NEW$ & VIEW$ (13 JUNE 2013)

Lightning  Nikkei Enters Bear Market

Markets suffered another bruising day as investors scrambled for the exits, with Japanese stocks entering a bear market. The Nikkei ended 6.4% lower. Declines continued in the U.S. and Europe.

Core benchmark indexes in Europe were all down more than 1%. (…)

The fear that the Fed could change its monetary policy, along with signs that the U.S. economy is recovering, has encouraged investors to pull money out of emerging markets that are typically perceived as risky.

The resulting outflows have hit some of Asia’s smaller markets the hardest—such as the Philippines and Thailand, which were down 6.8% and 2.1% respectively Thursday. Along with Japan, these markets were previously some of the region’s best performers before the selloff started. (…)

In Thailand where the baht has fallen recently, the finance minister said it is at an “appropriate” level and that outflows were to blame. In Korea, the central bank said the yen’s recent swings and the possible end to aggressive monetary easing in the U.S. are key downside risks for the country’s growth.

The other dampener to sentiment came from China. Chinese stocks plunged after markets in the mainland reopened after a three-day public holiday, getting their first chance to react to signs the economy is slowing.

The Shanghai Composite Index hit a six-month low of 2126.22 in the session and finished down 2.8% at 2148.36. The Hang Seng China Enterprises Index, a measure of Chinese companies in Hong Kong, plunged 3.4%, its worst percentage fall since May 2012.

The dollar was last at ¥94.35 compared with ¥96.01 late Wednesday in New York. The dollar hit a two-month low against the dollar of ¥93.76 earlier in the session and has now lost around 9.2% of its value against the yen from the multiyear peak it reached on May 22.

EM economies in danger of overheating, World Bank says
Development bank says growth may be unsustainably fast

Some of the world’s fastest growing emerging economies are in danger of overheating and should tighten monetary or fiscal policy, the World Bank has warned.

The world’s largest development bank called out the Philippines, Thailand and Vietnam in East Asia, Colombia and Ecuador in South America and Ghana in Africa as countries where growth may be unsustainably fast.

Emerging Markets Act to Stem Capital Flight

Emerging markets from Brazil to India took steps to stem an outflow of capital as concern mounts that developed nations are approaching the beginning of the end of an era pumping unprecedented liquidity.

India’s central bank sold dollars the past two days to stem the rupee’s slide, two people familiar with the matter said, while Indonesia unexpectedly raised its benchmark interest rate today. Brazil said yesterday it would unwind some of the capital controls it began putting in place in 2010 — when the Federal Reserve was embarking on its second round of quantitative easing, known as QE2. Thailand said it sold dollars in the past week.

 Indonesia Unexpectedly Raises Rate for First Time Since 2011

Bank Indonesia unexpectedly raised its key interest rate for the first time since 2011 as Governor Agus Martowardojo accelerates efforts to support the currency and cool inflation expectations. The rupiah pared losses.

The central bank increased the reference rate by a quarter of a percentage point to 6 percent, it said in Jakarta today.

Indonesia joins emerging markets such as Brazil in addressing an outflow of capital amid concern that developed nations will scale back the liquidity they have been pumping.

CHINA SUMMARY CHART: Still slowing(Ed Yardeni)

BoJ insider warns on impact of tax rises
Planned tax increases could derail Abe inflation targets

Addressing a meeting of business leaders in Hokkaido, Sayuri Shirai said that the chances of the BoJ hitting its two-year, 2 per cent inflation target were “tilted somewhat to the downside”, bearing in mind the planned rises in Japan’s rate of consumption tax from 5 per cent to 8 per cent next April, and to 10 per cent in 2015.

“If many firms perceive that the price increase triggered by the tax hikes could be sufficiently large to constrain household domestic demand, they may partially postpone raising their final sales prices”, Ms Shirai said.

If that happens, the rate of consumer price inflation “could be lower than that projected by the Bank,” she said. (…)

The comments from Ms Shirai, seen as one of the more dovish figures at the BoJ, mark the first time that a board member has spoken out on the feasibility of the inflation target in the context of Japan’s fiscal tightening.

The overhaul of the country’s consumption tax was the final act of Japan’s previous prime minister, Yoshihiko Noda, who pushed for a deal under which the tax would begin rising provided the government were convinced that the economy was strong enough to bear it.

Mr Abe is expected to make that judgment in October, with some close to the prime minister describing his decision as finely balanced. The last increase in Japan’s consumption tax, from 3 per cent in April 1997, is still blamed by some economists for tipping the country back into recession in 1998. (…)

Lightning  Spanish House Prices Slump

According to data released Thursday from Spain’s National Statistics Institute, or INE, house prices in the first quarter dropped 6.6% from the fourth quarter, the fastest pace since INE began collecting house price data in 2007. The annual pace of decline was 14.3% compared with a year earlier, accelerating from 12.8% in the fourth quarter.

The latest decline is expected to add to pressure on Spanish banks, which are still loaded with loans to developers and are already hurt by tumbling prices and property assets that keep depreciating. In recent months, many of them transferred €50 billion ($66.69 billion) worth of such assets to a “bad bank” created to relieve them of toxic assets in their balance sheets under the terms of a European Union bailout for the banks agreed on last year. But the continued slump in the housing market threatens to create more problematic assets further down the road.

Southern Europeans Flee to Germany

(…) The OECD said around 34,000 Greeks and 28,000 Spaniards moved to Germany between September 2011 and September 2012, according to preliminary data for that period. The number of Greeks and Spaniards emigrating over the four-year period to 2011 more than doubled, the OECD said.

“Altogether, this represents an increase of almost 40,000 additional immigrants from crisis countries to Germany in 2012 compared to 2011,” the report said.

The OECD said that altogether 116,000 people from “crisis countries” had moved to Germany in 2012, and while acknowledging that figure doesn’t constitute an “exodus,” it still shows a “significant contribution to workforce entries in Germany.”



Second-quarter earnings guidance looks extremely weak, with 93 of the 116 preannoucements negative. The healthcare sector has the most negative N/P ratio, and the consumer discretionary sector is also very negative.

Of the 116 second-quarter earnings preannouncements given by S&P 500 companies, 93 of them have been negative, while only 14 have been positive. The resulting 6.6 negative to positive guidance ratio is the most negative since the first quarter of 2001. As seen below in Exhibit 1, the recent trend has been toward more negative preannouncements as earnings growth has slowed. While there is still more guidance to come as the second-quarter earnings season approaches, the N/P ratio as it stands is significantly more negative at 6.6 than for the first quarter, which itself was the most negative since Q3 2001, at 4.3. Exhibit 1.  S&P 500: Negative to Positive Guidance Ratio, 2008–Present

Exhibit 2.  S&P 500: Q2 Guidance — Negative to Positive Ratio by Sector


U.S. Notches Biggest Gain in Oil Output

The U.S. last year posted the biggest increase in oil production in the world and the largest increase in U.S. history, the latest sign of the shale revolution remaking world energy markets.

imageIn the latest sign of the shale revolution remaking world energy markets, crude production in the U.S. jumped 14% last year to 8.9 million barrels a day, according to the newly released Statistical Review of World Energy, an annual compilation of industry trends published by BP PLC for more than six decades.

imageBeyond the U.S., oil production increased almost 7% in Canada, raising North America’s profile as a global oil producer. (…)

While the U.S. shale boom increased production, many other oil-producing regions struggled with declining volumes. U.K. production fell 13.4% in 2012, as some of its North Sea oil fields near their fourth decade of life. Former OPEC member Indonesia experienced a 3.9% decline.

Libya grew its production from 479,000 daily to 1.5 million, mostly because it was able to restart output following disruptions related to its civil war. Powerhouse Saudi Arabia raised its world-leading output almost 4% to 11.5 million barrels per day. (…)

BP said world consumption grew 0.9%. Europe and North America used less oil, while the rest of the world, led by China, used more. (…)

Measured in 2012 dollars, the average oil price last year of $111.67 per barrel of Brent crude was just $2 lower than in 2011, which was the highest price at any time since the post-Civil War boom in Pennsylvania in the 1860s, BP said. Both prices were higher than such watershed years as 2008, when oil nearly hit $150 a barrel in the summer and the average was $103.71 a barrel in current dollars; 1979, when the Iranian revolution roiled markets; and 1973, the year of the Arab oil embargo. (…)

Pointing up  Fed Could Drain the Oil Market’s Tank

There is a shadow looming over oil prices in the shape of a big tank—and a big central bank.

At around 394 million barrels, U.S. commercial stocks of crude oil, excluding the strategic petroleum reserve, are hovering around their highest levels since the early 1980s.

image(Bespoke Investment)

In part, that reflects the shale-led surge in U.S. supply, with domestic production outpacing imports in late May for the first time since January 1997. (…)

Meanwhile, domestic demand is sluggish. The IEA expects it to average slightly less than 18.6 million barrels a day this year, down for the third year in a row. (…)

But another factor keeping inventories high has nothing to do with roughnecks or commuters. It emanates from Washington.

Refiners and oil marketing and trading firms keep stocks on hand to ensure they can supply customers. Low interest rates, facilitated by the Federal Reserve’s policy of quantitative easing, make it cheaper to finance those inventories. Indeed, those low rates can make it very profitable to buy oil, store it and lock in a margin by selling futures.

Energy economist Phil Verleger estimates that with short-term interest rates around 0.25%—roughly in line with Libor—the financing cost of holding stocks today is around two cents a barrel every month. Right now, three-month oil futures trade at about a 30 cents a barrel premium to the spot price. On that basis, assuming 90% leverage, an investor could buy oil and sell it three months forward, earning a 2.5% return after costs.

That might not sound like much. But it is five times the yield on three-month U.S. Treasurys and a no-brainer for a trader at an oil firm with access to storage capacity.

But the trade is getting squeezed over time. Back in February, the spread was around $1 a barrel, implying a return over three months of almost 10%. While spot prices have held pretty steady over the past few years, futures further forward have been slipping, likely reflecting rising expectations for U.S. supply and acceptance that the global economy’s recovery will be a gradual, drawn-out affair.

The upshot is that, with bond yields rising as the end of quantitative easing becomes a more realistic prospect, profits on the carry trade are likely to shrink further. The same trade described above at current spreads but with a 1% financing cost earns a return over three months of less than 0.7%.

As this squeeze becomes more apparent, it can become self-fulfilling as those holding inventories sell them in the expectation that futures will decline further. That liquidation adds further pressure to prices as it increases available supply.

Say 50 million barrels were liquidated over the second half of the year, which would simply bring U.S. inventories down to around their five-year average. That would amount to almost 274,000 barrels a day. To put that in perspective, it equates to about a third of the IEA’s expectation for global oil-demand growth this year.

The past few weeks have seen yields rise globally as bond investors raise their expectations of the Fed taking its foot off the gas. Oil investors won’t be immune.

Smile  U.S. Set for Smallest Deficit in 5 Years

The budget deficit for the first eight months of the fiscal year, which started Oct. 1, totaled $626.33 billion, down about 26% from the same period a year earlier, the Treasury Department said Wednesday in its monthly report.

Under current policies, the deficit is expected to fall to $642 billion for the full fiscal year and get as low as $378 billion in 2015, according to Congressional Budget Office projections. The last time the deficit was under $1 trillion was 2008, when spending outpaced revenue by $458.55 billion.

The government isn’t spending less. Outlays totaled $2.427 trillion from October through May, compared with $2.408 trillion a year earlier.

Rather, receipts so far this year have jumped about 15% to $1.801 trillion, thanks largely to higher payroll taxes, higher tax rates for households making more than $450,000 and stronger incomes.


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