Transcript: Nightly Business Report – June 30, 2017

ANNOUNCER: This is NIGHTLY BUSINESS REPORT with Tyler Mathisen and Sue
Herera.

SUE HERERA, NIGHTLY BUSINESS REPORT ANCHOR: Down to the wire. States
across the country are struggling to pass a budget. The stakes are high as
financial pressures mount.

TYLER MATHISEN, NIGHTLY BUSINESS REPORT ANCHOR: High note. Stocks close
out the first half with big gains and there are some investments you may
want to consider for the second half.

HERERA: Sticker shock. Why that burger you`re about to eat is getting
kind of pricey.

Those stories and more tonight on NIGHTLY BUSINESS REPORT for Friday, June
30th.

MATHISEN: Good evening, everybody, and welcome.

The first half of 2017 is in the books, with Wall Street still in rally
mode. We`ll give you more on that in a moment.

But we begin tonight with state budget battles happening all across the
country. All but four states start their fiscal year tomorrow. And
lawmakers in about 20 percent of those states have yet to finalize a
budget.

Maine`s governor is threatening a shutdown for the first time since 1991.
Connecticut preparing for deep spending cuts. It`s the 11th hour
negotiations for many legislators that are running up against the start of
a long holiday weekend for most, and nowhere are the financial pressures
greater than in Illinois, which has faced its own unprecedented two-year
budget stalemate and is now on the verge of having its credit downgraded to
junk.

But there is some movement today. Today, the House gave initial approval
to a spending plan.

Our Leslie Picker reports from Chicago.

(BEGIN VIDEOTAPE)

LESLIE PICKER, NIGHTLY BUSINESS REPORT CORRESPONDENT (voice-over): If you
want to better understand the economic crisis in Illinois, look no further
than the 16-storey government building known as the James R. Thompson
Center in downtown Chicago. Everyone agrees it could be sold. It`s worth
about $200 million, money that could be used to help the state, which is
broke.

But the Democratic Mayor Rahm Emanuel and the Republican Governor Bruce
Rauner couldn`t find a way.

MAYOR RAHM EMANUEL, CHICAGO: The governor announced he wants to sell the
Thompson Center. That`s OK. With all these bells and whistles, I said
I`ll give it to you, everything you want. You sign the labor and municipal
pension reforms that we have made. He said no.

PICKER: This is just one example of the lack of political compromise that
has brought Illinois to one of the worst economic crises that any state has
ever faced. The government has been operating for two years without a
budget and is set to begin its third at midnight tonight.

(on camera): If the Democratic-led general assembly and Republican
governor can`t agree on the budget by the first minute of July, Illinois`
bonds could be downgraded to junk status, a first for any states. What
that means is it will become much more expensive for Illinois to borrow in
the future, making it even harder to climb out of this giant fiscal hole.

Governor Rauner declined our request for an interview.

(voice-over): Without a budget, Illinois hasn`t been able to pay its
bills. It currently owes about $15 billion in unpaid bills to everything
from Chicago public schools, to hospitals. Non-profits have had to lay off
staff and shut their own doors as a result.

ERIC WEINHEIMER, CEO, FOREFRONT: I was talking to an organization this
morning that, you know, they`ve laid off so many staff and they`ve gotten
rid of so many programs because they haven`t been getting paid and they`re
a youth service provider. So, they`re in the communities, working with
kids after school and they have to cut back. So, where do those kids go?

Well, you know, they`ve got nothing else to do. What are they going to do
besides do things they shouldn`t be doing?

PICKER: Some services are expected to stop if lawmakers can`t agree to a
budget tonight. The Illinois Department of Transportation said it would
start shutting down road construction projects beginning today. The IDOT
loses its ability to pay contractors, which could cause thousands to be out
of work.

Illinois Powerball sales have already stopped and Mega Millions are due to
be halted tonight because the state doesn`t have enough funds to pay the
winners.

It`s going to take more than lottery luck for this state to strike it rich.

For NIGHTLY BUSINESS REPORT, I`m Leslie Picker, Chicago.

(END VIDEOTAPE)

HERERA: John Hicks joins us now to discuss how the states got here and
what they need to do to resolve their issues. He is executive director of
the National Association of State Budget Officers.

John, welcome, nice to have you here.

JOHN HICKS, NATIONAL ASSOCIATION OF STATE BUDGET OFFICERS: Thank you for
having me.

HERERA: You know, a number of us find it kind of puzzling that such a
large number of states find themselves certainly not in the dire situation
that Illinois is at this point, but with these budget impasses, the economy
is doing pretty well, still in recovery road and unemployment is at very
low levels.

So, what are the basic reasons why we find ourselves looking at these
states across the country struggling?

HICKS: A couple of reasons. One is that states revenues are growing much
more lower than the economy is. There`s a disconnect between the growth in
the economy and the growth in their tax revenues.

And so, that combined with spending pressures, particularly about fixed
costs such as pensions and Medicaid spending and, of course, elementary and
secondary education is always a high priority for all-states in terms of
increase spending. And so, basically, in the eight year of a recovery,
states are under a fiscal struggle right now. So, that, in some states
combined with political divisions over things that are both financial and
nonfinancial have led us to an unusual situation here where we walked into
this morning with 11 states with having passed a budget.

MATHISEN: Illinois` most intractable problem seemed to revolve around its
pension situation. They`ve made promises to pensioners. They are locked
into those promises by state constitution and court decision. But they
seem averse to raising the taxes that they needed to do or to devote the
money to it.

How do you break that kind of Gordian knot?

HICKS: Yes, it`s very difficult. Illinois and other states, New Jersey,
Connecticut, Kentucky, have having significant unfunded liabilities and in
those cases where you can`t change the benefit structure of those that are
existing or employed or active retirees, you have to get out the checkbook.
You have the pay the actuarially determined contribution and a lot of
times, that`s very difficult.

States are resorting to some pretty creative ways not only raising revenues
and crowding out other funding, but they`re devoting new resources to
pension funds. In New Jersey, a proposal to have the lottery revenues go
to the pension fund. In California, internal borrowing of an investment
fund of $6 billion.

So, it is an important issue, but states do have to at some point, they
have to get out the checkbook and pay the bill.

HERERA: If indeed we get a compromise on health care reform in Washington,
which would include Medicaid, how much relief would that bring to states
with those fixed costs?

HICKS: Well, the legislation that`s been discussed so far in the House and
the Senate would bring no relief to states. And in fact, it would impose a
new financial risk on states by capping Medicaid funding that`s now an
open-ended shared financing arrangement. And so, states would have to make
the hard choices down the road with the current legislation and either
raising more revenues, cutting expenditures elsewhere or cutting the
Medicaid program.

HERERA: On that note, John, we will see what happens. John Hicks with the
National Association of State Budget Officers.

MATHISEN: Stocks ended mixed on this last day of 2017`s first half — last
day of the quarter, last day of the month, last day of the week.

The blue chip Dow index was helped by shares of Nike (NYSE:NKE), which
rallied about 11 percent on its strong earnings report that we told you
about last night.

Now, the major indexes lost some steam late in the afternoon. The Dow
Jones Industrials added 62 points to 21349, but that cut in half earlier
gains from the day. Nasdaq off about four, the S&P 500 added three.

As for the first half of the year, the Dow and the S&P were up 8 percent.
And the Nasdaq was the big winner, with a gain of 14 percent, first half
showing since 2009.

As for oil, it climbed for a seventh straight session today, but it is down
as you see there, 14 percent so far this year. Biggest first half decline
since 1998.

HERERA: Well, in the first half of this year, investors plowed a record
amount of money into exchange traded funds. These popular investors are
passive and less expensive than some others.

Bob Pisani takes a look at the momentous first half of ETFs.

(BEGIN VIDEOTAPE)

BOB PISANI, NIGHTLY BUSINESS REPORT CORRESPONDENT: ETFs are having a
banner first half of the year. They saw record inflows of $247 billion,
increased about 10 percent, and record assets under management, just shy of
$3 trillion. It`s been quite a run. Inflows have been positive for 16
straight months. Wow.

What`s going on? It`s mostly about saving money. Investors have been
switching to the ETFs because they`re cheaper. A typical ETF might charge
a fee of 0.3 percent a year, while a typical mutual fund would charge 0.8
percent to 1 percent. That doesn`t sound like much, but over decades, that
adds up to considerable savings.

It`s also about performance. Most ETFs are pegged to indexes like the S&P
500. Active managers who picked stocks themselves charged more and the
evidence is that most do not outperform their benchmark so why pay more.

Most money is still going into plain vanilla funds. They track the S&P
500, small cap Russell 2000, for example, but there`s also substantial
money going into Europe and emerging market funds as the global economy
continues to slowly improve.

Tech has been the hot sector all year, we all know that. But there are
signs of momentum is starting to shift against them. In June, for example,
there were outflows from the main NASDAQ 100 ETF, that`s a proxy for tech,
as well as from semiconductor ETFs.

All right. What about this argument that there is too much money going
into these kinds of passive investments?

Active managers are not happy about this, but most investment professionals
are not concerned that about this. ETFs are only 6 percent of all U.S.
equities. That`s pretty small number compared to, say, 401(k) plans.

For NIGHTLY BUSINESS REPORT, I`m Bob Pisani at the New York Stock Exchange.

(END VIDEOTAPE)

MATHISEN: So, the first half is over. What`s in store for the second?

Here`s what history tells us. The average return over the past 20 years
for the final six months of the year shows a gain of about 2.5 percent for
all three of the major indexes — a little higher than that for Nasdaq as
you see.

Brad McMillan, chief investment officer at Commonwealth Financial, joins us
now to discuss.

Brad, I see in your forecast that you have the S&P 500 moving up to about
2500. That`s about what? Two percent from here, right?

BRAD MCMILLAN, CHIEF INVESTMENT OFFICER, COMMONWEALTH FINANCIAL: Just
about there. And I think that`s going to be about par for the course.

MATHISEN: What do you think drives it to that level and what are your
worries?

MCMILLAN: Well, where we are right now, we`ve seen the market come back on
fundamentals. And I think the fundamentals, the earnings are going to
continue to improve. And that should carry the market up higher.

HERERA: So, what about the fact that economic growth has not been as
strong as some people thought it would be? The administration is hoping
for something close to 3 percent. But some of the forecasts that came out
this morning came out at 1.5 percent, 1.6 percent.

Does that worry you at all or not?

MCMILLAN: It does worry me because we are seeing signs that economic
growth may be slowing, but at the same time, confidence is high. Business
confidence is high. And actually, the economy despite the worries has
continued to grow about 2 percent or a little bit better for a long time.
I see that continuing.

MATHISEN: How big a headwind is monetary policy, basically higher interest
rates, likely to be in the second half? Not just in the United States, but
globally? And how big a headwind is lower government spending going to be?

MCMILLAN: As far as monetary policy, you have to remember, rates are still
very, very low. So, we`re just getting back to normal and we`re doing it
because the economy is actually still growing. As far as government
spending, right now, expectations are very, very low for spending growth.
So, there`s not a lot of hope built in there and there could be an upside
surprise.

HERERA: The consumer, let`s turn to the consumer because consumer spending
is so important. And they have been spending and personal income has been
up as well. That certainly bodes well.

MCMILLAN: Consumers can spend. Certainly income has been strong, and the
confidence shows they should be spending. But in fact, they`re not.
Again, that`s more of an upside. We`re still growing even though consumers
haven`t been spending that well, but that`s a real upside potentially once
consumers actually start spending.

MATHISEN: Let`s put your chief investment officer hat on, Brad. Where
have you been putting money lately?

MCMILLAN: Right now, we`ve seen a bit of a pullback in tech. But
investors are looking for growth and that`s one of the few areas where
we`re going to see growth. I think the energy sector offers some
opportunities. You may be early today, but nonetheless, the energy
industry isn`t going away.

MATHISEN: All right, Brad, thanks very much. Have a great long weekend.
We appreciate your time tonight.

MCMILLAN: Thank you. You too.

MATHISEN: Brad McMillan is with the Commonwealth Financial Network.

HERERA: And another sector to watch in the second half of the year maybe
defense. That group had a strong performance during the first six months
of 2017, and given the likelihood of an increase to the country`s defense
budget, some are upbeat about the second half as well.

Morgan Brennan has more.

(BEGIN VIDEOTAPE)

MORGAN BRENNAN, NIGHTLY BUSINESS REPORT CORRESPONDENT: So far, it`s been
another strong year for defense stocks. With the ITA aerospace and defense
ETF outperforming the broader S&P 500.

In the second half, it`s all about the budget. In the first phase,
congressional committees have proposed at least $18 billion more than
President Trump had requested, but there are still many steps to go before
the money actually makes it to the Pentagon. Three big competitions to
watch, all for the Air Force. The $16 billion T-X Trainer contract for 350
training jets will be awarded by year`s end after Lockheed Martin
(NYSE:LMT), Boeing (NYSE:BA), and Leonardo all submitted final flight test
data earlier this week.

Second, replacement of the flying surveillance aircraft known in shorthand
as JSTARS. That`s a $17 billion deal for 17 planes in two parts. Lots of
players, but three primes bidding for the integration contract, Boeing
(NYSE:BA), Lockheed and Northrop Grumman (NYSE:NOC).

Also watch for the number of contenders to replace the Minuteman 3 Missiles
to drop from three down to two, as a deal expected to be worth at least $60
billion over three decades. Northrop, Boeing (NYSE:BA) and Lockheed are
all bidding.

Lastly, expect the international sales to keep coming. NATO allies just
said they`ll boost spending by 4 percent this year after intense pressure
from President Trump. And while it will take time for approval, a flurry
of new arms deals could also boost future order books.

For NIGHTLY BUSINESS REPORT, I`m Morgan Brennan.

(END VIDEOTAPE)

MATHISEN: Still ahead, why small caps could deliver big returns in the
months ahead.

(MUSIC)

HERERA: Warren Buffett`s Berkshire Hathaway (NYSE:BRK.A) is buying 700
million shares in Bank of America (NYSE:BAC). That makes the billionaire
investor the largest shareholder in that bank. Berkshire plans to convert
warrants purchase in Bank of America (NYSE:BAC) back in 2011 into common
shares in that bank. A warrant gives the holder the right, but not the
obligation, to buy a security at a certain price and quantity at future
time. Buffett is also the top shareholder of Wells Fargo (NYSE:WFC).

MATHISEN: Cara Therapeutics tanks after a drug trial disappoints and that
is where we begin tonight`s “Market Focus”.

Janney Montgomery Scott cut its rating on the biotech stock today to
neutral from buy, saying the results from the company`s pain medication
study were disappointing. The trial showed that osteoarthritis patients
who were treated with the tested drug at lower doses did not experience
significant reductions in joint pain. Shares of the small cap plunged
nearly 40 percent to $15.39. Not a good day there.

Real estate investment trust Parkway Properties (NYSE:PKY) will be bought
by Canada Pension Plan for more than $1 billion. Canada`s largest public
pension fund said the deal compliments its long-term real estate strategy.
Parkway Properties (NYSE:PKY) up 12 percent to $22.89.

And E*TRADE could consider up for sale. “The Wall Street Journal” says
E*TRADE executives are calling on the CEO to define the brokerage`s future
by the end of the year or consider a possible sale of the business. The
board is looking for the CEO to rejuvenate the company`s core business to
stay competitive. E*TRADE shares up just about a percent at $38.03.

HERERA: Microsoft (NASDAQ:MSFT) will reportedly announce a restructuring
plan. Seattle`s “Puget Sound Business Journal” says the software giant
will reorganize its business to create a focus on cloud computing. The
company`s announcement is expected next Wednesday. Microsoft (NASDAQ:MSFT)
shares rose 44 cents to $68.93.

A regulatory filing shows hedge fund Engaged Capitals took a nearly 10
percent stake in organic food company Hain Celestial and also nominated
seven candidates to Hain`s eight-person board. Engaged Capital said a
potential sale of Hain is not off the table. Hain jumped nearly 9 percent
to $38.82.

And Tesla`s CEO, Elon Musk, said the automaker will make an announcement on
Sunday regarding the release date for the Model 3. The vehicle which was
unveiled last year has received more than 400,000 preorders and is expected
to begin production next month. Tesla shares rose fractionally to $361.61.

MATHISEN: And now to our market monitor, who says he`s not having a
problem finding new investment opportunities in small cap names. This is
his first time joining us on the program. He`s Chris Terry, portfolio
manager of the Hodges Intrinsic Value Fund.

I guess one way of looking at the fact, Chris, that small caps have
underperformed large caps, is that their prices haven`t risen so much and
you can find value there.

CHRIS TERRY, PORTFOLIO MANAGER, HODGES INTRINSIC VALUE FUND: You can, and
we continue to find value at the Hodges Intrinsic Value Fund. And the
Russell is more or less traded sideways the past six months. But overall,
in a broad market perspective, we think it`s going to continue to grind
higher. The resiliency of the market has been impressive, but also
indicative of the market is feeling like it wants to grinding higher.

HERERA: All right. Well, speaking of grinding higher — let`s get to your
first pick, which is Farmer Brothers (NASDAQ:FARM), which is a coffee
roaster and distributor.

TERRY: Yes, I think everybody`s familiar with coffee. Consumption is
growing. The demand for higher quality product is increasing. But the
interesting thing about these guys is a new facility that they`ve just
opened up which could virtually double the size of the company. So, if you
think about these guys and roasting coffee and selling coffee to large
national accounts, think McDonald`s (NYSE:MCD), Target (NYSE:TGT), but also
to convenient stores and hotel chains, this new facility allows them to go
out and win new national accounts, which again could be very material for
their business over the next several years.

MATHISEN: All right. Let`s go from consumable to a wearable. The next
one on your list is Steven Madden (NASDAQ:SHOO), the shoemaker.

TERRY: Steven Madden (NASDAQ:SHOO) is very interesting. I think we`re all
very well aware of what`s happened in retail land. And these guys, the
stock has really stood out. It`s held up really well in a difficult retail
space and these guys have trend right product and are taking market share.

And if you just look at the stock, they`re definitely bucking the trend in
what`s going on in retail land today.

HERERA: And finally, hopefully I`ll pronounce this correctly. Analogist?

TERRY: Analogic (NASDAQ:ALOG), ALOG. This is really top of mind
considering what`s come out of homeland security this week, in talking
about an enhanced security measures at airports. So, these guys make
baggage screening devices. Their legacy business has been the check
baggage side, but they`ve taken that same technology and have put anytime a
smaller box.

So, now, you have to ability with these newer superior technologies to
screen your carry-on and the nice thing about this is you don`t have to
take your liquids, your gels or your aerosols or even your laptop out of
your carry-on bag. So, the ultimate goal here is really to speed up the
security check-in process, which I think we would all agree is pretty
tedious today.

MATHISEN: Give me 20 seconds on your overall view of U.S. stocks.

TERRY: I think there`s always pockets of strength. There`s always pockets
of weakness. We are, you know, like you mentioned in the opening, we
continue to find a lot of opportunities.

It — and again, we`re looking for turnarounds in the intrinsic value fund.
We`re looking for hidden asset values. We`re looking for earnings
expectations that aren`t fully understood and we continue to see a lot of
that. And I think these three stocks that we talk about are indicative of
that.

MATHISEN: Well, we`ll fin out. Chris, thank you for being with us
tonight. Have a great weekend.

Chris Terry with the Hodges Intrinsic Value Fund.

TERRY: Thank you. Happy Fourth.

MATHISEN: You, too.

HERERA: You, too.

Well, coming up: why there`s some extra sizzle at steak houses this summer.

(MUSIC)

MATHISEN: Here`s look at what to watch next week. On Monday, the markets
will follow an abbreviated trading schedule and June auto sales, which
could see a summer slowdown starting will be released. Wednesday, we get
the minutes from the Federal Reserve`s last meeting. Policymakers hiked
interest rates that time as you`ll recall. And on Friday, the government
releases its closely watched employment report for June. That is what to
watch next week.

HERERA: Farmers planted a record amount of soybeans this spring. The hope
is that the fall harvest will meet strong export demand even as a bumper
crop in South America has increased global supply. Farmers steered away
from planting wheat, which fell to a record low on the expectation that
export demand will remain weak.

MATHISEN: As we head into the Fourth of July weekend, odds are, you may
well be going to eat burger or a steak, either grilling it yourself,
ordering at a restaurant, going to a party, and steak houses are noticing a
change this year in price — higher.

Aditi Roy explains why.

(BEGIN VIDEOTAPE)

ADITI ROY, NIGHTLY BUSINESS REPORT CORRESPONDENT (voice-over): It`s the
lunch rush at Bobby Van`s, one of Manhattan`s best known steak houses and
the rib eyes aren`t the only thing that`s sizzling. So are the costs of
prime cuts.

LENNY PASSARELLI, BOBBY VAN`S STEAKHOUSE GENERAL MANAGER: Anytime
something is out of your control, no one likes it. So, it`s especially in
business.

ROY: Lenny Passarelli`s family owns Bobby Van`s. He says the side of beef
cost him 30 percent more than it did a month ago. That`s a drag on his
bottom line. But so far, they`re eating the cost.

PASSARELLI: It`s really not much we can do. I mean, we are a steak house,
so people come here for our fine beef. Do we make adjustments? Yes, we do
make adjustments. But it`s not in the quality of the beef or cut of the
beef or the size of the beef.

ROY: Analysts say the whole sale prices of choice, select and prime beef,
usually peak around Memorial Day, before sliding down as demand wears off.
But this year, they`re not seeing a let-down in demand or prices. They say
it`s because the weak dollar has hiked up U.S. beef exports and reduced
imports.

According to the U.S. Department of Agriculture, U.S. beef exports are up
17 percent by dollar amounts this year. There`s also been talk that
resuming U.S. beef exports to China for the first time in 14 years would
further raise prices. But according to most analysts, there are so many
restrictions on the type of meat that could be exported to China, the new
trade relationship isn`t expected to impact prices for now.

The U.S. has also banned fresh beef from Brazil due to safety concerns.
That, too, isn`t expected to affect wholesale beef prices, but for
Passarelli, that`s little consolation.

PASSARELLI: Our best seller is still always meat and always probably will
be. And we`ll probably have to just adjust and live and die by the price
of prime beef.

ROY (on camera): I talk to some analysts who say typically, wholesale beef
prices go down over the summer. While they haven`t seen that yet, some
remain hopeful that demand will wear off after July Fourth, bringing the
cost of this burger in time for Labor Day.

For NIGHTLY BUSINESS REPORT, I`m Aditi Roy, San Francisco.

(END VIDEOTAPE)

HERERA: And finally tonight, one of the biggest music labels is bringing
back vinyl records. Sony (NYSE:SNE) Music Entertainment will start making
them again after stopping production nearly three decades ago. There are
few details, but the pressing will reportedly be in a factory in Japan.
Vinyl record sales have been rising. One estimate put sales at more than 9
million in 2014. Accounting firm Deloitte says vinyl records could grow
into a billion dollar industry in the coming years.

MATHISEN: And I threw all of mine out.

HERERA: You did?

MATHISEN: I threw `em all out. I`m sick.

HERERA: Oh, no. My husband makes me — come over to our garage.

MATHISEN: All right. Good. You got it. All right. Good.

HERERA: That does it for NIGHTLY BUSINESS REPORT tonight. I`m Sue Herera.
Thanks for joining us.

MATHISEN: And I`m Tyler Mathisen. Have a great weekend, everybody.
Abbreviated trading Monday, but we expect to see you here Monday evening on
NBR. Have a good weekend.

END

Nightly Business Report transcripts and video are available on-line post
broadcast at http://nbr.com. The program is transcribed by ASC Services II
Media, LLC. Updates may be posted at a later date. The views of our guests
and commentators are their own and do not necessarily represent the views
of Nightly Business Report, or CNBC, Inc. Information presented on Nightly
Business Report is not and should not be considered as investment advice.
(c) 2017 CNBC, Inc.

 

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