Daily Archives: December 19, 2018

Market Preview

Market Preview: Chairman Powell Delivers Coal to Trader’s Stockings

Market participants expecting a kinder, gentler Fed were sorely disappointed Wednesday. After the Fed hiked rates .25%, Chairman Powell indicated the Fed sees a strong economy, strong hiring, and still sees two interest rate hikes in 2019. Though expected, many analysts and market pundits had encouraged the Fed not to raise rates this week. And, to signal there would be no more rate hikes in 2019, at least until it became clearer how the economy was performing. Investors assumed the Fed had received the message Wednesday as the DJIA was up close to 400 points when the 2pm announcement was made. With the S&P 500 and Nasdaq both showing similar percentage gains, markets quickly sold off to flat before a brief pause, and then went into another nosedive. The DJIA finished off 1.49%, sending it into negative territory for the year. The Nasdaq closed off 2.17%, now down 3.67% in 2018. The S&P 500 clocked in down 1.54%, and is now off just over 6% on the year. The combination of tax loss selling, and most traders wrapping up their books this week, will likely lead to a continued volatile close to 2018.

Nike (NKE), Walgreens Boots Alliance (WBA) and Carnival Corp. (CCL) report earnings on Thursday. Nike fell with the rest of the market Wednesday, but is still up slightly on the year. The company is expected to post good numbers Thursday, as analysts expect positive momentum in sales and margins in the quarter. But, one question mark that may tarnish expectations is what impact Chinese tariffs had on the sports apparel company. The stock of Walgreens has been hit especially hard in the past few weeks. Investors are concerned Amazon’s (AMZN) entry into the pharmacy business could negatively impact earnings in the sector. The company would be well served to introduce some contingency plans to analysts on the earnings call as to how it would compete with the largest online retailer in the U.S.

Thursday’s economic calendar includes jobless claims, the Philadelphia Fed business outlook, and leading indicators. Jobless claims are expected to nudge higher this week after falling unexpectedly to an historic low of 206k last week. Analysts are also expecting a bounce back in the Philly Fed numbers to 16.9 from an unexpected decline to 12.9 in November. The Fed balance sheet, which Chairman Powell indicated will continue to be used for quantitative tightening, will be released after the close Thursday. Friday, the winter solstice, is a quadruple witching expiration. Index futures, index options, stock options, and single stock futures all expire, usually resulting in increased volatility in the market. Durable goods, GDP, and corporate profits will all be released before the market opens Friday. Personal income and outlays, consumer sentiment, and the Kansas City Fed Manufacturing numbers will also be released Friday morning. Both GDP and consumer spending are expected to maintain their current momentum, and come in at 3.5% and 3.6% respectively. After tax corporate profits are projected to average 5.9% on a year-over-year basis.

Carmax (KMX) wraps up the final week before the Christmas holiday when it reports earnings on Friday. Although the stock traded above $80 in 2018, it is now almost back to its lows for the year set in April, trading just over $57. Earnings for the quarter are expected to come in at $1.01 per share.  

 

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Dividends

Sell These 3 High-Yield Stocks That Will Collapse From Fed Rate Increases

Later this week the Federal Reserve Board is expected to announce another interest rate hike. The Fed will likely its target short term interest rate by 0.25% to a range of 2.25% to 2.5%. The new Fed Funds rate is up from 0.50% two years ago. While many investor fears concerning higher interest rates and dividend stock values are unfounded, there are certain high yield stocks that will be negatively affected by rising interest rates. To determine whether one of your high-yield stocks is at risk of a big dividend cut, you need to determine if the company is “pitching” or “catching” when interest rates change.

A company is “pitching” in the interest rate game if when interest rates go up, the business generates higher revenues or profits. For example, over the last few years the commercial mortgage REITs and several business development companies (BDCs) have only originated adjustable rate loans. If these loans are held in the company’s portfolio—as is typical—rising interest rates will result in the growth of interest income. If the company has done a good job with its own debt by locking in interest rates, rising rates will lead to growing profits.

If a company is “catching” an interest rate increase, it pays interest on variable rate debt which will require higher interest payments due to the Fed Funds rate increase. For the period from 2009 through 2015, short term rates were very low, near zero percent for a high-quality borrower. If a company took on variable rate debt, it was like getting free capital to invest to generate revenue. However, those short-term interest rates are now increasing, which means interest expense will be increasing and profit margins could be squeezed. The type of company that is most at risk is one which has a fixed rate revenue stream and variable rate debt. The residential mortgage backed securities (MBS) owning REITs are a good example of this type of company.

These REITs are the opposite of the commercial mortgage REITs. The residential MBS REITs own pools of fixed-rate, government agency backed, mortgage backed securities. These AAA quality bonds pay fixed interest rates with current yields at 3.5%. To turn those low yields into double digit dividend yields, an MBS REIT borrows large amounts of short term debt to leverage up the interest rate.

When short term interest rates are low this strategy produces a large amount of free cash flow. However, as short-term rates start to rise, the rate margin gets squeezed between the owned MBS bonds rates and the cost of the money borrowed to buy those bonds.

The Fed Funds rate stood at 0.50% near the close of 2016. The rate has been increased seven times since last year and is now at 2.25%. With this next Fed rate increase, short term rates will effectively be 2.5%. Long term rates have not increased, and the 10-year Treasury yield is about 2.5%. The 10-year minus the 2-year Treasury rate is a common way to view the spread between short term and long-term rates. Here is the 10 minus 2-year yield chart since last December 1.

You can see the rate spread has shrunk from over 0.80% in February to just above 0.10%. For a business model based on capturing the long minus short interest rate spread, that does not leave a lot of room for profits. Especially after spending money to hedge against rising interest rates and paying business expenses.

Do not believe management comments that they have hedged to protect from rising rates. Hedging only works for a short time against a portion of the interest rate change. It will not protect from a serious profit squeeze.

Here are three high yield stocks with significant variable rate debt leading to a high probability of a dividend reduction:

Annaly Capital Management, Inc. (NYSE: NLY) is a high-yield, agency MBS owning REIT. In its 2018 third quarter earnings report the company owned $91 billion worth of agency MBS.

The company owns $9 billion of other assets, including $2.7 billion of commercial property mortgages. This large pile of assets is held aloft by a total of $77 billion of debt.

In the quarter, Annaly reported an average asset yield of 3.21% and an interest cost of 2.08% leaving a net spread of 1.13%. This spread was almost half of the 2.28% spread reported in the first quarter of 2016 when the Fed got serious about rate increases.

The most recent 0.25% rate increase could reduce NLY’s profit margins by up to 25%.

AGNC Investment Corp (Nasdaq: AGNC) is another agency MBS REIT. NLY and AGNC are the two largest companies in this REIT sector. As of the third quarter AGNC owned $70.9 billion of agency MBS.

The company had $65.7 billion of debt. This works out to 8.2 times leverage of the company’s equity. Reported net interest spread was 1.30%.

The company reported net interest income of $0.61 per share and paid dividends of $0.54 per share. AGNC has some cushion against higher short-term rates, but that is because the company has reduced the dividend by 18% over the last three years to stay ahead of fallen net interest income.

You can expect another dividend cut after this or the next Fed rate increase.

Two Harbors Investment Corp (NYSE: TWO) is a smaller agency MBS REIT that is trying to stay relevant with its recent merger with CYS Investments Inc (CYS).

The $3.5 billion market value makes it a mid-cap residential MBS REIT. As of the 2018 third quarter, the company own $27.7 billion of mortgage backed securities. The portfolio was leveraged to five times the company’s equity. Reported interest margin was 1.93%.

The company has diversified with a significant investment in mortgage servicing rights, also called MSRs. These will offset some of the effect of higher interest rates, but there is still a lot of interest rate risk in the core MBS portfolio.

With the 0.25% Fed Funds rate TWO could be pushed into a dividend cut just six quarters after its last payout reduction.

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Source: Investors Alley 

Blockchain

21 Billion Reasons Why Blockchain Investors Have a Great Year Ahead of Them

Michael A. RobinsonMICHAEL A. ROBINSON

I hope you had the chance to catch my recent interview with legendary investor Frank Holmes. We talked about the need for investors to look beyond struggling cryptocurrencies to understand the enormous potential of the blockchain – the technology “underneath” that makes crypto work.

What kind of potential? Well, I believe – conservatively – that the technology could impact some $8 trillion in global transactions

See, the world’s total GDP runs at around $80 trillion a year. And blockchain tech could eventually underpin all of that buying and selling.

But I’m only assuming blockchain grabs a 10% market share of systems that have been archaic and outdated for years now.

Here’s the thing. As amazing as it sounds, trillions of dollars in trade each year still relies on rickety, less-than-totally-secure computer networks and, in some cases, even paper contracts!

Thanks in part to blockchain technology, that’s all about to change. In a big way.

That’s why today, I want to show you four industries where blockchain technology could add security and transparency – and greatly reduce business costs. I think this could boost bottom lines to the tune of $21 billion in 2019 alone – another conservative estimate – for the innovative firms using this technology.

This is the kind of “strategic info” that could make you look smart at your office Christmas party or next family gathering.

Better yet, put it to use wisely, and it could help you pinpoint your next few triple-digit winners – and that’ll be even more fun to share with friends and family.

So check it out…

Why an $8 Trillion Future Is Just the Start

Obviously, my estimate of blockchain’s impact on global business is very bullish; there are some pretty significant sums involved.

So I want to put my estimate of blockchain’s impact in some perspective. Gartner says blockchain tech will create $3.1 trillion in global business value by 2025.

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That’s a big number, too, of course, but there’s a problem with it: It understates how quickly this radical new tech platform is going mainstream. Last year, according to Gartner, blockchain value came in at $4 billion – and will rise to $21 billion next year.

That’s a 425% one-year increase – a 77,400% growth rate in just nine years. So my $8 trillion estimate is in line with that, meaning at that growth rate we’ll easily get there by 2030 – and probably sooner.

Now then, most folks think of blockchain in terms of cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH).

And it’s certainly true: All cryptos need access to a blockchain to be mined, distributed, and secured.

And once cryptos like Bitcoin see more widespread adoption, it’s going to send prices soaring to $100,000. That day is going to come sooner than many imagine, because, as I type, computer scientists are working furiously on Bitcoin’s “Lightning Fix.” This fix will essentially allow users to pay for everyday items like coffee or a pizza with Bitcoin.

But blockchain is much bigger than any one cryptocurrency. Its use as a global, secure, distributed ledger for smart contracts is proving irresistible to businesses and individuals alike.

You see, industries across the board can adopt this technology – and they don’t have to rely on any one centralized entity to be a gatekeeper or potential source of vulnerability.

In fact, a key feature of public blockchains is that they are decentralized. Moreover, blockchain can greatly reduce transaction costs and improve cybersecurity. It might shock you to learn that, even in 2018, it can take days for a “conventional” electronic banking transaction to fill and finally settle – that incurs costs and security risks. With blockchain, settlement times could be measured in seconds, not days.

Another benefit of blockchain tech is that, unlike centralized databases, the blockchain serves as not only an up-to-date database, but as a historical one as well. That simply means that all of the information of a given transaction that’s put on a blockchain will remain there, available for scrutiny at any time.

With that in mind, I’ve identified four sectors I believe will benefit greatly from this technology. Call them 2019’s “Blockchain Targets.”

Take a look…

Blockchain Target No. 1: Global Finance and Banking

The $1.45 trillion financial services industry has been an early adopter of blockchain technology, and that will remain so for the foreseeable future.

That’s because at its heart, blockchain tech serves as an excellent means to disentangle the dense layers of centralized bureaucracy, redundant paperwork, and exorbitant fees this sector has come to rely on.

Look at exchanges. Many financial industry players are using blockchain tech to develop auditing systems with almost instant clearing and consensus-based verification, according to a recent report by PricewaterhouseCoopers.

Trade finance is another area that’s ripe for disruption from blockchain technology. As it stands today, the $17 trillion industry is high volume, costly, and time consuming.

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Financial institutions have begun using blockchain technology to reduce their reliance on manual processes and digitizing trade documents like letters of credit to slim costs and increase efficiency.

And major international banks are joining forces to build their blockchain solutions. Firms like BNP Paribas SA (OTC: BNPQY), HSBC Holdings Plc.(NYSE: HSBC), and The Royal Bank of Scotland Group Plc. (NYSE: RBS) are among those leading these efforts.

They’re setting up smart contracts to help track and monitor cross-border transactions, digitally discount receivables, and secure credit risk insurance, among other back-office functions.

Blockchain Target No. 2: the Oil and Gas Industry

About a year ago, a group of the large oil companies – and their banks and trading houses – formed an alliance to launch a blockchain-driven platform for energy commodity training.

The alliance is headed up by firms like BP Plc. (NYSE: BP), Royal Dutch Shell Plc. (NYSE: RDS), and ING Group NV (NYSE: ING).

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Together, they have developed a blockchain platform known as Vakt, which will aid the energy industry’s transition from paperwork-driven transactions to smart contracts. That in turn can bring efficiency gains to trading, reduce the risk of errors, and cut back on the amount of time employees spend on paperwork.

Lyon Hardgrave, Vakt’s product development vice president, says that blockchain members will save up to 40% by speeding up processing trades much more quickly and cutting down on data errors.

Now, the platform will not yet be used to trade or settle any transactions – and not a single bit of cryptocurrency will be involved. But it will include deal recaps, confirmations, contracts, logistics, and invoicing.

The global energy market is worth $1.4 trillion, according to Advanced Energy Perspectives. Look for blockchain to save the sector tens of billions of dollars – or more – as it is further rolled out.

Blockchain Target No. 3: Prescription Drugs & Biotechnology

Meanwhile, the $1.2 trillion global drug industry is ripe for blockchain adoption.

To understand blockchain’s role here, you need to know about the Drug Supply Chain Security Act. This legislation outlines a 10-year time frame that will help track, verify, and notify anyone in the supply chain when counterfeit drugs enter the system.

Here again, we’re talking about a highly secure – and immutable – shared ledger of information that would be open to any and all participants.

By using the blockchain, any movement of counterfeit drugs into the system will be immediately flagged. That’s because there will be no record of it going back to the production source.

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“The public availability of the ledger would make it possible to trace every drug product all the way back to the origin of the raw material used to make it,” Tapan Mehta, an executive with DMI, a mobile technology and services company, told IT Healthcare News.

That’s bad news for the purveyors of counterfeit drugs that earn around $200 billion per year.

But it’s great for consumers that will soon be able to stop worrying about the risk of taking what’s known in the industry as substandard, spurious, falsely labeled, falsified, and counterfeit (SSFFC) drugs.

Blockchain Target No. 4: the U.S. Defense Industry

The U.S. military is rolling out its own blockchain system, under the name Pathfinder. This platform will offer far more security, not to mention a permanent record of every single item the Pentagon buys.

Simply put, the military can’t rely on the unsecure public cloud to transmit and store sensitive data. Global hackers, often sponsored by governments in China, Russia, and Iran, are constantly trying to access vital defense department data.

And when it comes to data encryption, nothing beats what blockchain can offer. Which explains why nearly every defense contractor is expected to adopt blockchain over the next several years.

Last July, Boeing Co. (NYSE: BA) said it is working with privately held SparkCognition Inc. to adopt blockchain technology for tracking and allocating flight corridors for drones.

Defense giant Lockheed Martin Corp. (NYSE: LMT) is working with Guardtime Federal LLC to provide blockchain cybersecurity. Lockheed, the nation’s largest defense contractor, counts cyber as a core product.

But civilian branches of the government intend to get in on the action as well. Last June, the $26.3 billion General Services Administration began piloting the federal government’s first blockchain project with vendors Sapient and United Solutions.

Add it all up, and you can see there is enormous potential for blockchain tech – and the firms that develop the products these sectors seek.

Now then, there are no pure blockchain tech plays I can recommend at present. But the companies I’ve just mentioned are hard at work carving out an unbeatable blockchain edge, and I expect bottom lines to fatten accordingly.

That said, there are some firms moving forward aggressively with developing the blockchain itself.

So you can bet I’ll be keeping a close eye on them as we move into 2019. I’m going to have plenty more to say about blockchain technology this year.

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Source: Money Morning