Financial Review

Sunshine Clean

…Talk of trade talks. Copper – the canary in the coal mine. Consumer sentiment slips. Short-termitis in earnings reports. Corporate governance.
Financial Review by Sinclair Noe for 08-17-2018

DOW + 110 = 25,669
SPX + 9 = 2850
NAS + 9 = 7816
RUT + 7 = 1692
10 Y un = 2.87%
OIL + .46 = 65.92
GOLD + 10.90 = 1185.60


For the week, the Dow industrials gained about 1.3%. The S&P 500 is up 0.6 percent this week, but the Nasdaq showed a loss. Investors pulled money from both stock and bond funds in the past week, and shifted money within U.S. equities to health care and out of tech and financials. According to Bank of America Merrill Lynch, investors pulled $3.6 billion out of equity mutual funds and ETFs, with $2.6 billion out of U.S. stocks. But as investors took a defensive posture on stocks, they also dumped government debt, with net outflows of $1.5 billion from Treasuries and government bonds, the biggest since December 2016. Overall, bonds lost a total of $2.3 billion. BofA notes that the top five performing sectors for the past three months have all been defensive — staples, utilities, REITs, health care and telecommunications.


Emerging-market stocks have shed 10.7% over the past three months, and they are on track for a 3.8% decline for the week, per FactSet data. That would represent the index’s third straight weekly drop as well as its steepest weekly decline since March. The declines have taken the index to its lowest level in about a year.


The price of copper has fallen 19 percent just since early June, and it’s now at its lowest in about a year. That’s a steeper drop than for other commodities like crude oil, which has also been falling in recent weeks. Concern about China, the single largest consumer of the metal, is the primary source of this weakness. Copper is a good predictor for the direction of industrialized economies. The country’s economic outlook has darkened since the trade war with the United States began, right around when copper prices were at their peak. The trade war is hitting China as it also faces a difficult transition away from the growth model that fueled the country’s rise. In the second quarter, nonperforming loans at Chinese banks notched their biggest rise in over a decade. China’s currency, the renminbi, has fallen more than 9 percent against the dollar in the last six months and China’s CSI 300 index of blue chip stocks is off 19 percent this year. If the slump in copper prices is a harbinger of a significant slowdown in global economic growth, American investors could eventually feel the pain. Last year, 44 percent of the revenues of companies in the S&P 500 came from foreign countries, with Asia being the single largest regional source of sales.


Stocks extended yesterday’s gains on reports of progress in talks between the United States and China and other trading partners. The talks haven’t happened yet, nothing definitive has been negotiated. The talk so far is about holding talks in the future. And just the thought that there will be talks was a boost for Wall Street. Meanwhile, Mexico’s economy minister, Ildefonso Guajardo, said he hopes to wrap up outstanding bilateral issues on NAFTA by the middle of next week. During second-quarter earnings calls, tariffs, higher margins, and wage growth were the three themes that stood out. Trade wars can have unintended consequences. Tariffs have already disrupted some supply chains and companies are finding it extremely difficult to pass the costs to consumers. American shoppers just won’t buy it.


According to the University of Michigan’s first look at consumer sentiment in August, consumers’ assessment of current economic conditions declined due to, “much less favorable assessments of buying conditions, mainly due to less favorable perceptions of market prices.” In other words, things got more expensive and consumers pulled back. The University of Michigan’s headline consumer sentiment index slipped to 95.3 in the beginning of August, down from 97.9 at the end of July and the lowest reading in 11 months. Buying conditions for large household durables sank to the lowest level in nearly four years. Headline inflation which captures the costs of food and gas rose 2.9% over last year, and consumers still expect inflation in the year ahead to be 2.9%.


Agricultural equipment maker Deere posted stronger than expected sales and its stock rose 2.3 percent to $140.60. The stock started lower after Deere disclosed a smaller profit than analysts expected and said rising costs for raw materials and freight are affecting its business. Deere’s numbers were a mixed bag. Deere shares fell as much as 6.8 percent in pre-market trading, before rebounding to trade up more than 2 percent as executives held a conference call to discuss the results. Deere says it’s working to offset the rising expenses with cost cuts elsewhere and increased prices. This was actually a fairly interesting conference call. Deere could be considered on the front line of trade wars – their products are essential for farmers; agricultural is a crucial part of tariffs with China.


And then out of nowhere, Trump said today that companies should stop reporting quarterly results and instead post earnings every 6 month. This echoes recent comments from Jamie Dimon of JPMorgan and Warren Buffett, as they called for more long-term planning for companies and investors. Today, Deere’s stock price went from negative to positive during management’s conference call as management struck an optimistic tone about its ability to navigate difficult market conditions. Maybe investors are not stuck on short-term numbers. Most investors can see through short-term challenges and focus on the bigger picture, even if that bigger picture includes short-term numbers. European companies operate on a semi-annual reporting system and that doesn’t seem to have saved them from pressure to make job cuts, do big share buybacks or pursue shake-ups or attempt financial engineering at the behest of activist investors. I really don’t think it makes much difference. Maybe we should let shareholders decide how they would like to report earnings. If JPMorgan or Berkshire Hathaway wants to report every 6 months – go ahead. If Deere wants to report every 3 months – go ahead. I understand CEOs’ frustration with short-term reporting, but the solution is not to hide critical information from investors. And companies need to stop playing games with the numbers, whether quarterly or semi-annually; they need to present the numbers with accuracy, clarity, simplicity, and honesty. Sunshine remains the best disinfectant.


Also this week, Senator Elizabeth Warren offered proposals for fixing corporate governance. Warren has written legislation and an op-ed in the Wall Street Journal advocating that the U.S. corporate structure be reformed to reduce the power of speculators in the economy. Instead of thinking of corporations as the sole property of shareholders, Warren’s proposal would return us to the days when corporations, as privileged legal creations of the American people, were thought to have responsibilities to the public welfare as well as to their shareholders. Warren’s plan starts from the premise that corporations that claim the legal rights of personhood should be legally required to accept the moral obligations of personhood. Warren argues that the shift in corporate governance ideology since the 1980s, from one of public purpose to one of private gain, has impoverished our economy while enriching a small elite. Before, wages grew alongside productivity, making the United States both prosperous and relatively equitable. But now, the emphasis on maximizing the extraction of “shareholder value” out of corporations has not only deprived workers of their just due, but has starved the U.S. economy of the long-term investments it needs to grow and compete in today’s world. Large corporations would be required to consider the interests of all stakeholders — workers, customers, the community — as well as shareholders’ interests. The hope is that considerations such as long-term investments, negative externalities and equitable growth would have a seat at the table along with those who have only their own short-term financial interests at heart.


Shares of Sears Holdings dropped about 13 percent, hitting a record low. A hedge fund owned by CEO Eddie Lampert offered to buy the troubled retailer’s Kenmore appliance division for $400 million. Lampert’s hedge fund, ESL Investments, also made an offer to buy Sears’ Home Improvement business for as much as $80 million in cash. The shares slid to an intraday low of $1.27 a share before closing at $1.32. It looks like Sears is being cannibalized for parts. Sears’ stock has fallen 84 percent over the past 12 months, bringing the retailer’s market cap to about $144 million. Amazon, for comparison, has a market cap of more than $910 billion. Department store chain J.C. Penney’s stock also hit an all-time low this week of $1.60 on the heels of its dismal quarterly earnings report.


In an emotional interview with the New York Times, Elon Musk has said the past year of his professional life has been “excruciating” and that stress over his business had caused his health to deteriorate. Musk said he had been working up to 120 hours a week and his health had been “not great”. He said his friends had been worried about him. Musk said there were times he didn’t leave the factory for three or four days at a time and days when he didn’t go outside. The interview follows on the heels of Musk’s totally-well-thought-out plan to take Tesla private which maybe involves Goldman and Silver Lake and the Saudis, or maybe not. Toss in a subpoena from the SEC. Clearly, sleep deprivation is not a key to success. Tesla’s shares fell close to 9% today, wiping over $5 billion off the company’s value.

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