Financial Review

June Jobs Report

Sinclair Noe — July 8, 2016

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DOW + 250 = 18,146
SPX + 32 = 2129
NAS + 79 = 4956
10 Y – .02 = 1.37%
OIL + .05 = 45.19
GOLD + 4.80 = 1365.60

*S&P just shy of intraday and closing record highs, going back to May 2015.

The Jobs Report for June showed the economy added 287,000 new jobs, and the unemployment rate rose to 4.9% in June from 4.7% as more people entered the labor force in search of work. The results topped consensus estimates around 175,000.

June payrolls were boosted by the return of 35,000 striking workers at Verizon. The May report was revised from 38,000 down to 11,000. April’s gain was revised higher to 144,000 from 123,000. April and May revisions resulted in a net loss of 6,000 jobs compared to initial estimates.

Goldman analysts blamed the month to month discrepancy on weather, saying that during April and May, industries most affected by weather barely hired. Construction, leisure and hospitality and retail, added just 4,000 jobs compared to 113,000 in October through March. Construction hiring was again low in June.

Another consideration is seasonal adjustments based on the school year. In May, we saw a decline in the unemployment rate and a drop in labor-force participation. The change suggested that unemployment was falling for “bad reasons,” as discouraged workers gave up looking for work. Reinforcing that notion, the share of unemployed workers leaving the labor force spiked, on a seasonally adjusted basis.

The unadjusted data painted a different picture. When schools finish up in May, more students start looking for work, which adds people to the labor force. So normally, in data that aren’t adjusted for seasonal fluctuations, fewer people drop out of the workforce from jobless rolls during the month.

That big slowdown in dropouts we usually see in May didn’t happen this year. So when the normal seasonal adjustment was applied, it magnified the flows out of the labor force. That, in turn, helped push the unemployment rate down to 4.7 percent, even though the report only showed 11,000 new jobs created.

In June, however, the slowdown in labor-force dropouts played out more fully. The unemployment rate jumped back 0.2 percentage point, while the participation rate rose 0.1 percentage point, and the economy added 287.000 new jobs.

The numbers in May and June were probably flukes, or outliers. So we can look at broader trends. The US added an average of 147,000 jobs in the past three months. Over the past six months the economy has averaged 172,000 net new jobs per month. Clearly the trend is down from an average of 230,000 per month in 2015, but that is to be expected at this point in the economic cycle.

Taking account of the growing numbers of retiring baby boomers and the population growth, a monthly gain of 75,000 to 100,000 jobs is sufficient to keep the unemployment rate steady, while a 125,000 monthly gain is what is required to nudge it down further.

The Labor Force Participation Rate increased in June to 62.7%, up from May’s 62.6 percent, close to its lowest level since the 1970s. The U-6 unemployment rate declined to 9.6%. The U-6 rate includes the unemployed, the underemployed and the discouraged – people who have given up looking and are no longer counted in the headline number.

While the U-6 rate has made substantial gains in the past years, it remains stubbornly at pre-recession levels. There are 1.97 million long-term unemployed (that’s more than 26 weeks), and that number is up from 1.88 million May. The number of part-time workers who prefer full-time jobs fell by nearly 600,000.

And the ranks of temporary workers increased by 15,000 after falling by 19,000 in May and posting meager gains in recent months. Employers often add such contingent workers before hiring permanent staffers. And even though more than 400,000 candidates jumped back into the labor market, the low labor force participation rate indicates there is still plenty of slack.

Leisure and hospitality added 59,000 jobs in June, following little employment change in the prior month. Job gains in leisure and hospitality have averaged 27,000 per month thus far this year, down from an average of 37,000 in 2015.

Health care and social assistance added 58,000 jobs in June. Employment in financial activities rose by 16,000 in June. Employment in information increased by 44,000 in June. Employment rose in telecommunications (+28,000), largely reflecting the return of workers from the Verizon strike.

Employment in professional and business services continued to trend up in June (+38,000). The industry has added an average of 30,000 jobs per month, compared with an average monthly gain of 52,000 in 2015.

Employment in retail trade edged up by 30,000 in June, after changing little over the prior 2 months; a positive sign for consumer spending. Retail trade has added 313,000 jobs over the year.

Employment in mining continued to trend down in June (-6,000). Since reaching a peak in September 2014, mining has lost 211,000 jobs. Employment in other major industries, including construction, manufacturing, wholesale trade, transportation and warehousing, and government, showed little or no change in June.

Average hourly wages rose 2 cents to $25.61 in June. In June, the average workweek for all employees on private nonfarm payrolls was 34.4 hours for the fifth consecutive month. Hourly pay increased 2.6% in the 12 months to June 2016, matching the highest level of the recovery; that’s good enough to outpace inflation, so wage gains mean more money in workers pockets, still the gains are not enough to raise concerns about wage push inflation.

More than a dozen cities and states raised wages this year, and those higher pay floors should cause a ripple of extra earnings for people making as much as 20 percent more than the minimum. For states like New York and California, which will increase wages to $15 an hour over the next few years, those benefits will extend to people making $18 an hour. Wage increases above the minimum wage are believed to be a response to what economists call “wage compression,” which occurs when more senior employees are no longer better compensated than less senior employees.

Say you worked at a fast food restaurant in Washington, D.C., at the old local minimum of $10.50. On July 1, your hourly wage increased to $11.50. That’s great news for you, but the shift manager getting paid $12 an hour may not be overjoyed about your sudden good fortune.  There is a hierarchy in wages, but anything above the minimum is discretionary, and that ripple effect only extends to about 20% of the wage scale, give or take.

Overall, only about 3 percent of workers are paid minimum wage, according to an analysis by the Brookings Institute. But nearly 30 percent of workers make less than 1.5 times the minimum wage. By that rough calculation, about 35 million workers could see raises if the minimum increased. The minimum wage does more than simply shift the wage distribution toward higher pay — it effectively compresses the lowest wages.

The end result is a reduction in wage inequality below the median wage — a little under $30,000 for individuals. Beyond that, the impact of increases in minimum wage don’t seem to affect middle income and upper income workers.

Of course, the bigger debate about minimum wage is whether it will mean fewer jobs; the basic idea is that raising the price of anything reduces demand. But there are other factors that must be considered. When workers earn more there is less turnover and productivity increases.

Also, lower wage workers tend to spend almost everything they make, meaning the wages are circulated, increasing the velocity of the money, and stimulating the economy. The net effect is mildly positive, with a lag time.

One of the recurring complaints from employers is that they have a hard time finding skilled workers. Wages of high school dropouts are lower than they were at the turn of the century in real terms. The same goes for workers with a high school diploma, and also for workers who went to college but stopped short of a bachelor’s degree. Although some of the hardest to fill jobs in the country don’t require college degrees: chefs, butchers, bakers, mechanics and electricians. These jobs certainly require skills.

The most obvious solution would be to train workers for skills that are in demand. The problem is that we don’t see much job training in the US. According to the Organization for Economic Cooperation and Development, the United States government spends only 0.03 percent of its gross domestic product on worker training, well below budgets for other developed nations. Penny wise, pound foolish.

The Federal Reserve is back in the game. That’s the simple message from the strong June jobs report. That said, don’t expect a rate hike this month. The May jobs report appeared to spook the central bank and convinced investors the Fed would keep rates on hold all year. Though most Fed officials have continued to signal a desire to raise rates at least once in 2016, minutes from the Fed’s June 14-15 meeting, released on Wednesday, showed the Federal Open Market Committee “generally agreed” they needed to see more data before contemplating another hike.

The Fed won’t overreact to one strong report any more than it would to a single weak one. The Fed will almost certainly remain on hold at their next meeting on July 26-27. Prior to the report this morning, markets had priced in one rate hike through the end of 2018; now the CME Fedwatch calculates a 23% chance of a rate hike by December.

Stocks See Solid Gains Following Jobs Report

Charles Schwab: On the Market

Posted: 7/8/2016 4:15 PM ET

Stocks See Solid Gains Following Jobs Report

U.S. stocks rallied early and never looked back in the wake of the June labor report which showed a solid improvement in monthly job creation, though the unemployment rate ticked higher and growth in average hourly earnings was shy of forecasts. Treasuries were mixed following the jobs report, while in the final hour of trading consumer credit was shown to have expanded more than expected. Crude oil prices edged lower, the U.S. dollar was nearly unchanged and gold was slightly higher.

The Dow Jones Industrial Average (DJIA) rallied 251 points (1.4%) to 18,147, the S&P 500 Index surged 32 points (1.5%) to 2,130, and the Nasdaq Composite jumped 80 points (1.6%) to 4,957. In moderately heavy volume, 920 million shares were traded on the NYSE and 1.9 billion shares changed hands on the Nasdaq. WTI crude oil was $0.27 higher at $45.41 per barrel, wholesale gasoline added $0.01 to $1.37 per gallon and the Bloomberg gold spot price increased $5.89 to $1,366.34 per ounce. Elsewhere, the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was nearly unchanged at 96.25. Markets were higher for the week, as the DJIA gained 1.1%, the S&P 500 Index increased 1.3% and the Nasdaq Composite rallied 1.9%.

Gap Inc. (GPS $23) reported that net sales for the five-week period ended July 2, 2016 rose by 2% to $1.57 billion, compared to a 1% decline a year ago, with growth from its Old Navy segment driving the results for the clothing retailer. Shares of GPS finished nicely higher.

Polycom Inc. (PLCM $12) announced that it has agreed to be acquired by privately-held Siris Capital Group LLC for a price of $12.50 per share in cash. The offer is subject to PLCM's termination of its existing merger agreement with Mitel Networks Corp. (MITL $7). The transaction is valued at roughly $2.0 billion, including debt, a 13.6% premium over its previous offer from MITL. Shares of both companies closed sharply higher.

U.S. jobs jump, but unemployment ticks higher, while consumer credit tops estimates

Nonfarm payrolls (chart) rose by 287,000 jobs month-over-month (m/m) in June, compared to the Bloomberg forecast of a 180,000 increase. The disappointing rise of 38,000 seen in May was downwardly revised to a gain of 11,000 jobs. The total downward revision to job gains in May and April was 6,000. Excluding government hiring and firing, private sector payrolls increased by 265,000, versus the forecasted gain of 170,000, after declining by 6,000 in May, negatively revised from the 25,000 rise that was initially reported. Gains were seen in professional & business services with an increase of 38,000 jobs, telecommunications, with a 28,000 rise following the 32,000 decline registered in May due primarily to the Verizon strike, while manufacturing jumped 14,000.

The unemployment rate rose to 4.9% from 4.7%, compared to expectations of an increase to 4.8%, while average hourly earnings grew by 0.1% m/m, below projections of a 0.2% increase, and May's 0.2% rise was unadjusted. Finally, average weekly hours remained at May's unrevised 34.4 hours level, matching projections.

Consumer credit, released in the final hour of trading, showed consumer borrowing expanded by $18.6 billion during May, topping the $16.0 billion forecast of economists polled by Bloomberg, while April's figure remained near a level of $13.4 billion. Non-revolving debt, which includes student loans and loans for vehicles and mobile homes, rose $16.2 billion, while revolving debt, which includes credit cards, rose by $2.4 billion.

Treasuries were mixed, with the yield on the 2-year note increasing 2 basis points (bps) to 0.61%, while the yield on the 10-year note decreased 3 bps to 1.36%, and the 30-year bond rate declined 4 bps to 2.10%. Bond yields have seen pressure lately, falling to record lows, as the global markets continue to grapple with the impact of the U.K. Brexit vote, and Schwab's Chief Fixed Income Strategist, Kathy Jones offers analysis in her recent article titled, Brexit: What Does It Mean for the Bond Market?, at www.schwab.com/marketinsight. Follow Kathy on Twitter: @kathyjones. Also, for more on the Brexit fallout with a focus on sectors, see the latest Schwab Sector Views: Sector Impact of Brexit from Schwab's Director of Market and Sector Analysis, Brad Sorensen, CFA, at www.schwab.com/marktetinsight, while you can also follow Schwab on Twitter: @schwabresearch.

European markets get a boost from U.S. labor report, Asia mostly lower

European equities finished the week on a high note, notching solid gains following an upbeat U.S. labor report. The British pound continued to slowly recover from its rout that pushed it to a 31-year low versus the U.S. dollar this week in the wake of the Brexit vote, while a one-off special consumer confidence survey in the U.K. to measure sentiment following the Brexit vote showed a drop to a reading of -9 from the -1 posted in an earlier, regularly-scheduled monthly release. For deeper analysis of the impact of the Brexit vote, see the Schwab Center for Financial Research's recent article, Brexit: What Investors Should Know, at www.schwab.com/marketinsight and be sure to check out the video from Schwab's Managing Director of Trading and Derivatives, Randy Frederick and Schwab's Chief Global Investment Strategist, Jeffrey Kleintop, CFA, titled Brexit Aftershock: When Will the Markets Calm Down?, at www.schwab.com/insights. Follow Randy and Jeff on Twitter: @randyafrederick and @jeffreykleintop. Additional economic news in the region was mixed, as trade data out of Germany and the U.K. were mostly in line with forecasts, while industrial production in France fell short of expectations. The euro lost ground versus the U.S. dollar, while bond yield in the region were lower.

Stocks in Asia finished mostly lower, as the post-Brexit rally lost steam amid global growth concerns, ahead of the release of Friday's U.S. employment report. Flight-to-safety continued to boost the yen, pushing Japanese equities lower, while some attention may have shifted to the country's upper house elections, to be held this weekend. Australian securities ticked higher despite a sharp cut in the forecast for iron ore prices from the nation's Department of Industry, Innovation and Science, and following the credit outlook downgrade from Standard & Poor's on Thursday. Chinese stocks were lower amid rising worries over the country's banking sector, after a report showed non-performing loans exceeded $299.2 billion in May, upping banks' bad-loan ratio to 2.15%. Meanwhile, South Korean equites fell and Indian listings also lost ground.

Jobs report gives boost to stocks

Despite a sluggish start, U.S. stocks were higher for the holiday-shortened week as equities rallied on Friday, shaking off some of the post Brexit hangover, with the Dow topping 18,000 and the S&P 500 closing above 2,100. Gains for stocks transpired on the heels of the June labor report, which showed a solid improvement from May's disappointing figures for jobs created during the month. Our experts note in the recent Schwab Market Perspective: Looking Beyond Britain, that healthy job growth and the possible support to inflation from higher wages lead us to wonder if market expectations around Fed policy may have gone too far. The futures market indicates roughly no chance of a hike for the balance of the year; while rate cut expectations have come back in play. Read more at www.schwab.com/marketinsight and follow Schwab on Twitter: @schwabresearch.

In addition to the jobs data, some other positive domestic economic reports included a decline in weekly jobless claims and a jump in mortgage applications, while the Institute for Supply Management (ISM) non-Manufacturing Index showed growth accelerated more than expected, rising to 56.5 in June, the highest since November 2015. However, factory orders declined and durable goods orders were revised to a 2.3% drop, slightly lower than the initial estimate.

Unofficial start to 2Q earnings season next week

Next week's economic docket will heat back up, with key releases of retail sales, the Consumer Price Index (CPI), the Producer Price Index (PPI), the Fed's Beige Book, industrial production and capacity utilization, along with the preliminary University of Michigan Consumer Sentiment Index for July.

2Q earnings season will also unofficially kick-off next week as Alcoa Inc. (AA $11) is expected to report results after the close on Monday. As noted in the recent Schwab Market Perspective, some questions have come to light recently regarding what consequences the uncertainty in Europe and a potential strengthening of the U.S. dollar may have. We'll start to get an initial view on those questions in the next few weeks as second quarter earnings season ramps up. Read the whole article at www.schwab.com/marketinsight and follow Schwab on Twitter: @schwabresearch.

International reports slated for next week include: Japan—machine and machine tool orders, PPI, industrial production and capacity utilization and the Tertiary Industry Index. China—foreign direct investment, trade data, industrial production, retail sales and 2Q GDP. India—car sales, CPI, industrial production and trade data. U.K.—construction output and the Bank of England will announce its rate decision. Germany—Wholesale Price Index and CPI. Eurozone—industrial production, trade balance and CPI.

Financial Review

Countdown to Liftoff

Sinclair Noe — June 17, 2015

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

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DOW + 31 = 17,935
SPX + 4 = 2100
NAS + 9 = 5064
10 YR YLD – .01 = 2.31%
OIL – .22 = 59.75
GOLD + 3.60 = 1186.10
SILV + 11 = 16.22

The Fed has wrapped up its June FOMC meeting. No surprises. The economy is getting better, so they say. While the Fed says they have made “considerable progress” toward its goal of maximum employment, “the committee wants to see evidence of some further progress.” They are not hiking rates right now; they will probably hike rates in September, but don’t worry about the exact date because it will be so small and gradual you will hardly notice. That’s the quick version from the Fed.

Further wage and job gains could give Fed officials confidence that inflation, which has lingered below their 2 percent goal for three years, is likely to move higher. Growth is poised to pick up as consumers start spending a windfall from lower gasoline prices, even though that hasn’t happened yet. The economy is likely to expand at a 2.5 percent annual pace in the second quarter after shrinking 0.7 percent in the previous three months. Officials now expect the economy to grow this year between 1.8 percent and 2 percent.

Just a few months ago, in March, they had predicted growth of 2.3 percent to 2.7 percent. The contraction in the first quarter was caused in large part by temporary forces, including unusually severe winter weather and a slump in energy-industry investment brought on by lower oil prices. The Fed is aware of risks overseas, such as the slowdown in China and the danger of a Greek default. The FOMC statement has dropped explicit forward guidance and now they say rate decisions will be data dependent and will be made on a month to month basis.

And so we can conclude from this that the Fed will raise interest rates in September. Based on new economic forecasts we can anticipate two quarter-point rate rises this year but a shallower pace of increases in 2016. They maintained their projection that the benchmark rate would rise to 0.625 percent in 2015, while dropping it to 1.625 percent next year, just a little lower than their March median forecast of 1.875 percent.

The end of free money is in sight. Markets have been feeding from the Fed’s free money trough for about 7 years, and soon that will change. Money will still be cheap but not free. We know that monetary policy has been a key to market performance for the past 7 years; just overlay a chart of the Federal Reserve’s balance sheet on the S&P 500 and it is easy to see the relationship. The Fed’s influence on markets can be measured on a macro level or a micro level. On days when Yellen has spoken to markets, the stock market’s performance has typically been positive. According to analytics firm Kensho, after her last 19 speeches since becoming Fed chair, the S&P was positive 63 percent of the time with an average return of 0.24 percent. On the 10 days when the Yellen Fed issued a post meeting statement, the S&P was higher 60 percent of the time with a return of 0.19 percent. Today, the S&P was up 0.2 percent. So, how will the Fed’s moves affect the markets?

Well, free money has been a boon to debtors, and one of the biggest debtors is the government; as interest rates inch higher the government will have to pay out about $2.8 trillion more in interest over the next 10 years, according to the Congressional Budget Office. Higher interest rates will directly lead to larger budget deficits. One way to reduce the deficit is to bring in more revenue, and the best way to do that is to have more people working. If the Fed were to allow the unemployment rate to fall to 4.0 percent and remain at that level, it would lead to substantially higher tax revenue and reduced payments for unemployment benefits and other transfer programs. The cumulative difference over the 10- year budget horizon is nearly $1.9 trillion. There is still considerable debate about the positive effects of a Zero Interest Rate Policy on unemployment, but working on the idea that easy money results in more jobs, it feels like the Fed is hasty in its desire to raise rates; certainly in terms of demand growth from more workers, plus a boost in wages, plus the positive impact on the federal budget.

But it doesn’t look like the Fed will wait for 4% unemployment; and a Fed rate hike might actually hurt job seekers because a rate hike would result in a stronger dollar. Other central banks are cutting rates and expanding the money supply, weighing down their currencies. The Fed hikes, the dollar appreciates; at least that is the theory. In today’s press conference Yellen said the dollar has largely stabilized, and I suppose you could make that argument for a roller coaster that is no longer at its highest point, but the ride isn’t over just yet. A stronger dollar makes it tougher for companies to sell their goods overseas. A stronger dollar from the rate increase will boost U.S. demand for products from Asia and Europe, helping lift corporate profits in those regions; imports will be cheaper but that helps global stocks, not US multinationals.

But higher rates and a stronger dollar won’t help all global stocks; emerging markets will likely be hurt. The Fed usually gives short change to emerging markets, but they may have reason to fret about something known as “spillback”. The term, coined by the International Monetary Fund, describes the threat to U.S. output from slumping import demand in emerging markets. As the Fed pushes borrowing costs higher, capital could flee developing countries, forcing them to cancel investment and settle for slower growth. That would be the spillover. But a buyers’ strike could rebound on U.S. exports of software, machines and services, undermining domestic recovery. That would be the spillback – and it could be quite significant. If you want strong growth in the US, you need emerging market buyers. Higher borrowing costs in emerging markets and a stronger dollar would further reduce U.S. exports, and the spillback risks of Fed monetary tightening are both real and large enough to cause serious concern.

Banks will like higher interest rates because they’ll be able to profit more from making loans. That, in turn could be bad news for mortgage rates, and by extension, the housing market. The good news on mortgage rates is that the Fed will move slowly, so rates will creep higher, not a quick rise. Insurance companies also like higher interest rates, because they invest customers’ premiums to be able to cover losses with the profits from those investments. If they can realize a higher yield on those investments, that goes directly to profits. Come on, you don’t think they’re going to lower the premiums.

Free money has been a boon for borrowers, and corporations have taken advantage. American corporations issued $757 billion in debt from January through May, a record volume 12 percent higher than during the first five months of last year. Companies have been borrowing at low rates and then buying back their own shares, or paying dividends, or buying up other companies. All that will dry up as the cost of money increases. Fed policymakers have expressed concern that an accommodative monetary policy has encouraged speculation in equity markets. With the prospect of higher rates, they are effectively calling for an end to financial engineering; think of buybacks and M&A as low hanging fruit. The stock market could still go higher but companies are going to have to work harder for their returns.

The Fed’s Zero Interest Rate Policy has been a nightmare for savers. Once upon a time money market funds paid almost 5%; that was 8 years ago. And don’t expect relief from the Fed any time soon. As the Fed begins tightening, yields on all short-term instruments won’t recalibrate higher, at least not soon. Right now, short-term Treasury bill rates are locked in just a smidgen above zero, and demand is strong, in part because financial institutions are required to have a little more of a liquid and safe cushion in the event of problems like 2008. Also, if rates move higher on the longer-maturity instruments, that means losses in price for bond funds or bond ETFs. Bond markets do not respond predictably to interest rate increases. There have only been a handful of tightening cycles in the Fed’s 100-year history, and on the whole, the differences have outweighed the similarities.

And there is concern that changes in financial markets since the crisis have reduced liquidity, or the ability of sellers to find buyers. The International Monetary Fund warned in its Global Financial Stability Report in April that central banks, by pumping money into markets, were concealing the decline of private participation in those markets. They concluded that: “Markets could be increasingly susceptible to episodes in which liquidity suddenly vanishes and volatility spikes.” And when liquidity dries up and volatility spikes, investors can run for the exits. That doesn’t necessarily mean a big sell-off or a crash; that might happen if the Fed surprised the markets, but this Fed seems content to telegraph every move and then move very slowly. Of course, we never know how markets will respond, and something like a Greek default or some other event could change the storyline very quickly, but the anticipated change is likely to be a more subtle shift from offense to defense.

A quick update on Greece; Prime Minister Alexis Tsipras said he’s ready to take responsibility for rejecting the terms of a deal on aid if creditors’ demands are unacceptable. Tsipras told reporters that without a satisfactory deal, he “will assume the responsibility to say ‘the big no’ to a continuation of the catastrophic policies for Greece.” Meanwhile, a Greek government committee has issued a report that determined public debt is illegal, and anti-austerity protestors are taking to the street in Athens. Negotiations between Greece and its creditors continue tomorrow in Luxembourg.

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.

FINANCIAL REVIEW

Jobs Report Friday

Sinclair Noe — November 7, 2014

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

DOW + 19 = 17,573
SPX + 0.71 = 2031
NAS – 5 = 4632
10 YR YLD – .06 = 2.31%
OIL + .60 = 78.51
GOLD + 36.50 = 1178.80
SILV + .32 = 15.85

The economy added 214,000 net new jobs in October. The unemployment rate dropped from 5.9% to 5.8%. The 5.8 percent official unemployment rate is the lowest since the summer of 2008.

The August report was revised higher to 203,000 and the September report was revised higher to 256,000; for a net increase of 31,000 jobs added from revisions. Employment is now up 2.64 million year-over-year, and up 2.3 million year to date. So far in 2014 the US has gained an average of 229,000 jobs a month, the fastest pace since 1999. October was the ninth consecutive month of 200,000 or more jobs gained, and that hasn’t happened since 1994. Total employment is up 10 million from the employment recession low and up 1.3 million from the previous peak; although it should be noted that full-time employment has not returned to the previous peak, while part-time employment is quite a bit higher than the peak. Private employment is up 10.6 million from the employment recession low.

This latest report represents 56 consecutive months of private-sector job growth, which represents the longest streak in US history, but it isn’t the strongest streak of job growth. The strongest recovery came in the early 1950s, a 13-month stretch that averaged 315,000 jobs created per month. And then there was the period from 1993 to 2000, an 85 month stretch that was interrupted in January 1996, when payrolls dropped 2,000 mainly due to blizzards and bad winter weather.

The net job growth of 214,000 was just a bit below analysts’ estimates of 225,000 to 235,000, but it wasn’t enough to send a shock wave; it was right in line with the trends for the past year. And this is the initial estimate, and revisions have been typically adding about 28,000 jobs to the initial estimates.

The Labor Department statisticians separately survey households, asking people if they have a job. This alternative measure of employment receives less emphasis, because it tends to be extremely volatile. Bearing this disclaimer in mind, it is notable that the household survey suggests that employment grew by an impressive 683,000 in October.

Also, a point to consider is that the numbers were seasonally adjusted; they always are; the adjustment smooths out volatility. In non-seasonally adjusted terms it was the best October for job growth ever, with 1.064 million net jobs created during the month. The previous record for an October was 980,000 in 2004. Now there are many reasons for seasonal adjustments, holiday workers, jobs that follow the seasons, teachers on break for the summer and then returning, census workers; and that is why the number is volatile and not used in most calculations. So, I’m not sure what to make of it, other than to say there is an anomaly, and it is a positive anomaly, and don’t be surprised if we see a big revision on the initial number.

The Labor Force Participation Rate increased in October to 62.8% from 62.7% in September. This is the percentage of the working age population in the labor force. So, it looks like a few people are coming back into the labor pool. Of course, over the past 6 years, millions of Americans left the workforce, and have not returned; the boomer generation is reaching retirement age, and whether they want to or not, many are retiring. There are now 37 million boomers over age 65, and another 50 million over age 55. This is a massive demographic shift. The boomers have had an outsized influence on everything ever since they were born, why should it change when they go into retirement?

Now, sometimes the unemployment rate goes down because people drop out of the labor pool but that was not the case in October; more people joined the labor pool in October and the unemployment rate went down because they found jobs.

There are 2.91 million workers who have been unemployed for more than 26 weeks and still want a job. This was down from 2.95 in September. Over the past year there has been a sizable decrease in the number of discouraged workers who have given up hope of finding a job, down 1.2 million; and the number of part-time workers who wanted full-time employment, down 1 million.

The number of persons working part time for economic reasons decreased in October to 7.02 million from 7.10 million in September. These workers are included in an alternate measure of unemployment known as U-6, which decreased from 11.8% in September to 11.5% in October.

The still large numbers of long term unemployed and underutilized workers is probably the best explanation for stagnant wage growth.

In late 2009, the unemployment rate for men topped 11%; for women, the unemployment rate never got past 9%. Now, the tide has turned and the unemployment rate for women is 5.9%, while the unemployment rate for men is 5.6%.

The October unemployment rate for workers age 25 and older with no high school diploma is 7.9%; for high school grads the rate is 5.7%; for workers with some college the unemployment rate is 4.8%, and for workers with a bachelor’s degree or more the unemployment rate is 3.1%.

Hiring in October was strongest at retailers, restaurants and bars; industries that typically boost employment ahead of the holidays. Leisure and hospitality added 52,000 jobs and retailers created 27,000 openings. Most of these jobs pay below the average national hourly wage. The health-care sector added 25,000 employees and professional jobs grew by 37,000. Manufacturers hired 15,000 workers and the construction trade added 12,000. Most of these jobs pay more than the average hourly wage, though half of the white-collar hires in October were temps who earn significantly less. State and local governments lost jobs for 4 straight years, but that trend is slowly changing and in October, state and local government added 8,000.

Only about 40% of the new jobs created in October were in fields that pay above the average hourly U.S. wage of $24.57. That’s down from 60% in September. There has been a slight shift to higher paying jobs, with 58% of the new jobs created this year paying above the average hourly wage, compared to 50% in 2013.

Average hourly wages were little changed in October. Hourly pay rose 3 cents to $24.57, putting the 12-month increase at 2%, the Labor Department said Friday. Year-over-year increases have ranged from 1.9% to 2.2% in the past two years. This suggests that despite the tightening labor market, employers are able to attract a sufficient number of applicants that they do not yet need to bid up wages. The amount of time people worked each week, however, rose a tick to 34.6 hours and sat at a post-recession high. Hours tend to increase as an economy strengthens.

And while average hourly wages are stuck in a 2% rut, the average weekly wages are starting to move up slightly. Workers aren’t getting more per hour, but they are getting more hours. Average weekly wage growth came in at 2.85% in October, the fourth month it has been above 2.5% growth rate. Now, that’s still indicates slack in the labor market, but it is a little less slack. Again, we need to see hourly and weekly wage growth moving to about 3.5% or 4%, but it would make sense that the weekly average leads the hourly average.

For now we do not have wage push inflation. The Federal Reserve will likely look at today’s report and conclude they are on course. If the economy adds about 229,000 jobs per month (that’s the average for 2014), then the unemployment rate would drop to 5.5% within the next 5 months. That is when the debate will get hot about the Fed raising interest rates.

Five years ago, we would have considered this a fantastically great jobs report; but wages are not growing; everybody feels overworked and underpaid. And you may not realize it but we keep moving closer and closer to a position of strength in the labor market.

*Note: forgive me for not including appropriate links. I’m still working out some issues related to this revision of the website, but here is a link for your weekend reading pleasure – http://www.rollingstone.com/politics/news/the-9-billion-witness-20141106

FINANCIAL REVIEW

Milk and Cookies in the Land of No Satisfaction

Sinclair Noe — November 5, 2014

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

Financial Review
DOW + 100 = 17,484
SPX + 11 = 2023
NAS – 2 = 4620
10 YR YLD un = 2.35%
OIL + 1.69 = 78.88
GOLD – 28.20 = 1141.00
SILV – .72 = 15.42

Record highs for the Dow Industrials and the S&P 500.

The midterm election is history, and it was a big night for the GOP. Republicans will have at least 52 Senate seats, a gain of 7. In the House, the GOP will now have at least 243 seats, a gain of 14. The GOP also gained 2 net governorships. So it was a big night. However, Obama was not on the ballot, even though some of the campaign ads made it sound that way; he’s got 2 more years and he still has veto power. It takes a two-thirds majority in both the House and Senate to override a veto. Republicans have nowhere near two-thirds of either chamber. So, get ready for 2 more years of gridlock.

One takeaway is that people are not satisfied with the economic progress of the past few years. While Wall Street is at record highs and the unemployment rate has dropped, that just isn’t enough. Fewer people participated in stock market gains and even though more people have jobs, the jobs aren’t paying what they used to. It doesn’t mean the numbers are wrong; the Dow closed at 17,484 and that is a real number, but the stocks in the Dow have used financial engineering to achieve price gains. The unemployment rate is 5.9%, not 32% (according to a survey released last week by Ipsos Mori, the average American guessed that the unemployment rate is 32%), but people have seen wages decline, they have seen their careers replaced by jobs. The top concerns of voters going into the midterms were economic growth and job creation.

According to national exit poll data, roughly half of the people interviewed as they left the polls said they expected life for the next generation of Americans to be “worse than life today.” Roughly four out of every five America voters were either “very worried” or “somewhat worried” about the direction of the economy in the next year, and just 22% said they were “not at all worried” or “not too worried”. Just 1% of voters felt the economy was “excellent.” Roughly 70% said the economy was “not so good” or “poor.” When asked whether the economy was getting better, getting worse, or roughly the same, voters were split evenly between the three choices. And when asked if a voter’s family financial situation had improved in the past two years, just 29% of respondents said it had. More than 60% of voters polled said they felt the US economic system “favors the wealthy.” On a side note, the new Credit Suisse 2014 Global Wealth Databook reports that each year since the recession, America’s richest 1% have made more than the cost of all US Social programs.

Since 1926, the S&P 500 has gained nearly 17% on average in Year 3 of presidential terms. The next-best years for stocks are presidential election years, when equities have gained 9.8% on average. The Stock Trader’s Almanac tells us that the Dow Jones industrial average has not suffered a third-year loss since 1939. Part of it has to do with the fact that the third year of an administration also tends to see the best growth in gross domestic product. Market strategists surmise that the party in power in the White House has a vested interest in stimulating the economy, and the markets as much as it can in the year before it faces re-election.

Researchers at Leuthold discovered that stocks have risen at an annualized rate of nearly 25% (including dividends) in the period that runs from the midterm elections in November to April of the following year. We are also moving into what is known as the best 6 months in the market; that November through April time is typically better than May through October. And then there is a tendency for an end of year, or Santa Claus rally. According to the Stock Traders’ Almanac, fourth quarters during years when midterm elections are held have produced an average gain of 8% over the past 65 years. They’ve been followed by rallies of almost that much in the next three months, making the average 16% two-quarter rally the best combination of the election cycles.

The S&P 500 has risen an average 15.1% in calendar years when a Democratic president has been opposed by a Republican-controlled Congress since 1945. These are tendencies and probabilities, not guarantees.

Let’s check the economic news. The Institute for Supply Management’s nonmanufacturing index dropped to 57.1% from 58.6% in September. New orders fell 1.9 points to 59.1% and production slipped 2.9 points to 60%. Yet the employment gauge, a sign of hiring intentions, rose 1.1 points to 59.6%, the highest level recorded since 2005.

ADP reports private employers added 230,000 jobs in October, the most since June. The monthly government jobs report is Friday, with most estimates around 225,000 net new jobs.

Productivity rose 1.5% in the third quarter, down from 2.3% in the spring. When workers and companies produce more and more goods and services with the same amount of labor and materials, firms make bigger profits and they can offer larger pay raises. The flip side of low productivity is that it’s often the result of companies that have too few workers to meet growing demand. So it’s usually a sign to hire more workers and rely less on overtime.

Bloomberg reports that of the S&P 500 members that have reported their latest quarterly results, 82% topped profit projections, while 61% exceeded sales estimates; that’s the fastest pace of earnings beats in 4 years.

Qualcomm reported a fiscal fourth-quarter profit of $1.89 billion, or $1.11 a share, on revenue of $6.69 billion. Both revenue and earnings missed estimates.

Chrysler reported a 32% increase in net income on stronger sales of SUV’s and pickup trucks.

Tesla reported third-quarter results that topped expectations after the close, but the electric car maker lowered its delivery forecast for 2014 to 33,000 cars (it had expected to deliver 35,000 cars).

SolarCity reported a 20% rise in quarterly revenue as it added more customers. SolarCity also reported a net loss of $70 million, wider than the $37 million loss it reported a year ago.

When Alibaba Group delivered its first quarterly report as a public company, they showed earnings of $1.1 billion, or 45 cents a share, up 15% from a year earlier; those numbers excluded some $490 million in expenses from Alibaba stock given to employees as part of their compensation. This stock-based compensation expense made up the vast bulk of items excluded from Alibaba’s preferred “adjusted” profit measure.
West Texas Intermediate crude rebounded from a three-year low, climbing to $78.88 a barrel after a government report showed that US oil supplies increased less than analysts expected last week, while refineries increased operating rates.

The recent plunge in oil (today’s move excluded) is propelling shares of airlines and truckers, and that has in turn pushed the transportation index to new highs. Dow theorists will tell you that the performance of the transports often indicates the market’s next move, as they are economically sensitive stocks. With the index at a record, though, some investors are asking a simple question: Is rally in the transports simply all about oil, or are they signaling a stronger economy ahead?

The Federal Reserve unveiled a final rule today designed to prevent large financial firms from becoming so big that their failure could shake the core of the financial markets. The final rule, required by the 2010 Dodd-Frank Wall Street reform law, prohibits banks and certain large financial firms from acquiring another company if that merger would cause their liabilities to exceed 10% of the total consolidated liabilities for all financial firms. The “too big to fail” rule applies to banks and to large financial firms who are designated as “systemic” by the Financial Stability Oversight Council. Richmond President Jeffrey Lacker delivered a speech today, saying that the Bankruptcy Code must be a viable option for large complex financial institutions to end the perception that some firms are too big to fail.

FINANCIAL REVIEW

The Only Winner is Gravity

Sinclair Noe — October 9, 2014

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Financial Review

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

DOW – 334 = 16,659
SPX– 40 = 1928
NAS – 90 =4378
10 YR YLD un 2.33%
OIL – 2.96 = 84.35
GOLD + 2.10 = 1224.60
SILV – .03 = 17.45

Triple-digit swings in the stock market have become common in recent days. Just this week, the Dow jumped 274 points Wednesday, reversing a 272-point decline on Tuesday. We’ll talk about volatility in just a moment.

In economic news:
Germany’s exports sank 5.8 percent in August, the biggest monthly drop in five years. The figure raised concerns that Europe’s largest economy may fall into recession. European Central Bank President Mario Draghi says Europe’s problems are structural, not cyclical and there can be no recovery without reforms. Draghi was speaking in New York; he said the Euro banking sector is still going through deleveraging; they are not lending; and there are limits to what the ECB can do to produce growth. And deflation is highly contagious.

The number of people who applied for U.S. unemployment benefits in the first week of October edged down by 1,000 to a seasonally adjusted 287,000, holding below 300,000 for the fourth straight week. Jobless claims are now 21% lower compared to one year ago. What we are starting to see is that so many businesses fired workers during the downturn and they have been very slow to rehire or hire new workers, which means not many people are losing jobs right now.

Wholesale inventories rose by 0.7% in August. Inventories of durable goods, such as autos and machinery, rose 0.8%, while inventories of nondurable goods rose 0.5%. Wholesale sales fell 0.7%, following a 0.4% gain in July.

The Bloomberg Consumer Comfort Index climbed to 36.8 in the period ended October 5 from a four-month low of 34.8. A gauge of attitudes about the world’s largest economy registered the biggest increase since 2007. According to Bloomberg, a pickup in hiring, more job openings and lower gasoline prices are combining to brighten Americans’ spirits even as the stock market languishes. While today’s figures showed confidence improved among the college educated, homeowners and almost all income groups, the weekly gain left sentiment close to its third-quarter average. Gas prices make US consumers happy, or at least semi-happy. And prices are falling.

Now, let’s take a look at volatility because this week the markets have been on a really wild roller coaster ride, and it looks like the only winner is gravity. All 30 stocks in the Dow Jones Industrial Average were down. The VIX, the volatility index jumped 24% to just over 18, which is its highest reading in 18 months but still below the 20-year average of about 20. Maybe the markets were just too complacent.

For now, volatility is back and it tells us the markets are uncertain. Traders and market makers and specialists are not sure about the next move, and when there is uncertainty there is a lack of bids. Typically, there are investors lined up to buy stocks, however when there is uncertainty, there are fewer traders in line. The spread between the bid and offer widens, and when prices drop fast, the bidders have two choices: widen the spread even further, or step away completely. The result can be a downward spiral. It works in both directions; spreads widen quickly both on down days when investors are anxious to get out at any price and on big up days when investors will pay up to get into a stock. For now, investors are getting out.

Maybe people forgot the Federal Reserve is in the process of exiting QE, the massive asset purchase plan that has poured trillions of dollars into the market over the past few years. Remember the taper tantrum? When the markets tanked at the mere thought of the Fed exiting QE; now it really is almost finished. The purchases are widely credited for fueling price increases of all kinds of investments.

Investors have had a lot of advance notice that the end is coming, and the hope is that the announcement won’t cause big markets swings given all the time they’ve had to prepare. Many mutual fund managers say their bigger concern is when the Fed will start raising short-term interest rates, which the central bank has said won’t be for a “considerable time.” Every time that the Fed has ended QE, rates have gone down, and stock prices have gone down; it happened in 2010 and 2011, and it looks like it’s happening again.

The Fed’s bond-buying program helped the stock market not only to surge but to do so in nearly uninterrupted fashion, even when the economy was improving only modestly. The last time investors saw a 10 percent drop for the Standard & Poor’s 500 index was three years ago. This week’s volatility may be a preview of things to come after QE ends.

Add in earnings season and you’ve got a lunch date with Pepto-Bismol. Now, here’s how CFO’s and CEO’s get ready for earnings season; they pull out the pots and pans and assorted crockpots and they turn the heat to medium high and they start cooking the books. A couple of years ago, Duke and Emory Universities conducted a survey of chief financial officers and they found that about one in 5 companies admitted to cooking the books, or “managing” earnings reports to mischaracterize economic performance. And about 60% try to pump up income.

The report found, “Earnings misrepresentation occurs most often in an attempt to influence stock price, because of outside and inside pressure to hit earnings benchmarks, and to avoid adverse compensation and career consequences for senior executives.” And the CFO’s admit that it is difficult to unravel the book cooking from the outside looking in.

Here are the expectations as we enter 3Q earnings season. Earnings growth is estimated from 4.5% to 5%, generally speaking. The telecom sector should come in with the highest earnings growth and consumer discretionary is expected to post year over year declines. (Think Sears and JC Penney). The healthcare sector is the only S&P 500 sector that saw earnings expectations increase during the quarter, rising to 10.6% from 9.4%.

Back in June growth expectations called for 8% to 9% growth, but that’s just part of the game; aim high and then ratchet down expectations. So far 82 S&P 500 companies have issued negative earnings per share guidance, while 27 have reported positive guidance. The current 12 month forward price to earnings ratio of the S&P 500 is 15.

The security breach and hack of JPMorgan Chase has raised more questions than it has provided answers. We still don’t know who was behind the hack. It looks like it came from Russia, but that’s not very specific. We still don’t know what the motive was. Was it plain old theft, or was it official government retaliation? Authorities believe that the hackers may have tried to infiltrate about a dozen financial institutions, but we don’t know how far they got, or the motives for the other hacks.

The FBI and the Secret Service have begun a criminal inquiry into the attacks, but the only thing we know for now is that the biggest, most fortified financial institutions in the world, entrusted to safeguard trillions of dollars of the nation’s wealth are in fact, clueless and extremely vulnerable.

A most entertaining trial has been taking place this week; this is the story of former AIG CEO Hank Greenberg, who mismanaged AIG, cooked the books, got involved in selling credit default swap insurance on almost every mortgage related security, which led to a near systemic catastrophe, and when AIG was about to go belly up, the government stepped in with a bailout. And now Greenberg says the terms of the bailout were a little too harsh for his liking.

The trial features all-star lawyers, two former Treasury Secretaries, and today, former Fed Chairman Ben Bernanke took the stand. Bernanke said allowing American International Group Inc. to go into bankruptcy would have been catastrophic; echoing comments earlier this week from Hank Paulson and Tim Geithner. Bernanke said he couldn’t recall whether federal officials discussed the interest rates and fees it charged the insurance giant in exchange for an $85 billion loan during the 2008 financial crisis.

Emails from Bernanke were introduced into court evidence, highlighting the government’s belief at the time that the restrictions on AIG should serve as a warning to other insurance firms that were allegedly acting irresponsibly. The emails also show that the Fed tried to keep the terms of the bailout secret from the public, because accountability and transparency were not the preferred currency of the crisis.

And we learned something very strange about Bernanke; he used to send emails under the alias of Edward Quince. An imaginary figure Bernanke created to send emails. Maybe he thought a pen name would give him a level of privacy. Maybe he thought this was some kind of cloak and dagger spy game. Maybe he was just a smidge schizophrenic. Maybe he thought a pseudonym would shield him from whatever he was doing. Maybe that’s how he plans to refinance his house. Nobody knows for sure.

Bernanke was scheduled to introduce ECB president Mario Draghi for the speech in New York, but the AIG trial made for a scheduling conflict. In the process, we learn that Bernanke now charges $200,000 for a speech, so his testimony today was expensive. It also raises the question of why he’s trying to refinance his house, when he could just make a couple of speeches and be done with it.

The Nobel Prize for literature has been awarded to Patrick Modiano; he is a French novelist who has written books, screenplays, and children’s’ books. And even though his work has been translated into several languages, I have never heard of him. If we lived in France, I’m sure I could tell you more.

http://www.ecb.europa.eu/press/key/date/2014/html/sp141009.en.html

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2103384