Financial Review

Upside-Down World

Financial Review by Sinclair Noe

DOW + 110 = 17,972
SPX + 19 = 2088
NAS + 56 = 4857
10 YR YLD un 1.98%
OIL + 2.28 = 51.12
 

A ceasefire between Russia and Ukraine is scheduled to start February 15, which apparently means that Putin’s little green men still have 2 days to grab as much land as they can. The agreement follows a 17 hour, four-way meeting between Russia, Ukraine, France and Germany in Minsk. The new deal revived a failed September ceasefire agreement, with commitments from each side to pull back heavy weapons, as well as greater autonomy for separatist regions in eastern Ukraine. IMF chief Christine Lagarde also announced today that Ukraine will receive about $40B in funding over the next four years.

 

Along with the new cease-fire agreement, that won’t actually end the fighting; there was a non-agreement agreement between Eurozone finance ministers to put off decisions on Greece’s bailout terms until next week. Greek officials were unable to reach a deal over its bailout program yesterday, but will return to Brussels on Monday to try to end the deadlock.

 

Meanwhile, Sweden’s central bank cut its main interest rate into negative territory and announced a bond-buying program this morning. Sweden now joins Denmark and Switzerland and the European Central Bank in negative rate land. So, now, if you want to make a deposit in Sweden, you have to pay. The reason is lowflation, which is another name for mild deflation. Countries around the world are seeing a sharp slowdown in price growth. In fact, much of Europe is in outright deflation right now, including Sweden if you go by its headline national consumer price index.

 

Falling prices are great if you are planning to buy something as an individual consumer, but it is problematic for countries or continents. Consumers put off purchases because hey, the price will be cheaper next week. So, nothing gets sold this week. Rinse, lather, repeat next week. Suddenly, there is no economic growth. Negative interest rates are supposed to penalize saving and prompt people to spend and invest instead. The Swedish Central Bank is creating new money electronically and using it to buy government bonds, in an effort to push more money into the economy and weaken the currency, which is another attempt to juice exports while pushing consumers to spend rather than save.

 

The Swedish Central Bank made a huge mistake in 2010 by raising interest rates to combat high unemployment and low inflation. That didn’t work, so now they turn negative and print money to buy government bonds, and that is supposed to work. In fact, Germany is printing money and buying German government bonds as well, and that is supposed to work; except of course in Greece, where nobody wants to print money to buy Greek bonds, despite outright deflation and depression. Economics is not particularly complicated but economic policy can be insane.

 

The ECB and the European Monetary Union have no one to blame but themselves. They deployed the monetary policy machinery to uphold the interest of creditors, and they thought the Greeks would remain subservient, but that hasn’t happened. What’s happening to Greece today will happen to Italy tomorrow and then Spain and then Portugal. In Italy, they have the Five Star movement; in Spain, Podemos. They make Syriza look conservative.

 

Germany thinks it can shut down Syriza here and now, and shut down any further dissent. But the Eurozone is like a house of cards, and if they pull out Greece from the deck, the most likely outcome is that everything falls.

 

Retail sales fell in January for the second month in a row as drivers spent a lot less on gasoline and didn’t appear to use that savings elsewhere. Retail sales declined by a seasonally adjusted 0.8% last month after a 0.9% drop in December. Sales at gas stations slumped 9.3% to mark the biggest pullback since 2008. Sales fell at auto dealers, home-furnishing stores, grocery chains, department stores, apparel retailers and outlets that sell sporting goods. Internet stores and restaurants, two of the largest retail categories, were among the few sectors to boost sales. Instead of spending the savings at the gas pump, Americans are saving a little; the saving rate increased to 4.9% in December.
Tesla posted quarterly results after the close of trade yesterday.  It was not a good report: deliveries fell short, problems affected production and a strong dollar hurt results. Tesla posted a loss of $0.13 a share, well below analysts’ consensus expectations for a $0.13 a share profit. Elon Musk struck an optimistic tone for the year ahead, however, and went as far predicting a market value of $700 billion by 2025, matching that of Apple. Of course there is nothing concrete to back that up, but when an earnings call is going bad, just say “Apple” and analysts’ eyes glaze over.

 

SpaceX launched a satellite, but scrubbed its rocket landing. This is Elon Musk’s other company; they successfully deployed the DSCOVR space weather satellite after several delays due to (ironically) bad weather, but had to cancel an attempt to land a rocket on a drone ship due to high seas and bad weather.

 

The electric car company and rocket company isn’t the only thing Elon Musk is working on. Tesla’s next innovation could take you off the electric grid. Tesla is planning to unveil a new lithium-ion battery pack that homeowners could buy to store and supply their own energy. Details are still sketchy, but the most obvious idea would be to combine battery packs with solar panels. Solar energy company SolarCity already offers Tesla battery packs in some markets that customers can use to store energy and use as a kind of emergency generator. Musk is the chairman of SolarCity and its largest shareholder.

 

The idea that Tesla could be as big as Apple in 10 years is still pretty preposterous, except it could happen; they already have a $25 billion market cap, and they haven’t even turned a profit. They could grow from here; not just by selling cars, but also by selling batteries, and changing the way we look at the electric grid. If you are looking for a fast growing industry, you can’t get much bigger than energy. And if you look at Tesla as just a car company, you miss the bigger picture.

 

So, you’re looking for a travel site. What do you do? Well, if you are Expedia, you search the web, compare sites and then buy Orbitz for about $1.4 billion, or $12 a share in cash. It worked out to about a 25% premium for Orbitz; other travel-related websites moved higher as well.

 

Chief executive John Chambers says Cisco is back with a vengeance.” Cisco reported impressive Q2 results following five straight quarters of slumping profit and sluggish sales. Cisco shares were up more than 9%.

 

And while we almost didn’t notice, the Nasdaq Composite has moved to within less than 4% of 5048; that’s the old record high from March 2000. The S&P 500 is just a couple points away from the 2090 record high close of December 29.

 

For quite some time I’ve talked about how the big banks repeatedly break laws, only to work out a settlement, and then go back and break even more laws. And one of the crazy things about that merry go round is that the banks settlements typically include something know as a deferred prosecution agreement.

 

For example, UBS, the largest Swiss bank, avoided prosecution in February 2009 when it admitted to helping Americans evade taxes, paid $780 million and handed over 250 secret accounts. In a deferred-prosecution agreement with the Justice Department, the firm promised to follow the law and cooperate with the US. Now investigators are supposedly looking into whether UBS aided wealthy clients in the use or transfer of bearer securities, which can be used to hide assets and potentially evade taxes; bearer securities have been illegal for decades.

 

Investigators suspect the conduct may have occurred when the bank was still bound by the deferred-prosecution agreement, which expired in October 2010. If that’s true, the Justice Department could reopen the accord and prosecute the bank on the original conspiracy charge. Prosecutors also could file new charges against UBS and seek stiffer penalties and oversight at sentencing for violating the previous agreement. In addition to the 2009 tax-evasion agreement, the bank settled an antitrust case involving the municipal-bond investments market in 2011. It resolved another Justice Department probe in 2012 for rigging Libor interest rates. The Justice Department has never reopened a closed deferred-prosecution agreement.

 

Meanwhile, last week 60 Minutes reported on the results of an International Consortium of Investigative Journalists’ research into documents leaked from HSBC, detailing tax evasion schemes at their Swiss subsidiary. Things have been pretty quiet following that report. The Department of Justice actually received the leaked documents 5 years ago, but the media only released the info this past weekend.

 

HSBC has its own recidivism problems. HSBC paid a $1.9 billion fine in 2012, in a deferred prosecution agreement over money-laundering with Mexican drug cartels and breaches of US sanctions; this was so blatant that the bank even got caught buying a smuggling plane for the Sinaloa cartel. Under that deal, HSBC escaped criminal charges and kept the banking charter that enables it to operate in the US. Then there was Libor rate rigging, illegal deals with Saudi banks linked to Al Qaeda, and still no one thought to reopen a deferred prosecution agreement.

 

And of course, no high level execs from HSBC or any other bank have been charged. It is now becoming sublimely ridiculous. We’re supposed to believe the CEOs never knew about any of the staggering number of frauds and scandals – and in the case of HSBC we are talking about hundreds of thousands of felony criminal acts. And at the same moment we are to believe that these are highly skilled executives capable of managing massive financial institutions.

 

Ultimately, scandals like HSBC’s Swiss tax evasion scheme are merely flash points offering us a clearer view of the hidden dynamics at work in the world economy: what is taken from one side shows up at the other. The timing of the scandal is delicious; Greece is going to Brussels to beg a reprieve from debtor’s prison and the failed policies of austerity. There is no such thing as austerity; there is only a highly skewed redistribution of scarce resources. In this upside-down world, money simply tends to flow upwards.

 

 

 

 

 

 

 

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