Until Something Breaks
Financial Review by Sinclair Noe for 10-29-2015
DOW – 23 = 17,755
SPX – 0.94 = 2089
NAS – 21 = 5074
10 YR YLD + .08 = 2.17%
OIL + .12 = 46.06
GOLD – 10.20 = 1146.50
SILV – .35 = 15.68
Gross domestic product, the value of almost everything a nation produces, rose at a 1.5% annual pace in the third quarter; that’s down from a 3.9% rate in the second quarter. The slowdown stemmed mostly from the biggest drawdown in inventories in three years. Companies cut spending on structures such as oil platforms and commercial buildings. Even as businesses showed more caution, consumers continued to spend money at steady clip. Consumer spending, the single largest determinant of U.S economic growth, rose at a 3.2% annual pace following an even larger gain in the second quarter. Some parts of the economy are performing well; technology, health care, and finance are enjoying conditions that echo the booming 1990s or the housing bubble a decade ago. The energy sector is hurting and cutting jobs and closing down projects.
Shipping is a measure of the real economy. Shipments usually increase from August to September. They did this year too. The number of shipments in September inched up 1.7% from August, according to the Cass Freight Index. But the index was down 1.5% from an already lousy September last year, when shipments had fallen from the prior month, instead of rising. And so, in terms of the number of shipments, it was the worst September since 2010. September is in the early phase of the make-or-break holiday shipping season. But it’s not happening.
Yesterday the Federal Reserve FOMC wrapped up a two-day policy meeting, leaving interest rates unchanged near zero – no surprise. The Fed described the economy as expanding at a “moderate” pace and turned up the heat around a possible December rate hike. Today’s GDP report takes some of the starch out of the Fed’s resolve to raise rates. Maybe the Fed should just accept the idea that the economy is neither depressed and deflating nor overheated and inflating. The stock market has been climbing almost since the Fed instituted Zero Interest Rate Policy; the economy has been adding jobs; inflation has flattened out, which seems the definition of price stability. Instead of all the hoopla over a possible rate increase, with attendant downside risks, there is a very real possibility the Fed could just stand pat for a very long time, or until something breaks.
Pending home sales fell 2.3% in September, the second drop in a row; still, the index of pending home sales is up 3% from the same level 12 months ago. The National Association of Realtors reported a shortage of available listings in the lower end of the market for first-time buyers.
The number of Americans filing new applications for unemployment benefits increased by 1,000 to 260,000, which is close to a 42 year low. It was the 34th straight week that claims were below the 300,000 threshold, which is normally associated with a fairly healthy jobs market.
John Boehner has officially resigned as Speaker of the House. Paul Ryan has been elected as the 62nd Speaker of the House. The House voted 266-167 to pass a two-year budget deal negotiated by Boehner, the White House and other congressional leaders that clears the decks for the new speaker and relieves market worries over a possible default next week. The plan extends the federal debt limit through March 2017 and eases automatic spending caps to add $80 billion in new discretionary spending over two years. The budget accord raises spending caps on domestic and defense spending over the next two years while raising the debt limit until March 2017. There are also changes to eligibility requirement in the Social Security disability program, and changes to claiming strategies for Social Security. A provision to cut crop insurance subsidies by $3 billion to help pay for the deal was removed from the bill at the last minute. Farm-state lawmakers had objected to the cut. There were also last-minute changes to the package in the House Rules Committee to recalibrate how the bill was scored with regard to money spent out of the Overseas Contingency Operations fund, an account that’s not subject to budget caps. There are many more details in the budget and there will likely be further changes; still, Senate leaders expect to pass the package next week.
After posting a €6 billion-euro net loss for the third quarter and scrapping its dividend for the next two years, Deutsche Bank has announced plans to exit 10 countries and reduce its workforce by 35,000 employees. The moves follow a recent writedown at its investment bank and the removal of three of the bank’s eight board members. A sanctions settlement may also be in the making. As early as next week, Deutsche is expected to pay at least $200 million to resolve investigations into its dealings with countries like Iran and Syria.
Following a better-than-expected earnings report, Samsung Electronics said it plans to buy back and cancel $9.9 billion of its stock over the next year in order to boost shareholder value. The tech giant’s operating profit jumped 82% to $6.5 billion during the quarter, its first year-on-year profit growth in two years, boosted by a recovery at its mobile division and strong semiconductor sales.
Royal Dutch Shell swung to a third-quarter loss after taking a $7.9 billion write-down on big ticket projects including an exploration venture in the Alaskan Arctic and a major oil sands endeavor in Canada. The company, however, is still moving ahead with its $70 billion acquisition of BG Group. Shell posted a quarterly loss of $6.1 billion, down from a profit of $5.3 billion a year earlier.
Volkswagen dealers across the country are offering hefty discounts on new gasoline models after the German automaker began more aggressive efforts to rebuild sales in the wake of its emissions scandal. According to an online survey, discounts of up to $7,000 are being offered on the Passat and Jetta, while gasoline-electric models such as the Jetta Hybrid have prices slashed by up to $6,000.
United Auto Workers leaders have approved a proposed contract with General Motors that promises raises, improvements in health care and a hefty signing bonus. Like a previous contract approved by Fiat Chrysler, GM’s agreement will also eliminate a two-tier wage system over eight years. The four-year deal will now be sent to GM’s 52,600 union workers for ratification.
Pharmaceutical giants Pfizer and Allergan are considering a merger. Allergan confirmed that it has entered into “preliminary friendly discussions” with Pfizer following an approach by the bigger drugmaker. No agreement has been reached. Stocks of both companies have been halted. Price could be an obstacle, as well as other issues including the extent to which Pfizer would want to lay off employees, close facilities and the general makeup of a combined management team. A tie-up between the two would create an entity with a market cap greater than $300 billion, and would be the biggest takeover announced this year.
It would also be the biggest ever U.S. tax inversion, a process by which a company shifts its legal address abroad to take advantage of lower tax rates and access to overseas profits, while keeping its operations in America. Allergan, for example, moved its legal address to Dublin, Ireland in a previous deal, while keeping its main executive offices in New Jersey. The U.S. Treasury Department issued a proposal in September 2014 to try to stop inversions. The notice said the government would make it harder for U.S. companies to borrow against their foreign cash to finance inversions. It also tightened the calculations for when a deal triggers anti-inversion restrictions in the tax code and changed how passive assets would be counted in those tallies. And it limited maneuvers by companies to shrink themselves by paying extraordinary dividends before a deal so they would escape the arithmetic tests in the anti-inversion law. While the rules aren’t final, they are retroactive and essentially in force, but that might not be enough to stop this deal.
In the past, the inversion threshold was 20%. Meaning that 20% of the new company had to be owned by a foreign entity in order to take full tax advantage of moving overseas. But the Treasury rule changes make it harder for U.S. companies to shift domestic earnings overseas at the 20% level. What’s more, companies can no longer use foreign cash tax-free to fund inversion deals if the deal ends up with just 20% foreign ownership. So the changes don’t eliminate the benefits of tax inversions. They just reset the threshold to 40%.
Pfizer’s market cap is roughly $220 billion. Shares of Allergan are up 17% today. That gives the company a market cap of almost $120 billion. For Pfizer to meet the 40% threshold, it would have to pay at least $147 billion for Allergan, or $27 billion more than what the market is currently guessing. That might actually make sense. Pfizer currently has about $70 billion in cash overseas. If it were to repatriate that at the corporate 35% tax rate, then it would have to pay $24.5 billion in taxes. So the Treasury rules might not stop this inversion play, but we are also heading into an election year and this will not sit well.
Today is October 29th, a rather notorious date also known as Black Tuesday, dating back to the Crash of 1929. The crash actually spread out over several days. It started in earnest on Thursday, October 24 with a 12% loss. The bankers and leaders of the stock exchange stepped in and tried to prop up the markets, with little success. The rout continued with 12% losses on Monday, Black Monday and then Black Tuesday; a two-day decline that remains the worst, in percentage terms, in US market history. The market would not return to the peak closing of September 3, 1929 until November 23, 1954. The Wall Street Crash was widely considered as the start of the Great Depression. Say what you will about the current state of affairs but we can look back in history 86 years today and we should all count our blessings.