Morning News: June 22, 2016
Posted by Eddy Elfenbein on June 22nd, 2016 at 7:21 am

Brexit Polls and Markets Disagree in Campaign’s Final Hours

In SolarCity Bid, Tesla’s Musk Targets Customers Wanting All

Close a Nuclear Plant, Save Money and Carbon, Improve the Grid, Says PG&E

Apple Pays Back E-Book Buyers Following Settlement

Hyperloop One Explores Building High-Speed Transport System in Moscow

FedEx Posts $70 Million Loss, Gives Cautious Outlook

Teva and Allergan Sell Generic Drugs to Impax In Latest Divestiture

Former Bangladesh Bank Chief Blames Global System for Theft

Volkswagen Leaders Struggle to Appease Shareholders at Meeting

Mitsubishi Motors Expects to Swing to $1.38 Billion Net Loss

A $541 Million Loss Haunts Deutsche Bank And Former Trader Dixon

United: Catching Up From a Long Delay

Ex-Jet QB Sanchez Among Athletes Cheated in Investment Fraud

Josh Brown: Five-Word Financial Advice For New Graduates

Roger Nusbum: “Zombie Fed”

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Yellen Warns
Posted by Eddy Elfenbein on June 21st, 2016 at 12:50 pm

Stocks Fluctuate as Yellen Warns of ‘Brexit’ Consequences

Fed Chair Janet Yellen Warns That U.S. Economy Faces ‘Considerable Uncertainty’

Yellen Warns Global Turbulence Could Hit Growth

Janet Yellen Warns of Domestic, Global Risks to US Economy

Yellen Warns of ‘Considerable Uncertainty’

Yellen Warns Against Fed Reforms

Yellen Warns on Waiting Too Long to Hike

Janet Yellen Warns Against Government Shutdown

Ex-Fed Chief Bernanke Denied Loan to Refinance His Home

Janet Yellen’s Testimony
Posted by Eddy Elfenbein on June 21st, 2016 at 10:03 am

Here’s what Janet Yellen will be saying to the Senate Banking Committee today:

Chairman Shelby, Ranking Member Brown, and other members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress. In my remarks today, I will briefly discuss the current economic situation and outlook before turning to monetary policy.

Current Economic Situation and Outlook

Since my last appearance before this Committee in February, the economy has made further progress toward the Federal Reserve’s objective of maximum employment. And while inflation has continued to run below our 2 percent objective, the Federal Open Market Committee (FOMC) expects inflation to rise to that level over the medium term. However, the pace of improvement in the labor market appears to have slowed more recently, suggesting that our cautious approach to adjusting monetary policy remains appropriate.

In the labor market, the cumulative increase in jobs since its trough in early 2010 has now topped 14 million, while the unemployment rate has fallen more than 5 percentage points from its peak. In addition, as we detail in the Monetary Policy Report, jobless rates have declined for all major demographic groups, including for African Americans and Hispanics. Despite these declines, however, it is troubling that unemployment rates for these minority groups remain higher than for the nation overall, and that the annual income of the median African American household is still well below the median income of other U.S. households.

During the first quarter of this year, job gains averaged 200,000 per month, just a bit slower than last year’s pace. And while the unemployment rate held steady at 5 percent over this period, the labor force participation rate moved up noticeably. In April and May, however, the average pace of job gains slowed to only 80,000 per month or about 100,000 per month after adjustment for the effects of a strike. The unemployment rate fell to 4.7 percent in May, but that decline mainly occurred because fewer people reported that they were actively seeking work. A broader measure of labor market slack that includes workers marginally attached to the workforce and those working part-time who would prefer full-time work was unchanged in May and remains above its level prior to the recession. Of course, it is important not to overreact to one or two reports, and several other timely indicators of labor market conditions still look favorable. One notable development is that there are some tentative signs that wage growth may finally be picking up. That said, we will be watching the job market carefully to see whether the recent slowing in employment growth is transitory, as we believe it is.

Economic growth has been uneven over recent quarters. U.S. inflation-adjusted gross domestic product (GDP) is currently estimated to have increased at an annual rate of only 3/4 percent in the first quarter of this year. Subdued foreign growth and the appreciation of the dollar weighed on exports, while the energy sector was hard hit by the steep drop in oil prices since mid-2014; in addition, business investment outside of the energy sector was surprisingly weak. However, the available indicators point to a noticeable step-up in GDP growth in the second quarter. In particular, consumer spending has picked up smartly in recent months, supported by solid growth in real disposable income and the ongoing effects of the increases in household wealth. And housing has continued to recover gradually, aided by income gains and the very low level of mortgage rates.

The recent pickup in household spending, together with underlying conditions that are favorable for growth, lead me to be optimistic that we will see further improvements in the labor market and the economy more broadly over the next few years. Monetary policy remains accommodative; low oil prices and ongoing job gains should continue to support the growth of incomes and therefore consumer spending; fiscal policy is now a small positive for growth; and global economic growth should pick up over time, supported by accommodative monetary policies abroad. As a result, the FOMC expects that with gradual increases in the federal funds rate, economic activity will continue to expand at a moderate pace and labor market indicators will strengthen further.

Turning to inflation, overall consumer prices, as measured by the price index for personal consumption expenditures, increased just 1 percent over the 12 months ending in April, up noticeably from its pace through much of last year but still well short of the Committee’s 2 percent objective. Much of this shortfall continues to reflect earlier declines in energy prices and lower prices for imports. Core inflation, which excludes energy and food prices, has been running close to 1-1/2 percent. As the transitory influences holding down inflation fade and the labor market strengthens further, the Committee expects inflation to rise to 2 percent over the medium term. Nonetheless, in considering future policy decisions, we will continue to carefully monitor actual and expected progress toward our inflation goal.

Of course, considerable uncertainty about the economic outlook remains. The latest readings on the labor market and the weak pace of investment illustrate one downside risk–that domestic demand might falter. In addition, although I am optimistic about the longer-run prospects for the U.S. economy, we cannot rule out the possibility expressed by some prominent economists that the slow productivity growth seen in recent years will continue into the future. Vulnerabilities in the global economy also remain. Although concerns about slowing growth in China and falling commodity prices appear to have eased from earlier this year, China continues to face considerable challenges as it rebalances its economy toward domestic demand and consumption and away from export-led growth. More generally, in the current environment of sluggish growth, low inflation, and already very accommodative monetary policy in many advanced economies, investor perceptions of and appetite for risk can change abruptly. One development that could shift investor sentiment is the upcoming referendum in the United Kingdom. A U.K. vote to exit the European Union could have significant economic repercussions. For all of these reasons, the Committee is closely monitoring global economic and financial developments and their implications for domestic economic activity, labor markets, and inflation.

Monetary Policy

I will turn next to monetary policy. The FOMC seeks to promote maximum employment and price stability, as mandated by the Congress. Given the economic situation I just described, monetary policy has remained accommodative over the first half of this year to support further improvement in the labor market and a return of inflation to our 2 percent objective. Specifically, the FOMC has maintained the target range for the federal funds rate at 1/4 to 1/2 percent and has kept the Federal Reserve’s holdings of longer-term securities at an elevated level.

The Committee’s actions reflect a careful assessment of the appropriate setting for monetary policy, taking into account continuing below-target inflation and the mixed readings on the labor market and economic growth seen this year. Proceeding cautiously in raising the federal funds rate will allow us to keep the monetary support to economic growth in place while we assess whether growth is returning to a moderate pace, whether the labor market will strengthen further, and whether inflation will continue to make progress toward our 2 percent objective. Another factor that supports taking a cautious approach in raising the federal funds rate is that the federal funds rate is still near its effective lower bound. If inflation were to remain persistently low or the labor market were to weaken, the Committee would have only limited room to reduce the target range for the federal funds rate. However, if the economy were to overheat and inflation seemed likely to move significantly or persistently above 2 percent, the FOMC could readily increase the target range for the federal funds rate.

The FOMC continues to anticipate that economic conditions will improve further and that the economy will evolve in a manner that will warrant only gradual increases in the federal funds rate. In addition, the Committee expects that the federal funds rate is likely to remain, for some time, below the levels that are expected to prevail in the longer run because headwinds–which include restraint on U.S. economic activity from economic and financial developments abroad, subdued household formation, and meager productivity growth–mean that the interest rate needed to keep the economy operating near its potential is low by historical standards (This is the Wicksell natural rate stuff – Eddy). If these headwinds slowly fade over time, as the Committee expects, then gradual increases in the federal funds rate are likely to be needed. In line with that view, most FOMC participants, based on their projections prepared for the June meeting, anticipate that values for the federal funds rate of less than 1 percent at the end of this year and less than 2 percent at the end of next year will be consistent with their assessment of appropriate monetary policy.

Of course, the economic outlook is uncertain, so monetary policy is by no means on a preset course and FOMC participants’ projections for the federal funds rate are not a predetermined plan for future policy. The actual path of the federal funds rate will depend on economic and financial developments and their implications for the outlook and associated risks. Stronger growth or a more rapid increase in inflation than the Committee currently anticipates would likely make it appropriate to raise the federal funds rate more quickly. Conversely, if the economy were to disappoint, a lower path of the federal funds rate would be appropriate. We are committed to our dual objectives, and we will adjust policy as appropriate to foster financial conditions consistent with their attainment over time.

The Committee is continuing its policy of reinvesting proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities. As highlighted in the statement released after the June FOMC meeting, we anticipate continuing this policy until normalization of the level of the federal funds rate is well under way. Maintaining our sizable holdings of longer-term securities should help maintain accommodative financial conditions and should reduce the risk that we might have to lower the federal funds rate to the effective lower bound in the event of a future large adverse shock.

Thank you. I would be pleased to take your questions.

Morning News: June 21, 2016
Posted by Eddy Elfenbein on June 21st, 2016 at 7:23 am

With Two Days To Go, Britain’s EU Referendum on a Knife-Edge

Brexit Vote in Balance in Polls as Soros Warns of Pound Plunge

German Market Sentiment Unexpectedly Rises Before U.K. Vote

The Fed Gets an Attitude Adjustment

Supreme Court Sides With R.J. Reynolds in RICO Case

SoftBank President Nikesh Arora to Step Down

Tencent Seals Deal to Buy ‘Clash of Clans’ Developer Supercell for $8.6 Billion

Boeing Signs Deal to Sell Jets to Iran’s State Airline

United Continental Targets $3.1 Billion in Revenue, Efficiency Gains

Credit Suisse Chief Contends With Rising Tensions, and a Sinking Stock

A Desperate Search for Gold After Brazil’s Worst Mining Disaster Ever

Carl Icahn Bid Pushes Shares of Federal-Mogul Up

Here Are The Tech Companies People Are Dying to Work For, According to LinkedIn

Cullen Roche: The Three Types of Financial Forecasters

Jeff Carter: Heuristics. Sometimes They Lead to Bad Decisions

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The 2/10’s Track Record
Posted by Eddy Elfenbein on June 20th, 2016 at 10:06 pm

There are lots of good metrics that tell you how well the economy did. There are very few that tell you how well the economy is doing. But there are almost none that tell you how well the economy is about to do.

One example of the last one is the spread between the 2- and 10-year Treasury yields. When the spread has turned negative, it’s been a fairly good indicator that a recession is close by.

Check out this chart showing the 2/10 spread along with the recession periods (the gray shaded areas).

That’s not bad. Compared with the Fed or Wall Street, it’s outstanding.

I wanted to run the numbers and see how well the 2/10 spread did. Here’s the 2/10 spread versus the number of times the economy was in recession 12 months in the future.

If the chart doesn’t make sense, here’s what I did: I sorted each month by its 2/10 spread and then I sorted the months into nine different buckets. (I’ve listed the upper and lower bounds on the table.) Next I looked exactly 12 months into the future and counted the total number of months and the number of months the economy was officially in recession.

In short, the lower the spread, the greater the odds of a recession. The tipping point is about 0.12%. Right now, the spread is at 0.92.

Exxon Surges Back
Posted by Eddy Elfenbein on June 20th, 2016 at 12:20 pm

Exxon Mobil (XOM) obviously follows the course of world oil markets. The stock plunged from an intra-day high of $104.76 on July 29, 2014 to an intra-day low of $66.55 on August 24, 2015. That’s a brutal loss of 36% in a little over a year.

But now XOM is hot again. The shares touched $91.59 today. That ties a 16-month high. The stock has made back roughly two-thirds of what it lost.

The market gods are capricious and rarely boring.

The Three Stages of the Post-War Economy
Posted by Eddy Elfenbein on June 20th, 2016 at 12:02 pm

Here’s a look at the growth of the U.S. GDP in real terms since 1947, but I’ve made one major change: I’ve divided the data series by a trend line growing at 3.2% per year.

Doing this shows the post-war economy in three distinct stages. In the early post-war period, from 1947 to 1966 (in green), the economy grew faster than 3.2% per year. Then, from 1966 to 2000 (in blue), the economy mostly kept pace with the 3.2% trend line. The final portion is since 2000 (in purple) as the economy has markedly lagged the 3.2% trend line.

Let me make it clear that I’m adding an artificial framework to this data. That criticism is accurate. Still, I believe I’m doing this in a fair way, and seen my way, the economy clearly outlines three different periods.

You can surely quibble with the precise turning points. I think some people may claim that the post-war extended until 1973. Either way, I don’t think these shifts are truly quite so abrupt, but the larger trend is obvious.

Why is this so?

I’ve left out an important variable, which is population growth. After WW2, the United States had a famous Baby Boom. In recent years, fertility rates have dropped although immigration has increased.

Adjusting for population, I wonder if we’ve seen a large drop-off at all.

But if we look at GDP growth per capita, I’m curious which age cohort ought to be used. Should we use the entire population, or would it be more appropriate to use those in the workforce? I’m not sure of the right answer. Perhaps the aging population doesn’t make our recent economic growth seem so poor.

Are we truly worse off, or are we just getting older? I don’t know the answer.

Market Set to Rally as “Remain” Gains
Posted by Eddy Elfenbein on June 20th, 2016 at 7:20 am

Remain isn’t going away!

The stock market looks to open very strong today. The S&P 500 futures are currently pointing to a gain of 27 points.

The latest polls are showing a gain for the “Remain” camp in this week’s Brexit vote. The British pound is close to making its biggest gain in eight years. The murder of MP Jo Cox may have influenced the latest results.

Janet Yellen plans to speak before Congress this week. She mentioned that Brexit is an issue facing the Fed.

Morning News: June 20, 2016
Posted by Eddy Elfenbein on June 20th, 2016 at 7:01 am

Could a “Brexit” Weaken Europe’s Ability to Tackle Global Poverty?

Modi Camp Critiques Rajan While Moving to Calm India Investors

Rosneft on Putin’s Agenda in China

Hong Kong Leader Vows Action After Bookseller Recounts Ordeal in China

Oil Rallies as Fears Over Brexit Abate

The Fed Totally Surrendered

LinkedIn Gets Lucky

A Final Checklist for Costco’s June 20 Credit Card Switch

In the Birthplace of U.S. Oil, Methane Gas Is Leaking Everywhere

Comcast CEO Prepares His Netflix Killer for an Olympics Showcase

Reckoning Near for Merger of Energy Transfer and Williams

BP Approves Investment in Egypt Gas Field 15 Months After Discovery

Saudi Unit of Auditor Deloitte Penalized by Market Regulator

Josh Brown: Future of FinTech: Millennials and the Great Wealth Transfer

Jeff Miller: What Does The Brexit Vote Mean For Financial Markets?

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CWS Market Review – June 17, 2016
Posted by Eddy Elfenbein on June 17th, 2016 at 7:08 am

“He that can have patience can have what he will.” – Benjamin Franklin

At the end of this month, the U.S. economic recovery will turn seven years old. (They grow up so fast!) Almost constantly for seven years, we’ve heard folks wonder, “When will interest rates finally return to normal?”

Yet every single prediction for higher rates has been wrong. All of them—and there have been many. At some point, you have to draw the line and say that seven years is long enough. What we have now is normal. It’s the new normal.

This week, the Federal Reserve once again decided against raising interest rates. That was hardly a surprise. There’s now a reasonable chance the central bank may go all year without touching interest rates. We’ve seen a big disconnect between what the Fed’s been saying and what the Fed’s been doing. Hawkish talk and dovish walk.

In this week’s CWS Market Review, we’ll take a closer look at the Fed’s plans for 2016 and what they mean for investors. We also had some exciting news for our Buy List. Microsoft announced that it’s buying LinkedIn for $26.2 billion. We also have an upcoming earnings report from Bed Bath & Beyond. The home-furnishings stock has been beaten up, and I think it’s a good value here. But first, let’s look at what the Fed didn’t do and why they didn’t do it.

Welcome to the New Normal

If you look at the Fed’s projections from three years ago, they predicted that interest rates would be a lot higher by 2016. Yet here we are, and interest rates are still just above 0%. As low as they are here, rates are even lower in Europe. The 10-year bond in Germany is negative. This week, the Swiss Central Bank decided to leave rates unchanged at, hold on, -0.75%! Germany has negative interest rates out to ten years. Japan’s are negative out to 15 years and Switzerland’s are out to 30 years!

The Federal Reserve met on Tuesday and Wednesday of this week. On Wednesday afternoon, they released their latest policy statement which said they’re keeping interest rates unchanged. Earlier this year, Janet Yellen and other Fed members expressed their belief that rates need to go higher at some point. They’ve always left wiggle room, saying that they’re going to be “data dependent” and such. But whenever the time has come to strike, the Fed has always seemed to pass. They’ve only hiked once, and that was in December.

Two weeks ago, we got the May jobs report, and it was a bust. That convinced me, and a lot of folks besides, that the Fed wasn’t about to raise rates. The good news for the economy is that the unemployment rate is down, but there are still large gaps. Wage growth, for example, has been pretty weak. Business investment isn’t terribly strong. The economy probably did better in Q2 than it did during Q1, but it’s hard to make an argument that the economy is overheating.

Just look at inflation. This week, we got the latest CPI, and it showed that inflation is still well contained. Consumer prices rose by just 0.2% last month, which was below what economists had forecasted. The core rate, which ignores food and energy prices, also rose by 0.2%. Inflation is hardly a problem.

Now comes the interesting part. In addition to the Fed’s policy statement, the Fed members also updated their economic projections. I should add that the Fed has a pretty lousy track record, but it’s interesting to see what they’re thinking.

There are 17 members who provide forecasts. Of them, six see the Fed raising interests just once this year, while nine members see two rate hikes. Not that long ago, the Fed was expecting four rate hikes this year, plus another four next year. How times have changed. With every meeting, it seems, the Fed gradually cedes more ground to reality. As I said, hawkish talk and dovish walk.

What struck me is that the Fed sees the real Fed Funds rate, meaning adjusting for inflation, as being negative through 2017. That means real rates are expected to be negative for another 18 months. At least!

The 10-Year Treasury Yield Plunges

The bond market responded by going absolutely bonkers. The yield on the 10-year Treasury got as low at 1.52%. That’s astounding. Think of what the market is saying here. You can loan your money to Uncle Same for a decade, and in that time, you’ll make a total return of 15%. That’s pathetic.

The 10-year bond yield reached its multi-decade low four years ago when it touched 1.39%. At the time, I wondered if that marked the end of a 30-year bull market for bonds. By late 2013, the yield soared all the way up to crazy, insane, nosebleed levels. By that, I mean 3%. (Three whole percent!)

Here’s an interesting tidbit: The 10-year yield touched its generational low the same day Mario Draghi made his famous proclamation that he’ll do whatever it takes to preserve the euro—“believe me, it will be enough.” Four years later, there’s a couple trillion dollars’ worth of negative-yielding bonds floating around, and Draghi is now buying corporate bonds.

Let’s break down some math. The 10-year TIPs (inflation-protected bonds) yield a minuscule 0.15%. The regular 10-year yield closed Thursday at 1.564%. Compare that to the S&P 500, which has an indicated dividend yield of 2.18%, and that’s for the whole index. Remember that 85 stocks (or 17%) in the S&P 500 don’t even pay a dividend. Yet the financial markets are offering 60 basis points extra to take on stocks compared with bonds, and that ignores the big fact that stocks can raise their dividends. It’s right there in the name; fixed income is fixed.

The bottom line is that the market is asking you—begging you—to ignore bonds and lock in blue-chip stocks for the long term. There’s simply nowhere else to go.

I want to reiterate another point I’ve made a few times, that the market has shifted toward cyclical stocks. That means stocks like Transports, Industrial, Chemicals and Energy. Unfortunately, our Buy List is underweighted in those sectors, so we haven’t ridden the recent rally as much as I would have liked.

For the time being, we should expect interest rates to stay near 0%. This is the new normal. I’m not expecting things to go back to where they were. The larger question, and one that I’m not equipped to answer, is, “Have we reached the limit of what monetary policy can do for the economy?” The Fed is powerful, but there are things even beyond their control. Perhaps the U.S. economy needs deep structural changes that can be addressed with free money. Until then, we should need Mr. Franklin’s advice and be patient.

Microsoft Buys LinkedIn for $26.2 Billion

Microsoft (MSFT) shocked us this week by announcing that it’s buying LinkedIn (LNKD), the resume folks, for $26.2 billion. That works out to $196 per share for LNKD, which is a 50% premium. That sounds like a lot, but it’s still well below LinkedIn’s peak price of $276 per share.

This is a bold move for Microsoft. It’s their largest deal ever. The software giant actually had the chance to buy LinkedIn more than 10 years ago for $250 million. Critics point out that this is an expensive buy, and I have to agree, but I’m leaning towards liking this deal. Microsoft has been rightly criticized for a string of lousy deals, but those were done by Steve Ballmer, the former CEO. Satya Nadella, the current CEO, seems to have a more cautious approach.

The deal will have almost no impact on Microsoft’s earnings this year or next. After that, it should start giving a boost to MSFT’s bottom line. Microsoft said they intend to finance the deal with debt. Moody’s said that they’re going to review Microsoft’s AAA-rating. My response: Who cares if they lose their AAA rating? They’re sitting on $117 billion in cash and liquid assets (much of that is outside the U.S.)

This ties in to what I said earlier about bonds. I imagine there are lots of European investors who are getting nothing on their bonds that would love to load up on some newly minted Microsoft bonds. Mr. Nadella can do them the favor of borrowing their money on the cheap. Microsoft still has its gigantic $40 billion share-repurchase authorization that it’s planning to wrap up by the end of this year. In other words, Microsoft has no problems with cash flow.

Shares of Microsoft dropped to $49 after the deal was announced, but have since rallied back to $50.39. I’m going to give Nadella the benefit of the doubt here. Look for a good earnings report from Microsoft on July 19. The shares currently yield 2.86%.

Bed Bath & Beyond Earnings Preview

We’re in one of the quiet stretches for our Buy List earnings reports. There’s only one earnings report due for the month of June: Bed Bath & Beyond (BBBY). The company is scheduled to report its fiscal Q1 earnings on Wednesday, June 22.

Shares of BBBY have been very unpopular lately, and I think the selling is overdone. The last earnings report wasn’t so bad. Earnings came in near the top of expectations. Same-store sales adjusted for currency grew by 2.1%. That’s not bad at all.

A big problem for Bed Bath is that their margins are getting squeezed. That’s a tough headwind for any business. The company made $5.10 per share last year. They said they expect earnings to be near the high end of their range of $4.50 to $5 per share. That means the stock is going for less than 10 times this year’s earnings.

Wall Street expects Q1 earnings of 86 cents per share which is down from the 93 cents per share they made in last year’s Q1. Bed Bath also recently initiated a quarterly dividend of 12.5 cents per share. They also love to buy back enormous amounts of their own stock.

For all the talk of Bed Bath being stuffy and insular (which is fair), they struck back this week by announcing the purchase of One Kings Lane, an online retailer. One Kings Lane had been valued at nearly $1 billion. For a time, it was one of the hottest businesses around. They raised a ton of VC money, but weren’t able to get into the big leagues. Now Bed Bath has stepped in with an undisclosed offer. By all measures, BBBY is a cheap stock.

That’s all for now. We’re nearing the end of the first half of 2016. Next week, we’ll get reports on new and existing home sales, plus orders for durable goods. But the big event for world finance will be the Brexit vote on June 23 when Britain decides if it wants to remain in the EU. Polls show that it’s very close. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy