Financial Review

Sideways

Sinclair Noe — November 19, 2015

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DOW – 4 = 17,732
SPX – 2 = 2081
NAS – 1 = 5073
10 YR YLD – .02 = 2.25%
OIL – .24 = 40.51
GOLD + 11.30 = 1082.30
SILV + .04 = 14.32

The biggest rally in stocks in 4 weeks fizzled today. The S&P is up 2.9% so far this week. The S&P 500 has surged almost 12% from its August lows, including an 8.3% gain in October. Treasuries rose and the dollar fell. The MSCI Emerging Markets Index rallied 1.9%, heading toward the biggest weekly gain since the period ended Oct. 9. Equity gauges in South Korea, India and South Africa jumped more than 1%. Oil touched the lowest level in almost three months.

The number of Americans filing for unemployment benefits fell last week. Initial claims for state unemployment benefits slipped 5,000 to a seasonally adjusted 271,000 for the week ended Nov. 14. Claims have now held below the 300,000 threshold for 37consecutive weeks, the longest stretch in years, and are not too far from levels last seen in the early 1970s. Claims below this level are usually associated with a healthy jobs market.

Other data showed a slight pick-up in factory activity in the mid-Atlantic region in November after two straight months of declines. In a separate report, the Philadelphia Federal Reserve said its general activity index rose to 1.9 this month from -4.5 in October. It was the first positive reading in three months.

Arizona gained a net 33,800 jobs in October, dropping Arizona’s unemployment rate to 6.1% from 6.3%. Even so, the state remains well behind the nation’s 5% unemployment rate. In October, Phoenix had 1.9 million workers, about 3,000 fewer than it had in the same month eight years earlier.

Rebuilding the US energy industry to substantially reduce reliance on carbon-based fuels may result in a net gain of 2 million jobs by 2050 while increasing disposable household income, according to a new study sponsored by a nonprofit that advocates clean energy. The report found that a large-scale shift to renewable sources for generating electricity could increase U.S. employment by 1 million jobs by 2030 and 2 million by 2050, even after accounting for job losses related to fossil fuels. The transition would also provide between $300 and $650 in additional disposable income per household annually in 2050. A majority of the 2 million new jobs would be in the construction, utility and manufacturing industries.

Two IPOs came to market today: Square and Match. Both IPOs were underpriced, although the market will probably adjust in time. Square raised less than it had sought in its initial public offering, selling 27 million shares for $9 each, totaling $243 million. The price realized is well below the offer price of $11 to $13 a share and puts the company’s market value at about $2.9 billion, less than half the $6 billion valuation it had in its latest financing. In trading, the price popped to a high of $14.78.

Match Group, the owner of online-dating services Tinder, Match and OkCupid, priced its shares in its IPO at the bottom end of a $12 to $14 per share offering. The sale gives the company a market value of $2.9 billion. The price jumped as much as 24% in the first day of trading, valuing the company at $3.57 billion.

The U.S.’s biggest health insurer is considering pulling out of Obamacare, a month after saying it would expand its presence in the program. UnitedHealth Group is scaling back marketing efforts for plans it’s selling this year under the Affordable Care Act, and may quit the market entirely in 2017, because the business has proven to be more costly than expected. It’s an abrupt shift from October, when the health insurer said it was planning to sell coverage in 11 new markets next year, bringing its total to 34. The company also cut its 2015 earnings forecast.

MetLife, the largest U.S. life insurer, said the Financial Industry Regulatory Authority’s staff has indicated the agency will seek a “significant fine” from the company’s broker-dealer unit as part of a probe into possible violations tied to variable annuities. MetLife said in its quarterly regulatory filing that the company is cooperating in this investigation. MetLife said in the filing that the probe focuses on potential violations “regarding alleged misrepresentations, suitability, and supervision in connection with sales and replacements of variable annuities and certain riders on such annuities.”

Wall Street’s private stock markets would have to reveal whether they favor any particular users including high-frequency traders under a proposal approved Wednesday by the Securities and Exchange Commission. Many of the new disclosure requirements sought by the SEC mirror those currently reserved for public markets such as The New York Stock Exchange.

The regulatory effort follows a series of enforcement actions in which Investment Technology Group and UBS Group paid tens of millions of dollars to settle allegations they misled investors about how their dark pools worked. The proposal would require dark pool operators to make a new public filing that spells out their conflicts of interest, including whether an affiliate trades in the dark pool. If the dark pool creates advantages for any particular users, it would have to reveal that in the filing.

Japanese exports fell for the first time in more than a year in October. Exports slumped 2.1% last month, while imports fell 13.4%, hit by soft demand in China and other Asian economies. Despite the weakness, the Bank of Japan held its current pace of monetary stimulus steady at its policy meeting today.

Volkswagen is expected to announce substantial spending cuts on Friday, the day the carmaker must inform U.S. regulators of how it plans to bring its diesel cars into compliance with air-quality standards. VW is facing class action lawsuits around the globe. Volkswagen has also disclosed that 120,000 U.S. owners have signed up for its $1,000 goodwill package – or about one quarter of the 482,000 vehicle owners covered by the emissions scandal.

Meanwhile, Reuters is reporting that federal prosecutors with the Department of Justice are examining whether Bosch, the world’s largest auto supplier, knew or participated in Volkswagen’s years-long efforts to rig diesel emissions tests. Bosch built key components in the diesel engine used in six Volkswagen models and one Audi model. Federal authorities are also investigating how deeply the scheme permeated VW’s hierarchy. The probe is at an early stage and there is no indication that prosecutors have found evidence of wrongdoing at Bosch.

A proposed four-year labor contract between Ford and the United Auto Workers appears to be in trouble after more than half of those voting so far have rejected the pact and only two days remain for workers to cast ballots. Newer UAW members are providing the most resistance over the length of time it takes for younger workers to reach the top wage level. Older workers feel they gave up too much in earlier contracts. Results of voting are due on Saturday.

Pfizer is in advanced talks to buy Allergan  for as much as $380 per share in a deal that would value the Botox maker as high as $150 billion. The companies might announce an agreement as soon as Monday. Shares in Ireland-based Allergan had dropped due to plans by the U.S. Treasury Department to deter tax inversions, a major motivation behind Pfizer’s pursuit of the company.

The US Treasury Department will release new “targeted guidance” this week designed to reduce the tax benefits available to US companies that move their tax addresses overseas. Treasury Secretary Jack Lew informed lawmakers of the coming announcement in a letter on Wednesday. The administration previously has said it was examining “earnings stripping,” a practice by which companies load up their US operations with deductions and effectively push profits to low-tax countries.

In September 2014, the Treasury Department announced rules against inversions, including limiting companies’ ability to use their offshore profits to finance a deal. That change caused AbbVie to abandon a planned inversion, but other companies moved ahead. The Treasury hasn’t yet issued the formal regulations it promised last year, and congressional efforts to revamp the international tax system have stalled.

The September 2014 announcement included a warning that rules against earnings stripping might be retroactive to inverted companies. That means the Treasury announcement coming later this week could affect companies such as Medtronic and Mylan that finished their inversions in the past 14 months, plus a half dozen more deals that haven’t closed yet.

Cutting Pfizer’s tax rate to 15% would save $2.1 billion in 2017 based on analysts’ estimates. At a multiple of 10, that’s worth just over $20 billion. At the reported deal price, Pfizer would be paying a premium of more than $35 billion for Allergan based on its undisturbed price. If Pfizer can’t get the deal done, it might face a breakup fee of 2 to 3%. And the more companies try to weasel out of taxes through inversions, the greater the likelihood there will be legislative change, which could make any savings short-term or even non-existent.

The attacks in Paris may have finally spurred a brand change for Isis Pharmaceuticals, a drug maker that until now has held on to its name despite the terrorist group’s rise in the Middle East. Named after Isis, the Egyptian goddess associated with good health, the company has had the moniker since its founding 26 years ago. Its ticker symbol is also under review.

The House of Representatives has easily passed a bill to restrict the admission of Iraqi and Syrian refugees to America by requiring extra security procedures. The American Security Against Foreign Enemies Act of 2015, or the American SAFE Act of 2015, would require the secretary of Homeland Security, the head of the FBI and the director of national intelligence to sign off on every individual refugee from Iraq and Syria, affirming he or she is not a threat.

It’s unclear whether the Senate will take up the legislation. President Obama has already said he would threaten such a bill, and the perfect venue for a veto would be directly in front of the Statue of Liberty.

Financial Review

Until Something Breaks

Sinclair Noe — October 29, 2015

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DOW – 23 = 17,755
SPX – 0.94 = 2089
NAS – 21 = 5074
10 YR YLD + .08 = 2.17%
OIL + .12 = 46.06
GOLD – 10.20 = 1146.50
SILV – .35 = 15.68

Gross domestic product, the value of almost everything a nation produces, rose at a 1.5% annual pace in the third quarter; that’s down from a 3.9% rate in the second quarter. The slowdown stemmed mostly from the biggest drawdown in inventories in three years. Companies cut spending on structures such as oil platforms and commercial buildings. Even as businesses showed more caution, consumers continued to spend money at steady clip.

Consumer spending, the single largest determinant of U.S economic growth, rose at a 3.2% annual pace following an even larger gain in the second quarter. Some parts of the economy are performing well; technology, health care, and finance are enjoying conditions that echo the booming 1990s or the housing bubble a decade ago. The energy sector is hurting and cutting jobs and closing down projects.

Shipping is a measure of the real economy. Shipments usually increase from August to September. They did this year too. The number of shipments in September inched up 1.7% from August, according to the Cass Freight Index. But the index was down 1.5% from an already lousy September last year, when shipments had fallen from the prior month, instead of rising. And so, in terms of the number of shipments, it was the worst September since 2010. September is in the early phase of the make-or-break holiday shipping season. But it’s not happening.

Yesterday the Federal Reserve FOMC wrapped up a two-day policy meeting, leaving interest rates unchanged near zero – no surprise. The Fed described the economy as expanding at a “moderate” pace and turned up the heat around a possible December rate hike. Today’s GDP report takes some of the starch out of the Fed’s resolve to raise rates. Maybe the Fed should just accept the idea that the economy is neither depressed and deflating nor overheated and inflating.

The stock market has been climbing almost since the Fed instituted Zero Interest Rate Policy; the economy has been adding jobs; inflation has flattened out, which seems the definition of price stability. Instead of all the hoopla over a possible rate increase, with attendant downside risks, there is a very real possibility the Fed could just stand pat for a very long time, or until something breaks.

Pending home sales fell 2.3% in September, the second drop in a row; still, the index of pending home sales is up 3% from the same level 12 months ago. The National Association of Realtors reported a shortage of available listings in the lower end of the market for first-time buyers.

The number of Americans filing new applications for unemployment benefits increased by 1,000 to 260,000, which is close to a 42 year low. It was the 34th straight week that claims were below the 300,000 threshold, which is normally associated with a fairly healthy jobs market.

John Boehner has officially resigned as Speaker of the House.  Paul Ryan has been elected as the 62^nd Speaker of the House. The House voted 266-167 to pass a two-year budget deal negotiated by Boehner, the White House and other congressional leaders that clears the decks for the new speaker and relieves market worries over a possible default next week. The plan extends the federal debt limit through March 2017 and eases automatic spending caps to add $80 billion in new discretionary spending over two years.

The budget accord raises spending caps on domestic and defense spending over the next two years while raising the debt limit until March 2017. There are also changes to eligibility requirement in the Social Security disability program, and changes to claiming strategies for Social Security. A provision to cut crop insurance subsidies by $3 billion to help pay for the deal was removed from the bill at the last minute. Farm-state lawmakers had objected to the cut.

There were also last-minute changes to the package in the House Rules Committee to recalibrate how the bill was scored with regard to money spent out of the Overseas Contingency Operations fund, an account that’s not subject to budget caps. There are many more details in the budget and there will likely be further changes; still, Senate leaders expect to pass the package next week.

After posting a €6 billion-euro net loss for the third quarter and scrapping its dividend for the next two years, Deutsche Bank has announced plans to exit 10 countries and reduce its workforce by 35,000 employees. The moves follow a recent writedown at its investment bank and the removal of three of the bank’s eight board members. A sanctions settlement may also be in the making. As early as next week, Deutsche is expected to pay at least $200 million to resolve investigations into its dealings with countries like Iran and Syria.

Following a better-than-expected earnings report, Samsung Electronics said it plans to buy back and cancel $9.9 billion of its stock over the next year in order to boost shareholder value. The tech giant’s operating profit jumped 82% to $6.5 billion during the quarter, its first year-on-year profit growth in two years, boosted by a recovery at its mobile division and strong semiconductor sales.

Royal Dutch Shell swung to a third-quarter loss after taking a $7.9 billion write-down on big ticket projects including an exploration venture in the Alaskan Arctic and a major oil sands endeavor in Canada. The company, however, is still moving ahead with its $70 billion acquisition of BG Group. Shell posted a quarterly loss of $6.1 billion, down from a profit of $5.3 billion a year earlier.

Volkswagen dealers across the country are offering hefty discounts on new gasoline models after the German automaker began more aggressive efforts to rebuild sales in the wake of its emissions scandal. According to an online survey, discounts of up to $7,000 are being offered on the Passat and Jetta, while gasoline-electric models such as the Jetta Hybrid have prices slashed by up to $6,000.

United Auto Workers leaders have approved a proposed contract with General Motors that promises raises, improvements in health care and a hefty signing bonus. Like a previous contract approved by Fiat Chrysler, GM’s agreement will also eliminate a two-tier wage system over eight years. The four-year deal will now be sent to GM’s 52,600 union workers for ratification.

Pharmaceutical giants Pfizer and Allergan are considering a merger. Allergan confirmed that it has entered into “preliminary friendly discussions” with Pfizer following an approach by the bigger drugmaker. No agreement has been reached. Stocks of both companies have been halted. Price could be an obstacle, as well as other issues including the extent to which Pfizer would want to lay off employees, close facilities and the general makeup of a combined management team. A tie-up between the two would create an entity with a market cap greater than $300 billion, and would be the biggest takeover announced this year.

It would also be the biggest ever U.S. tax inversion, a process by which a company shifts its legal address abroad to take advantage of lower tax rates and access to overseas profits, while keeping its operations in America. Allergan, for example, moved its legal address to Dublin, Ireland in a previous deal, while keeping its main executive offices in New Jersey.

The U.S. Treasury Department issued a proposal in September 2014 to try to stop inversions. The notice said the government would make it harder for U.S. companies to borrow against their foreign cash to finance inversions. It also tightened the calculations for when a deal triggers anti-inversion restrictions in the tax code and changed how passive assets would be counted in those tallies.

And it limited maneuvers by companies to shrink themselves by paying extraordinary dividends before a deal so they would escape the arithmetic tests in the anti-inversion law. While the rules aren’t final, they are retroactive and essentially in force, but that might not be enough to stop this deal.

In the past, the inversion threshold was 20%. Meaning that 20% of the new company had to be owned by a foreign entity in order to take full tax advantage of moving overseas. But the Treasury rule changes make it harder for U.S. companies to shift domestic earnings overseas at the 20% level. What’s more, companies can no longer use foreign cash tax-free to fund inversion deals if the deal ends up with just 20% foreign ownership. So the changes don’t eliminate the benefits of tax inversions. They just reset the threshold to 40%.

Pfizer’s market cap is roughly $220 billion. Shares of Allergan are up 17% today. That gives the company a market cap of almost $120 billion. For Pfizer to meet the 40% threshold, it would have to pay at least $147 billion for Allergan, or $27 billion more than what the market is currently guessing.

That might actually make sense. Pfizer currently has about $70 billion in cash overseas. If it were to repatriate that at the corporate 35% tax rate, then it would have to pay $24.5 billion in taxes. So the Treasury rules might not stop this inversion play, but we are also heading into an election year and this will not sit well.

Today is October 29^th, a rather notorious date also known as Black Tuesday, dating back to the Crash of 1929. The crash actually spread out over several days. It started in earnest on Thursday, October 24 with a 12% loss. The bankers and leaders of the stock exchange stepped in and tried to prop up the markets, with little success. The rout continued with 12% losses on Monday, Black Monday and then Black Tuesday; a two-day decline that remains the worst, in percentage terms, in US market history.

The market would not return to the peak closing of September 3, 1929 until November 23, 1954. The Wall Street Crash was widely considered as the start of the Great Depression. Say what you will about the current state of affairs but we can look back in history 86 years today and we should all count our blessings.

FINANCIAL REVIEW

Work Hard and Invest in the Future

Sinclair Noe — November 17, 2014

DOW + 13 = 17,647
SPX + 1 = 2041
NAS – 17 = 4671
10 YR YLD + .02 = 2.34%
OIL – .37 = 75.45
GOLD – 2.00 = 1187.50
SILV – .18 = 16.24

Another day, another record on Wall Street. A record high close for the S&P 500. The Dow did not close above Thursday’s record close of 17,652.

The Dow Transports were down today, but Transportation stocks are the best performing names on the market over the past month. Since the market bottomed out on October 13th, the Dow Jones Transportation Average has soared an incredible 18%. So if you thought the S&P’s furious 11% rally has been a sight to behold, you clearly weren’t paying attention to the soaring plane, train and trucks.

Another Merger Monday; Halliburton agreed to buy Baker Hughes for about $34 billion. Actavis agreed to buy Allergan for $66 billion.

The Halliburton acquisition of Baker Hughes will unite 2 major oilfield services companies. Halliburton and Baker Hughes began discussions in mid-October; an interesting time as oil prices were falling, raising questions about the viability of expanding oil and gas exploration and development. The acquisition was on again, off again, and briefly turned hostile last week. The deal could still face regulatory scrutiny, even though Schlumberger is still the largest oilfield services company, bigger than a combined Halliburton/Baker Hughes. Halliburton has agreed to sell off businesses that generate up to $7.5 billion in revenue to appease the federal government.

Low oil prices tend to trigger consolidation, mainly because the big oil companies do not believe low oil prices will last, so they consider acquisitions as value plays. Buyers with cash to spend aren’t going to let the cheapest valuations in years pass them by and targets threatened by lower prices may become more willing sellers. So, the speculation ramped up with today’s announcement. Possible deals include General Electric going after National Oilwell Varco, and there is even speculation that someone might target BP. Some potential smaller targets include Oasis Petroleum, Pioneer Natural Resources, and Laredo Petroleum.

Allergan has agreed to sell to Actavis. The $66 billion deal, or $219 per share in cash and stock, ends months of speculation about a possible hostile takeover led by activist investor Bill Ackman, who had been working with Valeant Pharmaceuticals to court the Botox manufacturer. So, the Actavis deal would be the largest of the year; bigger than the $45 billion proposed acquisition of Time Warner Cable by Comcast; bigger than AT&T’s $48 billion purchase of DirecTV; and the third largest health care deal ever in the US. Combining Actavis and Allergan will create one of the 10 largest global drug makers, with about $23 billion in revenues expected next year.

Actavis was until recently based in Parsippany, N.J. But last year it agreed to acquire an Irish drug maker, Warner Chilcott, and relocate its headquarters abroad, striking one of the first big tax inversions. Actavis’s deal to move abroad and reduce its tax bill caught the attention of other drug companies, and set off a rush of similar deals. In September, the Treasury passed new rules to make it harder for companies to use inversions to skip town on taxes. But Actavis is like the cow that got out before the barn door was closed; Actavis completed its move overseas and is exempt from new inversion rules.

In economic news, industrial production fell a seasonally adjusted 0.1% in October, a bigger than expected drop and the second drop in the last three months. In October, manufacturing output rose 0.2%, but mining output dropped 0.9% and utilities output fell 0.7%. Capacity utilization fell to 78.9%. Oil and gas well drilling fell 0.8% in October, the first decline since February. Despite the drop, industrial production is up 4% over the last 12 months. Based on the recent weakness in manufacturing it is estimated that fourth quarter GDP may be running at about a 2% annual pace, down from 3.5% in the third quarter.
Separately, the Federal Reserve Bank of New York reported its Empire State manufacturing index rebounded a bit to 10.2 in November from 6.2 in October. The index had been up to 27.5 in September, so the readings over the last two months indicate a downshift in activity.

Last week was light on economic data; this week the big story will be Wednesday as the Federal Reserve FOMC releases minutes of the October 28-29 FOMC meeting, which was the meeting that ended Quantitative Easing 3. The minutes will be parsed for clues on labor markets, global weakness, a stronger dollar, and the inflation-deflation debate.

This week’s economic calendar will also include reports on homebuilders’ sentiment and home sales. Tomorrow we’ll look at inflation on the wholesale level with the Producer Price index. Lower oil prices will likely play a big role in tomorrow’s report. Wholesale gasoline prices were down 11% in October, which could knock 0.6 to 0.8 percentage points from the headline inflation number. In September, weakness in miscellaneous service prices drove a 0.1% decline. The Consumer Price Index, which measures inflation at the retail level, will be released on Thursday, and again energy prices will be an important component. Best guess is that inflation is running at a 1.8% annualized rate according to the CPI.

The general feeling seems to be that oil prices will rise. OPEC holds a meeting November 27 in Austria, and there will certainly be discussion about cutting production and supply. A decrease in global demand and the boom in US shale have pushed prices down more than 25% since June, but OPEC’s 12 member countries are not unanimous on production cuts. Last week, Kuwait’s oil minister said he didn’t think there would be a reduction in output. Over the weekend, Kuwait’s cabinet and Supreme Petroleum Council held a meeting to consider options to halt the slide in prices. It’s a sign the nation is becoming increasingly concerned. The Saudis have said they could live with lower prices, and they don’t want to lose market share if they do agree to a cut, so they won’t try to cut back production on their own, but if other nations agree to a production cut, the Saudis will probably go along.

Another question OPEC will have to consider is global demand, specifically in light of the economic weakness in Europe, announced last week and the news from Japan today. Japan Is In Recession. Unexpectedly poor GDP data confirmed Japan has been in recession, with a 1.6% rate of contraction in the third quarter when a 2.2% rate of growth was expected; this followed a 7.3% rate of decline in second quarter.

The Central Bank of Japan and Prime Minister Shinzo Abe has thrown everything but the kitchen sink at the Japanese economy. The problem is that certain parts of the government got worried, and decided they could not live with the debt, and they needed to raise taxes, which turned out to be a terrible idea. Japan was expected to hike tax rates for the second time this year. Given that the first tax hike has been blamed for this year’s economic woes that second hike is likely to be delayed. And it is now recognized that a Valued Added Tax, or VAT increase was the cause of the recession. Japan also tipped into a recession after a 1997 consumption-levy rise, leading to the fall of the government of the day. Today’s report comes two days before the Bank of Japan’s next policy meeting. Governor Haruhiko Kuroda last month led a divided board to expand what was already an unprecedentedly large monetary-stimulus program.

The unexpected shrinkage of the Japanese economy sent Japan’s major stock index, the Nikkei, tumbling 2.9%. The yen tumbled to a 117.05 per dollar, the lowest level since October 2007. Markets were down in Europe, and it was expected US markets would tumble on the news, but it didn’t really happen.

This is the sixth time in the past 20 years that Japan has dropped into recession and you might think there are a few things we could learn from the Japanese experiment. First, Japan’s famously stagnant economy may not be all that unique, and if it can happen to Japan, it can happen anywhere.

When the asset-price bubble first burst in Japan in the early 1990s, they did not pursue an aggressive fiscal stimulus program and they did not force banks to quickly recognize losses and recapitalize. Instead, Japan’s ill-timed effort to balance its budget with a consumption-tax increase in 1997 sent the economy into recession, and a paralyzed banking sector contributed to an extended period of stagnation that has done much more to worsen the debt burden than well-targeted government spending would have.

Japan’s problems in the 1990s look a lot like the problems facing the Eurozone today: undercapitalized banks, lethargic business lending, and rolling recessions that turn into extended periods of stagnation.

By the way, the 2-day summit of the G-20 wrapped up in Australia, and like most G-20 meetings, it was not very productive. It will likely be remembered for Vlad Putin’s boorish behavior, but there were a few things that might count as accomplishments. The G-20 managed to sign off on anti-tax-evasion measures and on anti-corruption guidelines. One of the biggest accomplishments might be agreement by leaders to boost their economies by a collective $2 trillion by 2018. IMF Managing Director Christine Lagarde told the leaders that in order to avoid the “new mediocre” of low growth, low inflation, high unemployment and high debt, all tools should be used at all levels.

The G-20 plan to boost global growth is long on ambition but short on specifics. The mostly structural policy commitments spelled out in each country’s individual growth strategy include China’s plan to accelerate construction of 4G mobile communications networks, a $417 million industry skills fund in Australia and 165,000 affordable homes in the U.K. over four years. So the plan to avoid stagnant economies is to invest in housing, education, and infrastructure. Now, whether any of this comes to pass remains to be seen, but really this economics stuff is pretty simple. Work hard and invest in the future.