Stocks finished the week and the quarter on a high note. After this week’s presidential debate, House Financial Committee hammering of Wells Fargo CEO, and a stopgap spending bill averting a government shutdown, investors have lots of reason to be hopeful.
Perhaps the biggest announcement this week was the agreement by OPEC countries to cut oil production for the first time in eight years. The group has agreed to drop production to 32.5 million barrels per day which would be almost a million lower than that produced in August. This deal could not have been reached without an agreement between Saudi Arabia and Iran which is significant considering they back opposite sides in the Syrian conflict. While Russia attended the meeting, it is not an official party to the deal and its output hit a new post-Soviet record of 11.1 million barrels per day this month. Oil prices shot higher on the news.
The news that was plastered everywhere this week was the testimony of Wells Fargo CEO, John Stumpf, in front of the House Financial Services Committee. If you thought the Senate Banking Committee took it hard on Mr. Stumpf last week, you didn’t see what happened to him this week. Trying to get out ahead of the damage, its board announced Mr. Stumpf will forfeit unvested equity awards valued at $41 million and his salary while the investigation is ongoing. The bank added, he will not receive a 2016 bonus. While the bank will survive, its reputation has been tarnished. The state of California announced it will suspend business with Well Fargo, which is headquartered in the state. It is actively working with CALPERS and CALSTERS (two of the nation’s largest pension funds), which have a combined $2.3 billion invested in Wells Fargo, to pursue governance reforms.
It seems this week was all about banks. Deutsche Bank has been under pressure for some time, culminating in speculation of a collapse this week. It is one of the last banks to settle with the Department of Justice (DOJ) over the subprime mortgage scandal. Analysts believed the DOJ was looking to hit the bank with a $14B fine which is more than the bank’s working capital. Upon hearing the news, several prominent hedge funds proceeded to liquidate their accounts sparking a further selloff in the stock. It wasn’t until a rumor that Germany was working on a bailout plan that the stock slowed its decline. Since its peak just over a year ago, shares have fallen more than 65%, and the company has erased more than half of its market value, from nearly $50 billion to just $16 billion. It’s not a good time to be a bank.
The last bit of banking news has the potential to hit U.S. banks. In prepared remarks before the House Financial Services Committee, Janet Yellen says the financial condition of U.S. banks has strengthened, but the Fed is nevertheless mulling even larger capital requirements for the largest lenders. This new requirement is being called a “stress capital buffer.” These new rules are set to take effect next year and could raise capital requirements by 3 or 4 additional percentage points. Looking at the big picture, it seems the Fed isn’t at all confident that the “too-big-to-fail” banks pose less of a hazard than they did in 2008.
Since this week is all about banks, the story of the week regards cash. Specifically, the trend pushing cash to the verge of extinction in some countries. You’ve no doubt heard the phrase “cash is king” or “hold onto it” when the economy gets tough. But what if some day we look back on this phrase as an anachronism. In the Netherlands, cash has ceased to be recognized as legal tender. More and more Dutch stores take only credit or debit cards. In countries moving toward a cashless society, banks charge for making deposits. Therefore, small businesses, looking to cut expenses, have moved away from taking cash. Further making cash less desirable, some supermarkets have moved to make cash-only lines, which tend to have long waits. For now, this phenomenon appears to be isolated to Scandinavian countries, but it isn’t hard to imagine this catching on here for a whole host of reasons. It’s hard to say if the move away from cash is being orchestrated or simply an organic change, but some day in the not too distant future we might all wonder why “cash was king.” Now you know.
September 30, 2016
After weeks of waiting, IT finally happened. By IT, I mean NOTHING. The Federal Reserve announced this week it has once again kicked the can down the road by not raising interest rates now. To be fair, the market pegged the probability of a rate hike around twenty percent, but it is becoming increasingly difficult to know what the Fed is thinking. One thing is clear, the Fed has bought the markets a few more months of breathing room to get past the presidential election and its potential fallout. The next FOMC meeting will occur December 13, 2016.
For more detail on the Federal Reserve’s decision, Janet Yellen summed it up by basically saying, in a jumble of doublespeak, what’s the rush? She was clear to point out that the decision doesn’t reflect a lack of confidence in the economy. Saying otherwise might have sent the market down. Instead, she points to a lack of inflation which has become more important now that full employment has been achieved. Some would argue the low price of oil and gas has artificially lowered the rate of inflation, after all, we know the cost of food and healthcare is certainly going up. It is the reverse argument of when gas prices were soaring at the pump and the Fed was telling us there was no inflation. The problem for analysts and investors is that the Fed keeps moving the goalpost on what it would take to tighten policy. This shouldn’t be underestimated and creates a credibility problem for the Fed.
Several weeks ago the European Union (EU) went after Apple for what it considers tax evasion. This week we learned McDonalds may face a similar charge. The company’s arrangement of setting its headquarters in Luxembourg is under investigation as part of a broad probe into state tax avoidance schemes by multinationals. As Europe’s economies continue to weaken, it should come as no surprise that the EU sees multinationals as a means to balance its budgets. Not to be outdone, Indonesia plans to pursue Google for five years of back taxes, including $400 million for 2015 alone if it is found to have avoided tax payments. I imagine there will be more of these cases in the year ahead as countries look to find ways of shoring up their economies. In an ironic twist, multinationals may find it cheaper keeping their cash here rather than abroad.
In company news, Federal Express (FDX) has been on quite a run this year. It announced earnings this week, beating analysts’ expectations. On the downside, the company announced it plans on raising its shipping rates effective January 2, including an average increase of 3.9% for U.S. domestic and 4.9% for its freight services. Earlier this month, rival UPS announced a 4.9% rate increase. No inflation right? In light of the recent Wells Fargo debacle, it should be noted that nothing has been heard from Warren Buffet whose company, Berkshire Hathaway, owns approximately 10% of Wells Fargo and is its largest shareholder. How one walks away from a 10% position in a company as large as Wells Fargo is unclear, which could account for his complete silence on the matter. Time will tell what he will do.
For the story of the week, I turn to the Ig Nobel awards. The awards are given annually for the rather-less-noble-than-the Nobel awards for “improbable” research and accomplishments. This year the awards were given for rat pants, fly catchers and rocks with personalities. The honorees include a man who lived as a goat, a man who lived as a badger, a man who put tiny pants on rats and a team who investigated the personalities of rocks. Most of the awards were rather silly. There was the Perception Prize, for Japanese researchers who investigated “whether things look different when you bend over and view them between your legs.” For the Psychology Prize, researchers explored how liars lie over a lifetime – based on the liars’ descriptions of their own lie frequency. And the Economics Prize was given to marketing theorists who explored how people perceive rocks, you know, personality-wise. To learn more about this year’s recipients, click here. Now you know.
September 23, 2016
For the second week in a row, volatility remained moderately high. Investors are anxious to learn what the Federal Reserve will announce next week after the FOMC meeting. While expectations remain low that it’ll raise interest rates, the probability has increased in recent weeks. In light of this, we are all in a holding pattern until it makes its announcement this coming Wednesday. If it does decide to raise rates unexpectedly, be prepared to hold on. The ride will get a little bumpy. More likely, Chairwoman Janet Yellen will telegraph that a rate hike is coming before the end of the year, preparing markets for the inevitable.
Everywhere I turned this week, I ran into another story about debt. With yields so low, it shouldn’t come as a surprise that some “creative” investments are coming back. For example, some European companies are issuing payment-in-kind (PIK) bonds. Instead of paying interest, issuers pay interest with additional debt instead of cash. In another story, it appears corporate leverage is soaring with debt issuance having topped $1 trillion or roughly 2.4 times their collective earnings. The leverage ratio has been on a particularly steep rise over the past five quarters as debt moves higher alongside declining earnings. In 2010, the ratio stood at 1.7 times earnings. And lastly, junk bond defaults are accelerating (mostly in the energy sector). August’s dip in defaults looks like a temporary blip in trend as $3.8 billion in defaults have already been announced this month. One analyst at Fitch’s rating agency believes energy defaults could come to 16-18% by year-end and that’s assuming oil doesn’t decline from these levels.
In other news, the third largest U.S. bank, Wells Fargo, seems to be up to its old tricks. It boasts of its cross-selling, reporting its customers hold an average of 6.27 products per household. The banks “Eight is Great” motto refers to its goal of how many products per household it would like to hit. This led to one former employee saying, “I’d have seniors come in with their kids and say, ‘Why does my mom have five checking accounts?’” The answer is because some banker needed the credit to make his or her quota for the month. While Wells Fargo has been caught, it is an industry wide practice and tightly tied to the incentive structure and culture of these banks. Executives at Wells Fargo are being called to testify in both the House and Senate regarding these fraudulent practices. Adding insult to injury, Ms. Carrie Tolstedt, who ran the community banking division during the entire time these abuses took place is retiring at year’s end with a $124.6 million payday. Some things never change.
As for company news, I have to admit I was a little surprised to find out Starbucks has plans to sell tea in Asia. It announced plans to expand Teavana with more than 6,200 stores across the Asia Pacific region following its entry into China last week. I suppose if the company can manage to sell espresso to Italians, perhaps it might just sell tea to China. General Motors revealed figures on its new Chevy Bolt electric car and it is clear its focus is on beating Tesla. The new Bolt will be rated at 238 miles on a single charge when it comes to showrooms later this year, giving it a longer range than the Tesla 3 which isn’t expected to go on sale until 2017. While Tesla gets most of the media attention, rest assured the other manufacturers aren’t sitting by idly.
For the story of the week, I turn to Wal-Mart. I’ve talked about autonomous cars and most recently autonomous cargo ships, but today I bring you the autonomous shopping cart. Wal-Mart received patent approval for the design of a unique self-driving cart with sensors and video cameras. The company says it will help improve the customer experience, specifically when employees are busy. I’m sure there’s no alternative agenda, i.e. hiring fewer employees right? And it should be noted that just because they received a patent on this idea, doesn’t necessarily mean we’ll see it anytime soon. The day of the cart wrangler in the parking lot may be coming to an end. Now you know.
September 16, 2016
Rate hike fears hit stocks today as the market closed the week to the downside. The S&P 500 had its first 1% move in two months, with the index currently lower by 2.13%. Rate hike fears make for a good excuse, but conditions couldn’t remain so tightly range-bound forever. As predicted, volatility is due to increase the closer we get to the next Federal Reserve meeting on September 21st and again in the run-up to the presidential election.
This week the European Central Bank passed the $1 trillion Euro mark with its controversial quantitative easing program. The volume of purchases is putting pressure on policymakers to address the scarcity of available assets, including government bonds. Despite being well beyond halfway to the $1.7 trillion Euro program, inflation remains virtually non-existent at 0.2% through August. Adding to, or perhaps demonstrating, the malaise is the fact that Eurozone growth has yet to show any signs of life. Eurozone GDP growth came in at just 0.3% for the second quarter, according to Eurostat which is below the 0.5% achieved in the first quarter. Setting aside the Brexit vote, Europe is facing some difficult challenges.
Among the challenges are the number of European countries that now have negative yields on their bonds. Jeffrey Gundlach, CEO of DoubleLine Capital, describes a bleak picture where almost 25% of global GDP is governed by central banks with negative interest rates. Global government bonds with negative yields now top $14.6 trillion. Some even suggest negative-yielding junk bonds are coming to Europe. How do investors justify paying to lend to junk-rated companies as fundamentals are deteriorating? It’s a question worth pondering.
As for the United States, the economic backdrop remains modestly good with pockets of strength. The Beige Book showed modest gains continued through August. Most districts reported a “modest” or “moderate” pace of overall growth. Kansas City and New York reported no change of activity and Philadelphia and Richmond say activity has slowed. Labor market conditions remain tight, with an increase in wage pressure, while retails sales are declining broadly in line with a reduction in consumer spending. With the latest round of economic data, economists are now increasing the probability of an interest rate hike in September. To a large extent, this is what riled the markets today and could continue to do so in the weeks ahead as a rate hike is priced into the market.
In company news, Apple had its much-anticipated event this week during which it revealed the new iPhone 7 and Watch Series 2. The company decided to forgo the traditional headphone jack, instead choosing to push its lightening connector. It made modest improvements to its camera and designed a new and faster chip to power the phone. Whether these incremental changes will be enough will remain to be seen. In other news, after more than sixteen years, Priceline is no longer letting travelers name their own price for airline tickets. The CEO attributes this change to the consolidation in the airline industry.
To close out this week, I have a rather unusual property I’d like to share with you. Some of you may be familiar with Longaberger, an Ohio company that makes expensive wicker baskets. The company may be most known for its unusual headquarters built in the shape of a basket. According to The Columbus Dispatch, the building’s design came about after months of wrangling with architects who apparently weren’t seeing Dave Longaberger’s vision. The story goes, Mr. Longaberger stormed out of the meeting, grabbed one of the company’s medium-sized baskets, came back in and put it on the conference room table saying, “Make it look exactly like that.” They took his passion to heart and built an office shaped like a basket. The company has fallen on difficult times and put its headquarters up for sale eighteen months ago. It can be yours for only $5 million. Now you know.
September 9, 2016