier than initially planned. Center-right Samaras needs to get two-thirds of the 300 members of parliament to back his party in either the Wednesday vote or a second round, which is expected just before Christmas. Should he fail, the threshold drops to 180 votes in the third round, possibly held on Dec. 29. If Samaras fails to secure enough support in the third round, parliament must be dissolved, meaning a possible snap election in late January; which seems very possible. And in a snap election, the far-left, anti-austerity Syriza Party is leading the polls. They don’t necessarily want to exit the Euro Union, but the Euro Union might want to kick them out. We’ll see. But the whole thing has really messed with the Greek stock market and threatens the Euro financial theater.

Meanwhile, a snap election was held in Japan yesterday. Prime Minister Shinzo Abe’s Liberal Democratic Party and Komeito, its junior partner in the ruling coalition, won the Lower House election by a landslide. In an election billed as a touchstone for the LDP’s economic policies, the ruling bloc secured a two-thirds supermajority in the 475-seat House of Representatives, giving it the power to override the Upper House. Sunday’s poll was widely seen as a referendum on Abe’s economic policies, dubbed “Abenomics” — a policy mix of radical monetary easing, fiscal stimulus and structural reform vows.

Russia’s currency is plunging yet again today. Currency prices are all about supply and demand. And just about everything that’s transpired in the past year has made the world far less interested in buying Russian money. Last year, one-third of Russia’s exports came from crude oil. When the value of your exports collapse, so does your currency. Worse yet, the Russian government, ever dependent on oil revenue, needs about $100 per barrel to balance its budget. And so, in a rather surprising and dramatic move late today, the Russian Central Bank raised interest rates from 10.5% to 17%. The ruble has lost 18 percent of its value just this month and if the slide continues it might just end up as the worst performing currency of the year—even worse than the Ukrainian hryvnia. Sometimes irony can be completely delicious.

The main event in the US is the Federal Reserve rate decision, where most observers are on the lookout for any change in the central bank’s rhetoric, especially around the timing of a rate hike. No one really expects the Federal Open Market Committee to do anything to the Fed’s ultra-low interest rates when they meet on Wednesday. That’s why most traders will instead focus on any changes to the language in Fed chairwoman Janet Yellen’s statement: Will it finally drop the phrase “considerable time” when discussing when it may make its first rate hike?

One of the thing the Fed should do, if they are really serious about raising rates, is to explain how they will handle the disconnect between the US and the international bond markets, because it is a disconnect that just might lead to a big sell-off in bonds.

US central bank policy makers expect the main Fed funds rate to rise from near zero today to 1.25 per cent by the end of next year, with the first rate rise penciled in for next June. The market projects rates to end 2015 at 0.50 per cent, with the first rate rise in October.

By the end of 2016, the Fed’s policy makers forecast rates at 2.75 per cent, while the market has them at 1.50 per cent. By the end of 2017, Fed policy makers expect rates to be 3.75 per cent compared with market forecasts of 2.0 per cent.

Keep in mind that we are likely to see much more monetary easing in Japan, now that Abe has scored a victory in the snap election. Also, there is a very strong likelihood that Mario Draghi will indeed deliver full blown quantitative easing in the Eurozone early next year, which should keep Euro bond yields in the extremely low to negative range.

But in the US, there has to be risks that yields will rise sharply, should the Fed stick to its forecasts and start tightening policy aggressively in the middle of next year.

With yields on 10-year US Treasuries close to all-time lows and nearly a percentage point lower than they were when the year began, yields surely have only one direction to go — and that is up. If US yields do head north, then yields in other government bonds are likely to follow, despite benign inflationary pressures and the launch of QE by the European Central Bank and continued QE in Japan.

It means 2015 could be a tricky year for fixed income fund managers, particularly those running long-only portfolios. This might explain why absolute return funds have become more popular, as these funds can short the market and use derivatives to protect capital in the event of a blow-up in bonds.

For example, some absolute return funds have bought emerging market credit default swaps to protect portfolios against a sharp jump in yields. I don’t want to play the game of trying to predict where bond yields will be a year from now; that’s a fool’s errand, as the spectacular failure of most bond forecasts this past year proved. But it seems that something big might happen, just because there is a big disconnect between global bond markets.

The US Senate was still at work today because there are a few more pre-holiday tasks ahead. However, there will be no government shutdown as a spending bill was passed Saturday. There were some very strange provisions that were tacked onto the spending bill, but the strangest by far was allowing Citigroup to open a branch office in the cloakroom of the House of Representative. Lawmakers said it was just a matter of convenience and would make it easier to collect their payments and take there marching orders. (not confirmed, it just seems that way)

FINANCIAL REVIEW

Something is Rotten

Sinclair Noe — December 12, 2014

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

DOW – 315 = 17,280
SPX – 33 = 2002
NAS – 54 = 4653
10 YR YLD – .08 = 2.10%
OIL – 2.52 = 57.43
GOLD – 5.60 = 1222.80
SILV – .06 = 17.14

The fall in oil prices has been dramatic, now down almost 47% since June. Nobody was expecting it would fall that far that fast. Goldman was forecasting $85 oil for 2015 as recently as October 29. Crude-oil futures fell to their lowest since May 2009 on Friday, briefly dropping below $57 a barrel, after the International Energy Agency delivered the latest reduction in forecasts for global oil demand. On the week, oil futures have lost slightly more than 12%. So, oil is a bit oversold right here but it is never a good idea to try to catch a falling knife.

And the whole drop just tells us that something is rotten in the markets. The fundamentals of oil have not changed in concert with the price. We don’t have double the oil we had in June. So why is the price cut in half? I know that’s overly simplistic, but either the market is too negative on energy, or it is not diligent enough in thinking about broader implications. Low prices lead to oil being left in the ground. Low oil prices lead to debt defaults. Low oil prices can lead to collapses of exporters. Benefits to consumers likely smaller than expected. Hoped for renewables lose luster with low oil prices. The sharp decline in the price of oil has disoriented markets and changed the perception of the creditworthiness of companies and countries. And don’t forget, deflationary pressures, which is great when you go to the gas station to fill up but not so great in a number of other ways.

Bill Gross, who used to run the world’s largest bond fund before joining Janus Capital in September, said the Federal Reserve may become more “dovish” after oil prices plunged in recent weeks. Gross says the Federal Reserve would have to take lower oil prices “into consideration.” Why would they start to eliminate language that talked about an extensive period of time when the US itself is, not deflating but disinflating, and certainly not moving in the direction of its 2 percent inflation target?

The drop in oil prices likely reflective of world reaching debt expansion limit. The worry, as always, has nothing to do with the central banks’ concern for you, your job, your children, wealth equality, or the future, and everything to do with the simple fact that the stability of the banking system absolutely depends on a steady stream of new loans being created. The core of the problem is that we have a monetary system that is either expanding or collapsing. It has no steady state. Oil has been an engine of growth, resulting in global spending of nearly $3 trillion over the past decade, and that means a bunch of financing. We have never spent more money developing new oil supplies than we did last year, nearly $700 billion; and for all that spending, we did not double the current production. Something is very wrong with that equation, and that means something has to give. New oil drill programs are being scrapped left and right. New drill permits in the U.S. shale plays were down 40% in November compared to October and for good reason: most of the plays are uneconomical at current prices.

The shale miracle could easily turn into the shale collapse. This calls into question the sky-high valuations we currently see for stocks and bonds. Central banks have tried to prop up financial assets and financial markets, and one way was to finance the energy sector; after all, they already blew up the housing market. A decline in oil prices is not only due to supply issues but demand issues.

So, right now, the market players are having a hard time figuring out what all this means, and when they are clueless, they sell. The S&P 500 ended the week with the biggest loss in two-and-a-half years, while the Dow Jones Industrial Average recorded its biggest weekly decline since Sep 2011. The S&P 500 lost 3.5% for the week. Maybe it is just that we were due for a down week. The Dow was down 3.8% for the week, and the Nasdaq Comp lost 2.9% for the week.

A couple of economic reports today. Producer prices, or prices at the wholesale level, fell a seasonally adjusted 0.2% in November, the second decline in the last three months. The rate of wholesale inflation over the year fell to a nine-month low of 1.4%. The Federal Reserve policy committee will meet next week and this is another bit of data showing inflation should not be a concern.

The University of Michigan and Thomson Reuters consumer sentiment gauge rose to a preliminary reading of 93.8 from 88.8 in November; it’s the highest reading since January 2007. The global economy may be going to hell in a hand basket but if we can fill up the SUV and still have money to go to a movie, life is pretty sweet.

Sometime tonight or maybe Monday, the Senate will vote on whether to fund the government. Late last night, the House passed a spending bill and a two day extension to give the Senate time to vote. The idea of funding the government isn’t really controversial. We all know that the government will be funded, but the politicians use it as leverage to tack on poison pills, or provisions that probably would not pass on their own merit but they are accepted to avoid a shutdown. Perhaps the most controversial of these add-ons is a Wall Street-friendly provision which made its way into the bill at the last minute, the weakening of the so-called “swaps push-out rule” from the 2010 Dodd Frank financial reform law.

The push-out rule bans big banks from using taxpayer-insured depositor funds to back certain risky derivatives trading. It also requires financial institutions to move parts of their business involved in those trades to separate groups or affiliates, without FDIC insurance. The new provision would allow banks to gamble in the derivatives markets with FDIC insured depositor money. If their bets turn out to be losers, the taxpayers would bail them out, again. Imagine going to Las Vegas and gambling; if you win you get to keep all the money but if you lose the taxpayer has to pay for your losses.

If this sounds like a sweetheart deal for the big banks, well it is. The language in the bill appeared to come directly from the pens of lobbyists at Citigroup. Yes, this is the same Citigroup that was bailed out in 2008 because they were ready to implode under the weight of bad bets in derivatives. The Citi-drafted legislation will benefit five of the largest banks in the country: Citigroup, JPMorgan Chase, Goldman Sachs, Bank of America, and Wells Fargo. These financial institutions control more than 90 percent of the $700 trillion derivatives market.

The Washington Post is reporting that the provision was so important to the profits at the big banks that JPMorgan’s chief executive Jamie Dimon himself telephoned individual lawmakers to urge them to vote for it. You should try that, call your Senator; you’ll either get a recorded message or an aide who will write down your message and then throw it in the wastebasket. Jamie Dimon has a direct line. Why? Because money is more important than a vote.

Yes, this is the same JPMorgan that is the subject of an open criminal investigation by the Department of Justice for manipulating foreign exchange rates. Yes, this is the same JPMorgan that has paid billions of dollars in fines for a variety of transgressions and signed deferred prosecution agreements that if they ever broke the law again they would be criminally liable. Yes this is the same JPMorgan that gambled in the derivatives markets in the London Whale deal, and then lied about it.

And what they are likely to win is the repeal of the Dodd-Frank Act provision that requires them to separate their gambling from their banking; they fought against inclusion in the Act in 2010, and they’ve been fighting it ever since. So JPMorgan and Citigroup wrote new legislation and there is a good chance it will pass, without debate or amendment because they slapped it on the spending bill. But in finally getting what they wanted, big banks also thrust themselves back into the limelight in the worst possible way, simultaneously reminding the public of their role in causing the financial crisis and in their continuing influence over the various levers of the government. In one fell swoop, they undid whatever recovery to their battered reputation they’d made in the past four years and once again cast themselves as the sleazy casino gamblers and the bribers of politicians who offer a one-finger salute to taxpayers who bailed them out.

Sheila Bair, the former chairman of the Federal Deposit Insurance Corporation said in an interview yesterday that the bankers are trying to blackmail us by making sure government is not funded unless they get their way. Now consider that repealing the swaps provision, which was Section 716 of Dodd-Frank, is likely to only help banks on the margins, since they are allowed to continue engaging in the activity through affiliates. So, why are they fighting so hard to repeal it? Wall Street’s business model depends on the ability of large financial conglomerates to keep exploiting the cheap funding provided by their “too big to fail” subsidies.

Last year Bloomberg calculated that the top 10 US banks received a taxpayer subsidy worth $83 billion because the largest banks can borrow money at a lower rate because creditors assume the government, on behalf of taxpayers, will rescue them in an emergency. And so if this banker written legislation passes, we the taxpayers will be on the hook for the next bailout of the banksters, because the bankers’ money is more important than anything. And it will only be a matter of time.

FINANCIAL REVIEW

Before the Flood

Sinclair Noe — December 11, 2014

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

DOW + 63 = 17,596
SPX + 9 = 2035
NAS + 24 = 4708
10 YR YLD + .01 = 2.18%
OIL – 1.22 = 59.72
GOLD + 1.30 = 1228.40
SILV + .04 = 17.20

We have a lot to cover. Let’s start with the economic news. The government reported early this morning that retail sales in November expanded at the fastest pace in eight months, rising 0.7%. A wide variety of retailers reported healthy sales last month. Retail sales growth hit 1.7% for autos, the most since August; and 1.2% for clothing, the most since April. Sales at building material and garden equipment stores jumped 1.4%, the most since April; while online or non-store retailers saw a 1% sales gain.

The Commerce Department reports business inventories rose 0.2% in October, as building material and clothing stores both built stocks heading into the holiday season. That represents a 4.8% gain from October 2013.

The number of people who applied for unemployment benefits hit the lowest level in three weeks, as employers continued to lay off very few workers. Initial claims for regular state unemployment-insurance benefits inched down by 3,000 to 294,000 in the week that ended Dec. 6.

The prices paid for imported goods fell 1.5% in November, the largest drop since June 2012, dragged down by lower fuel prices. Excluding fuel, import prices declined by 0.2% last month. The price of US-made goods exported to other nations, meanwhile, fell by 1% in November, the biggest decline since April.

Household wealth in the US dropped $140 billion from July through September, or 0.2% from the previous quarter to $81.3 trillion. The Federal Reserve used to call this report the flow of funds survey. Survey says the net worth of households dropped because of stock market weakness over the summer; the value of financial assets, including stocks and pension fund holdings, held by American households decreased by $315 billion in the third quarter. So the drop may be temporary, as stocks have rebounded in the fourth quarter. Household real-estate assets climbed by $214 billion.

The OECD, the Organization for Economic Cooperation and Development has ranked 43 nations on various economic measures. The typical American is even poorer than his or her equivalent in Greece. The median Australian is four times wealthier. The Canadians are twice as wealthy. The US continues to lead the world in billionaires (571 in 2014, with China a distant second at 190). But Americans rank 26th in median wealth (defined as assets owned, minus debts owed for the person on the middle rung of the wealth ladder).

Oil prices continued to crumble. I thought $60 would be an important level of support, but the price cut through that level like a hot knife through butter, to settle at 59.72, the lowest closing price since July 2009. Oil prices are now down 39% year to date. There are several reasons for the drop in oil prices. First, the US has been producing more oil, including shale oil, and yesterday the US Energy Information Administration reported that supplies had increased 1.5 million barrels for the week ended December 5th. Meanwhile, OPEC has not cut production as they try to maintain market share against the shale producers. Also, there is some geopolitical positioning as Saudi Arabia plays hardball with Russia and Iran over Syria. This makes any rapid recovery of oil prices unlikely, especially as additional supply looks set to reach the market from northern Iraq and Libya. Next, the Chinese economy is slowing slightly and the Eurozone is stagnant. The International Energy Agency estimates global oil demand for 2014 will now average 92.4 million barrels per day, reflecting the weakest growth in 5 years. OPEC predicts that demand for its oil will drop by about 500,000 a day in 2015. Also consider that oil is purchased in dollars and the dollar is strong; as the dollar increases in value relative to other currencies, it means you can buy more oil with each dollar. Oil’s price plunge started not long after the dollar rally began to accelerate; if the dollar rally falters, look for oil to find support, but it hasn’t happened yet.

As oil prices have dropped, the yield on junk bonds has been climbing because there are a bunch of junk bonds financing oil development projects; prices on high-yield bonds have declined 2.4% this month and 5.7% since the end of August, even as US equities have climbed to new highs. The divergence may signal junk-bond traders are picking up on a fundamental problem of overvalued energy companies in frothy markets. The energy sector accounts for 22% of US high-yield issuance and 16% of loan issuance through December. Some analysts are predicting a wave of defaults in the next couple of years. New York-traded oil futures around $60 a barrel would push energy companies with a riskier credit profiles to a level that would imply a 30% default rate.

Treasury Secretary Jacob Lew said today it was “premature” to talk about risks of contagion in US financial markets from the drop in oil prices. Asked for his reaction to the fact that many leveraged loans are tied to the energy sector, Lew said in general there will be winners and losers from the drop in energy prices. Overall, he said the drop in oil prices was like “a tax cut for the economy.” It may be premature to talk about contagion but don’t expect Secretary Lew to ring a bell when contagion is no longer premature.

In Washington, the politicians are wrangling over a spending bill to fund the government. A vote was supposed to take place today, but so far no vote. Then the vote was pushed back to 8PM Eastern, but that may or may not happen. The reason is that they aren’t sure they can muster enough votes for passage. Both Republicans and Democrats are opposed to the funding bill for different reasons that are not directly related to funding the government. Some Republicans are upset that the spending bill would delay any action to confront Obama over immigration. Some Democrats are upset about provisions that would scrap parts of the Dodd-Frank Financial Reform Law regarding federal insurance of some banks’ derivatives trades, plus a provision that would loosen campaign finance restrictions. The omnibus appropriations bill also combines a continuing resolution, and the whole thing is reportedly 2871 pages. I haven’t read it. The politicians that may or may not vote on it, have not read it. This is no way to run a government, which may shut down at midnight.

Can you name the worst performing global stock market in 2014? If you answered Russia’s RTX Index, you are correct; it is down 43% year to date. The Russian central bank raised interest rates again today, the fifth rate increase this year; rates now stand at 10.5%. It didn’t work. The Russian ruble fell 1.6% today.

Can you name the second worst performing stock market this year? The answer is the ASE Index, or the Athens Stock Exchange in Greece, which has been dropping like a rock this week, down 7.9% today, and down 29% year to date. The ASE had rallied to an almost three-year high in March. Greece’s government said this week it would start the process of electing a new president early, like next week early, even though they haven’t even figured out who the candidates will be.

A US appeals court has overturned the convictions of 2 former hedge fund managers for making illegal insider trades. The court held that defendants can only be convicted of insider trading if the person trading on confidential information knew the original tipper disclosed it in exchange for a personal benefit. So, if you were wondering how to get away with insider trading, the courts have now laid out the secrets. You cannot ask for a specific insider tip, pay for that insider information, and then trade and profit from that information. You can ask for specific insider tips but you must not pay for it directly; you can provide indirect compensation such as meals, travel, hookers, cocaine, box seats to a basketball game or even future compensation at some unspecified future moment in time; then you can trade on that information and profit from that information. So, apparently the courts have ruled that insider trading is acceptable as long as the trader is not blatant about directly paying for the insider information.

Insider trading is still cheating, of course. And it hurts the honest traders on Wall Street; and it hurts regular everyday investors; and it erodes the integrity of Wall Street, which I must admit is an oxymoron; and it further diminishes the integrity of the legal system, which is currently pretty low.

If you’re planning on traveling to California, think again. The Golden State is getting pounded by the Pineapple Express, a massive Pacific storm that is causing flooding and high winds and power outages. The storm is still centered out at sea but it is expected to bring up to 6 inches of rain to some areas near San Francisco and 4 feet of snow to the Sierra Nevada Mountains. We’ll get some remnants of the storm in Arizona over the next few days. The term Pineapple Express refers to a warm, moist air mass that brings rain to the Pacific. It’s called a Pineapple Express because the moisture stream comes from near Hawaii where pineapples are grown. Another way to think of the Pineapple Express is a river of water in the sky. In 1862, a Pineapple Express hit California and reportedly dumped up to 8 feet of rain on some places, leading to the worst flooding in recorded history of California, Oregon, and Nevada. Known as the Great Flood of 1862, both the Sacramento and San Joaquin valleys flooded, and there was extensive flooding and mudslides throughout the region. Nowadays, the extensive waterways and earthen dams from San Francisco to Sacramento would be demolished by that kind of flooding.

There is another round of storms expected to hit the coast next week, but it is nothing like the great storm of 1862, and it is not enough to end the drought in California, which some scientists say has been the worst drought in California in more than 1,000 years. Meteorologists say we would need to see 5 more storms like this before they would consider the drought to be ended. Meanwhile, much of the rain from this storm will wash away, leaving some landslides in its wake.

FINANCIAL REVIEW

Strange Bedfellows

Sinclair Noe — December 10, 2014

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

DOW – 268 = 17,533
SPX – 33 = 2026
NAS – 82 = 4684
10 YR YLD – .05 = 2.17%
OIL – 2.64 = 61.18
GOLD – 6.30 = 1227.10
SILV – -.05 = 17.16

Well, that was ugly. This is why we enjoy milk and cookies while we can. We’ve seen a lot of record highs in the major indices this year, but they remain rare birds. When we fall from record highs the drop can be fast, as it was today. The worst day since the start of October; wiping out gains from the past month.

The month of December has brought positive returns to the Dow every single year for the last five consecutive years. As you might imagine, there’s a lot of pressure to make it six. And it might still happen, despite the past couple of days. Still it’s a good reminder to stay awake through the holidays, keep your stop loss in place, however you employ your stop loss; and if you don’t have a stop loss it is time to wake up and smell the coffee.

Beyond that, it was just an ugly day, with decliners beating advancing issues 4 to 1. All 10 S&P industry sectors were down, with the energy sector down 3.3% as oil prices continue their slide. Brent crude dropped to $63.56, a 5 year low; and West Texas Intermediate dropping down to a critical area of support just above $60. If prices drop below $60 a barrel, the next level of support is around $50, and then further support at $33 from back in January 2009, at the depths of the financial crisis. Oil is cratering; it hasn’t done the full belly flop to $33 but this has been a wild drop.

The latest drop in oil comes as the US Energy Information Administration issued its weekly status report, showing weekly crude stocks were up 1.45 million barrels, against expectations for stocks to drop by 2.2 million barrels. In short, there was an increase in stockpiled crude inventory last week. This morning, Reuters reported that the falling oil prices have started to affect US domestic production, with the US Energy Information Administration (EIA) cutting its forecasted growth by 100,000 barrels per day, a move linked to generally weaker oil demand.

Also, in a report released today, OPEC also reduced its global demand forecast to 28.9 million barrels per day for 2015, the lowest since 2002, and about 1 million barrels a day less than current production. Increased US production and decreased demand have been cited as the culprits for crude’s rapid decline over the last several months. Now there are a couple of reasons for decreased demand; first, the technology has improved and we now have more fuel efficiency; conservation works (and a side note: Bishops from every continent have called upon the 1.2 billion Catholics worldwide to support renewable energy at a climate change conference in Lima, Peru. “As the church, we see and feel an obligation for us to protect creation and to challenge the misuse of nature.” The other reason demand is down is that the global economy is slowing and there is just less activity.

Again, think back to late 2008 and early 2009 when the global financial system was on the verge of meltdown. Today’s oil prices force us to question whether something is not quite right in the global financial markets. And if we have global economic problems, then that would imply that some things in the financial market have been mispriced. Start with the bond market. The Treasury yield curve has been flattening, meaning short-term rates have been rising, while longer-term rates have been falling. If oil were to hit $40 a barrel – and I’m not saying it will and we still have an important level of support at $60 – but if oil hit $40, that would most likely imply a 10-year Treasury with a yield of around 1%, especially in light of global markets where Greece is crumbling, the Eurozone is stagnating, China is slowing, and Japan is frozen in place. Consider that Germany’s two-year bonds have been negative, meaning that if you buy a German 2 year, you pay Germany to park your money.

Meanwhile, as stocks have tumbled and oil has cratered, volatility has picked up. The VIX is up almost 50% since Friday, rising from around 11 to almost 19 in less than 4 sessions. The VIX was up to around 26 in October, when we nearly had a market correction, but for much of the year, the VIX was almost asleep; back in the summer, a big story was how low the VIX was and how volatility had completely disappeared. And while markets were shook up in the fall, the VIX has still remained historically low.

There has been volatility at the gas pumps as well. The lower prices have been a windfall for drivers, with estimates that it puts billions of dollars back into our wallets. Goldman Sachs had estimated the savings at $75 billion; now they say it will be closer to $125 billion. Goldman analysts wrote a research report stating: “History suggests that higher gasoline consumption should show up quickly, while the boost to other categories of spending may take a bit longer to materialize,” and that should lift real gross domestic growth by up to half of a percentage point in 2015. And think about it, when oil prices go up, we have seen that it can throw the economy into a recession, but when oil prices drop it inevitably leads to economic growth.

So, heading into 2015, we have a boost from lower oil prices, then let’s make a comparison to same time last year. In 2013, we were just coming off a government shutdown that cost somewhere around $50 or $60 billion and by some estimates lopped off almost a full percentage point of GDP growth. And then there was the sequester, which lopped off another half a percentage point of GDP growth, more or less. And then there was the polar vortex, all that lousy weather that hit much of the country to start 2014. By comparison, the economy is looking pretty good right now.

The Treasury Department reported this morning that the budget deficit for November shrank 58% compared with a year ago. The November shortfall was $57 billion, compared with a deficit of $135 billion in November 2013. And the November deficit would have been $92 billion, or 8% less than the November 2013 shortfall, if not for calendar quirks. For instance, $41 billion in payments of veterans’, active military and other benefits that would usually have been made in November were sent in October since Nov. 1 was a Saturday. November is the second month of the 2015 fiscal year. For the fiscal year to date, the deficit is $179 billion, 21% lower than in the first two months of fiscal 2014. The shortfall for fiscal 2014 was $483 billion. Last year’s deficit was 2.8% of gross domestic product—the lowest by that measure since 2007.

And late last night, House and Senate lawmakers reached an agreement on a nearly $1.1 trillion bill to fund most of the government through September and avert a shutdown. It still faces an actual vote, which could be messy, because there are a bunch of things that are included in the bill that aren’t really part of the budget. And one thing not many people have heard about that may be a real problem.

If you have a pension and if House and Senate lawmakers approve the $1.1 trillion bill to fund most of the government through September and avert a shutdown, there is a provision in the spending bill would allow the promised pension benefits of up to 1.5 million workers and retirees to be cut. It would affect the pooled pension plans – called multiemployer plans – of mostly union workers across a bunch of companies, where it looks like the plans won’t be able to cover full benefits in coming decades. This would not affect all private pensions. The 31 million people in so-called single employer plans wouldn’t be affected by the bill. The bigger fear is about the 10 million workers and retirees in pooled plans. Ten to 15% of those workers are in plans that may need to make cuts. And the cuts could be drastic. For example, a retiree with a pension of $24,000 per year and 25 years of service could see his or her annual benefit cut in half; although not all troubled pensions would need to be cut that deeply.

Again, this doesn’t affect everybody with a pension. Nothing in the proposed bill affects pooled plans that are in good financial shape, or any of the plans offered by single employers. Still, I’m thinking this one will tick off a bunch of retirees, especially because this is not something that has been debated openly, but just seems tacked on because it can be tacked on.

But wait there’s more! It’s not just retirees, there is another little provision tacked onto the spending bill that would cut $303 million or 1.3% of the $22.5 billion for the Pell grant program. This is the grant program for low income college students. Not a huge part of the overall budget, but the interesting thing is where the money will go. Part of it will be used to fund student loan debt servicers. So, they cut the grants and spend the money for debt collectors on the loans.

And then there is the partisan bickering over the spending bill. Some Democrats are opposed to a Republican-backed provision in the $1.1 trillion measure to ease regulations imposed on big banks in the wake of the 2008 economic meltdown. They also opposed a separate section that eases limits on campaign contributions to political parties. Some Republicans are upset that the measure left the administration’s controversial new immigration policy unchallenged, at least until the end of February.

It seems there is something for everyone to hate. The AFL-CIO and the Heritage Foundation have both called for the spending bill to be defeated, proving that politics makes strange bedfellows. And maybe, just maybe setting the stage for the 113th Congress to make one more mess of things before they convene.

FINANCIAL REVIEW

Fed Should Avoid Knee Jerk Hikes

Sinclair Noe — December 8, 2014

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

DOW – 106 = 17,852
SPX – 15 = 2060
NAS – 40 = 4740
10 YR YLD – .05 = 2.26%
OIL – 2.80 = 63.04
GOLD + 11.10 = 1205.20
SILV + .09 = 16.48

No records today. Energy stocks pulled the market lower; 42 of the 43 energy stocks in the S&P 500 posted losses today. Falling oil prices have also hit exchange rates of energy producers, especially in emerging markets. Russia’s ruble continues to slide, and an index tracking 20 key exchange rates has fallen to levels last seen more than a decade ago, down 10.2 percent this year and headed for the biggest annual slide since 2008. While some developing nations may welcome a weaker currency because it makes their exports more competitive, for others the pace of decline is destabilizing their economies by fueling inflation and eroding investor confidence.

While the International Monetary Fund expects developing economies to pick up next year, it still sees them falling short of their longer-term growth. The IMF predicts expansion of 4.95 percent across emerging markets in 2015, up from a forecast of 4.43 percent this year and compared with average growth of 6.44 percent over the past decade.

Let’s start with a quick recap of Friday’s jobs report. The economy added 321,000 jobs in November, well above estimates, the highest monthly gain since January 2010 and the 10th-straight month above 200,000. Payroll gains for October and September were revised up a combined 44,000. The unemployment rate held steady at 5.8%, matching a 6-year low. The average workweek rose to 34.6 hours, the highest since May 2008. Average hourly earnings rose 0.4%, the biggest jump since June 2013, bringing the annual rate of increase to 2.1%.

And suddenly there was talk about the need for the Fed to tighten monetary policy. The Fed has its own measure of the labor market, a 19-point list of various aspects of the labor market, known as the dashboard; it dropped from 3.9 to 2.9. So, don’t expect a knee jerk reaction from the Fed.

One thing we should have learned is that a recovery in the labor market will likely be tougher than many suspect. The reason why I say that is past performance. Seven years ago, the economy slipped into a depression (small “d’ depression, but nasty enough) and we have struggled to recover; although we have made progress, we do not have full employment, and there is a chance we won’t. Long-term unemployment is still very high, more like the days of the Great Depression. Millions of families lost their jobs, lost their homes, their savings, and more. Young Americans looking for a first job in a career, ended up back in their parents’ basement. Some job skills were forgotten and turned rusty while other job skills never developed. Careers that could have been or should have been, instead jumped off the rails and will never really get back on track.

Estimates of the economy’s potential, the amount it can produce if and when it finally reaches full employment, have been ratcheted lower as the economy was unable to recover. In other words, the severity and duration of the downturn damaged future potential. If you need an example, consider Japan, which has now lost a couple of decades to rolling recessions mixed with lethargic growth. Today, Japan revised third quarter GDP lower to negative 1.9%; the second quarter of contractions; the definition of a recession that has seen private consumption drop, which in turn led to businesses cutting production and capital expenditures. Even aggressive monetary policy has been like pushing the proverbial string.

And just as the Great Depression left lifetime scars, so too the small “d” depression has changed the psyche of a generation. More people are more averse to falling into the old debt traps. Today, The Federal Reserve reported that consumers increased their use of credit in October at the slowest pace in a year, despite more jobs and stronger economic growth. Americans increased overall credit by an annual rate of 4.9%, or $13.2 billion, to $3.28 trillion in October. That follows a 5.7% gain in September and 5% in August. The slowdown follows a four-month stretch from the early spring to the start of summer during which credit grew at an 8% average rate. Credit card debt rose by just 1.3%, while non-revolving debt (things like auto and student loans, grew by 6.2%).

When the small “d” depression hit, it did lasting damage, which has taken an inordinate amount of time to repair and which may never be fully repaired. Now, after the strong Friday jobs report, one of the first things we heard about was what the Federal Reserve will do. If we maintain the current pace of job creation, sometime around the middle of 2015 the unemployment rate will be around 5%, which would point to the Fed raising interest rates. Weighing against the Fed tightening is the very low inflation rate. And the Fed has to balance what might be considered full employment versus low-flation. Again, the Fed is expected to raise rates starting around June, but they might want to wait. Here’s why.

First, the more accurate measure of unemployment is the U-6, which measures underutilized workers; U-6 unemployment rate is 11.4% and dropping, which is still high. As workers are more fully utilized and the labor market gets tighter, the long-term unemployed and discouraged workers are more likely to re-enter the labor market, expanding the labor pool, and effectively creating a floor for the unemployment rate and reversing the loss of potential output brought about by the prolonged period the economy spent depressed. In other words, we are still a very long way from full employment, even as the headline rate gets closer to 5%.

The monetary concern about full employment is that it will result in cost-push inflation; higher wages resulting in inflation. And we started to see a little increase in wages in November, up 0.4%; one month does not make a trend. The other part of cost-push inflation calls for an increase in raw materials. In other words, general price levels rise (which would be inflation) due to increases in the cost of wages and raw materials. But we are not seeing an increase in the prices of raw materials; just the opposite, raw material prices are disinflationary, just look at the oil market, and most of the commodity markets where prices seem to have turned to a secular bear. Also consider that profit margins are so wide right now that it will take several years of stronger wage growth to generate cost-push wage inflation.

And if we get to the point where there is cost-push inflation, so what? The Fed has shown that it can tamp down inflation fairly quickly by tightening monetary policy. The Fed can put the brakes on inflation but they have a much harder time reversing dis-inflation, and they get downright desperate to do anything about deflation. Which is to say the Fed is better at slowing growth than creating growth. So, if the Fed should allow a period of full employment that results in cost-push inflation, so what? It is much better than underutilized the potential workforce. And the Fed might just discover that the natural rate of unemployment is actually lower than 5%, and it would be very glad not to have tightened too soon.

It looks like Congress has come to some sort of agreement on a spending bill. Congressional negotiators will wait until tomorrow to release the legislation which is expected to keep most of the government open through September 2015; the Department of Homeland Security will likely only be financed through February. Republicans are trying to use a funding debate over the agency responsible for immigration to roll back President Obama’s action easing deportation for undocumented immigrants. There are a variety of smaller issues that may or may not be tacked onto the spending bill including a possible repeal of part of the Dodd-Frank financial-services law to allow more swaps trading to be conducted at banks that have federal insurance, which basically means the banksters could continue to gamble with taxpayer money.

The Supreme Court rejected BP’s challenge to a multi-billion settlement related to the 2010 Gulf of Mexico oil spill. BP had appealed the settlement, claiming that it let businesses collect despite being unable to prove their damages were linked to the spill. The company had lost previous appeals in lower courts. Today’s decision marks a major setback for BP, which wanted to reduce the amount of damages it would pay. Plaintiffs accused the company of merely trying to nullify a settlement it had already agreed to. It’s expected that BPP may need to pay an additional $4.2 billion in claims to businesses and individuals affected by the oil spill. So far, the company has paid about $2.3 billion. BP already settled U.S. criminal charges and agreed to pay $4.5 billion in fines related to that. In January, BP will go on trial for penalties associated with the U.S. Clean Water Act. It could pay as much as $18 billion for that.

In economic news: The Congressional Budget Office reports the government ran a budget deficit of $59 billion in November, $76 billion less than in November 2013. Receipts for the month were $191 billion, up $8 billion from the same month a year ago. The government spent $249 billion in November, $68 billion less than a year ago.

This week’s economic calendar report on retail sales on Thursday which should provide more detail on Black Friday and how holiday shopping is shaping up. On Friday we get the producer price index, a look at inflation on the wholesale level; also consumer sentiment will be reported Friday. We’ll also find out more about the labor market with the JOLTS report tomorrow; that report measures job openings and labor turnover, or how many people are leaving current jobs for greener pastures.

We have a few companies reporting earnings this week, including,: Costco, Burlington Stores, Mens’ Warehouse, and Adobe.

Also tomorrow, the Norwegian Nobel Committee will formally award the 2014 Nobel Peace Prize to Kailash Satyarthi and Malala Yousafzai in Oslo. The two were commended for their struggle to secure the right to education for children and young people around the world.