Author: ColinTwiggs

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The Fed Sends A Frightening Letter To JPM | Zero Hedge

From Pam Martens and Russ Martens via WallStreetOnParade.com:

Yesterday the Federal Reserve released a 19-page letter that it and the FDIC had issued to Jamie Dimon, the Chairman and CEO of JPMorgan Chase, on April 12 as a result of its failure to present a credible plan for winding itself down if the bank failed……

At the top of page 11, the Federal regulators reveal that they have “identified a deficiency” in JPMorgan’s wind-down plan which if not properly addressed could “pose serious adverse effects to the financial stability of the United States.”

How could one bank, even one as big and global as JPMorgan Chase, bring down the whole financial stability of the United States? Because, as the U.S. Treasury’s Office of Financial Research (OFR) has explained in detail and plotted in pictures (see below), five big banks in the U.S. have high contagion risk to each other….

….Equally disturbing, the most dangerous area of derivatives, the credit derivatives that blew up AIG and necessitated a $185 billion taxpayer bailout, remain predominately over the counter. According to the latest OCC report, only 16.8 percent of credit derivatives are being centrally cleared. At JPMorgan Chase, more than 80 percent of its credit derivatives are still over-the-counter.

Contagion and derivatives exposure….. two facets of the same problem. To me the question is: why are too-big-to-fail banks allowed to carry such high derivative exposure? Wells fargo (WFC) seems to be the only big bank who is not swimming naked.

Source: The Fed Sends A Frightening Letter To JPMorgan, Corporate Media Yawns | Zero Hedge

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Land tax is needed but won’t happen | Macrobusiness

Taxes

By Leith van Onselen. Reproduced with kind permission from Macrobusiness.

The Australian’s Adam Creighton has written a ripper post explaining why, in the wake of tax avoidance scandals (e.g. multinational and the Panama Papers), a broad-based land tax is needed more than ever, but will never see the light of day due to vested interests and weak politicians:

Windfall gains to private land owners stemming from developments outside their control are a far better object for taxation than income and consumption, which prop up vast avoidance industries…

Taxes on land are unique economically because they can’t be avoided and they don’t distort supply…

In fact, over time land tax (which should apply only to the unimproved part) could even ­reduce rents by encouraging development, including more apartments, on undeveloped land…

Land taxes may well be fairer, too. Just as the owners of land adjacent to new railway stations have done nothing to generate their windfall, land owners don’t lift a finger to generate increases in unimproved land values…

A comprehensive national, flat rate tax on unimproved land taxes was part of Labor’s platform from 1891 to 1905. The party should consider resurrecting this policy and using the proceeds entirely to slash personal income and/or company tax to unleash a productivity, investment and spending boom. This would help affordability; property prices would automatically fall…

A 1 per cent annual land tax without any exemptions could raise around $44bn based on the ABS’s estimates…

The economic ignorance and self-interest of land owners will, however, prevent any shift towards land tax, however beneficial it might be in the long run for almost everyone.

Vested interests would launch a hysterical defence of existing arrangements, wrongly claiming poor renters would be harmed.

Others would argue even stupid policies can’t be changed because some people have arranged their affairs around them.

Creighton has nailed it.

Land taxes are one of the most efficient sources of tax available, actually creating positive welfare gains to the domestic population of $0.10 for each dollar raised, since non-resident home owners are also taxed (see below Treasury chart).

ScreenHunter_6774 Mar. 30 10.24

Even just switching inefficient stamp duties (which cost the economy $0.70 per dollar raised) to a broad-based land tax would produce an estimated 1.5% increase in GDP, or $24 billion, without changing the amount of tax raised.

Unfortunately, while the arguments for shifting the tax base towards land taxes are impeccable, there are several key factors holding politicians back.

Consider the proposal to merely junk stamp duties in favour of a broad-based land tax levied on all land holders.

As shown by the RBA, only around 6% of the housing stock is transacted on average in a given year:

This means that in a given year, only a small minority of households pay stamp duty (albeit tens-of-thousands of dollars of dollars). And once they pay it, they automatically become a roadblock to reform (“why should I pay tax twice”, is the common retort).

While having such a small group of taxpayers supporting services for the whole community is ridiculous, rather than governments sharing the tax burden by levying each household a much smaller amount on a regular basis, it is far easier politically to tax a small group than everyone.

The other major roadblock with land taxes is that they would be levied on retirees that are asset (house) rich but cash poor. They would, therefore, squeal like stuffed pigs if they were required to pay tax.

The obvious solutions to these roadblocks are:

  1. To overcome concerns around “double taxation”, provide a credit to anyone that has purchased a home in the past 10 years, equal to the amount of stamp duty paid, and then subtract the hypothetical land tax that would have been paid since the home was purchased.
  2. Allow retirees to accumulate their land tax liability, with the bill payable upon death (via the estate) or once the house is eventually sold (whichever comes first), with interest charged on any outstandings.

However, even with such arrangements in place, politicians would still face the option of maintaining the status quo and taxing only a small number of people each year (easy) versus reforming and taxing almost everyone (hard).

Add in a fierce scare campaign from the property lobby – especially if land taxes were extended beyond just stamp duties to replace income taxes – and the likelihood of achieving meaningful reform is slim, especially with the current useless crop of politicians.

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Citigroup (C) adds to banking woes

Citigroup (C) was the last of the bank heavyweights to release their first-quarter (Q1) 2016 earnings this week, reporting a sharp 27 percent fall in diluted earnings per share ($1.10) compared to the first quarter of last year ($1.51).

Revenues (net of interest) dropped 11% while non-interest expenses reduced by 3%. There was a modest 7% increase in the provision for credit losses (including benefits and claims). The fall in net revenues was largely attributable to a 27% decline in institutional business from Europe, Middle East & Africa (EMEA) and an 8% decline in North America. Consumer business also dropped in Latin America (13%) and Asia (9%).

Tier 1 Capital (CET1) improved to 12.3% (Q1 2015: 11.1%) of risk-weighted assets, while Leverage (SLR) improved to 7.4% (Q1 2015: 6.4%).

The dividend was held at 5 cents (Q1 2015: 5 cents), increasing the payout ratio to a parsimonious 5%, from 3% in Q1 2015.

C is in a primary down-trend, having broken primary support at $48. Long-term Momentum below zero confirms. Expect a rally to test resistance at $48 but respect is likely and would warn of another test of the band of primary support at $34 to $36. Breach would offer a target of the 2011 low at $24*.

Citigroup (C)

* Target calculation: 36 – ( 48 – 36 ) = 24

We have had four heavyweights, JPM, BAC, WFC and C, all report declining earnings per share. Most had cut non-interest expenses but insufficient to compensate for falling revenues and rising provisions for credit losses.

It looks like we are on track for a tough earnings season.

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Iron ore taper | Motley Fool Australia

Mike King – April 15, 2016:

Chinese iron ore imports are….. soaring, thanks to the lower-cost, higher quality Australian and Brazilian product. Many of China’s steel mills are also located along the coast, making imported ore much more accessible than domestic mines located hundreds of kilometres away.

Those same steelmakers are also looking to substantially lower their costs in the face of subdued steel prices, and one way to do that is to replace lower-quality ore with the higher quality ore from Australia and Brazil.

The major miners, Vale, Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) are profitable at current prices, and the world’s fourth-largest producer Fortescue Metals Group Limited (ASX: FMG) has joined the party with C1 cash costs of below US$15 a tonne in the last quarter.

Gina Rinehart’s Hancock Prospecting is probably not too far away once it ramps up to full production at Roy Hill too.

…..There are still storm clouds on the horizon though, with Rio’s CEO Sam Walsh telling reporters in London that prices may fall in the second half of the year, with global output set to increase and offset improving demand from China. Research firm, Liberum Capital, has echoed others’ forecasts with its estimate that prices will fall below US$40 a tonne in the second half, saying demand had been “front-end loaded and will taper off.”

Methinks demand will taper over time while the surge in supply seems inevitable when Roy Hill gets going.

Source: Here’s why iron ore prices aren’t crashing | Motley Fool Australia

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Bank heavyweight earnings slip

Thursday was a big day for earnings releases, with two bank heavyweights reporting first-quarter (Q1) 2016 earnings.

Bank of America (BAC)

Bank of America reported a 19 percent fall in earnings per share ($0.21) compared to the first quarter of last year ($0.26). The fall was largely attributable to a drop in investment banking and trading profits. Provision for credit losses increased 30% for the quarter, to $997 million.

Tier 1 Capital (CET1) improved to 11.6% (Q1 2015: 11.1%) of risk-weighted assets, while Leverage (SLR) improved to 6.8% (Q1 2015: 6.4%).

The dividend was held at 5 cents (Q1 2015: 5 cents), increasing the payout ratio to a modest 24%, from 19% in Q1 2015.

BAC is in a primary down-trend, having broken primary support at $15. Long-term Momentum below zero confirms. Expect a rally to test resistance at $15 but this is likely to hold and respect would warn of another decline, with a target of $9*.

Bank of America (BAC)

* Target calculation: 12 – ( 15 – 12 ) = 9

Wells Fargo (WFC)

Wells Fargo reported a 5 percent fall in (diluted) earnings per share ($0.99) compared to the first quarter of last year ($1.04). Provision for credit losses increased 78% for the quarter, to $1.09 billion, primarily due to exposure to the Oil & Gas sector.

Tier 1 Capital (CET1) improved to 10.6% (Q1 2015: 10.5%) of risk-weighted assets. No leverage ratio was provided..

The dividend of 37.5 cents is up on Q1 2015 dividend of 35 cents, increasing the payout ratio to 38% from 34% in Q1 2015.

WFC is in a primary down-trend, having broken primary support at $48. Long-term Momentum below zero confirms. Expect a rally to the descending trendline but respect is likely and reversal below $48 would warn of another decline, with a target of $40*.

Wells Fargo (WFC)

* Target calculation: 48 – ( 56 – 48 ) = 40

So far we have had three heavyweights, JPM, BAC and WFC all report similar performance: declining earnings per share despite deep cuts in non-interest expenses, partly attributable to rising provisions for credit losses.

Citigroup (C) is due to report Friday 11:00 am EST.

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NYSE Short Interest Nears Record, Pre-Lehman Level | Zero Hedge

From Tyler Durden:

In the last two months, NYSE Short Interest has risen 4.5%, back over 18 billion shares near the historical record highs of July 2008 (and up 7 of the last 9 months). There are two very different perspectives one could take when looking at this data….

Either a central bank intervenes, or a massive forced buy-in event occurs, and unleashes the mother of all short squeezes, sending the S&P500 to new all time highs, or….

Just as the record short interest in July 2008 correctly predicted the biggest financial crisis in history and all those shorts covered at a huge profit, so another historic market collapse is just around the corner.

Else the S&P 500 oscillates between 2100 and 1800 for most of the year…. and the shorts keep climbing.

Source: NYSE Short Interest Nears Record, Pre-Lehman Level | Zero Hedge

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Pros and cons of scrapping dividend imputation

From Matthew Smith | 14 Apr 2016:

In a low-growth economy — which we are in — any barrier to future growth is fair game to be considered for removal, so it should come as no surprise that Australia’s beloved dividend imputation system is the target of some debate.

John McIntosh, a private investor and doyen of the finance industry, makes the case for scrapping dividend imputation along these lines: If companies are incentivized to pay dividends it takes money away from what they might otherwise use to invest to deliver future earnings.

An already high corporate tax rate relative to the rest of the world means multinationals are using every trick in the book to avoid paying tax here, he adds. The government could reduce corporate tax by as much as 20 per cent if it was to do away with franking credits, he reckons.

McIntosh also says the dividend imputation system is harbouring a dividend paying culture which is distorting the decision making of our corporate executives.“If you have the confidence in a corporate executive, surely you’d rather have them manage the money rather than leave it in the hands of a funds manager who makes money from fees,” McIntosh, who was the founding partner and chairman of McIntosh Securities before it was sold to US investment bank Merrill Lynch in 1996, says in an interview with FINSIA’s InFinance.

McIntosh joins finance luminaries including Bill Ferris, a veteran venture capitalist and chairman of Prime Minister Malcolm Turnbull’s innovation and science advisory committee, along with other prominent VC investors who have been beating the drums for a review of the dividend imputation tax system.

…..One thing we know for sure, the JASSA article [by Andrew Ainsworth and Graham Partington from University of Sydney Business School Department of Finance and Geoffrey Warren from the Centre for International Finance and Regulation] explains, is the imputation system has encouraged higher dividend payouts – there’s a stark divergence in the dividend payout ratios for the Australian and world equity markets after imputation was introduced.

I am all for a flat tax system, with the same low rate (between 10 and 15%) of income tax payable by both individuals and corporations, which would make dividend imputation redundant (you simply make dividends exempt from tax). But, with the present system, it doesn’t make any sense.

Removing dividend imputation would certainly encourage large corporations to distribute less of their profits, resulting in large risk-averse corporations with bloated balance sheets. That is not a formula for growth. Quite the opposite. And when large corporations decide to expand, many do so offshore, either because they already dominate or face fierce competition in local markets. And apart from the patchy record that Australian corporations (not just NAB) have with international investments, offshore investment won’t generate local jobs or taxes.

What is needed is to remove the structural impediments to growth. Until we improve the tax system, over-regulation, labor practices, infrastructure, and bloated cost structures, Australia will struggle to be internationally competitive.

In Queensland we pay 35.378 cents per Kilowatt hour for electricity, or 27 US cents (AUDUSD at 0.76). The average price in the USA is 12 cents with some states as low as 8 cents. That is just one of many impediments to establishing competitive industry in Australia.

To attract industry we need to create fertile soil for them to grow.

Source: The pros and cons of scrapping dividend imputation

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7 golden rules for SMSF investors

I found myself nodding in agreement when I read this list from Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital. I have added my comments in italics.

Investing during times of market stress and volatility can be difficult. For this reason it’s useful for SMSF investors to keep a key set of things – call them rules – in mind.

1. Be aware that there is always a cycle
The historical experience of investment markets – be they bonds, shares, property or infrastructure – constantly reminds us they go through cyclical phases of good times and bad. Some are short term, such as occasional corrections. Some are medium term, such as those that relate to the three to five year business cycle. Some are longer, such as the secular swings seen over 10 to 20 year periods in shares. But all eventually contain the seeds of their own reversal. The trouble with cycles is that they can throw investors out of a well thought out investment strategy that aims to take advantage of long term returns and can cause problems for investors when they are in or close to retirement. In saying this, cycles can also create opportunities.

Most important is to identify the long-term, secular trends that may last several decades and position your portfolio to take advantage of this. Examples of secular trends are the ageing population in developed countries; the rapidly expanding middle-class in India and China; and global warming. Sectors that may benefit from them are Health Care and Consumables.

2. Invest for the long term
The best way for most investors to avoid losing at investments is to invest for the long term. Get a long term plan that suits your level of wealth, age and tolerance of volatility and stick to it. This may involve a high exposure to shares and property when you are young or have plenty of funds to invest when you are in retirement and still have your day to day needs covered. Alternatively if you can’t afford to take a long term approach or can’t tolerate short term volatility then it is worth considering investing in funds that use strategies like dynamic asset allocation to target a particular goal – be that in relation to a return level or cash flow. Such approaches are also worth considering if you want to try and take advantage of the opportunities that volatility in investment markets through up.

Invest for the LONG term, otherwise invest in low-risk assets (cash and near cash) and not clever strategies.

3. Turn down the noise and focus on the right asset mix
The combination of too much information has turned investing into a daily soap opera – as we go from worrying about one thing after another. Once you have worked out a strategy that is right for you, it’s important to turn down the noise on the information flow surrounding investment markets. This also involves keeping your investment strategy relatively simple – lots of time can be wasted on fretting over individual shares or managed funds – which is just a distraction from making sure you have the right asset mix as it’s your asset allocation that will mainly drive the return you will get.

True.

4. Buy low, sell high
One reality of investing is that the price you pay for an investment or asset matters a lot in terms of the return you will get. It stands to reason that the cheaper you buy an asset the higher its prospective return will be and vice versa, all other things being equal. If you do have to trade or move your investments around then remember to buy when markets are down and sell when they are up.

Very important but this requires loads of patience, waiting for the right time to invest in the market.

5. Beware the crowd and a herd mentality
The issue with crowds is that eventually everyone who wants to buy will do so and then the only way is down (and vice versa during periods of panic). As Warren Buffet once said the key is to “be fearful when others are greedy and greedy when others are fearful”.

This is simply a repeat of Buy Low Sell High.

6. Diversify
This is a no brainer. Don’t put all your eggs in one basket as the old saying goes. Unfortunately, plenty do. Through last decade many questioned the value of holding global shares in their investment portfolios as Australian shares were doing so well. Interestingly, for the last five or so years global shares have been far better performers and have proven their worth.It appears that common approaches in SMSF funds are to have one or two high-yielding and popular shares and a term deposit. This could potentially leave an investor very exposed to either a very low return oif something goes wrong in the high -yield share that they’re invested in. By the same token, don’t over diversify with multiple – say greater than 30 – shares and/or managed funds as this may just add complexity without any real benefit.

Diversify into asset classes, geographic areas and strategies that have low correlation but don’t diversify into asset classes that offer negative real returns (after tax and inflation) or high risk relative to low returns.

7. Focus on investments offering sustainable cash flow
This is very important. There’s been lots of investments over the decades that have been sold on false promises of high returns or low risk (for example, many technological stocks in the 1990s, resources stocks periodically and the sub-prime asset-back securities of last decade). If it looks dodgy, hard to understand or has to be based on obscure valuation measures to stack up, then it’s best to stay away. There is no such thing as a free lunch in investing – if an investment looks too good to be true in terms of the return and risk on offer, then it probably is. By contrast, assets that generate sustainable cash flows (profits, rents, interest payments) and don’t rely on excessive gearing or financial engineering are more likely to deliver.

Most important. Invest in businesses with strong brands, patents or other competitive advantages that give them the ability to generate stable earnings over the long-term. Invest in stocks that you are likely to never sell but leave to the kids in your will. Occasionally you may sell one that falters but this should not affect long-term performance if you are well diversified.

Final thoughts

Investing is not easy and given the psychological traps that we are all susceptible to – in particular the tendency to over-react to the current state of investment markets – a good approach is to simply seek the advice of a coach such as a financial adviser.

Short-termism is the biggest danger to your investment portfolio. Too often I see investors do the exact opposite of what they should: buy high, when everyone else is buying, and sell low when everyone is a seller. Your best approach is to regularly consult an investment specialist.

Source: SMSF Suite – 7 golden rules for SMSF investors to keep in mind

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JP Morgan earnings dip but stock rallies

First of the financial heavyweights to report first-quarter (Q1) earnings this week, JP Morgan (JPM) reported a 7 percent fall in earnings per share ($1.36) compared to the first quarter of last year ($1.46). The fall was largely attributable to a 90 percent increase in provision for credit losses for the quarter, to $1.8 billion, primarily from a sharp increase in net charge-offs in the Consumer division but also exposure to Oil & Gas and Metals & Mining in Investment Banking.

Tier 1 Capital (CET1) improved to 11.8% (Q1 2015: 10.7%) of risk-weighted assets, while Leverage (SLR) improved to 6.6% (Q1 2015: 5.7%).

The dividend was held at 44 cents (Q1 2015: 40 cents), increasing the payout ratio to a modest 32% from 27% in Q1 2015.

The monthly chart shows long-term Momentum is slowing, with JPM forming a broad top above $54. Declining peaks since August 2015 warn of a primary down-trend and breach of $54 would confirm, offering a target of $40*.

JP Morgan Chase

* Target calculation: 55 – ( 70 – 55 ) = 40

The market responded well to ‘positive’ news that JPM beat its earnings estimate, boosting the stock by 4.6%. This is a game we will see a lot more of this year: give really low guidance if you expect a bad quarter. When the result comes out, the gullible will focus on the fact that you beat your estimate rather than that your earnings are falling. This chart from Zero Hedge shows the rising percentage of companies guiding next quarter earnings below consensus:
Earnings Guidance

Don’t be mis-led by the latest ‘froth’. The reality for the banking sector is net interest margins are near record lows and credit losses are rising.

Major US Banks Net Interest Margins

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