NEW$ & VIEW$ (25 FEBRUARY 2013)

The sequester and the fragile U.S. economy. Truck tonnage. Car sales. Rising inventories? ObamaCare. House prices. Canadian economy struggling. Social unrest. China’s PMIs. China housing. Earnings watch. Sentiment watch.


Long Impasse Looms on Budget Cuts

Lawmakers anticipate that looming spending cuts will take effect next week and won’t be quickly reversed, likely leading to protracted uncertainty that presents risks both to Congress and the president.

Never mind the political risks. How about the real world?


GDP could shrink in the first and second quarters — two consecutive declines is the popular definition of a recession — and stretch into the third quarter, according to Charles Dumas of Lombard Street Research in London — a prospect he says Wall Street is “blithely ignoring.” Federal spending could be reduced by 0.5% under sequestration, which would come atop the 1% fiscal tightening under the 2011 debt-ceiling agreement and 0.8% impact of the end of the payroll-tax cut on Jan. 1, he points out.

LEI – Is There A Disconnect? (Lance Roberts)


(…) the negative trend of the LEI since the turn of the century has not only been a reliable indicator of the maturity of the economic cycle but a cross below the ZERO bound has been closely associated with a market peak. However, with the Fed artificially suppressing the yield spread and boosting asset prices (both of which are major components of the index) through repeated QE programs the artificial inflation of the index is likely masking the weakness in the economy.

Speaking of underlying weakness in the economy – the next chart is the annual change in the LEI versus the annualized growth rate of GDP.


(…) Historically, when the annual rate of change in the LEI drops below zero the economy either has been, or was close to, a recession.  At a current reading of 2.06% there is not a tremendous margin for error with regards to missteps with either fiscal or monetary policy.  Furthermore, as discussed recently, with the global recession already providing a drag on the domestic economy – any drastic moves toward austerity could easily push the economy over the ledge. (…)

ATA Truck Tonnage Index Posts Best Ever January (via CalculatedRisk)

The American Trucking Associations’ advanced seasonally adjusted (SA) For-Hire Truck Tonnage Index increased 2.9% in January after jumping 2.4% in December. … Tonnage has surged at least 2.4% every month since November, gaining a total of 9.1% over that period. As a result, the SA index equaled 125.2 (2000=100) in January versus 121.7 in December. January’s index was the highest on record. Compared with January 2012, the SA index was up a robust 6.5%, the best year-over-year result since December 2011.

“The trucking industry started 2013 with a bang, reflected in the best January tonnage report in five years,” ATA Chief Economist Bob Costello said. “While I believe that the overall economy will be sluggish in the first quarter, trucking likely benefited in January from an inventory destocking that transpired late last year, thus boosting volumes more than normal early this year as businesses replenish those lean inventories.” (emphasis added)


Inventory restocking seems to be confirmed by rail traffic. Intermodal volume has been very strong in the past several weeks.

The problem with the above is that the consumer is 70% of the U.S. economy and indications are that consumer spending has stalled. Restocking could rapidly lead to destocking.

ISI company surveys revealed softness from truckers and retailers and restaurants last week while manufacturers and homebuilders improved.

Pent-Up Demand Drives Auto Sales

More than 1.2 million new vehicles were estimated to have been sold in the month, a 4.3% increase over a year earlier and a 15% increase over January, according to If accurate, that would put the seasonally adjusted annual rate at 15.5 million vehicles. (…)

Analysts, however, will be searching Friday’s reports for signs that auto makers may be too far ahead of the sales curve (…)

ObamaCare’s Tax Net Snares Middle Class, Economy

When the subsidized exchanges open in 2014, ObamaCare will become a redistribution program. This year, it’s primarily a tax collection program.

The health law will shrink the fiscal 2013 deficit by $34 billion due to $36 billion in revenue, the Congressional Budget Office predicts.

Thus, ObamaCare’s ramp-up will be an economic drag, made steeper by employers’ shifts to avoid fines that kick in next year.

While much of the new taxes will come from high earners, ObamaCare’s tax net will be impossible to avoid for the middle class. Pretty much anyone who uses medical care will pay up, since fees on insurance policies, prescription drugs and medical devices are sure to be passed along to consumers.

Likewise, tax penalties for employers who fail to offer affordable and comprehensive coverage would come at least partly out of wages for moderate earners.

In all, ObamaCare is expected to raise about $800 billion in revenue over 10 years, including penalties on individuals and firms for not complying with new mandates.

January Annual Home Value Increase Is Largest Since Summer 2006

Zillow’s January Real Estate Market Reports, released today, show that national home values rose 0.7% from December to January to $158,100. January 2013 marks the 15th consecutive month of home value appreciation. On a year-over-year basis, home values were up 6.2% from January 2012 – a rate of annual appreciation we haven’t seen since July 2006 (when the rate was 7.5%), before the peak of the housing bubble.


The rental market remains strong, even as the housing market regains strength. (…) Investors are still playing a big role in the housing recovery, as they purchase homes (many times lower priced homes or distressed inventory) and convert these into rental units to satisfy the increase in demand for rental housing. Their involvement in the marketplace has often squeezed out first-time buyers and has contributed to high home value appreciation. (…)

Pointing up  Fig4The rate of homes foreclosed continued to decline in January with 5.54 out of every 10,000 homes in the country being liquidated. Nationally, foreclosure re-sales continued to fall, making up 13.05% of all sales in January. This is down 3.6 percentage points from January 2012 and down 6.9 percentage points from its peak level of 19.9% in March 2009.

See also: 2 Million Homeowners Freed From Negative Equity in 2012; 1 Million More to Come in 2013


Canada’s Economy Struggles as Inflation and Sales Slow

Canada’s inflation rate fell in January to its lowest since 2009 and retail sales plunged in December, adding to evidence the country’s economy is struggling to accelerate from its slowest pace since the 2009 recession.

Consumer prices rose 0.5 percent in January from a year earlier, the least since October 2009, Statistics Canada said today from Ottawa. Retailers in December recorded a 2.1 percent drop in sales, the biggest decline in almost three years, the agency said separately.

France asks Brussels for budget pass
Finance minister seeks extra year to hit deficit targets Surprised smile
Risk of instability hangs over Italy poll
Result that yields strong government ‘would be a miracle’
Social Unrest In Europe? (BCA Research)

Three crucial stabilizing factors have de-fused the risk of an imminent social explosion in Europe.

  • First, in the powder keg that ignites major social unrest one vital ingredient is missing: inflation. An INSEAD study of social upheaval shows that the young can tolerate unemployment so long as prices are stable, and they expect a brighter future when they eventually find jobs. The good news is that inflation in Europe’s troubled economies is well contained, and coming down.
  • The second stabilizing factor is the role of the family as a vital shock absorber. For example, note that the countries with the highest youth unemployment rates are also the ones with the highest proportion of young adults living with their parents. Effective transfers at the family level are providing the young jobless with essential economic and social support.

Social Unrest In Europe

  • Third and probably most important the official unemployment numbers in some European countries are a fiction. It is an open secret that many of the officially jobless in countries like Greece and Spain are actually working in the shadow economy which encapsulates activity that is unrecorded, unregulated, and untaxed.

Bottom Line: The social, political and economic stability of Europe is much greater than widely believed. Hence, any sell-off on renewed social or political tensions in the coming weeks or months is a possible opportunity to shift into euro area assets.

I don’t subscribe to that view. Today’s youth has little patience. I expect a hot spring in Europe.

UK loses triple A credit rating  Moody’s action cites deteriorating outlook

Sterling hits two-year low on downgrade Moody’s action rattles currency in final minutes of trading


China’s farm produce prices down  Farm produce prices in China have seen a marked decline since mid-February, according to a survey conducted by Xinhua News Agency.

The average price of 21 monitored vegetables declined 11.2 percent from February 10-22, while the price of eggs was down 0.4 percent, said the survey released Friday.

The price of pork, a staple meat in China, dipped mildly, but the price for chicken held steady. Prices of beef and mutton also nudged down.

Food prices account for about one-third of the prices used to calculate the consumer price index (CPI), a main gauge of inflation, in China.


The overall index rose sharply to 61.8 in February. The New Orders index rose again.


High five  Note: this MNI index goes totally against this morning’s Markit flash PMI.

Is China’s Property Market Topping Out?

Investing in property is very important to Chinese people, who are unable to easily move their money overseas and distrustful of the stock market. According to Jing Ulrich, a property cycle in China only lasts about 14 months from beginning to end.

(…) Chinese home buyers in tend to put down a lot more cash and borrow less than their Western counterparts, so interest-rate hikes have less impact on the market. Instead, the government has used requirements for minimum down payments and restrictions on buying multiple homes to cool things down.

Though they never formally relaxed the rules, Ms. Ulrich said authorities judiciously started taking a more laid back attitude to enforcement when it became clear the market was stuttering in the second half of 2012.

Now she is on the lookout for renewed signs of zeal in enforcing the curbs, which would be the easiest way to suppress demand. Buying restrictions could also be extended beyond the 40 or so cities where they are now in force. (…)

Vietnam Inflation Rate Eases as Economy Struggles to Revive  Vietnam’s inflation eased in February as domestic consumption struggled to rebound after a credit crunch that slowed economic growth to a 13-year low.

Consumer prices climbed 7.02 percent from a year earlier after rising 7.07 percent in January, the General Statistics Office in Hanoi said today.

The World Bank in December forecast that Vietnam’s economy will expand 5.5 percent this year, which would mark a third straight year of below-6-percent growth. The increase in gross domestic product averaged 7.3 percent annually in the first decade of this century.


Q4 earnings season ends this week. Factset on S&P 500 companies:

Of the 429 S&P 500 companies that have reported earnings to date for the fourth quarter, 72% have reported earnings above estimates. This percentage is slightly above the average of 69% recorded over the past four quarters. (…)  In terms of revenues, 66% of companies have reported sales above estimates. This percentage is well above the average of 50% recorded over the past four quarters.

Bespoke on NYSE companies: Earnings Season Ends with a Thud

Not only did the season end on a down note regarding the market, but the underlying earnings numbers fell hard this week as well.  As shown below, the final reading for the percentage of US companies that beat Q4 earnings estimates was 61.4%.  This is still a solid number compared to recent quarters, but it actually fell 2.2 percentage points this week.  Of the 252 companies that reported this week, only 48% beat earnings estimates, causing the overall beat rate to drop from 63.6% down to 61.4%. While it hasn’t been mentioned, maybe weak earnings has been a key reason for the market’s drop this week.


The revenue beat rate ended at 62.7% for the fourth quarter reporting period.  As shown below, this is much better than what was seen in the prior two quarters, and it’s the exact same beat rate that was seen during the Q1 2012 reporting period.  Just like the earnings beat rate, the revenue beat rate also fell this week, dropping 1.3 percentage points from a reading of 64% last Friday.


The official S&P tally as of Feb. 21:

Of the 445 companies having reported, 65.8% beat and 24% missed earnings estimates. Ex-IT companies which beat by 83%, the beat rate drops to 62.8%.

Pointing up Q4 EPS are now seen at $23.28, down $0.04 from last week and $0.55 (-2.3%) from Jan. 31. This is the lowest earnings level since Q1’11. It also marks the second consecutive Y/Y decline (-5.1% in Q3).

Trailing 12-month EPS now total $96.95, down 0.5% from Q3’12 and 1.8% from Q2’12. Valuation based on trailing earnings is now facing a mild headwind after enjoying a strong tailwind since mid 2009 (EPS +149%).

Q1’13 estimates remain upbeat at $25.57, +5.5% Y/Y, even though they keep declining albeit at a slower rate lately. If met, trailing earnings would resume growth and reach $98.28 after Q1’13.

Note this, however:

Corporations and analysts are lowering earnings expectations for Q1 2013. In terms of preannouncements, 72 companies have issued negative EPS guidance for Q1 2013, while 23 companies have issued positive EPS guidance.


As of last week, nearly 20% of the S&P 500 companies have pre-announced and 76% were negative. The last few weeks seem to have been particularly difficult for consumer-centric companies. This could begin to hit producers potentially facing excess inventories. Then there is the looming sequester which will hit a host of companies which may have been hoping for a solution that now seems elusive. The risk is clearly tilted toward negative earnings surprises. Read on:

Darden Cuts Guidance, Citing Payroll Tax, Gas Prices

Darden Restaurants Inc., which owns Olive Garden and Red Lobster, cut its fiscal-year profit and revenue outlook, citing “headwinds” from consumers pinched by higher payroll taxes and gasoline prices.

Its less-rosy view comes amid similar warnings from U.S. food and retail chains that have blamed the economy for slowing sales. (…)

“While results midway through the third quarter, [which will end Sunday], were encouraging, there were difficult macroeconomic headwinds during the last month,” Chief Executive Clarence Otis said. Two of the most prominent culprits were increased payroll taxes and rising gasoline prices. (…)

Restaurant analyst Bonnie Riggs, from market research firm NPD Group Inc., said that three weeks ago, which is about when consumers likely saw the impact of the higher payroll tax in their paychecks, restaurants reported a 4% decline in same-store sales, marking the first industrywide, weekly decline that NPD has seen in more than a year and a half. (…)

For the year, Darden now expects earnings from continuing operations of $3.06 to $3.22 a share on sales growth of 6% to 7%, down from its previous view of $3.29 to $3.49 a share in earnings on 7.5% to 8.5% sales growth.

Darden said it expects fiscal third-quarter earnings from continuing operations between $1 and $1.02 a share, below estimates of $1.13 from analysts surveyed by Thomson Reuters.

Q3 will miss by 11% while full FY mid-point EPS are shaved 8%. Big impact.


RBC Capital Markets’ latest sentiment indicator:

Bullishness recently hit its highest level since July 2005 according to our
sentiment indicator. Of the six components that comprise the composite, only the CBOE Put/Call Ratio and the AAII Bull Ratio stand at relatively depressed readings. Unbalanced optimism sets the stage for a pullback in share prices, one in which investors will need to decide whether to lean into or against.



(…) The Standard & Poor’s 500-stock index has gone 505 days without a correction, deemed a 10% drop from a recent high. Since 1962, the index has rallied for at least 500 days without a correction during five separate instances, according to data provided by stock-market research firm Birinyi Associates.

In all five rallies, stocks averaged another 9.2% gain over the next six months and a 13% increase over the ensuing one-year time frames. (…)

“This market’s rally without a 10% pullback is not out of the ordinary,” Kevin Pleines, research analyst at Birinyi, told MarketBeat. He said there is little historical merit to the notion that the market is overdue for a sizable drop. (…)

In a note to clients on Friday, Thomas Lee, chief equity strategist at J.P. Morgan, advocated some near-term caution. He said the S&P 500 would look more compelling if it fell to the 1400-to-1450 range.

Such a drop would be consistent with patterns that have played out since the market bottomed in March 2009. On average, rallies have lasted 55 days and risen 18% in between 5% pullbacks over the last four years, according to research firm Stone & McCarthy Research Associates.

Lately, the S&P 500 has risen 12% throughout the last 66 trading days since its most recent pullback that concluded in mid-November. There have only been four other instances throughout the last four years in which the market has rallied for a longer period of time without at least a 5% pullback, the research firm said.

“We think there could finally be a minor pullback at any time,” said Mark Arbeter, chief technical strategist at S&P Capital IQ. “While we continue to think that the market will grind higher in the weeks to come, risk appears to be rising and the call from here may get a little trickier.”

But on a longer-term time horizon, the rally may have more momentum behind it.

“We are still positive on stocks and believe the bull market will continue,” said Birinyi’s Mr. Pleines. (WSJ)


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