STOCKS GO NOWHERE: Here's what you need to know

Myles UdlandFeb 27, 2016, 02:30 IST

flickr via bartolomeo perrotta

Stocks finished the day little-changed to cap a busy week that saw little action in the final day of trading for the equity markets.

First, the scoreboard:

Dow: 16,640, -57.3, (-0.3%)
S&P 500: 1,948.1, -3.7, (-0.2%)
Nasdaq: 4,590.5, +8.3, (+0.2%)
WTI crude oil: $32.95, (-0.1%)

Stock Market

Jeff Gundlach bought some stocks.

"I thought it was a good buy point two weeks ago Wednesday and so we bought some," Gundlach told Reuters' Jennifer Ablan.

Congrats, Jeff!

Recall that last month Gundlach said he wasn't interested in buying oil or high-yield bonds - at that point - as he prefers to avoid things that go down in price every single day. And look, we know that most investors don't buy things they think will get less valuable, but Gundlach - who is a bond fund manager - doesn't need to go outside his usual asset class unless he has a real strong conviction. So, he bought stocks. Noted.

Meanwhile, research out of UBS indicates that the volatility of earnings estimates is at the highest since 2010, setting the stage for continued choppiness in stocks. Julian Emanuel, the top stock strategist at UBS, notes that indications are the risks for big swings in stock prices currently point upwards.

"Putting it all together," Emanuel writes, "we believe that earnings risk remains largely balanced with the potential for upside surprises to 'be more surprising' given the historically high volatility and unidirectional (down) aspect of consensus revisions. Paired with historically defensive investor sentiment which has frequently presaged meaningful rallies, we continue to view risk to US equities as skewed to the upside."

And in hedge fund land, stocks investors are selling short are rising.

Or as Goldman Sachs writes, the return on the most shorted stocks in the US over the last three months, "reached heights not seen since the third quarter of 2011 - when Standard & Poor's cut the US's triple-A credit rating - and even exceeded the peak during the financial crisis in 2008."

Not great.

If you wanted to do something great in the stock market, investing with Warren Buffett back in the day would've done the trick. (Of course, that's not really fair to either Buffett or investors who didn't invest with him: it was a once-in-a-lifetime buy 30 years ago and looking for these kinds of returns is simply not realistic.)

Recession Watch, 2016

In the fourth quarter of 2015 the US economy grew at a 1% pace.

This is faster than the 0.7% pace initially reported last month with the BEA's first estimate of GDP and Friday's second estimate for the measure beat expectations for a 0.4% increase in the economy.

And while a less-disappointing end to 2015 - and make no mistake, growing at a 1% pace is disappointing - is another win for those arguing the US economy is not heading for recession, Ian Shepherdson at Pantheon Macroeconomics noted that this likely takes some growth that had been forecast for the first quarter of this year and pulls it forward. (Or something like that.)

Here's Shepherdson:

"Other things equal, the upward revision to inventories implies weaker growth than currently expected in Q1, because the difference between the level of inventory and where it needs to be - in order to restore prior norms, relative to sales - is bigger than previously believed."

The Atlanta Fed's GDPNow tracker sees first quarter GDP growing at a 2.1% pace.

Atlanta Fed

Elsewhere, consumer confidence topped expectations on Friday with the final reading on sentiment in February out of the University of Michigan coming at 91.7, better than the 91.0 that was expected. This reading is, however, down from January's 98.1 reading.

Richard Curtin, chief economist for the survey, said Friday that, "Consumers' most important concern involves how much the slowdown in GDP growth will affect employment growth. At present, consumers anticipate only a slight negative impact on jobs."

The February jobs report is next Friday.

Inflation

We're seeing inflation make a comeback.

On Friday the latest data on "core" PCE - an alternative inflation measure that excludes the more volatile costs of food and gas and is favored by the Federal Reserve - showed prices rose 1.7% over last year in January.

Last week, the consumer price index, a more widely-cited measure of inflation, showed "core" prices ticked up 2.2% over last year. PCE prices are what goes into the GDP calculation.

"Core" PCE was expected to show prices rose 1.5% in January.

And so with inflation perking up the Fed is getting ever-closer to satisfying the second of its two mandates - we'd argue that the "full employment" mandate has been met - the March policy statement from the Fed seems likely to be a closer call than previously assumed by the markets.

"Okay, okay, did you hear the news, it was like a cannon shot heard round the world," Chris Rupkey at MUFG wrote following the report. "There's inflation out there, and it's the Fed's own indicator, PCE inflation. It's not just CPI inflation that's hot. Policy is hopelessly behind the curve, that is if they didn't break the curve by flat-lining interest rates at zero for so many years. The bond market's been down so long it doesn't know what up is anymore."

Rupkey - who we'd note has long been a hawk on Fed policy, arguing the economy is far stronger than policymakers believes and, therefore, interest rates should be higher - thinks that March is now firmly on the table.

Of course, economists at Societe Generale early Friday cut expectations for the Fed this year, saying they now see just one additional rate hike from the Fed in 2016.

The Law

Here's Dow Chemical (all emphasis ours):

The Dow Chemical Company (NYSE: DOW) has entered into a settlement agreement to resolve the In re Urethanes Class Action litigation. In this settlement agreement, Dow has agreed to pay the plaintiff class $835 million... The settlement will resolve the $1.06 billion judgment (and also resolve post-judgment interest and an anticipated award of attorney's fees) against Dow entered in 2013.

[...]

Growing political uncertainties due to recent events within the Supreme Court and increased likelihood for unfavorable outcomes for business involved in class action suits have changed Dow's risk assessment of the situation. Dow believes this settlement is the right decision for the company and our shareholders.

While Dow is settling this case, it continues to strongly believe that it was not part of any conspiracy and the judgment was fundamentally flawed as a matter of class action law. Further, the judgment covered alleged legacy activity between 2000 and 2003. Dow cooperated with an extensive investigation by the U.S. Department of Justice, which closed its investigation in 2007 without taking any or proposing any action against Dow. Dow's position at the U.S. Supreme Court is that the judgment violates class action law in multiple ways, notably with respect to the Supreme Court's Walmart decision of 2011 and the Comcast decision of 2013, both authored by Justice Scalia.

And as Elena Holodny writes, "the big takeaway form all of this is that the settlement reflects just how things might change going forward for other businesses after the Scalia's death."

Negative Interest Rates

So, here's what might happen to your bank account if negative rates come to the US, via Deutsche Bank's recent meetings with PNC Bank CEO Bill Demchak:

"If rates go negative, consumer deposit rates go to zero and PNC would charge fees on accounts."

And here's Bob Bryan:

For example, in New York City a PNC savings account with under $2,500 earns 0.01% interest monthly - 0.05% if you have a PNC checking account - according to the company's website. Standard savings accounts with over $2,500 earn 0.10% interest with a PNC checking account.

In terms of fees, a PNC savings account with under $300 in average monthly assets is charged a $5-a-month service fee. This is waived if the balance is above that threshold.

But based on Demchak's remarks, however, these fees seem likely to increase.

Look: it's a tax on the banking system.

Warren Buffett

Tomorrow is the big day: the Berkshire Hathaway annual letter will be released to shareholders on Saturday morning.

Here's what Buffett said last year about accounting:

Our income and expense data conforming to GAAP is on page 49. In contrast, the operating expense figures above are non-GAAP and exclude some purchase-accounting items (primarily the amortization of certain intangible assets). We present the data in this manner because Charlie and I believe the adjusted numbers more accurately reflect the true economic expenses and profits of the businesses aggregated in the table than do GAAP figures.

I won't explain all of the adjustments - some are tiny and arcane - but serious investors should understand the disparate nature of intangible assets. Some truly deplete over time, while others in no way lose value. For software, as a big example, amortization charges are very real expenses. The concept of making charges against other intangibles, such as the amortization of customer relationships, however, arises through purchase-accounting rules and clearly does not reflect reality. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when earnings are calculated - even though from an investor's viewpoint they could not be more different.

In the GAAP-compliant figures we show on page 49, amortization charges of $1.15 billion have been deducted as expenses. We would call about 20% of these "real," the rest not. The "non-real" charges, once nonexistent at Berkshire, have become significant because of the many acquisitions we have made. Non-real amortization charges will almost certainly rise further as we acquire more companies.

The GAAP-compliant table on page 67 gives you the current status of our intangible assets. We now have $7.4 billion left to amortize, of which $4.1 billion will be charged over the next five years. Eventually, of course, every dollar of non-real costs becomes entirely charged off. When that happens, reported earnings increase even if true earnings are flat.

Depreciation charges, we want to emphasize, are different: Every dime of depreciation expense we report is a real cost. That's true, moreover, at most other companies. When CEOs tout EBITDA as a valuation guide, wire them up for a polygraph test.

Our public reports of earnings will, of course, continue to conform to GAAP. To embrace reality, however, you should remember to add back most of the amortization charges we report.