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Authored by Nicholas Colas via DataTrekResearch.com,

“The one fact pertaining to all conditions is that they will change.” 
– Charles Dow

We start with that quote because today’s note is about the Dow Jones Industrial Average and, of course, about change. The easy bit first: GE is leaving the Dow after being there for 111 years – longer than any other company. The company replacing it, Walgreens Boots Alliance, is all of 4 years old in its current form. At a closing price of $65, it will have roughly 5x more influence on the Dow than GE with its $13 price.

Why Walgreens and not Amazon or Google? Ironically, it is because Charles Dow’s namesake market measurement didn’t anticipate change. Specifically, he never envisioned a world where individual stock returns would be so asymmetric that one group (Tech) would see share prices rise to hundreds of dollars while the rest of the market saw share prices remain around $50. So he made his index price-weighted…

Big mistake, that, because since Google and Amazon trade for $1,168 – $1,735 they will never see the inside of the Dow. Remember that the Dow’s largest weighting is Boeing, with a $340 share price and a 9.8% weighting. Google and/or Amazon would swamp the Average.

Moreover, with the rise of indexing, companies have less pressure to split their stocks so that’s probably not going to happen with Google or Amazon. Not only is single-stock investing less popular, but also exchange traded/passive funds actually like high priced stocks since US trading commissions are paid per share. Fewer shares for the same trade size equates to lower costs.

Of course the other reason the Dow was in the news today was its 13th trip to the unchanged line on the year.

That’s notably worse than the S&P 500, which is still up 3.3% on the year. We pulled the data on what stocks have represented this tug of war in 2018. Here’s the data:

• 3M (down 15.3% YTD) is responsible for the biggest hit to the Dow in 2018, at 224 points. This is 28% of the Average’s underperformance versus the S&P 500. Worth noting: 3M is one of the most international companies in the Dow, with just 39% of revenues coming from domestic sources.

• The next 3 losers for the year represent 389 points of headwind, or 49% of the Dow’s slippage to the S&P 500. They are Goldman Sachs (down 10.4% YTD, 174 points), Johnson & Johnson (down 12.3%, 112 points) and Caterpillar (down 9.1% YTD, 103 points).

• The remaining quarter (23% really) of the Dow’s underperformance to the S&P comes from Proctor & Gamble (down 16.9%, 98 points) and Walmart (down 15.3%, 97 points).

So what does this Dow math lesson tell us about equity market sentiment as we come up on the half-year mark? Three observations:

#1. Home is where the heart and stock market returns are. We mentioned that 3M generates just 39% of its revenues from the US. The numbers for: JNJ (48% non-US revenues), CAT (54% non US), and PG (55% non-US sales). As for Walmart, although its revenues are still 73% US-based, much of what it sells is obviously made elsewhere.

In fact, you can draw a YTD stock price performance line from the zero-return Dow’s heavy non-US exposure to the S&P 500 (39% non-US) at +3.3% to the much more domestic Russell 2000, up 10.3%.

#2. Trade war concerns are one explanation, and certainly a good one for the Dow’s flat-line in 2018 but the S&P 500’s performance needs a few words of explanation. The Tech sector here has both the highest international revenue exposure (58%) in the index and the best performance (+11.7%). Why?

By virtue of China’s home grown tech giants (Tencent, Alibaba, Baidu) and the US’s own leaders (AAPL, GOOG, FB, etc), there is little overlap between the two countries and that’s proving to be a powerful positive for US large cap Tech stocks. Yes, Apple has China exposure but Facebook and Google are both banned. And, of course, Apple’s largest manufacturing partner is China, which helps.

#3. There seems little doubt that the trade-war-of-words between the US and China will only get worse but we take some comfort in Charles Dow’s quote. Things will change, and eventually for the better. But for now, big cap Tech is (and will remain) a popular parking lot for equity capital.

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Remember when David Rosenberg flipped from bear to bull, claiming that inflation – especially for wages – had finally arrived back in 2012 (spoiler: it hadn’t)? That odd phase lasted a few years, but the former Merrill strategist is once again back to his bearish self. Permabearish that is, because in a presentation to Canada’s Inside ETFs conference in Montreal, Rosenberg echoed Morgan Stanley’s Michael Wilson in stating that January was the “peak of the bull market”, and that the next recession will start in 12 months.

“Cycles die, and you know how they die?” Rosenberg said, quoted by Bloomberg. “Because the Fed puts a bullet in its forehead.”

Rosenberg’s bearish case is familiar to those who follow him: the market is in a classic late cycle, wages are rising thanks to full employment,  while commodities are cooling amid potential trade wars. What happens next? “The result will be higher inflation”, he said, which is odd because the last time Rosie saw higher inflation it made him bullish.

In addition to timing the next recession – a decision which promptly led to some jeers among the fintwit echo chamber – Rosenberg also admitted that any bullish phase he may have had in the past was really just a simple oversight:

“We are seeing a significant shift in the markets. The Fed was responsible for 1,000 rally points this cycle so we have to pay attention to what happens when the movie runs backwards.“

(Some of us still recall that Rosie made no mention of the Fed’s contribution to the S&P during abovementioned bullish phase).

In any case, the biggest catalyst for Rosenberg’s current bearish phase is his repeating of what Albert Edwards said two weeks ago, namely that if one takes into account the Shadow Fed Funds rate, the Fed has already tightening 500bps:

The Shadow Fed Funds rate hit negative 3% in mid-2014, but more importantly that a pronounced tightening cycle actually started through 2015, and by the end of that year the Shadow rate had converged back with the effective nominal Fed Funds rate (see charts below).

… although the six Fed Funds rate hikes since Dec 2015 amount to a total of 170 basis points (bp) of tightening, one can argue that if we add the 300bp (Shadow) rate hike to the current Fed Funds rate of 1.70%, the degree of monetary tightening in the current cycle stands at 470bp.

One can add another 25bps to the above numbers after the latest rate hike by the Fed. Edwards’ conclusion:

“it is therefore reasonable to argue that the US has already faced a “normal” tightening cycle and any additional rate hikes are taking us into territory not seen in recent times. This already may be enough for the Fed to have broken something.”

Fast forward to today when Rosenberg effectively carbon copied what Edwards said:

If the Fed raises rates and shrinks the balance sheet as much as it says it will, the cumulative de facto tightening by the end of 2019 will have totaled 525 basis points.

If you don’t think this is enough to cause a recession, take note that the Fed tightened 425 bps from 2004 to 2006, by 350 basis points prior to the 2000 downturn, and by nearly 400 basis points in the lead up to the 1990 pullback

If you don’t think this is enough to cause a recession, take note that the Fed tightened 425 bps from 2004 to 2006, by 350 basis points prior to the 2000 downturn, and by nearly 400 basis points in the lead up to the 1990 pullback. <2/2>

— David Rosenberg (@EconguyRosie) June 21, 2018

He’s right, but what he forgets is that the second stocks drop by the maximum permitted 20%, the Fed will immediately halt the tightening cycle, and proceed with rate cuts, NIRP, QE4 and so on, because in the current, final phase of the global asset ponzi, even a small loss of control means the entire financial system gets it.

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Authored by Duane Norman via Free Market Shooter blog,

In a recent segment on Fox News, Tucker Carlson took the FAA to task for putting “diversity over safety” in its hiring practices:

Starting in 2014 the FAA added a biographical questionnaire to the application process. Applicants with a lower aptitude in science got preference over applicants who had scored excellent in science. Applicants who had been unemployed for the previous three years got more points than licensed pilots got. In other words, the FAA actively searched for unqualified air traffic controllers. That is insane and they knew it was insane when they did it but they did it anyway.

Today we obtained new information, it is an internal email written by an executive at the firm that devised the FAA’s biographical questionnaire. In that email, the executive admits that the test he devised has nothing to do with finding the best air traffic controllers. If you want good air traffic controllers, find people with experience, that was his advice. The FAA ignored this and used the biographical screen anyway. They didn’t care about finding the best air traffic controllers. Compared to diversity, your safety meant nothing to them.

Most of the segment consisted of an interview with former ATC Michael Pearson, who detailed his lawsuit against the FAA…

…but the segment itself didn’t offer any external confirmation beyond Carlson’s word.  Unsurprisingly, Carlson was correct – the FAA’s own website clearly says so…

The FAA has made an historic commitment to transform the agency into a more diverse and inclusive workplace that reflects, understands, and relates to the diverse customers we serve. To meet this goal and satisfy the requirements of the Equal Employment Opportunity Commission MD-715, the Administrator tasked the Office of the Assistant Administrator for Civil Rights to conduct barrier analyses of the Air Traffic Control Specialist (ATCS) Centralized Hiring Process, Aviation Safety Inspectors, and Airway Transportation Systems Specialists.

The first study, completed in 2013, is on the ATCS series. These reports reflect a collaborative effort undertaken by the FAA’s Office of Civil Rights, Office of Human Resources, and the Air Traffic Organization. The primary purpose of these reports is to identify and analyze potential barriers to equal employment opportunities within the ATCS Centralized Hiring Process and to offer solutions to establish the foundation for improving the process.

A second study was conducted in 2015 and addressed potential barriers and solutions in the hiring process for aviation safety inspectors.

…and three years ago, The Wall Street Journal blew the horn on how the FAA itself stated that its affirmative action process, the “biographical questionnaire” (BQ), not only was inferior to the existing AT-SAT exam, the agency disqualified prior experience in its hiring criteria:

“The FAA says it created the BQ to promote diversity among its workforce,” reported Adam Shapiro of Fox Business. “All air traffic control applicants are required to take it. Those who pass are deemed eligible and those who fail are ruled ineligible.”

The FAA would not tell Fox Business what the biographical test is trying to measure and did not return my phone calls. But an FAA report released in October, “Using Biodata to Select Air Traffic Controllers,” concluded that the AT-SAT exam, not the biographical questionnaire, is a much better predictor of performance. “The biodata items assessed did little to improve our ability to select applicants most likely” to complete training successfully, said the study. “If biodata are to be used to select controllers, additional research is required to identify those biodata items that will add to the prediction of controller training performance over and above the effect of AT-SAT score.”

After the FAA changed its screening process in 2014, thousands of applicants who were already in the pipeline—people who had obtained an FAA-accredited degree, taken the AT-SAT exam and had been designated “well-qualified” to become air-traffic controllers—were told by the government that they would have to start the process again. “But this time, when they applied for a job, their college degrees and previous military experience would mean nothing,” reported Fox Business. “They would now compete with thousands of people the agency calls ‘off the street hires’; anyone who wants to, can walk in off the street without any previous training and apply for an air traffic control job.”

Any affirmative action program that involves experience being meaningless to the hiring process will seldom end well…

…but one would think one of the last places that would disqualify college and military experience in the name of “diversity” would be an air traffic control center.

If and when an incident occurs, undoubtedly the blame will shift away from policies that led to unqualified hires, and land squarely on whatever command the incident occured under.  This is precisely what happened in the case of Minneapolis police officer Mohamed Noor, as Free Market Shooter has already covered:

So the facts support a different conclusion; this was clearly an affirmative action hire, which resulted in a poorly-trained and unqualified officer winding up on the force.  You might be stunned, but you should hardly be surprised to learn that Hodges quickly changed her tune about Noor following the incident…

At a press conference to respond to Saturday’s fatal officer-involved shooting in southwest Minneapolis’ Fulton neighborhood, Mayor Betsy Hodges said she was “heartsick and deeply disturbed” by the incident that left a woman dead.

…but that didn’t stop her from blaming the incident on the policies of her police chief and forcing her out.  Notably, the chief might have gotten her own job as a result of Hodges’ “commitment to diversity” on the police force:

The chief’s departure came at the request of Mayor Betsy Hodges, who promptly nominated Assistant Chief Medaria Arradondo, a 28-year veteran of the force, to replace Harteau. The move ended Harteau’s 4½-year run as the first woman and first openly gay person to head the department.

Additionally, when Free Market Shooter asked if the US Navy crashes in 2017 were a result of “hacks”, some questioned whether or not affirmative action played a role in allowing unqualified seamen to operate Navy vessels:

Could it be that simple complacency and/or lack of proper training has resulted in these incidents? Given the professionalism of our military, that seems unlikely, but it wouldn’t be the first (and almost certainly won’t be the last) time it has happened.

It has to be noted that many of the crashed vessels had been on extended deployments, with crews that were undoubtedly overworked – conditions that could make an incident all but inevitable.  The Navy itself blamed “a lack of adherence to sound navigational practices” and “complacency, over-confidence and lack of procedural compliance” for the incidents.  But, given the Obama administration’s conduct with the FAA, affirmative action leading to poor seamanship and command of Navy vessels cannot be ruled out.

Whether it is policing streets, operating Navy vessels, or managing the nation’s air traffic, the standards for employees with top-tier responsibilities needs to be impeccably high – poor hires cannot be permitted to “slip through” the cracks.  While it seems unlikely that this has occurred in the US Navy, police forces have clearly relaxed and “fast-tracked” hiring in an effort to onboard more “minority” candidates, highlighted by the aforementioned case of Mohamed Noor.  If the Obama administration has relaxed hiring standards in the nation’s air traffic control system, something must be done to confirm the wrong individuals aren’t on the job…

…before it’s too late.

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With the US and China now actively engaged in several rounds of tit-for-tat tariffs and retaliations, it is easy to lose track of a) where we currently are in the escalating trade standoff and b) what has actually been implemented.

As a handy guide, Goldman reminds us that in the latest overture by the US on June 18, the White House announced that it would impose 10% tariffs on an additional $400 billion of products from China if intellectual property policies and related issues are not addressed or if China retaliates; China vowed to retaliated immediately.

Put in context, this would potentially involve tariffs on two successive rounds of $200 billion each. And since previously, President Trump had previously proposed a 25% tariff on a second round of $100bn in imports from China, this latest proposal amounts to a net $300bn increase in products affected.

If implemented this would raise the total amount of tariffs the Trump administration has proposed from around $500bn to nearly $800bn, or about 4 times the cumulative amount that had been proposed as of a month ago, before President Trump proposed tariffs on global auto imports on national security grounds.

All of this is summarized in the chart below, which perhaps more importantly also shows that up until now, the amount of US imports actually subject to implemented tariffs is virtually negligible compared to what has been proposed. However, that may change very soon as the first round of the trade war with China takes effect on July 6.

As a first bonus chart, Goldman shows how the first rounds of 25% tariffs would compare with hypothetical later rounds. It finds that in the first round of $34bn in imports, imports from China account for only 8% of total imports in the affected categories, and 23% of imports from low-cost countries. In subsequent rounds, these shares rise, and if the White House moved forward with the proposed tariffs on an additional $200bn in imports, imports from China would account for more than half of total imports from low-cost countries, leaving little room for substitution from other US trading partners.

Finally, here is Goldman’s estimation of the potential composition of the next group of $200bn in imports that the White House might impose tariffs on. It is meant to reflect the basics of the USTR process, which aims tariffs at import categories where China represents a small share, ideally less than 1/3 of total imports.

Columns 1 and 2 show US imports from China in each category of goods on which USTR has already proposed to apply a 25% tariff. The third and fourth columns, under “Potential Retaliation,” show value for each category we estimate as most likely to be subject to a 10% tariff should the US choose to impose tariffs on an additional $200bn of goods. In our view, the US is likely to respond first with tariffs on remaining goods that are relatively easy to substitute (column 3). A low share of imports from China (column 5), a higher share from low-wage countries excluding China (column 6), and a lower share of goods from high-wage countries (column 7) would suggest relatively easy substitutability and thus a higher likelihood of being subject to tariff in the next round.

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Authored by Tsvetana Paraskova via OilPrice.com,

The fastest-growing oil producing region in the United States, the Permian, is nearing the limits of its pipeline takeaway capacity and some producers may be forced to shut in wells within months, according to the chairman of one of the biggest U.S. shale producers, Pioneer Natural Resources.

“We will reach capacity in the next 3 to 4 months,” Pioneer’s chairman Scott Sheffield told Bloomberg in an interview on the sidelines of an OPEC conference in Vienna, which is attended by representatives of some U.S. oil companies.

“Some companies will have to shut in production, some companies will move rigs away, and some companies will be able to continue growing because they have firm transportation,” Sheffield told Bloomberg, commenting on the Permian constraints that threaten to slow down the relentless pace of production growth.

Oil production in the Permian is rising by 800,000 bpd annually, with current production at 3.3 million bpd, Sheffield said, adding that total pipeline capacity is 3.6 million bpd, so producers – especially those that don’t have firm deals for pipeline transportation – will be bumping into the limit of takeaway capacity in the next three to four months.

The Permian oil production in June is expected to reach 3.277 million bpd, and projected to rise by 73,000 bpd in one month to reach 3.350 million bpd in July, according to EIA’s latest Drilling Productivity Report.

A lot of new pipelines are being planned and approved, but none of them are expected to come online before the second half of 2019 – possibly leaving production stranded.

The Permian pipeline bottleneck is unlikely to ease for at least one year, Sheffield told Bloomberg, noting that this constraint will continue to affect U.S. oil prices, with WTI at Midland, in the heart of the Permian, likely to trade at a huge $25 discount to the WTI priced at Cushing, Oklahoma.

With Permian production booming and pipeline capacity tightening, producers are forced to sell their crude at a painful discount to benchmarks, and they have also recently lost billions of U.S. dollars in market capitalization. 

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The Supreme Court just overturned a 1992 ruling (which had limited online tax collections), thus freeing states and local governments to start collecting billions of dollars in sales taxes from internet retailers that don’t currently charge tax to their customers.

Siding with states and traditional brick-and-mortar retailers on a 5-4 vote, Bloomberg reports that the court overturned a 1992 ruling that had made much of the internet a tax-free zone. That decision had shielded retailers from tax-collection duties if they didn’t have a physical presence in a state.

This follows last year’s string of successes, when retailers helped to kill a levy on imported goods and saw their federal taxes slashed with a national overhaul.

The full implications are not clear for now but leveling the playing field with brick-and-mortar and sent internet retail stocks tumbling…

Wayfair, Amazon.com, Overstock, Etsy, Shopify, Blue Apron among Internet retailers falling on news.

And that is hitting Nasdaq…

 

Finally, we note that this decision comes less than 24 hours after Goldman Sachs told their clients to go overweight tech stocks…

Internet retail analysts are rushing to explain away this decision as a nothing-burger, noting that the retail brick-and-mortar survivors have one fewer excuse to blame for their woes.

“They have, in some ways, been hiding behind excuses like a tax differential,” said Edward Yruma, an analyst for KeyBanc Capital Markets. Their complaints have resonated less in recent years as shoppers’ migration online has been more rooted in convenience than price, he said. “What’s driving the success of online players is this is how the consumer wants to shop today,” Yruma said. “It’s that simple.”

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With Israeli Prime Minister Benjamin Netanyahu already under close legal scrutiny for his role in the Bezeq-Walla Affair, on Thursday his wife was also indicted on Thursday over allegations that she misused state funds.

Sara Netanyahu stands accused of ordering hundreds of meals using government funds to the prime minister’s residence totaling over $100,000. At the same time she deceptively claimed the residence had no cook, even though there was a cook employed on the state’s dime, presumably in order to keep the expensive outside ordered meals coming and to avoid exposure. 

What’s now being called the “Prepared Food Affair” exploded in Israeli media the moment Attorney-General Avichai Mandelblit issued the indictment. Though reporters first learned of the impending charges two weeks ago, all attempts at plea bargaining failed and resulted in the formal charges. 

Sara Netanyahu’s lawyers reportedly exhausted every avenue to avoid her being slapped with a criminal record, even offering for her to give public apology while returning some of the fraudulently obtained funds, according to the Jerusalem Post.

The indictment has added immense pressure and further scrutiny upon the legally embattled prime minister, who could face an indictment related to bribery charges in the Bezeq-Walla case sometime within the next year. Though PM Netanyahu is not expected to resign over his wife’s fraud case, a similar scandal in the 1970’s involving Leah Rabin, wife of then-prime minister Yitzhak Rabin, forced Rabin’s resignation from office during his first term (1974–77). 

Notably, a key witnesses in the prime minister’s bribery scandal, a former close adviser to the Netanyahu family named Nir Hefetz, is also a key witness against Sara.

The Jerusalem Post summarizes the details of the indictment as follows:

In the Prepared Food Affair, the prosecution alleges that from September 2010 until March 2013, Sara Netanyahu acted in coordination with then-Prime Minister’s Office deputy director-general Ezra Seidoff falsely claiming that the Prime Minister’s Residence did not employ a cook, even though it did during that time.

According to the allegations, the two made the false claim to circumvent and exploit regulations that stated, “in a case where a cook is not employed in the official residence, it is permitted to order prepared food as needed.” The two hoped to obtain state funding both for the cook at the residence and for prepared food orders. In this way, the two allegedly fraudulently obtained from the state NIS 359,000 in hundreds of prepared food orders.

More than merely ordering expensive food, paperwork was deliberately falsified to line the pockets of residence staff with state funds:

Furthermore, in 15 instances, invoices to chefs who were brought in from outside were falsified in order to circumvent limits on how much could be paid toward outside-chefs. Seidoff directed the chefs, the house managers and Netanyahus’ secretaries to falsify the invoices in these 15 instances.

Netanyahu’s defense has been to claim she was not directly involved to the point of being unaware of the forged paperwork and food orders, blaming the Prime Minister’s Residence managers. The charges stem from food orders and invoices going all the way back to 2010, soon after PM Netanyahu first assumed office. 

One residence manager at the heart of the affair, Meni Naftali, has already admitted to criminal wrongdoing in the episode. The defense will try to build a case that it was Naftali and other staff that mishandled the orders and falsified paperwork of their own volition and not under supervision of Netanyahu. 

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Something’s different today…

Instead of the ubiquitous panic-bid open (after overnight weakness), that is not happening today…

 

And VIX is running notably back above 14.00…

 

 

 

 

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