Financial Review

Don’t Bet the Farm

Financial Review by Sinclair Noe for 09-16-2015

DOW + 140 = 16,739
SPX + 17 = 1995
NAS + 28 = 4889
10 YR YLD + .02 = 2.30%
OIL + 2.56 = 47.15
GOLD + 14.10 = 1120.20
SILV + .53 = 15.03

 

The cost of consumer goods fell in August for the first time since the beginning of the year, owing mostly to another sharp drop in gasoline prices as the summer driving season came to an end. The consumer price index, or the cost of living, fell by a seasonally adjusted 0.1% last month. That’s the first decline since January. Retail prices are up just 0.2% in the past year. Excluding food and energy, so-called core consumer prices rose 0.1% in August. Core prices have risen just 1.8% in the past 12 months, unchanged from in July.

 

Energy prices declined 2% in August. Most of the relief came in the form of lower prices at the pump. The cost of a regular gallon of gas fell about 8% last month. The price of fuel had risen three straight months before the decline in August. Still, energy prices are down 15% over the past year. Food prices rose again, however. They increased 0.2% in August, spurred by higher costs of eggs, fruits and vegetables. The cost of airline tickets dropped for the second straight month. The price of new cars and medical care were unchanged. Lower inflation is also giving American workers more relief. Real hourly wages jumped 0.5% in August, a combination of lower inflation and a bump in pay. Real wages have climbed a modest 2% in the past 12 months.

 

By the way, the CPI-W is used to determine the COLA, or Cost of Living Adjustment; and it is based on the third quarter Consumer Price Index for Urban Wage Earners and Clerical Workers, which came in at negative 0.3% in August. We will still have to wait for September to determine the COLA, but we know it can’t go negative, so it looks like there will be no cost of living adjustment for Social Security benefits, or anything else.

 

The Federal Reserve will certainly consider inflation, or the lack of inflation, in their FOMC meeting today and tomorrow. An improving labor market and a growing economy are seen giving the Fed enough fodder to justify a hike. But many analysts see enough concern over low inflation and the impact of a rate move on fragile emerging markets as likely to stay the Fed’s hand. The World Bank and the International Monetary Fund have both argued against a Fed rate increase out of concern a move could add to turmoil in emerging-market economies, which has been fueled by a collapse in commodity prices and related concerns about China’s economy and Beijing’s decision last month to devalue its currency.

 

If you want to understand what the World Bank and IMF are worried about, you can look to 1997 and the Asian financial crisis. In 1997, speculative attacks against the Thai baht forced the country to float and devalue its currency in a move that was swiftly followed by the Philippines, Malaysia, Singapore, and Indonesia. Then came a massive decline in Hong Kong’s stock market that led to losses in markets around the globe. Eventually the Russian ruble collapsed. Long Term Capital Management, a hedge fund run by John Meriwether and a few Nobel laureates, made some highly leveraged bad bets, and for a while it looked like the whole thing might result in a global financial meltdown.

 

While parallels exist between 1997 and the current emerging market selloff, notably in the form of a stronger dollar, which makes it more expensive for emerging-market countries to finance their debts, plus lower commodity prices and slowing trade, it could be more dangerous today; there are more highly leveraged hedge funds, and sovereign funds, and derivative trades. At the least, emerging market debt will become more expensive, commodities (denominated in dollars) will become less expensive, trade will likely slow, and defaults could become more common.

 

The Fed’s decision tomorrow will be felt around the world because the dollar is still the reserve currency and the Fed’s monetary policy determines what happens to currencies, stock markets and economies right around the world. The markets are pricing in roughly a one-third likelihood of a rate rise this week, but, in truth, no one has any real idea whether the trigger will finally be pulled or not. I think there is a much higher probability the Fed will hike rates. We’ve been warned, it has been telegraphed and signaled and communicated in almost every way other than an official proclamation. And if they don’t do it tomorrow – when will they? ZIRP, or Zero Interest Rate Policy was instituted in response to emergency financial conditions nearly 7 years ago. Where is the emergency today to justify ZIRP? The economy is less than stellar but it’s not like Lehman Brothers just shut their doors. And so my best guess is the Fed will raise rates tomorrow, but I’m not betting the farm because I don’t know what will happen. Neither do you. Plan accordingly.

 

Home-builder confidence in the market for newly constructed single-family homes rose a point to 62, the highest level since Nov. 2005, according to the National Association of Home Builders/Wells Fargo housing market index. Any reading above 50 indicates good conditions.

 

The Energy Information Administration reports oil stockpiles slipped 2.1 million barrels last week. Refineries increased operating rates for the first time since July, and supplies of gasoline and distillate fuels surged. Stocks of oil exploration and production companies rallied, while those of refiners fell. WTI crude rose 5.7%; it was the highest close and biggest one-day gain since Aug. 31.

 

So, how is the economy on Main Street? The Census Bureau has some answers. The median household income was $53,657 last year, down from $54,462 in 2013 but not statistically different. The poverty rate was 14.8%, which means 46.7 million people were impoverished — the fourth straight year in which the number of people in poverty was not statistically different. The percentage of people without health insurance coverage for the entire 2014 calendar year was 10.4%, down from 13.3% in 2013.

 

The Obama administration has begun preparations for a possible federal shutdown next month as a series of obstacles threaten a repeat of 2013. Lawmakers have just 15 days to reach a budget agreement before September 30, when current funding expires.

 

Snapping a major two-day slump, China’s Shanghai Composite Index jumped 4.9%, with all of the gains coming one hour before markets shut in a pattern that’s generally interpreted as government intervention.

 

Japan debt ratings were cut today by Standard & Poor’s over doubts the government will revive economic growth and end deflation in the next two to three years. The country currently has some $450 billion of debt outstanding; and the credit rating was cut to AA- rating instead of an A+ report card. The S&P downgrade is the most recent of the major credit-rating companies to do so; Moody’s was the first, in December 2014, followed by Fitch in April. S&P justified its downgrade by saying that the outlook for Prime Minister Shinzo Abe’s “Abenomics” program is grim.

 

Eurozone officials are racing against the clock to restructure Greece’s banking system before new rules kick in that could wipe out corporate deposits and result in disastrous effects for the country’s economy. The rush has been complicated by Sunday’s snap parliamentary elections, which could produce no clear winner and prolong negotiations over a governing coalition.

 

Anheuser-Busch InBev has informed rival SABMiller that it intends to make an offer to acquire the British firm in a deal that would bring together the world’s two largest beer makers. SAB Miller issued a statement saying, “No proposal has yet been received and the board of SABMiller has no further details about the terms of any such proposal.” So, the deal is far from certain, but if it happens, it would probably value SAB Miller around $75 to $92 billion, and create a brewing giant that would dominate much of the global beer market; which raises some questions about whether such a deal could pass anti-trust muster.

 

Also, since Anheuser Busch InBev is now a Belgian company trying to acquire SABMilller, a British company, there are some unique rules that come into play. Stringent rules on disclosure require a company to confirm or deny any hint of a deal, whether that comes from an anonymously sourced news article or unusual stock movement. The disclosure triggers a 28-day timeline for a formal, fully financed bid. Known as the put-up-or-shut-up rule, if AB InBev decides to walk away from the transaction it can’t come back for six months.

 

General Motors has agreed to sign a deferred-prosecution agreement to end a US government investigation into its handling of an ignition-switch defect linked to 124 deaths. The company will pay less than the $1.2 billion that Toyota paid to resolve a similar case, but the exact amount was not immediately known. The deal means GM will be charged criminally with hiding the defect from regulators and in the process defrauding consumers, but the case will be put on hold while GM fulfills terms of the deal.

 

The United Auto Workers union has reached a tentative labor deal with Fiat Chrysler after a long drawn-out night of negotiations. The union hopes the terms can be used as a template for Ford and GM, which also extended their deals past a midnight deadline on Monday to allow more time to wrap up negotiations. Under the agreement, Fiat Chrysler will eventually phase out the two class wage system between new factory workers and more senior employees.

 

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