Dear Fellow Shareholders,

Jamie Dimon’s latest letter to shareholders has an interesting section on “how the table is set” for the next financial crisis (“Where do you want me?” asks future rogue criminal).  First, some good news: “We will enter the next crisis with a banking system that is stronger than it has ever been.”  Harder! Better! Faster! Stron–“There is a greatly reduced supply of Treasuries to go around — in effect, there may be a shortage of all forms of good collateral…It is unlikely that we would want to accept new deposits the next time around because they would be considered non-operating deposits (short term in nature) and would require valuable capital under [new regulations]…Non-bank competitors are increasingly beginning to do basic lending in consumer, small business and middle market…it is my belief that in a crisis environment, non-bank lenders will not continue rolling over loans or extending new credit except at exorbitant prices that take advantage of the crisis situation.”  K.  Speaking of nonbanks, “many big banks have retreated from the repo market following the adoption of costly new regulations…This opens up a potential new revenue opportunity for nonbank brokers and others who aren’t subject to the same regulations.”  And the good taxpayers of Kentucky aren’t (directly) subject to the same regulations: “Stephen Jones, who oversees about $4 billion of state money at the Commonwealth of Kentucky, said he completed his first direct repo trade in January, without using a large, bank-owned broker-dealer.  The state is lending $123 million this month to a REIT called Invesco Mortgage Capital Inc., up from $50 million earlier.”

 

Basically Nobody Knows The Difference Between A Bubble And A Bull Unless We’re Talking China

“The question of whether or not we are in a tech bubble has been raised regularly for years now…it’s easy to look at numbers, whether that be valuations, revenue multiples, or simple counting stats, but any analysis is incomplete without understanding markets.  In 1999 most consumer markets were simply not ready, whether it be for lack of broadband, logistics build-out, etc…Today, by contrast, many of the most valuable unicorns are consumer-focused companies like Uber or Airbnb.  Moreover, these companies are competing not with other tech companies but rather with entirely new (to tech) industries like transportation or hospitality.”  “Optimism in the face of growing uncertainty is hard to sustain.  That seems to be the crux of the problem facing the market.  The current situation — very optimistic implied earnings growth and deteriorating economic uncertainty — is a temporary condition…If the market’s pricing of earnings growth drops to the long-term realized growth mean of 7%, the S&P 500 would drop 11% to 1850.”  Meanwhile, Dan McCrum has dropped the mic on China.

 

USA: FAA Appears To Be Giving The OK On Drones For Insurance Companies

 

USA: “Could A Computer Do My Job?” Is A Decent Question To Be Asking Yourself

 

Oil: Is Volatile

Wealth Management: Robo-Advisers, Cautious Investors And Survivorship

Robo-advisers, or “algorithmic investment services,” are becoming more popular these days.  Here are some things to consider: “It seems possible that an algorithm could determine a person’s financial ability to take risks, but an algorithm is assuredly less effective than a human practitioner in determining a client’s emotional ability to take on those same risks…Although they do not currently present an obvious competitive threat for traditional advisers, they soon may, as individuals from Generation X and Millennials come to make up the majority of advisory clients.”  Meanwhile, here’s an interesting survey of investors from STA Wealth Management: “When asked what is most important to them the survey showed that, by a wide margin, the majority are more focused on loss avoidance rather than chasing stock market returns.  That mentality is reflected in their asset allocation models with the roughly on 44% [sic] invested in stocks and 48% in bonds and cash…The loss of capital, due to both declines and inflation, combined with the loss of ‘available time’ to save for retirement has crippled investor psychology on many levels.  The problem is that investors today have ‘seen this film’ before and are fairly confident in how it ends.”  Also, take a second to notice that only 2% of these investors said they receive financial advice from watching television.  Meanwhile, the current tech/momentum selloff is different from the 2001 tech meltdown in at least one way (alt): “A Wall Street Journal analysis of 148 U.S. tech companies with recent or pending initial public offerings found none on a path to burn through their cash within a year, based on their pace of spending in 2013.”  Also, here’s something to watch out for when considering a fund’s historical performance: survivorship bias.  Generally speaking, when historical returns for a category of funds are calculated, “funds which have shut down are thrown out of the tally.  Since the failures take a lot of bad performance with them to the grave, category averages look better than the returns investors experienced in the real world.”  Therefore, actively-managed funds will overstate performance relative to their low-turnover, more diversified passive brethren, thanks to active funds’ lower rate of survival.

Global Trade Update

“The US, EU and others have framed the Information Technology Agreement (ITA) negotiations as a test case for China as it seeks to join much larger US-led discussions to set new global rules for the $4.6tn annual trade in services (alt)…Talks to update the ITA with 256 additional tariff-free product categories ranging from flat screen TVs to next-generation semiconductors broke down last November after China, which is now the world’s largest exporter of IT goods, sought to maintain its tariffs on more than 100 of those products.”  Meanwhile, “US steel imports surged 25.7 per cent in the first quarter (alt), fueling concerns that it is foreign producers, rather than American manufacturers, that are reaping the benefits of the shale gas revolution…The oil and gas boom is increasing the size of the market for steel tubes used in drilling, pipelines and processing plants, and reducing the cost of energy used in steelmaking…However, these companies are facing growing competition from imports… ’American producers are increasingly losing sales to foreign competitors like Korea because OCTG (Oil Country Tubular Goods) imports are being dumped into the US market.’”  Also, “to promote manufacturing services such as logistics, marketing, information and technology and research and development, China will encourage more financing and relax market access to the sector, the cabinet said after its weekly meeting.”

EU: ECB Readies Package Of Rate Cuts And Targeted Measures

“The ECB’s deposit rate already stands at zero and a cut into negative territory would see it essentially charge banks for holding their money overnight – a move that could spur more lending, though analysts are unsure how banks would react…’This will be the first major central bank to move to a negative deposit rate.  That would move the exchange rate.’…Should it decide to cut rates, the ECB is looking at also deploying either a targeted long-term loan operation, or LTRO, or else announcing a purchasing programme to buy asset-backed securities (ABS) comprised of bundled SME loans…The idea behind this second option is to build the market in Europe for SME loans bundled as ABS, with a view to making it larger and more liquid to aid the flow of credit to the smaller firms that form the backbone of the euro zone economy.”

USA: Someone Is Front-Running The Fed

Researchers have found “robust evidence of informed trading during lockup periods ahead of the Federal Open Market Committee (FOMC) monetary policy announcements…Across the four markets that we examine, estimates of informed traders’ aggregate dollar profits during lockups ahead of all FOMC’s surprise announcements range between $14 and $256 million…we find no evidence of informed trading ahead of nonfarm payroll, CPI, and GDP data releases by other government agencies.”

USA: In Shift, Regulator Says Fannie And Freddie Should Stay In Housing Market

“Watt said that the government’s takeover of the companies should not be viewed as a ‘permanent condition or a desirable end state.’  But to arbitrarily reduce the companies’ share of the market without having an alternative plan in place would be ‘irresponsible.’”

Head Scratching And Diverging Correlations

“This is small caps’ 36th peak-to-trough decline of at least 10% since 2000, with an average decline of 17.1% (the current decline sits at about 10%).  Of the first thirty-five corrections, every one of them was accompanied by large-caps also falling, until now (an average decline of 12.8%).  The thing that has people scratching their heads is why large-caps have been blessed with impunity while small-caps have begun to roll over.”  Meanwhile, the recent stock market jitters have Reuters saying “Buy in May”:  “looking back at the four ‘sell in May’ corrections since 2010, all have been triggered by sudden scares about a U.S. growth slowdown.  Once these growth panics subsided, the corrections sharply reversed.  The big difference this year is that a U.S. growth scare has already happened, and all leading indicators suggest accelerating activity in the next few months…The once-in-a-generation divergence suggests that this could be an ideal time to rebalance portfolios by buying equities and selling bonds — the opposite strategy that has worked every May since 2010.”  Meanwhile, tech and momentum stocks are cheaper, but not cheap: “Money managers say it is no mystery what has been at work.  These stocks rose to stratospheric prices compared with their earnings outlooks, driven by so-called momentum traders such as hedge funds that pile into rising shares.  But these firms were equally quick to hit the sell button…’The challenge these stocks are going to face is who is the buyer here that steps in now that the bloom is off the rose.’”  Meanwhile, divergence shouldn’t necessarily surprise us: some things just aren’t meant to correlate.

China’s New Normal

“China’s new bank lending and total social financing weakened in April, but money supply growth picked up slightly, indicating the central bank is treading cautiously in steering policy to support the slowing economy…Central bank governor Zhou Xiaochuan was reported as saying on Saturday that China will not use any large-scale stimulus to boost its economy, in response to speculation that authorities might lower reserve requirements for banks to spur growth.”  Meanwhile, “President Xi Jinping said the nation needs to adapt to a ‘new normal’ in the pace of economic growth and remain ‘cool-minded’ amid a slowdown that analysts forecast will lead to the weakest expansion since 1990.”  Also, “almost half of the economists surveyed by Bloomberg News last month predicted a cut in the reserve requirement ratio this year as part of an easing of monetary policy to support the economy.  Expectations for a reduction have increased after a government report last week showed consumer inflation moderated to an 18-month low in April and factory-gate prices fell for a 26th month.”  Meanwhile, here’s a word you don’t often hear used to describe China: deleveraging.  “even as the state sector continues to leverage up…non-state entities saw the ratio falling…If we treat the debt of SOEs and local government guaranteed corporates just as government debt, China’s situation is, to some degree, similar to the post-Lehman US: rising public debt, declining private sector leverage.  Particularly, the state sector as a whole generates sub-par economic return.  Loss-making industrial SOEs account for more than a quarter of total industrial SOEs, double the ratio among non-state industrial enterprises.  Granting credit to profitless corporates is not too much different from having quantitative-easing liquidity trapped in the commercial banks’ vault.”  Also, this patriot isn’t buying the fifth season of America’s Decline: Chinese Edition.

USA: Pension Funds Wrestle With What To Do With Cash From Private Equity

“U.S. pension funds face a dilemma that might be considered a nice problem to have: record amounts of capital flowing back from private-equity investments…all that cash coming back from private-equity investments is upsetting the careful balance of investments that pension funds must maintain to achieve steady returns over decades to pay thousands of retirees.”  

USA: America On The Move Becomes Stay-Home Nation For Young

Americans are moving around less than they used to: “In the year ended March 2013, just 20.2 percent of those aged 25 to 34 relocated, the lowest rate for that age group in data going back to 1947, down from 31 percent in 1965, Frey said.  While the decline in mobility is more pronounced among the young, older Americans, too, have become less inclined to pull up stakes.  Among all Americans, 11.7 percent moved in 2012-13, just above the 11.6 percent all-time low reached two years earlier…a combination of relatively low-paying opportunities, the burden of student loans and an aversion to taking risks explains the reluctance to relocate.”

Quality Over Quantity: Unhappy Interns Living At Home And The Next America

The problem with the current economic recovery isn’t quantity.  It’s quality: “Lower-wage industries accounted for 22 percent of job losses during the recession, but 44 percent of employment growth over the past four years…Higher-wage industries accounted for 41 percent of job losses, but 30 percent of recent employment growth.’  Lower-paid industries like food services, restaurants, temp help, and retail trade accounted for 39 percent of job gains over the last four years.”  Meanwhile, “at a time when the still sluggish economy has sent a flood of jobless young adults back home, older people are quietly moving in with their parents at twice the rate of their younger counterparts.  For seven years through 2012, the number of Californians aged 50 to 64 who live in their parents’ homes swelled 67.6%…Among 18-to 29-year-olds, 1.6 million Californians have taken up residence in their childhood bedrooms…that’s a 33% jump from 2006, the pace is half of the 50 to 64 age group.”  Furthermore, a recent Gallup survey indicates the average age of retirement is 62 and has been steadily increasing since 2010.  Also, “according to a recent Gallup survey of 5.4 million working adults, 52% say they are not engaged in their work…Another 18% describe themselves as ‘actively disengaged’ — disgruntled and spreading bitterness among co-workers.  With the exception of recession periods, the majority of employees start each new year vowing to look for a new job.”  Meanwhile, “in recent years, internships remain as prevalent as ever — but their ability to confer a real career has faded along with the economy.”  Furthermore, “Millennials would rather take an internship with the hopes of scaling the ladder at an existing business rather than risk being shut out of their desired field or venturing out on their own,” and “many of the Millennials taking internship after internship can only do so thanks to their parents’ resources.”  Finally, here is a look at the Next America: “Demographic transformations are dramas in slow motion.  America is in the midst of two right now.  Our population is becoming majority non-white at the same time a record share is going gray.”  (Do yourself a favor and click on the link.  The website is beautiful and their research is extremely coherent.)

Fama And French And The Shift Back Into Value, Profitability And Investment

“Fama and French are famous for their three-factor model, which uses market, value, and size characteristics to explain stock returns…After more than 20 years, Fama and French have embraced the notion that size and value may not be the best factors to explain stock returns.  Their new paper, the first draft of which was released in June 2013, finds that two additional factors — profitability and investment — make redundant the value factor.  In other words, value stocks — defined as those with low price/book — only beat growth stocks because they historically tended to be more profitable and less voracious users of capital.”  Meanwhile, JC Parets believes“we are now witnessing the shift back into Value and out of Growth.”  Also, the selloff in tech stocks continues, and that’s a good thing:  “hot money is becoming downright respectable (or at least is trying to).  Markets are going through a rebalancing, with money leaving the high-flying stocks with stretched valuations and finding a home in shares of companies with higher dividends and more reasonable price-earnings ratios.  This is something to embrace, not reject.”

USA: Mortgage-Loan Limits Hit Buyers In High-Cost Housing Markets

“Until 2008, there was one national loan limit for the entire U.S.  But when the housing crisis erupted and private lending retreated for larger ‘jumbo’ mortgages, which exceed the conforming limits, Congress raised the limits in certain counties where homes were more expensive…The logic of loan limits is to prevent two quasi-government agencies (Fannie and Freddie) from subsidizing the purchase of luxury homes.  But in some areas of the country, there’s nothing cheap to buy.”  For example, in San Francisco, “a majority of homes — 61% — is above the local loan limit of $625,500,” which is already “50% higher than the $417,000 maximum in most of the rest of the country.”  Meanwhile, here’s a really fun depiction of urban development through Google street view.

USA: Infrastructure: Broken System (Alt)

“Unless it begins to spend more, the US risks squandering the global lead it gained in the 1950s and 1960s, when it invested in big projects such as the Eisenhower Interstate Highway System.”  Here’s the problem: States receive funding for vital transportation and infrastructure projects through the Federal Highway Trust Fund.  The Highway Trust fund relies on a gasoline tax for revenue.  “No politician has dared raise the federal gas tax since 1993.  That decision has conspired with declining fuel sales to bring the Highway Trust Fund close to exhaustion.  The US transportation department estimates the fund could run out as soon as August.”

TOY: Toyota Moving US Base From California To Texas

“Toyota delivered a surprise pink slip to California on Monday, announcing the company would move its U.S. headquarters and about 3,000 jobs from the Los Angeles suburbs to the outskirts of Dallas.”

China: Reuters’ China Tea Leaf Index

Einhorn Cries Bubble, Apple Splits 7-1

David Einhorn of Greenlight Capital says “we are witnessing our second tech bubble in 15 years,” and “what is uncertain is how much further the bubble can expand, and what might pop it.’  He described the current bubble as ‘an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm.’”  Einhorn gives 3 reasons for his bubble call: 1) “the rejection of ‘conventional valuation methods,’” 2) “short sellers being forced to cover positions,” and 3) “big first-day pops for newly minted public companies that ‘have done little more than use the right buzzwords and attract the right venture capital.’”  Even though he isn’t “predicting a complete repeat of the collapse [of the first Tech bubble ~ 2001], history illustrates that there is enough potential downside in [momentum “Cool Kid” stocks] to justify the risk of shorting them.”  And, oh yeah, “the last time the internet bubble burst in the early 2000s, Cisco Systems dropped 89% and Amazon.com Inc. fell 93%.”  Speaking of which, “Amazon raised the stakes in its battle with Netflix (alt) for supremacy in online video streaming by striking a deal with HBO to gain access to some of the most popular shows from the pay-TV channel’s library.”  Meanwhile, “Apple Inc. raised eyebrows Wednesday afternoon by announcing a 7-for-1 stock split along with its (positive) second-quarter earnings…At Wednesday’s closing price of $524.75, the split would price shares at $74.96.”  Here’s something to consider: Apple stock priced at ~$75 as opposed to ~$500 makes it eligible for inclusion in the Dow.  Not only that, but “It makes the stock more attractive to the smaller buyers…It’s better priced and more people will buy it.”  Furthermore, stock splits can sometimes create “a shift in ownership toward less sophisticated individual investors…This creates more liquidity in the stock.”  Which is kind of an argument for market inefficiency?  Meanwhile, here are 5 things to know about Alibaba’s IPO.  And finally, MIT’s 10 most significant breakthroughs in technology over the past year.  

GM Recall Also Looks Bubbly

“General Motors recorded its worst quarter (alt) since returning to public listing in 2010 after the costs of its botched ignition switch recall slashed first-quarter net income to $100m.  The results — down 89 per cent in the same period in 2013 — were hit by a $1.3bn charge for the costs of car recalls, mainly related to the ignition switches on a series of older compact cars.”  Meanwhile, “General Motors’ liability for defective ignition switches in its cars is complicated by its bankruptcy in 2009.”  Furthermore, “it seems that the bankruptcy case will probably mean that G.M. has no legal obligation to pay a good chunk of these claims.  Whether it faces political pressure to pay nonetheless is another story.”  Meanwhile, while everyone talks about Mary Barra getting thrown under the bus, I can’t help but notice the warm water and suds everywhere.

Liquidity Drops, ECB Plays “Fantasy” QE

“The amount of spare cash in the euro zone banking system fell to its lowest levels in 2-½ years on Thursday, pushing up short-term money market rates and adding impetus for the ECB to loosen policy further…The last time liquidity fell so low it nudged the ECB to introduce its Long-Term Refinancing Operation, a series of emergency loans to banks…The euro zone overnight bank-to-bank lending rate, settled around 0.22 percent, up about 2 basis points from the previous day but still below the rate of 0.25 percent which the ECB charges banks to borrow cash, known as the refinancing rate.”  This adds fuel to the “QE in Europe” debate; the Financial Times thinks that an ECB asset-purchase program would be ineffective in boosting investor confidence (alt), and that “the ECB is trying to talk the euro lower by playing fantasy QE.”  The more probable scenario for monetary easing could come from sterilization of the ECB’s Securities Market Programme.

Housing-Led Recovery?

Goldman Sachs would like you to know that mortgage-lending standards are choking a housing recovery.  That being said, we may want to temper our expectations for a housing-led recovery in the United States.  While growth in housing prices has been pretty strong over the last two years, the number of people borrowing cash against their home (cash-out refinancing) has been very little, and indicates there is “very little spending out of housing wealth currently.”  Also, “home builders have not been responding to rising home values nearly as aggressively as they did prior to the Great Recession.”

Fed: Forward Guidance: A Pattern Of Always Expecting Higher Interest Rates In Two Years

Global: Home Is Where The Money Is

TerrificHeadlines: Icahn Looking To Launch An Army Of Mini-Icahns

Online Credit Growing; Loan Loss Reserves And Re-Fi Shrinking

“Manually collecting and analysing the information needed to understand whether a business can remain solvent is a costly activity.  That usually makes it uneconomic to lend the small amounts of cash that small businesses need — and explains why many proprietors opt to meet short-term cash needs with their credit cards.”  But several “online credit” startups are changing the landscape (alt): “the ability to pull in accounting data automatically from a borrower’s own books, for instance, has been made easier by the fact that much of that information now resides in cloud services.  Most lenders also draw on other pools of data — from government census surveys to user reviews on online sites such as Yelp — to build their risk models and gather a full picture of a business’s prospects.”  Furthermore, “crunching the data with algorithms, rather than human analysts, has further reduced overheads.”  Meanwhile, JP Morgan didn’t come up with as many cookies as hoped for in Q1: “Ahead of the bank’s earnings report, analysts at KBW had said they expected a reserve release in the first quarter of $1 billion at J.P. Morgan, compared with what it said was management guidance for a release of $400 million.  That could foreshadow a trend that rivals reporting over the next few days could also demonstrate.  Analysts widely expect banks to start building their provisions for potential losses as they start to make more loans.”  Keep this in mind, however: “earnings are viewed by many investors as more repeatable and indicative of a strong financial picture when they don’t’ include big loan-loss reserves.”  Meanwhile, should we put a nail in the coffin of the re-finance boom?  Wells Fargo, “the country’s biggest mortgage lender,” lent “$36 billion worth of mortgages in the first quarter — a big number until you consider that it’s down 67% from a year ago, when the bank originated some $109 billion worth of mortgages.”  Finally, it doesn’t take a Wonkblog to figure out that Jamie Dimon is making the big bucks (then again, maybe it does).

Nasdaq Does The Tax Day Sway; Outlook Bright For Tech, E-Commerce And Trailer Parks

The markets are pretty volatile right now (alt) in case you didn’t notice.  Yesterday, the Nasdaq dropped 3.10 percent, “its worst daily decline since 2011.”  It appears to be a one part Tech, one part Momentum selloff, with a dash of Tax Day sway.  Demand is strong, however, for a good stock market story.  Like this one: “soon there will be more than 6 devices leaking information connected for every man, woman and child on the planet.”  That comes from a Citigroup analysis of the future for cloud computing/IT companies like Cisco.  By 2020, they predict 6.58 small, thinking robots per human.  Here’s the kicker: ~14% growth in online retail sales over the next 3 years.  Meanwhile, you won’t believe this hot new investment “vehicle”!!!  “Trailer parks have unusual economics…It’s a supply and demand curve that’s super attractive to investors…What’s at work here is the shrinking middle class.  People with bad credit and criminal histories are often unable to rent or buy homes, and are forced into trailer parks — where owners are usually willing to overlook credit and criminal activity.”

Trading In The Dark Makes Throwing Darts Only Slightly Worse

This isn’t what Michael Lewis had in mind: “U.S. securities regulators are considering testing a proposed reform that could drive business to major stock exchanges and away from alternative trading venues such as “dark pools” that critics say may be hurting investors by reducing the quality of pricing…They say that the amount of trading being done in the “dark” means that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is, meaning that investors may not be getting the best prices for their trades.”  Also, SEC Chairwoman Mary Jo White says “high-frequency traders have added liquidity and some price advantages” to the markets.  But its not all bad for Michael Lewis: “If we are setting our agenda by Michael Lewis books, we have to take them as we see them.”  Meanwhile, Fidelity and BlackRock are leading other asset management companies (alt) by “discussing the creation of a joint equity trading venue…that would rival traditional stock exchanges and so-called “dark pools” of liquidity.”

EU: “We Will Do Something” About Low Inflation

Zis is ‘ow you do Forward Guidánce!

China: The Optimist’s Take On Credit In China

USA: Activist Investor Of The Year

That’s an actual proxy statement filed with the SEC by Joseph Stilwell, a shareholder in Harvard Illinois Bancorp, Inc.  Scroll down for the gold.