Financial Review

Slow to Patch

Financial Review by Sinclair Noe

DOW + 75 = 18,112
SPX + 10 = 2106
NAS + 33 = 5011
10 YR YLD un = 1.90%
OIL + 2.67 = 55.96
GOLD + 9.60 = 1202.50
SILV + .18 = 16.41


The Federal Reserve reports industrial production dropped 0.6% in March. The biggest drop since August 2012. For the first quarter, industrial production was down at 1% annual rate, the first quarterly decline since the end of the recession.


The National Association of Home Builders/Wells Fargo index of home builder confidence increased to 56 in April from 52 in March. Readings over 50 indicate that more builders see sales conditions as good rather than poor. All three components of the index improved in the month: sales expectations, buyer traffic, and the component gauging current sales conditions all moved higher.


China grew at its slowest pace last quarter since the global financial crisis in 2009; GDP expanded 7% in the three months to March from the year ago period, down from 7.3% the prior quarter. Retail sales and industrial output data broadly missed expectations, however, with the latter expanding at the slowest pace since 2008.


Japan overtook China as the top foreign holder of US government debt for the first time since the global financial crisis. Each country holds a little more than $1.22 trillion in US Treasuries, but Japan has about $7 billion more than China.


Saudi Arabia pumped close to a record amount of crude oil last month, leading the biggest surge in OPEC output in almost four years just as the US shale boom shows signs of slowing. The International Energy Agency said average US oil production of 12.6 million barrels a day in the first six months of 2015 will slide to 12.5 million by the fourth quarter as companies curb drilling. Meanwhile, Saudi Arabia and other OPEC producers raised output by 890,000 barrels a day to 31 million a day in March. Demand for oil will be higher this year than previously thought, according to the International Energy Agency report. The IEA’s expectation for a “notable acceleration” in demand for oil in 2015 comes as Iran called on fellow OPEC members to cut production. If you think you know where oil prices are going just consider the International Energy Agency’s conclusion to their Oil Market Report; they say, “The outlook is only getting murkier.”


There has been a lot of talk about oil prices and supply and demand; most of the talk is short-term and it can be confusing. We know that many drillers have shut down rigs but then we hear that North Dakota’s Bakken production is expected to surge in the second and third quarters of this year, as that state puts the screws on companies to complete wells and rolls out some new tax incentives. According to the new annual energy outlook by the Energy Information Administration, the government appears to be even more bullish about U.S. oil production this year than it was last year. Despite a nearly 50% drop in the price of crude-oil since then, the government’s expectation for oil production growth is even more robust than in last year’s energy forecast.


Where it gets more interesting is in the long-term outlook; there we are seeing a fundamental shift. The EIA report says longer-term, US crude oil production will peak at 10.6 million barrels per day in 2020, a million barrels more than the high forecast a year earlier. Crude production will then moderate to 9.4 million barrels per day in 2040, 26% more than expected a year ago. Despite lower prices, higher production will result mainly from increased onshore oil output, predominantly from shale formations.


Perhaps the most interesting long-term idea is that the US could become a net energy exporter over the next 2 to 15 years. And it’s not just a result of more drilling, but rather advanced technologies that are reshaping the energy economy, including the greater use of renewable energy sources, along with conservation efforts, including more efficient cars and trucks. The report found that solar is the fastest growing source of renewable energy with an annual growth rate of 6.8%. The report predicts that 77GW of renewable generation capacity will be added up until 2040 with 44% of that (33.9GW) from solar. Of this 31GW will be solar PV. Only 9GW of nuclear and 1GW of coal capacity is expected to be added in the same period.



This afternoon the Federal Reserve published its Beige Book, a collection of anecdotal reports from the 12 Fed districts; the report is published 8 times a year, just a couple of weeks before the FOMC meetings to determine monetary policy. Once again, the districts reported that the economy continues to grow moderately or modestly.


Nonfinancial firms saw rising activity across all districts with demand picking up for high-tech services such as cybersecurity and web development. The Boston and Richmond Fed districts saw an increase in healthcare services, and Service providers in Boston, Philadelphia, Kansas City, and Dallas were optimistic about near-term growth trends for their firms. Many districts said that savings from lower gas prices was fueling consumer sales. Auto sales rose in most districts, and all districts expected corporate and leisure travel to be up in 2015. Most Fed districts reported a tight supply of residential real estate, and only New York reported softening conditions in the residential real estate market. In Chicago, inventories of homes were near historic lows, especially for lower-priced homes. And the Fed says banking conditions are generally favorable.


Agricultural conditions worsened slightly across the nation, thanks to wet fields, persistent drought, and a cold winter. Weather was an important consideration in the Beige Book, mentioned 71 times, and it was mostly bad weather.  Energy market conditions declined in the oil patch. Falling oil prices hurt new orders to energy supplier companies. Manufacturing activity was mixed, hurt by the soaring value of the dollar, which makes US goods more expensive overseas.



Another big day for earnings reports. Bank of America reported a better-than-expected first-quarter profit, reversing from a year-earlier loss, as legal costs fell to $370 million for the quarter. BofA has paid at least $70 billion so far to settle legal issues related to the financial crisis. It turns out that throwing away tens of billions of dollars on legal problems is a flawed business model. Who knew?

CSX beat estimates with earnings, while revenue was essentially in line. The rail operator also announced a $2 billion stock buyback, and raised its dividend by 13 percent to 18 cents per share.

Delta Air Lines posted better-than-expected earnings. The carrier said it plans to cut seating capacity later this year on international routes as the strong dollar and declining oil prices damps overseas travel demand.

Charles Schwab said its first-quarter profit fell 7.4%, as the company was hurt by higher one-time costs and a slowdown in trading.

Netflix, the online video-streaming service, reported revenue of $1.57 billion in its first quarter, on earnings of 38 cents per share. Analysts expected earnings of 69 cents per share, but share price moved higher in after-hours trading because they added 4.9 million new subscribers, topping estimates of 4 million.


Keep in mind that this week we’ve seen several of the big financial institutions reporting earnings, and they were expected to turn in good results. Starting next week, we’ll start to see other sectors reporting, and as we get into the energy sector or the manufacturing sector, we are more likely to see ugly numbers.


The European Union has accused Google of anti-trust violations; cheating competitors by distorting Internet search results to favor its shopping service; and regulators also launched another antitrust investigation into its Android mobile operating system. Google now has an opportunity to explain itself and the case might be settled by the company making commitments to change its products.  The EU regulator can demand sweeping changes to Google’s business practices and might impose fines up to $6.6 billion. Google plans to defend the charges.


Nokia has agreed to acquire telecom equipment company Alcatel-Lucent for $16.6 billion, in a deal that would solidify its ambitions to become a major provider of networking equipment. The deal is expected to close in the first half of 2016. The combined company will have about 114,000 employees and combined sales of around 26 billion euros. The new Nokia will have stronger exposure to the North American market, with key contracts with AT&T and Verizon.


With the FCC’s new net neutrality rules published in the Federal Register – let the lawsuits begin.  AT&T and three industry trade groups representing cable companies and wireless carriers have filed separate lawsuits challenging the rules. AT&T is the first large individual challenger, joined by the National Cable and Telecommunications Association, wireless group CTIA and the smaller American Cable Association.


After months of negotiations, Target is close to a settlement with MasterCard that would reimburse banks with roughly $20 million for costs they incurred from its massive data breach two years ago. In 2013, Target said at least 40 million credit cards were compromised by a hack during the holiday shopping season, and the attack might have resulted in the theft of personal information. Target also faces a big payout in its negotiations with Visa.


Verizon has published its annual report on cyber security. The report was based on the details of 79,790 “security incidents” given to Verizon’s researchers by 70 organizations, and that’s just for the past year. Phishing may be the oldest trick in the hacker’s book, but it’s still the method behind many of the breaches we’ve seen in recent months. Nearly a quarter of people who receive phishing e-mails open them, according to the report, and 11 percent proceed to download file attachments.


The Verizon report also suggests that companies adopt “improved detection and response capabilities.” Put simply, companies rarely figure out on their own that they’ve been breached. Security professionals often fail to update their systems with patches for known vulnerabilities, and hackers take full advantage of those weaknesses. According to the report, “71 percent of vulnerabilities had a patch available for more than a year prior to the breach.” In other words, many paths hackers took to break into networks last year could have been rendered dead-ends if someone had installed these updates. Worse yet, the issuance of a patch may be a green light for hackers to attack, because it highlights a vulnerability and the hackers know most organizations are slow to patch.



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