The Calm Before a Storm?

In the U.S., the University of Michigan/Thomson Reuters Consumer Confidence index increased to 85.1 in July, up from 84.1 in June (the highest level since 2007). In Japan, consumer prices rose in June for the first time in over one year. In Spain, its unemployment fell for the first time in two years in the second quarter to 26.3%, down from 27.2%. In China, its Ministry of Industry and Information Technology ordered over 1,400 companies to reduce production as it seeks to establish more sustainable (but slower) economic growth. In Egypt, as former President Mohamed Morsi was charged with espionage, his supporters and opponents clashed during various demonstrations throughout the country. In Tunisia, gunmen on motorcycles assassinated prominent political leader Mohamed Brahmi as his family watched. The event triggered nationwide outrage. 

In addition, as the S&P 500 has moved higher in recent months, equity volatility continued to decline – which can indicate investor confidence or complacency. Also, as August approaches, a month associated with significant travel and vacations, especially in Europe, it has also been a time when several financial crises have occurred including European exchange rates issues in 1993; a Russian debt default in 1998; initial signs of the global financial crisis in 2007 and Eurozone and American credit issues in 2011.

MY TAKE

• Regarding global dynamics – The global economic news flow remains mixed, with the U.S., Japan and Spain providing signs of improving trends; China challenges investors with signs of slowing growth and Egypt and Tunisia remind us that the increased political conflicts that started during the spring of 2011 still confront the region. Also, many investors are focusing on who will be the next U.S. Federal Reserve Chairman (expect an announcement in September) and how stimulus reduction will be managed.
• Regarding August and Volatility – as some investors begin their holiday travels and leave junior traders and money managers to monitor the markets, August may become more vulnerable to market shocks than other months of the year. Markets may move sideways or encounter a jolt of volatility during the next few weeks.

On the Bankruptcy of the City of Detroit

City Manager Kevyn Orr & Governor Rick Snyder

Last week, Detroit became the largest U.S. city to file for bankruptcy as it attempts to restructure over $18 billion of debt. Michigan Governor Rick Snyder said “the fiscal realities confronting Detroit have been ignored for too long”, Detroit City Manager Kevyn Orr said "we simply cannot kick the can down the road any further," Lee Saunders, president of the American Federation of State, County and Municipal Employees said “apparently Governor Snyder and Kevyn Orr want Detroit’s public service workers to rely on their children for food and shelter, or have to work until they die.”

Note: as Detroit’s population declined from about 2 million during the 1950 to about 700,000 today, its revenue base significantly declined. As a result, many city services are impaired with about 70% of its ambulances out of service and 60% of its streetlights not working.

MY TAKE
Detroit problems are likely worse than many other cities because of a decline in manufacturing, many businesses and residents moving to the suburbs, poor management and some corruption. However, with other U.S. communities confronting significant budget issues, there will be significant attention on how Detroit’s bankruptcy process affects employee pension and health care funds as well as its bondholders.

On a Mix of Corporate Earnings Results

As corporations continue to report second quarter earnings results, comments from firms delivering positive results included General Electric’s CEO Jeff Immelt - “we executed in a business environment that was slightly improved versus the first quarter. Emerging markets remain resilient, and in the U.S. we saw strong growth in orders this quarter. Europe is stabilizing but still challenged” and Honeywell’s CEO David Cote - “we remain focused on seed planting, funding cost savings initiatives across the portfolio, and remaining flexible given the continued uncertain global economic outlook”.

At the same time, technology firms that disappointed investors included Microsoft, its Chief Financial Officer Amy Hood said “we know we need to do better” after it had weak sales of Windows 8 and a $900-million write-off for its Surface tablet; Intel, it’s new CEO Brian Krzanich said "I've made it Intel's highest priority to create the best products for the fast growing ultra-mobile market segment" and Google missed expectations as its average cost-per-click for advertising dropped 6% from last year and 2% from last quarter.

MY TAKE
While revenue growth remains muted, many firms continue to cut costs as a way of delivering corporate earnings. Within the technology sector, some participants continue to encounter turbulence as desktop computer use declines and mobile devices become more pervasive.

As Washington D.C. changes the Investment and Finance Landscape

Last week U.S. Senators Elizabeth Warren, John McCain, Maria Cantwell and Anugus King introduced a banking bill being called “The 21st Century Glass-Steagall Act” which intends “to reduce risks to the financial system by limiting banks’ abilities to engage in certain risky activities and limiting conflicts of interest, to reinstate certain Glass-Steagall Act protections that were appealed by the Gramm-Leach-Bliley Act, and for other purposes.” (Note: Glass-Steagall was passed in 1933 to address banking problems that led to the Great Depression. In 1999, Gramm-Leach, which reversed Glass-Steagall, was passed in the U.S. Senate by a vote of 90 to 8).

In addition, Federal Reserve Chairman Ben Bernanke, while speaking at the National Bureau of Economic Research (Cambridge, MA) said that the central bank will likely continue to provide economic stimulus "for the foreseeable future” and “we need to be more accommodative".

Finally, the Securities and Exchange Commission announced that it will eliminate a ban on “general solicitation” and “general advertising” of private securities offerings that has been in place since the Securities Act of 1933 was passed. This change is part of the Jumpstart Our Business Startups Act (JOBS Act) and should become effective within 60 days.

MY TAKE

• Regarding the 21st Century Glass-Steagall Act – While Wall Street may be resistive to this bill and some cynics suggest a final version will be watered down with a provision citing “compliance with any or all of the above provisions is purely voluntary", a desire to break up the “too big to fall, too big to jail” banks is a view shared by many Americans on Main Street.
• Regarding Bernanke’s comments - Since late May, global markets have had many strong negative and positive moves triggered by suggestions of reduced stimulus. While his recent remarks reduce short-term concerns that the Fed will decrease stimulus in the short term, last week’s strong market move is another indication that the current era of investing is mostly a game of chasing central banker stimulus efforts, while positioning for their eventual withdrawal.
• Regarding the JOBS Act - Given the broad media coverage of investing and global market dynamics, lifting the advertising ban seems to make sense. At the same time, questions remain on how this and other potential changes by the S.E.C. will improve the dynamics crowd funding, which seeks to democratize the investment process by connecting individual investors with small start-up efforts.

On U.S. Jobs and Autos, European Weakness, Egyptian Conflicts, Wireless Changes and Bitcoin Investing

Last week, in the U.S., the Department of Labor reported the 195,000 jobs were created in June and revised its estimates for April and May upward as well; also, research firm Autodata Corp. reported that U.S. auto sales during June grew at the strongest rate in 5 years. In Europe, Mario Draghi, head of the European Central Bank (ECB) said “The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time", in order to address the continued economic weakness within its 17 member countries. In Portugal, reacting to austerity measures associated with its $101 billion financial bailout, the country's finance and foreign ministers resigned. In Egypt, clashes by supporters and opponents of the ousted President Mohamed Morsi contributed to a sharp upward move in the price of crude oil.

Also, the U.S. Federal Communications Commission approved the $21.6 billion purchase of wireless carrier Sprint Nextel by Japan’s SoftBank and South Korea’s Samsung Electronics expects weaker than expected profit and revenue results, suggesting a slowdown in the high-end smartphone market. In addition, Cameron and Tyler Winklevoss, the twins known for their legal battles with Facebook’s Mark Zuckerberg, filed with the Securities and Exchange Commission to start a fund investing in the alternative currency Bitcoin.

MY TAKE

• Regarding the U.S. economy – with the positive jobs growth and auto sales trend providing welcome news, the associated increase in interest rates will impact various sectors of the economy in different ways.
• Regarding the ECB and Portugal - these actions remind us that the financial crisis in the region is not over. Regarding Egypt – if conflicts continue, it is likely that heightened oil prices will persist.
• Regarding Softbank's acquisition of Sprint Nextel – this will likely lead to increased competition among wireless service providers in the U.S. market, which should be good news for many consumers.
• Regarding Samsung’s profit warning – this is another indication that the high-end smartphone market may be approaching saturation.
• Regarding the Winklevoss Twins and Bitcoin – with the twins owning about 1% of the Bitcoin market, creating this investment vehicle may make sense for them. For investors, it does not reduce the many risks associated with the Bitcoin market.