Financial Review

Assume They Are Still Listening

Financial Review by Sinclair Noe

DOW + 82 = 17,924
SPX + 7 = 2088
NAS + 25 = 4945
10 YR YLD – .06 = 2.18%
OIL – 1.95 = 58.98
GOLD – 7.00 = 1185.20
SILV – .19 = 16.40

 

Britons voted today in one of the tightest elections in decades. Final opinion polls showed Prime Minister David Cameron’s Conservatives and Ed Miliband’s opposition Labour Party almost in a dead heat, indicating neither will win enough seats for an outright majority in the 650-seat parliament. Exit polls indicate a victory for the Conservatives but not enough for a majority, so talks will begin tomorrow with smaller parties to strike deals.

 

And those smaller parties could have a big influence on major decisions. The U.K. Independence Party is on track to become the country’s third largest political party. Its key goal is putting Britain’s EU membership up for an in-or-out referendum, sooner rather than later. UKIP is expected to prop up a Conservative government in exchange for an EU vote. For the financial markets, this is the No. 1 worry.  The Scottish National Party looks set for big gains in Scotland, which it wants to see split off from the rest of the U.K.

 

So, in addition to worrying about a possible Greek exit from the Euro-union, we now are supposed to be concerned with a British exit, and the whole thing is putting pressure on German bunds, or bonds. And you’re thinking “So what? I don’t own any German bunds.” You don’t have to own German bonds to be affected by that market. The bund is a benchmark and the recent selloff in Euro-debt affects global markets, including the US, and it affects everything from the strength or weakness of the dollar, to corporate profits, to the interest rate on your mortgage to the price of gasoline at the pump.

 

Yesterday, Fed Chairwoman Janet Yellen suggested stock prices might be too high. Many investors agree that the U.S. stock market is trading at stretched levels. Quarterly corporate earnings were better than expected, but those expectations were low in the first place. Investors are paying about $17 for every dollar of earnings in the Standard & Poor’s 500-stock index, not excessively high but still above the $15 that investors have historically paid for similar results. That doesn’t mean stocks can’t go higher. Mrs. Yellen doesn’t know, you don’t know, I don’t know. The market can stay irrational longer than you can stay solvent; that much we do know.

 

It’s very hard to know what markets reflect at any given point in time. It’s really hard to know, except in retrospect when market prices, valuations are defying gravity,” so says Timothy Geithner, the former Treasury Secretary. Geithner thinks the US economy is more stable and resilient than before the 2008 financial crisis; even so he expects that a financial crisis will happen again at some point but the structural reforms could also lead to an extended period of financial stability.

 

The Federal Reserve is making plans to prevent an abrupt contraction in its balance sheet next year, when some $500 billion in bonds expire. Though it ended a stimulative asset-purchase program last October, the Fed is still buying mortgage and Treasury bonds to replenish its $4.5-trillion portfolio as holdings mature. The central bank has said it will keep reinvesting until some time after it begins raising interest rates later this year. Asked publicly and privately about the longer-term strategy, Fed policymakers say they are in no rush to shrink the portfolio, suggesting they will seek to avoid a “cliff” – a disruptive end to reinvestments that might come if bonds are simply allowed to run off through maturity or prepayment. So, it’s really like QE is never-ending.

 

The number of people applying for U.S. unemployment benefits rose by 3,000 in the last week to 265,000 – which is near a 15 year low. Continuing jobless claims – people already collecting unemployment checks – declined by 28,000 to 2.23 million to the lowest level since November 2000. Tomorrow morning the Labor Department will report the April Jobs numbers. The guesstimates call for somewhere around 225,000 to 245,000 new jobs added in April, and the unemployment rate to drop to 5.4%. In March, the economy only added 126,000 new jobs, the worst report in more than a year; so it will be important to see a strong rebound; any weakness would suggest a trend of underperformance. We’ll also be watching for trends in wage growth.

 

The Federal Reserve reports that consumer borrowing increased at a 7.3% pace in March, the largest increase since July. The report looks at outstanding consumer credit, or total debt not including mortgages. Total debt increased by $20.5 billion to $3.36 trillion in March. The latest data follows a pattern similar to last year’s, when consumers started spending again after taking a break following the holiday season and harsh winter weather.  In line with recent trends, car and student loans continued to dwarf credit-card usage in March. Credit card debt rose by a seasonally adjusted $4.4 billion in March, or at a 5.9% annual rate. This is the largest percentage increase since last July. It follows two straight 3.3% declines. Consumers remain reticent to fund consumption with credit and they will probably remain so until the prospects for wage growth improve.

 
The International Monetary Fund warns the balance of risk in the Asia-Pacific region is tilted toward the downside due to rising debts and a strong U.S. dollar. Asia is still seen as a global growth leader; the region is forecast to have a growth rate of 5.6% in 2015 and 5.5% in 2016, according to the new IMF survey. Positive factors for Asia in the near future include moderating commodity prices, strong labor markets, and solid demand from the U.S. and Europe.

 

Tesla reported first quarter results and beat on the top and bottom lines.  The company delivered just over 10,000 Model S vehicles in the first quarter and believes it will deliver 55,000 vehicles by year-end. Model X deliveries are expected to begin late in the third quarter. Tesla is fresh from its battery announcement; last week, the company unveiled its stationary battery for homes and small businesses, the Powerwall. CEO Elon Musk called battery demand: “crazy off the hook.”

 

Whole Foods posted a mixed quarter; earnings beat expectations but revenue fell short.   The company expects comparable same-store sales in the “low-to-mid single digits.” Whole Foods plans to open a sister chain of smaller stores aimed at younger, more cost conscious shoppers, because apparently some shoppers don’t like paying $15 for a watermelon. They’re still trying to come up with a name for the new stores, you know, something other than Whole Paycheck.

 

Earlier this week we told you that Corinthian Colleges had closed its for-profit college campuses and declared bankruptcy. Add a couple more to the list. Career Education will shut or sell all of its career colleges to focus on its two universities, while Education Management will close 15 of its Art Institute campuses. Career Education and Education Management both said they’ll continue offering instruction for existing students to finish their programs while not accepting new enrollments, a process known as a “teach out.” By shutting down over time, the schools won’t have to cancel student loans, as many Corinthian College students are demanding.

 

Sotheby’s has wrapped up its first major spring auction of the year. The event brought in a total of $368 million, thanks in part to a $66 million dollar sale of a painting by Van Gogh. The last time this same painting was sold was 2003 when it sold for $12 million. A 452% return in 12 years. Not bad.

 

A US federal appeals court has ruled that the bulk collection of US telephone records by the National Security Agency is not permitted by laws passed after the 9/11 attacks to increase intelligence collection. The challenge was brought by the American Civil Liberties Union against James Clapper, the director of National Intelligence, along with the heads of the NSA, the FBI, the Department of Justice, and the Department of Defense. (Of the five officials named in the suit when it was filed in January 2014, only Clapper remains in the same role.)

 

The ACLU was prepared to argue that the government’s dragnet violated the US constitution’s prohibitions on unreasonable searches, but it didn’t have to. A three-judge panel agreed first that the Patriot Act does not allow for the collection of data without a warrant. Specifically, they cited section 215 of the act which permits demands for documents “relevant to an authorized investigation.” However the judges found that the government hasn’t even attempted to identify a particular authorized investigation associated with the collection of bulk metadata of virtually all Americans’ phone calls.

 

Put another way, the government argues that there is only one enormous “anti-terrorism” investigation, and that any records that might ever be of use in developing any aspect of that investigation are relevant to the overall counterterrorism effort. The government’s approach essentially reads the “authorized investigation” language out of the statute. The United States Court of Appeals for the Second Circuit said that if Congress wanted to permit a bulk phone program, it must say so unambiguously. The ruling arrives just as Section 215 is set to expire on June 1st, unless lawmakers enact legislation to extend it; now the court says, in essence, that a simple extension would not pass muster.

 

The judges also cite Edward Snowden, the NSA whistleblower now living in exile in Russia, as the key source of the revelation of this illegal program. Snowden, of course, has not returned to the US for fear of prosecution.

 

The ruling focuses on the phone-records program, but it might also apply to many of the government’s other mass-surveillance programs. It’s not clear how the government will respond to this decision; Congress could repeal bulk data collection, or at the very least alter the process; the government could appeal to the US Supreme Court. Until such time, just assume they are still listening.

 

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