Financial Review by Sinclair Noe for 08-10-2015
DOW + 241 = 17,615
SPX + 26 = 2104
NAS + 58 = 5101
10 YR YLD + .06 = 2.24%
OIL + .95 = 44.82
GOLD + 10.30 = 1105.10
SILV + .41 = 15.33
Berkshire Hathaway is buying Precision Castparts for $235 per share in cash in a deal worth about $37 billion. On Friday, Precision Castparts closed at $193.94, meaning Berkshire is paying a 21% premium to own the company. Berkshire originally began investing in Precision Castparts in 2012 and had already acquired a 3% stake before today’s announcement. Berkshire Hathaway posted disappointing earnings on Friday. Revenue for the second quarter came in at $54 billion.
Precision Castparts makes parts for the aerospace industry, and also the energy industry; their major customers are Boeing, General Electric, and Airbus. This is a company with a large moat; there is a big barrier for new competition; GE isn’t going to outsource parts inside a jet engine for a couple of dollars savings. And there is a good chance that PCP can make some decent sized acquisitions to consolidate its industry, or what Buffett calls “bolt-on’ acquisitions.
When you consider some of the recent acquisitions by Warren Buffett, it becomes clear that Berkshire Hathaway is no longer a pseudo-hedge fund or quasi-mutual fund. It is a diversified conglomerate with interests in heavy industry, transportation, consumer staples, and much more. On the industrial side, consider the acquisitions of Iscar Metalworking in 2006 and Lubrizol in 2011, plus industrial component producer Marmon, and US Chemical; or what Warren calls the Powerhouse Five. You could also include in that list, the $27 billion deal for Burlington Northern in 2009.
In 2013 Buffet teamed with 3G Capital to purchase Heinz Foods, and last year Heinz merged with Kraft Foods in a deal backed by Berkshire. And in 1998, Buffett purchased General Re, a global reinsurance company for a little over $16 billion; the $5.6 billion deal for NV Energy in 2013; and the $4 billion purchase Van Tuyl Auto Group last year. Today’s purchase of Precision Castparts is the biggest deal ever for Buffett.
Stanley Fischer, the Federal Reserve’s vice chairman, says inflation in the US is “very low” due in part to commodity prices. Fisher says: “A large part of the current inflation is temporary. It has to do with the decline in the price of oil; it has to do with the decline in the price of raw materials,” but he expects prices will stabilize at some point. Fisher’s statements cast doubt on quick action from the Fed to raise interest rates; the statements also suggested low energy prices won’t last.
A rebound in U.S. drilling signaled production is withstanding the slump in prices; after data from Baker Hughes showed that drillers added rigs for the fifth weekly gain in six. Meanwhile, OPEC’s largest members have sustained record output, while U.S. stockpiles remain almost 100 million barrels above the five-year seasonal average. The average price of gasoline has dropped 11 cents over the past two weeks to $2.71 a gallon-about 81 cents below the year-ago. Oil prices bounced higher today, but they are coming off a 5-month low. The dollar traded at a 2-week low, which helped commodity prices across the board. And that might be the most important consideration in the commodities markets. If the dollar continues to show strength, commodities will remain under pressure.
Of course many bullish investors have tried to call a bottom in oil and commodities; it has been a painful exercise. The S&P GSCI Commodity Index is down 17% in the past 3 months, and down 42% in the past 2 years. It’s not just an energy issue, either; copper, platinum, lumber, coffee, sugar, wheat, oats and lean hogs are all down double-digit percentages this year. While each specific commodity obviously responds to its own distinct supply-and-demand dynamics, the biggest fundamental factor weighing on commodities appears to be a strong dollar.
Stocks in China rallied with the Shanghai Composite Index closing 4.9 percent higher, its biggest gain in a month. The rise comes after the nation’s cabinet approved plans to overhaul state-owned enterprises to boost the economy. Disappointing economic data released over the weekend which showed exports declining more than expected in July did little to dent equity market optimism; Shenzhen +4.3%; Chinext +5%.
The Greek government is seeking to conclude talks on a new rescue program by tomorrow to allow national parliaments to pass the deal and give Greece access to funds ahead of a payment due to the European Central Bank on August 20. If agreed to, the plan would make as much as $93 billion available to Greece.
Ukraine and international creditors will also seek to hammer out a debt deal this week, in what many see as the last opportunity for an agreement before a $500 million bond matures next month. The country has been looking to reduce its debt burden as part of the $40 billion IMF rescue plan aimed at stabilizing its economy. If a restructuring deal is not reached, Ukraine has threatened to impose a debt moratorium in September.
These are tough times for high-yield bond investors. For the third week in a row mutual funds and ETFs reported outflows from risky asset classes, including stocks and high-yield bonds. This week, outflows from high-yield bond funds totaled $820 million after $1.3 billion in the prior week. The commodity rout has pushed bond yields in the energy sector higher since mid-July. That suggests that investors are worried about risk, and are demanding to be better compensated for it. Meanwhile, the stress has seeped from the energy and materials sector into the broader high-yield market.
After the close of trade, Google announced a big restructuring of its business. CEO Larry Page will take the reins of a new publicly traded company called Alphabet, which counts Google, among other companies, as a subsidiary. Alphabet Inc will replace Google as the publicly-traded entity and all shares of Google will automatically convert into the same number of shares of Alphabet, with all of the same rights.
The Department of Labor will hold four days of public hearings this week to discuss its proposed fiduciary rule, which is aimed at requiring brokers to put client interests ahead of their own when handling retirement money. The DOL asserts that the lack of consumer protection costs investors as much as $17 billion annually, or 1% of their assets, but the industry says it’s too expansive and would significantly increase liability risk and regulatory costs.
Coca-Cola, the world’s largest producer of sugary beverages, is backing what they are calling a new “science-based” solution to the obesity crisis: To maintain a healthy weight, get more exercise and worry less about cutting calories. Which is about half true. The beverage giant has teamed up with scientists who are advancing this message in medical journals, at conferences and through social media. To help the scientists get the word out, Coke has provided financial and logistical support to a new nonprofit organization called the Global Energy Balance Network, which promotes the argument that weight-conscious Americans are overly fixated on how much they eat and drink while not paying enough attention to exercise. Which is about half true. And of course the other name for a half truth is….
Last week a team from the Environmental Protection Agency was investigating an abandoned mine near Durango, Colorado. The Gold King mine was last active in the 1920s, but it had been leaking toxic water at a rate of 50 to 250 gallons a minute for years. It is owned by a group called the San Juan Corporation. But last week something went wrong; the EPA team made a mistake and a bright yellow toxic sludge spilled from the old mine into the Cement Creek; from there it flowed to the Animas River. The river has literally turned a bright mustard yellow color. At first the EPA thought the spill was about 1 million gallons; they hoped they could contain the mess. Now, they say the spill is more like 3 million gallons, and they are not sure what is spilling into the water but it is suspected to contain arsenic, lead, copper, zinc, aluminum and cadmium. Residents along the contaminated rivers are being advised to have their water tested before drinking, cooking or bathing. The toxic brew is now flowing through the San Juan River near Farmington, New Mexico; has moved into Utah and is expected to flow into Lake Powell on the Colorado sometime Wednesday.
The chemical spill is now making its way through the Navajo nation. The infiltration of toxic material is a haunting memory for the Navajos. In 1979, a dam failed in a uranium waste pond spilling 1,100 tons of solid radioactive mill waste and approximately 93 million gallons of acidic and radioactive tailings solution into a nearby river tributary. There have been claims the amount of radiation released in the Churchrock incident exceeded Three Mile Island. Navajo Nation President Russell Begaye announced that he intends to take legal action against the EPA for last week’s chemical spill.
Until the late 1970s there were no regulations on mining in most of the region, meaning anyone could dig a hole where they liked and search for gold, silver, copper or zinc. Abandoned mines fill up with groundwater and snowmelt that becomes tainted with acids and heavy metals from mining veins which can trickle into the region’s waterways. The federal government says 40 percent of the headwaters of Western waterways have been contaminated from mine runoff.