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Markets are showing very little volatility as traders grapple for direction. Stocks opened higher with good reports from the Wall Street brokers, then dipped the line and hovered near breakeven as we approached the lunch hour. Treasury bonds and notes are dead flat with a small bid in the 30-year bond and the dollar is modestly lower versus all major currencies except the Canadian dollar, which is higher by 7.5% against the dollar since late May. Overall the markets are still trying to sort-out the near-term impacts of the destruction on the Gulf Coast, with a keen focus on energy supply and the impact higher energy costs will have on Fed policy and interest rates. The headlines in the news are not good for stocks, but the bears are still not getting their way….only frustration so far. Here’s a quick snapshot of the early headlines from CBS MarketWatch: U.S.
stocks lower of drop in crude inventories Bankruptcy
fears pressure the airline sector U.S.
August retail sales sink 2.1%, more than expected Lehman
profit surprises with 74% rise Retail sales clearly took a hit in August as consumers retrench to find more money to spend or credit to borrow. Even with retail sales showing their biggest decline in nearly four years, we still have no savings in the USA. Our savings rate has in fact gone to negative 0.6%, as consumers are forced to borrow since wage growth has not kept up with inflation, especially relative to housing and energy costs. The retail sales decline would have been worse without a gain of 4.4% for gasoline, and overall I believe we are in the early stages of curtailed consumption in the United States as paychecks go from hand to mouth without the buffer of savings. Market analysts on CNBC are busy finding all the “good stuff” in the retail sales figures as they split hairs on the headline number versus the core numbers ex-autos and gasoline. The hurricane was cause for some of the weakness at the end of the month, but let’s face it…how many more widgets and superfluous gadgets do we need from China? I expect retail sales to decline further. They will need to do something to make sure consumption remains strong through the Holiday Season. As Retail Sales wane in the U.S., let’s have a look at the developments in Japan and China. On Monday Bloomberg ran the headline, “Japan’s Economy Grew Three Times Faster Than Expected.” Following the unexpected growth report out of Japan we got August Retail Sales figures from China yesterday. Chinese Retail Sales rose 12.5% year over year in August versus growth of 12.7% the previous month as Chinese incomes rise. China also reported foreign direct investment fell 3% since the beginning of this year. I believe money is coming out of China and other nations as U.S. corporations take advantage of tax incentives to repatriate funds back to our shores. More on that as time permits. Another headline came from the Federal Reserve as they reported August industrial output rose 0.1% after consensus expectations called for a gain of 0.3%. The final week of August was negatively affected by shutdowns of oil and gas production in the Gulf. Economists are expecting a much bigger drop in the September numbers with a rebound coming in October and November. All we can do for now is monitor the situation in the Gulf for energy imports/production and export shipments (especially the grain products at harvest) from the operations in the Port of New Orleans. Today the Energy Department announced a much bigger than expected draw in crude inventories of 6.6 million barrels, while expectations called for a draw of only two million barrels. Analysts expected the lack of refining capacity to moderate the drop in crude inventory, but not so! Distillate inventories were expected to come in flat, but instead declined by 1.1 million barrels. As I write, crude is up $1.09 to $64.20, unleaded gas is slightly higher to 1.90 a barrel, heating oil for December is higher by 4.5 cents to $1.956, and natural gas for December is 14 cents higher to $12.01/Mbtu’s. At the beginning of 2002 natural gas cost just over $2.00 per million btu’s and crude oil cost $19.00 a barrel!!! Three years later we have natural gas FIVE TIMES more expensive with crude and distillate products more than THREE TIMES higher. Discretionary spending is on the ropes…the consumer is getting tapped-out! So What’s Going On?? With the damages from Katrina, a hawkish Fed that wants to raise interest rates, higher energy costs, and the consumer tightening the purse-strings, the Dow should be somewhere around 9,000…but it’s not! The dollar and bond prices should be lower, but likewise they are not! There are massive amounts of liquidity flying through the markets looking for a home…for the most part in “paper assets,” because that’s how our paper fiat money game is played. We have piles and piles of paper stacked on top of more paper. Based on a Bloomberg article today, the Fed is now concerned the piles of paper are not being managed properly from an operational standpoint. Bill Murphy regularly refers to the Fed’s concern as the “Derivatives Neutron Bomb” and Warren Buffet refers to the massive derivatives pyramid as “Financial Weapons of Mass Destruction!” It looks like the Fed wants to make sure the big banks have a plan in the event we have big credit defaults similar to the crash of Long-Term Capital Management back in 1998. Here’s a few excerpts from the Bloomberg article: Fed Calls in Bankers for Failure to Erase Backlog of Derivatives Paperwork Sept. 13 (Bloomberg) -- The Federal Reserve Bank of New York called in representatives from 14 of the world's largest banks because a failure to erase a backlog of paperwork in the $8.4 trillion market for credit derivatives concerns regulators. The meeting, announced by the Fed on Aug. 24, will be at the central bank's New York office on Sept. 15. It will bring bank representatives and risk managers together with U.S. and European regulators to discuss ``market practices,'' New York Fed spokesman Peter Bakstansky said in an interview. Banks and securities firms are struggling to keep up with administration as the credit derivatives market grows. They risk being overwhelmed by investors seeking settlement of contracts if there is a corporate default… The global credit-derivatives market more than doubled last year, mostly on demand for credit-default swaps, according to the International Swaps and Derivatives Association, or ISDA. The credit derivatives market wasn't even tracked until 1997. The New York Fed brought together 14 banks and securities firms in 1998 to orchestrate the rescue of LTCM to avert a mass sell-off in financial markets. Banks and securities firms had loaned the collapsed hedge fund about $120 billion to make its bets. The Fed says they don’t need to regulate hedge funds and over-the-counter derivatives, but it sure looks like they have some concerns to voice with the big-boys that hold all the piles of paper. New York Fed President Timothy Geithner warned in a speech to the Securities Industry Association’s national conference in New York in November 2004 of risks to the global financial system from the use of derivatives by hedge funds. The price of credit default swaps jumped as much as 35% in May after Standard and Poor’s reduced GM and Ford debt from investment grade to junk status. The Fed remembers the bailout of LTCM and knows it can happen again with about 8,000 hedge funds out there….time for contingency plans! American Jobs Creation Act of 2004 Earlier I said the dollar, stocks and bonds should all be lower, but they’re not! WHY?? In a nutshell, the Jobs Creation Act of 2004 gives U.S. corporations a tax break on repatriated earnings from foreign subsidiaries. Normally the money that comes home to the parent U.S. corporations is taxed at 35%, but on October 22, 2004 the legislation was passed reducing the tax to 5% until Oct. 22, 2005. In my research I found that though the legislation was signed into law, there was no guidance from the government until early this year. It is estimated that as much as $400 billion could come back into U.S. dollars…some already has, but based on the late guidance, the money was “back-loaded” to come in right about NOW…and there could be a rush in October to take advantage of the enormous corporate subsidy the Federal government has offered. When the foreign currencies are sold, dollars are bought to bring the money home. The money coming in is expected to lower interest rates by moving into bonds, and could add as much as 5% to 6% to the S&P500 stock index. It looks like the Bill was presented in 2003 as the “JOBS” Act, meaning “Jumpstart Our Business Strength Act of 2003." I don’t believe the legislation was passed in 2003, but later morphed into the American Jobs Creation Act of 2004. I cite the prior legislation because I found a great report from Decision Economics as to the economic impact of the repatriated funds. Here is an excerpt of the analysis with a link to the full article: Macroeconomic
Effects of a Temporary Reduction in the Tax Rate The Jumpstart Our Business Strength (JOBS) Act (S. 1637), as reported on October 2, 2003 by the Senate Committee on Finance, provides for a temporary one-year reduction in the tax rate on above average repatriated earnings of U.S. foreign subsidiaries, to 5.25% versus the current 35%. The purpose is to provide stimulus to business spending and the U.S. economy through increased outlays on capital goods, more business-to-business purchases, improved cash flow, strengthened corporate balance sheets, and higher employment. Based on surveys of U.S. multinational companies performed by Price Waterhouse Coopers, LLC and J.P. Morgan Securities, estimates based on the surveys, and analyses of how the unrepatriated funds have been, and are being, used abroad, anywhere from $265 billion to $406 billion of repatriated funds could occur, relatively quickly, after passage of the Act. Using a lower end of the range estimate of $300 billion of repatriated funds, an estimate of J.P. Morgan Securities, and assuming an effective date of January 1, 2004, simulations were performed with a large-scale quarterly macroeconometric model of the U.S., the Sinai-Boston (SB) Model, to estimate approximate effects of the JOBS Act. (Note: the estimates are now between $300 to $500 billion.) Please click on the link if you want to see the detailed breakdown for the estimated effects of the of the repatriated funds. I realize this WrapUp is getting a bit long, but please bear with me. It is important to see what this legislation was really all about and what it can do for third quarter profits! The following snippets from an article on tude.com gives you some of the flavor of the legislation that was pawned-off as a Jobs Creation Act: THE "AMERICAN JOBS CREATION ACT OF 2004" DOES CREATE JOBS. OVERSEAS. You'd think with a name like that, it would be a bill for creating jobs in America, wouldn't you? Instead, it's cover for corporate pork and subsidies for off-shore jobs. This bill, created in the House a couple of years ago, includes $43 billion for off-shore subsidies, as well as enough pork to provision every luau in the world for decades. It passed the Senate on October 11th as a bipartisan rip-off (no gridlock here, folks). President Bush signed it into law on Friday. And now there's even more corporate pork, pork that has little to do with trade and jobs, but everything to do with campaign contributions and the selfish interests of your Congressmen. "Among the biggest winners was General Electric Co., which stands to save as much as $8 billion over 10 years on its foreign operations. "Before they were finished, lawmakers went far beyond the original game plan, adding scores of special tax breaks for makers of bows and arrows, operators of NASCAR race tracks and importers of ceiling fans, among others. One of the biggest was a $10-billion buyout of the holders of coveted tobacco quotas ... nearly 500 individuals, companies or estates will get more than $1 million. And this from the Wall Street Journal: "A key to the bill is its elastic definition of manufacturing. In recent weeks, as the bill moved through Congress in an election year, the term was stretched to accommodate a range of interests. 'I think you'll find that manufacturing grew a little bit beyond what Webster said,' Sen. Grassley observed dryly over the weekend.” "One tax-committee staffer put it more cynically: ' Everybody with a Republican lobbyist is a manufacturer.'” "Under the bill, farmers, oil producers and software producers are deemed manufacturers. So are architects and civil engineers who do work in the U.S. for U.S. construction projects. Construction counts as manufacturing, too, as long as it involves "substantial renovation," not "mere cosmetic changes such as painting," according to the House-Senate conference committee's 600-page explanation of the 650-page bill. Among the beneficiaries of those provisions are giant Bechtel Corp. and Halliburton Co.” "Making, renting and licensing movies constitutes manufacturing, too -- as long as the movies don't show 'actual sexually explicit conduct.' Though the Senate initially sought to exclude newspapers and other media that are 'primarily topical or transitory in nature,' the final bill deems them to be manufacturers as well.’” I did some more digging for information to see if I could find any actual results from companies that have already repatriated funds. I found this little nugget on what the legislation can do for a company’s bottom line: For the quarter, the electricity and natural-gas company's earnings rose to $49 million, or 24 cents a share, from $9 million, or 5 cents a share, a year earlier. Ongoing earnings for the quarter were 20 cents a share, compared with 22 cents a share a year ago. Ongoing earnings measure operating financial performance, unaffected by discontinued operations, asset sales or other items Analysts polled by Thomson First Call had called for fourth-quarter earnings, excluding items, of 18 cents a share. The results for the latest quarter included a benefit of $21 million, or 12 cents a share, from a planned repatriation of $80 million from the company's foreign units and lower deferred taxes due to tax provisions from the American Jobs Creation Act. CMS Energy surprised the Street with earnings of 24 cents when they were expecting 18 cents per share. The company bumped their bottom line by 30% with the repatriation of a measly $80 million. How many billions do you suppose our big oil conglomerates can bring home. They have had RECORD PROFITS, and now get their taxes cut from 35% to 5% for all their offshore business. As the article above emphasizes, even Haliburton is considered a manufacturer!! They got uncontested contracts to rebuild parts of Iraq, and can now bring home the profits nearly tax-free! From yet another article I found a quote from Senator John McCain, (R-AZ) who did not vote on the bill. Senator McCain called the legislation, “the worst example of the influence of the special interests I have ever seen.” We are getting ready to close the books on the third quarter in just a couple weeks. Based on the bumper earnings for CMS Energy, I have to assume the BIG, BIG multinational conglomerates could bring in some surprise numbers when earnings come out in October. A few of the corporations that will benefit the most are listed in the articles above, but use your imagination to think what Exxon, or Coca-Cola, or Gillette, or Haliburton, or GE could do with some short-term accounting games. As most of you know I am quite bullish on gold and silver, and I’ve been gathering long positions in Swiss francs and yen. These positions are highly sensitive to changes in dollar strength/weakness. We are entering the seasonal period where gold and silver usually perform well and many market players are looking for $500 gold by the end of the year. The bull will try to shake everyone off before the big move higher, so remember you have to hold on for the full eight seconds if you want to hear the whistle blow! Today cash gold could not break through the $450 level and cash silver tried five times to crack the $6.99 level, but met selling each and every time. More on the metals next week….in the meantime…much patience is required! Late addition: Gold could not take out the spot $450 level and silver could not get above $6.99 during the New York session, but when trading opened in Australia, gold took-off and now stands at above the $450 mark with spot silver at $7.03. Let’s see what tomorrow brings! I presented the info on the American Jobs Creation Act because it could well come into play as we approach the end date of October 22 for the big tax breaks and corporate-pork subsidies. If Alan Greenspan maintains the façade of being hawkish on inflation at the next meeting in six days and we get a last minute wave of dollar buying due to repatriated funds, we could see a surprise dollar rally. Longer-term the dollar must be devalued. That is why we are putting so much pressure on China to revalue the yuan. We MUST devalue the dollar….it’s just the timing that can be a bit tricky, especially with China’s lack of cooperation!! Does the Fed loosen-up to help the economy, or remain on a measured pace to defend the dollar? I still say the Fed will do what it has always done…inflate, inflate, and inflate some more, as they meet with banks behind closed doors just in case we get some ugly credit defaults. Based on all the red I see on my screens today, the multinationals better get with the program and bring those dollars home. I call these “Hat-Trick” days when we see stocks, bonds and the dollar all down in the same day…and to add injury, energy prices took-off even higher as the day wore on. Maybe the repatriated funds will only help to offset the hundreds of billions of dollars lost on the Gulf Coast. By far the best investment I have made in the last five years is the pile of silver bullion I own…that is a true investment (along with a few stocks), while I really enjoy trading futures to exploit the markets for profit!! It’s marvelous to see both sides of the market as we watch the bears and bulls in the perpetual tug-o-war of the financial markets!! Have a Great Evening! Mike Hartman
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