Diminished Expectations
by Sinclair Noe

(to listen to Financial Review audio visit MoneyRadio.com)
DOW – 110 = 13,473
SPX – 14 = 1441
NAS – 47 = 3065
10 YR YLD – .03 = 1.72%
OIL – .23 = 92.16
GOLD – 11.60 = 1764.90
SILV – .08 = 34.00
PLAT – 8.00 = 1692.00

On this day five years ago, the Dow and S&P 500 hit record highs; the Dow closed at 14,164 and the S&P 500 closed at 1,545. The Dow is currently 4 percent below that peak, the S&P is 7 percent below its record. So, will the current cyclical bull market end tomorrow? It’s not a crazy question; it happened on this date 5 years ago. It looked a little like it today.

It’s earnings reporting season. Back in July, analysts said they expected Alcoa to report earnings of 12 cents per share, then expectations were lowered and now the hope was for break even. Alcoa reported a net loss of $143 million, or 13 cents per share, compared with a profit of $172 million, or 15 cents per share, in the same quarter last year. Revenue decreased 9 percent to $5.83 billion from $6.42 billion a year ago. The first report I read on Alcoa earnings after the close said, Alcoa reported quarterly earnings and revenue that topped analysts’ expectations. Excluding charges from the settlement of a civil lawsuit and environmental remediation of a New York state river, earnings were 3 cents per share. Here’s the thing; lawsuits and environmental remediation are part of the business model, not exclusions.
Overall earnings for the 500 companies in the S&P 500 are expected to grow slower. It should be an ugly earnings season. The companies have cut costs to the bone; they can’t cut more. While most companies plan to keep a lid on spending, lower expenses aren’t leading to the same kinds of increases they reported earlier this year. The executives have been afraid to take on new projects because that involves some investment even if the results are positive net value; they’re afraid of any investment if it would lower current earnings expectations. The captains of industry are, in truth, deer caught in the headlights of shareholders.
US and European economies are more integrated than most think; 25% of S&P earnings come from Europe. The International Monetary Fund had been predicting back in July that the world economy would grow by 3.5%, now they say the global forecast is 3.3%. They also say next year there will be 3.6% growth, but over the summer they said it would be 3.9% growth; back in the spring they said it would be 4.1% growth.
The IMF said that evidence from 28 countries shows that so-called fiscal multipliers, used by governments to assess the impact on growth of fiscal cutbacks, have underestimated the damage to the economy. The multipliers used in generating growth forecasts have been systematically too low since the start of the great recession. It turns out that austerity tends to slow growth in an economy. It’s like the person who wants to lose weight could cut off their leg and lose 40 pounds immediately, but it turns out that amputation is not considered part of a healthy diet. And it turns out that a contractionary policy results in contraction. Who knew?
Are you sensing a pattern? Expectations get ramped down.
The IMF says the fate of the global economy lay in the hands of US and European policymakers; somehow this has been reported without any trace of irony.
The IMF forecast that Greek public debt will rise to 171% of gross domestic product this year and 182% next year; and they say Greece must restructure and that it will still be almost impossible to reduce the country’s debt levels to a target of 120% debt to GDP by the year 2020. The IMF says the beatings in Europe will continue until morale improves.
So, today, German Chancellor Angela Merkel visited Greece to offer words of support. Still don’t know if she’ll offer cash. The Greeks did not welcome her warmly, which seems to be a traditional Greek welcome for German leaders. There were signs that said not welcome; there were protesters that brought up that whole Nazi thing; there were rocks thrown and tear gas was lobbed. Merkel wore the same green jacket she was wearing when the German soccer team beat the Greeks in the European Football Championship. Probably just a coincidence.
Spaniards continue their protests to decry tough austerity measures as the protest movement gains momentum, with signs it could culminate in a general strike in November. There has been a series of protests staged by hundreds of thousands of Spaniards almost on a daily basis over the past few months. The protests have presented the center right government with a headache as it is due to hold regional elections. Spanish labor unions said they would call a general strike if the government did not hold a referendum on unpopular spending cuts. Prime Minister Mariano Rajoy unveiled $16.9bn in additional savings in a tough budget last month. In the wake of violence during a protest in Madrid on September 25, Rajoy urged a business audience in New York last week to focus on the “silent majority” of Spaniards who do not protest. But a survey in El Pais newspaper on Sunday showed 77 per cent of Spaniards support the protesters, while more than 90 per cent think protests will become more frequent. Poverty is returning to Europe and the Spaniards are not happy, so the ruling political class is now being punished, sort of, by the people; something that would never happen in the US, unless the referees missed a call that cost the game.
Over most of history, most countries have wanted a strong currency, or at least a stable one. In the days of the gold standard and the Bretton Woods system, governments made great efforts to maintain exchange-rate pegs, even if the interest rates needed to do so prompted economic downturns. Only in exceptional economic circumstances, such as those of the 1930s and the 1970s, were those efforts deemed too painful and the pegs abandoned.
In the wake of the global financial crisis (vintage 2008), though, strong and stable are out of fashion. Many countries seem content for their currencies to depreciate. It helps their exporters gain market share and loosens monetary conditions. Rather than taking pleasure from a rise in their currency as a sign of market confidence in their economic policies, countries now react with alarm. A strong currency can not only drive exporters bankrupt, it can also, by forcing down import prices, create deflation at home.
QE’s effect on other currencies has not always been what traders might at first have expected. The first American round was in late 2008; at the time the dollar was rising sharply. The dollar is regarded as the “safe haven” currency; investors flock to it when they are worried about the outlook for the global economy. Fears were at their greatest in late 2008 and early 2009 after the collapse of Lehman Brothers. The dollar then fell again once the worst of the crisis had passed.
The second round of QE had more straightforward effects. It was launched in November 2010 and the dollar had fallen by the time the program finished in June 2011. But this fall might have been down to investor confidence that the central bank’s actions would revive the economy and that it was safe to buy riskier assets; over the same period, the Dow Jones Industrial Average rose while Treasury bond prices fell.
After all this, though, the dollar remains higher against both the euro and the pound than it was when Lehman collapsed. This does not mean that the QE was pointless; it achieved the goal of loosening monetary conditions at a time when rate cuts were no longer possible. The fact that it didn’t also lower exchange rates simply shows that no policies act in a vacuum. Any exchange rate is a relative valuation of two currencies. Traders had their doubts about the dollar, but the euro was affected by the fiscal crisis and by doubts over the currency’s very survival. Meanwhile, Britain had also been pursuing QE and was slipping back into recession. The Bank of Japan has seen ongoing QE. And the ECB spells QE, OMT.
And that is my best explanation for why gold slipped again today.
The government filed a civil mortgage fraud lawsuit today against Wells Fargo, the latest legal volley against big banks for their lending during the housing boom. The complaint, brought by the US Attorney in Manhattan, seeks damages and civil penalties from Wells Fargo for more than 10 years of alleged misconduct related to government-insured Federal Housing Administration loans.
The lawsuit alleges the FHA paid hundreds of millions of dollars on insurance claims on thousands of defaulted mortgages as a result of false certifications by Wells Fargo.
The complaint alleges, yet another major bank has engaged in a longstanding and reckless trifecta of deficient training, deficient underwriting and deficient disclosure, all while relying on the convenient backstop of government insurance. The bank denied the allegations. We’ve seen similar cases in the past year, including one against Citigroup’ CitiMortgage Inc, which settled the case for $158.3 million in February, and against Deutsche Bank, which paid $202.3 million in May to resolve its case. The US Attorney’s office in Brooklyn brought the biggest such case, against Bank of America’s Countrywide unit, which agreed in February to pay $1 billion to resolve the allegations.
The joke of the day comes from David Einhorn via Barry Ritholtz: “What do you call a stock that’s down 90%? A stock that was down 80% and then got cut in half.” 
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