Friday, December 30, 2016

Finding the Russians Guilty - Buyer Beware

The recent release of the Department of Homeland Security's report on Russia's "malicious cyber activity" provides us with an analysis that proves the guilt of America's former Cold War adversary for actions that it took during the 2016 American election.  The analysis is supposed to provide "...technical details regarding the tools and infrastructure used by the Russian civilian and military intelligence Services (RIS) to compromise and exploit networks and endpoints associated with the U.S. election, as well as a range of U.S. Government, political, and private sector entities."  As it does in its combat operations around the globe, Washington has even given these operations by RIS a clever name; GRIZZLY STEPPE.

One of the most interesting bits of information that DHS provides in this report is found right at the top of the first page:

The disclaimer clearly states that the report is provided on an "as is" basis and that the Department of Homeland Security "...does not provide any warranties of any kind regarding any information contained within."

One would think that such a boilerplate disclaimer would not be necessary if the Department of Homeland Security and the National Cybersecurity and Communications Integration Center (NCCIC) were certain of the "facts" stated in the report, particularly given that its findings are driving the Washington's anti-Russia agenda.  This is looking more and more like the kind of propaganda that was used by Washington in the decades after World War II to justify their spending of trillions of dollars on arming America for the Cold War. 

What is the Cyclically Adjusted Price-Earnings Ratio Telling Us About Stock Market Valuations?

In this, my last posting of 2016, I want to examine the story of the year, the rather miraculous performance of the U.S. stock market, particularly since Donald Trump's surprise win in November.  

Here is a chart showing the one year performance of the Dow Jones Industrial Average:

During the first two months of 2016, Dow fell from its 2016 opening level of 17,405 to a low of 15,460 on February 11.  It rose to its 2016 high (and all-time high) of 19,987 on December 20, an increase of 14.8 percent from its 2016 opening level.  It has retreated to its closing level of 19,762 on December 30, however, the index still shows a year-over-year gain of 13.5 percent.  Since corporate earnings are a key part of stock growth, by way of comparison, here is what happened to growth in after-tax corporate profits on a year-over-year basis since the beginning of the Great Recession:  

Profits in the third quarter of 2016 grew by 4.3 percent on a year-over-year basis, the strongest growth rate since the third quarter of 2014.

Since I haven't visited Robert Schiller's CAPE or Cyclically Adjusted Price-Earnings Ratio also known as the P/E 10 Ratio since August, I thought it was time to take another look at what this indicator suggests about the current level of the stock market.  The CAPE Ratio is defined as follows:

"...the price of stocks (or the stock market as a whole) divided by the moving average of ten years of earnings adjusted for inflation."

Higher than average CAPE Ratios suggest that there will be lower than average long-term annual returns and lower than average CAPE Ratios suggest that there will be higher than average long-term annual returns on stocks.

Here is a line graph showing how the CAPE Ratio has varied on a monthly basis since 1881:

There are 1631 data points in Dr. Schiller's analysis which provide us with an average CAPE Ratio of 16.63 over the 135 year period keeping in mind that this includes the extremely anomalous CAPE Ratios that resulted from the tech sector bubble in the early 2000s.

Let's focus on the period of time since the Great Recession began at the end of 2007:

As you can see, the CAPE Ratio fell to a low of 13.32 in March 2009, the lowest level since March 1986 when the CAPE Ratio stood at 13.19.  Over the past six and three-quarters years, the CAPE Ratio has risen to its current level of 28.26 in mid-December 2016, an increase of 112.2 percent.  That said, the current CAPE Ratio is very high compared to the long-term average, in fact, at 28.26, it is 69.9 percent above its 135 year average as noted above.  

The current level of the CAPE Ratio suggests that the stock market is significantly overvalued, unfortunately, the CAPE Ratio does not telegraph when the stock market will return to normal valuations.  My suspicion is that the flight out of the bond markets have led investors into equities and that only time will tell when sanity returns and market valuations better reflect the reality of stagnant profit growth. 

Thursday, December 29, 2016

Russia's Preemptive Response to America's Latest Sanctions

While those of us who live outside of Russia rarely actually hear what Russia's political leadership has to say about its relationships with western nations, a quick trip to the Ministry of Foreign Affairs of the Russian Federation will provide us with a glimpse at the inside workings of Russia.

This is particularly pertinent given Barack Obama's December 29th, 2016 announcement about additional sanctions being placed on Russia for their supposed role in the 2016 election that saw his party's candidate, Hillary Clinton, suffer a humiliating loss at the hands of the supposedly unelectable Donald Trump.  Fortunately, Russia had already preemptively commented on the imposition of additional sanctions on December 28th, 2016.  Here is the comment on the situation from Russia's Foreign Ministry Spokesperson, Maria Zakharova:

"The outgoing US administration has not given up on its hope of dealing one last blow to relations with Russia, which it has already destroyed.   Using obviously inspired leaks in the US media, it is trying to threaten us again with expansion of anti-Russian sanctions, “diplomatic” measures and even subversion of our computer systems. Moreover, this final New Year’s “greeting” from Barack Obama’s team, which is already preparing to leave the White House, is being cynically presented as a response to some cyber-attacks from Moscow.

Frankly speaking, we are tired of lies about Russian hackers that continue to be spread in the United States from the very top. The Obama administration launched this misinformation half a year ago in a bid to play up to the required nominee at the November presidential election and, having failed to achieve the desired effect, has been trying to justify its failure by taking it out with a vengeance on Russian-US relations.

However, the truth about the White House-orchestrated provocation is bound to surface sooner or later. In fact, this is already happening. On December 8, US media quoted Georgia’s Secretary of State Brian Kemp as saying that the local authorities tracked down the origin of a hacker attack on his voter registration database after the election. The attack was traced to an IP address of the Department of Homeland Security. This was followed by an attempt to quickly cover up this information by a flood of new anti-Russian accusations that did not contain a single piece of evidence.

We can only add that if Washington takes new hostile steps, it will receive an answer. This applies to any actions against Russian diplomatic missions in the United States, which will immediately backfire at US diplomats in Russia. The Obama administration probably does not care at all about the future of bilateral relations, but history will hardly forgive it for this apr├Ęs-nous-le-deluge attitude." (my bold)

In case you were wondering, apres-nous-le-deluge translates to "after us, comes the flood" and refers to someone who acts irresponsibly without caring about what impact their actions will have in the future.  In this case, it refers to the outgoing Obama Administration and the incoming Trump Administration.

It looks like it's more business as usual in the ongoing ramping up of hostilities between the United States and its former Cold War adversary.

Addendum - December 30, 2016

Here's what the Kremlin had to say after the Obama announcement of December 29th:

"Reserving the right to retaliate, we will not stoop to the level of "kitchen" irresponsible diplomacy and further steps to restore U.S.-Russian relations will build on the basis of the policy, which will hold the presidential administration of D. Trump.

Returning to his homeland, Russian diplomats will spend the New Year holidays in the circle of relatives and friends - at home. We will not create problems for American diplomats. We will not send anyone home. We will not prohibit their families and children to use for their usual vacation spots in the New Year's holidays. Moreover, all children of American diplomats accredited in Russia, I invite you to New Year's and Christmas tree in the Kremlin.

It is a pity that the President Obama administration completes its work this way, but, nevertheless, I congratulate him and wish his family a Happy New Year." (my bold)

The Unintended and Expensive Consequences of the Anti-Russia Sanctions

Updated July 2017

A December 2016 Department of Defense press briefing on the situation in Afghanistan by General John W. Nicholson Jr., Commander of Resolute Support and the United States Forces in Afghanistan, provides us with a glimpse into the current anti-Russia sentiment that is becoming pervasive throughout Washington.  As you will see, in this case, this anti-Russia sentiment could end up costing American taxpayers a very significant amount of money.

When the Afghanistan war began in 2001, Afghanistan's fledgling Air Force included a number of aging Soviet-era helicopters.  Since the Afghani pilots had experience with Soviet equipment, the United States made the decision to replace this aging equipment with Mi-17 helicopters purchased from Russia and the Czech Republic with the deal being signed in 2011.  The Mi-17 is a multi-use transport helicopter that can operate at high altitudes and the United States had the goal of purchasing at least 80 Mi-17s by the end of the acquisition program.  By 2012, 50 Mi-17s had been purchased and, according to the U.S. Army, by 2011,  an additional 22 Mi-17s had been purchased for use in Iraq and the existing 50 Mi-17s in Afghanistan were being serviced by Northrop-Grumman, a massive U.S.-based military contractor.  In November 2014, the Pentagon announced that the last of 63 Mi-17s had been delivered.
Interestingly, the U.S. Government Accountability Office did an analysis of the Department of Defence's decision to cancel competitive soliticitation for the purchase of 21 civil Mi-17s (along with an option to purchase 12 additional aircraft) which would have been refitted with a military configuration after delivery, even though this had never been done previously.   with the necessary materiel.  As well, according to Human Rights Watch, the Department of Defense likely paid too much for the helicopters; between 2008 and 2012, the price rose from $4.4 million to $17,5 million.  Here's a quote:

"The industry documents appear to show that the United States is paying far more than most other countries for similar helicopters.  As was reported in today’s Wall Street Journal, a 2007 letter from the factory in Ulan-Ude, Russia, offered to sell three new Mi-171E helicopters for $8.55 million each. In 2009, the U.S. navy bought two Mi-171s for $10.5 million from a contractor called Defense Technology Inc. The following year, Argentina reportedly paid $12.7 million each for two Mi-171s. In 2011, the United States paid $13.6 million each for 14 Mi-171s destined for Iraq.  The price paid by the United States was 40% higher than four years earlier – an eye-opening markup given that bulk aircraft can usually be purchased at a lower price than small numbers.
The Russian price apparently jumped another 32% in a single year, when DoD bought 12 Mi-17 helicopters for Afghanistan for $18 million each. The Mi-17 V5 is equivalent to the M-171 and the cost is roughly the same, industry sources said.  A July 2013 Pentagon document indicates the Mi-17 choppers are now estimated to cost $19 million each, with annual maintenance costs of $4.8 million, for a total cumulative costs of $1.45 billion for 30 aircrafts over the 30-year lifespan of the helicopter."

With that background, let's go back to the subject of this posting, the recent press briefing by General Nicholson on the situation in Afghanistan.  Here's a question that he was asked by Thomas Gibbons-Neff from the Washington Post during the December 2, 2016 briefing:

"And the second question on the -- the Afghan Air Force, talking about how that's kind of a capability you guys are constantly building and heavy relied on the MI-17 fleet by far, the most experienced fleet in the Afghan Air Force.  And there's been some reports that you'll -- you'll be replacing them with Black Hawks.

How does that kind of factor into keeping this force going forward without taking two steps back?"

Here's is the General's response:

"Right.  So the -- the -- as you know, the decisions on the MI-17s were made prior to Crimea, prior to Ukraine, prior to the international sanctions on that.  So the Afghans traditionally had a core of MI-17 pilots who were trained on the airframe and some of them very experienced.  So early before Crimea, Ukraine, before sanctions, there was international support for continuing with Russian-made airframes.

That all changed after 2014 and after those sanctions were imposed.  So the issue now is the sustainment of that -- of that fleet to continue while we field a new fleet.  President Obama forwarded to the Hill a request and the supplemental for purchase of UH-60 alpha model helicopters.  So these helicopters will be modified with an improved drivetrain transmission so to enable them to operate better in the environment up there.  But it will involve a transition for the pilots.

So in addition to the equipment that's being purchased -- so it's not just the UH-60, it's also more A-29s, more MD-530s.  So an increased close air support capability, an increased lift capability and then a transition program for the pilots and for the maintainers.  So I already mentioned in my opening remarks about the -- fielding 120 Afghan tactical air controllers, so they're out in the field able to start doing this.

So it's a -- it's a comprehensive program to not only get the airframes there, but the -- but the pilots trained, the maintainers trained, the -- the attacks trained so that we'll field a complete capability.  And then -- and then during this period, we need to sustain the MI-17s long enough to bridge through this period.  So we're getting help from some allies on this and partners on the this, the Australians, others are helping to fund maintenance on the MI-17s to -- to enable them to bridge this period until the UH-60s are fielded." (my bold)

Here's the followup question:

"But ideally, they'd want to keep the MI-17s, correct, because this is a step back as far as having to retrain pilots?"

Here again is the General's response:

"Well, the MI-17s are a great airframe that the Afghans use and they're comfortable with.  The -- the issue's gonna be the ability to maintain them.  And so this -- so maintaining the airframe -- you know, keeping the airframe in the inventory but not being able to maintain it was not -- would not be positive.  And so the -- the Afghan government has gone to the Russians and asked for their assistance in this.  The Russians have not provided it.

And -- and so the Afghan government solicited from them help with maintaining these airframes.  They haven't -- they have not agreed to do it.  And because of the sanctions on Russia, the maintenance of this fleet's gonna be very difficult." (my bold)

Apparenlty, this is yet another fine example of unintended consequences of questionable political policies and, as you will see, a very expensive example.

Let's summarize.  The American military picked the Mi-17 as the helicopter of choice for Aghanistan (and let's not forget Iraq) because it was most suitable for the existing pilots in the Afghanistan Air Force, closing the purchase in November 2014 which was actually seven months after the residents of Crimea voted to declare independence from Ukraine and rejoin the Russian Federation.  The first round of American sanctions against Russia were invoked on March 6, 2014 followed by a second round which banned business transactions with Russia on April 28, 2014 and a third round which was imposed on July 17, 2014.  Despite that, the United States continued with its purchase of Mi-17s despite the sanctions and now finds itself in a situation where it can no longer get parts necessary for maintenance because of sanctions that Washington imposed on Russia.  To get themselves out of this mess, the Department of Defense plans to replace the Russian-built Mi17s with the Blackhawk UH-60 which is manufactured by Sikorsky Aircraft, an American aircraft manufacturer located in Stratford, Connecticut which is now a unit of Lockheed Martin, America's largest defense contractor.  According to Aeroweb, the unit cost of a Sikorsky UH-60M in fiscal year 2015 was $16.96 million (flyaway cost) without armament.  If the existing Afghani fleet of 63 Mi-17s were replaced one-for-one with UH-60s, it would cost U.S. taxpayers a total of $1.07 billion not including armament costs and the cost of retraining the Afghanistan Air Force pilots. 

In closing, let's look at how much Lockheed Martin has spent on lobbying since 1998:

In its last full year, Lockheed Martin has spent $3.615 million on getting Washington to see things its way, putting it in 13th place out of 3,623 lobbyists.  As well, it contributed an additional $6,103,241 to political campaigns during the 2016 cycle, putting it in 51st place out of 18,184 contributors.

One really doesn't have to think too hard to gain an understanding why Washington is suddenly changing course mid-stream when it has just finished taking delivery of hundreds of millions of dollars worth of new Russian-built helicopters at the end of 2014.  Looking at the acquisition dates in relation to the dates that Washington imposed sanctions on Russia makes one realize that American voters have a very good reason to be cynical about their political leadership who is quite adept at speaking out of both sides of their the same time.