NEW$ & VIEW$ (15 JULY 2013)

THE SEQUESTER HITTING LATE?

Market watchers have marvelled at the relative ease by which the U.S. economy has been absorbing the negative impact of the Sequester so far this year. Perhaps the big test is still to come. According to the latest budget data, the federal government achieved a surplus for the second time in three months. As today’s Hot Chart shows, the balance shows an excess of $100 billion over that period – the biggest since 2007.

The big difference between the April and June surpluses, however, is how they were achieved. In June, it was all about a reduction in spending outlays. As shown, net government outlays fell precipitously to their lowest level since 2003 in June. In fact, the 49% drop between May and June was the biggest drop since at least 1954 for this time of the year. The Sequester is biting and the teeth marks will show on Q3 GDP. (NBF Financial)

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ISI’s company surveys, and particularly their diffusion index, have turned down. “Slower results at homebuilders, auto dealers, and shopping guides were the primary reasons for the deceleration.”

Goods Disinflation Reappears, but Shouldn’t Worry Fed The latest readings on producer prices and import prices show disinflation has not disappeared when it comes to goods.

The core PPI, which excludes food and energy, rose 0.2%. Yearly core inflation at the factory gate has held at just 1.7% for the past four months, compared with 2.6% in June 2012.

Meanwhile, foreign-made goods are becoming cheaper. Import prices excluding oil fell 0.3% in June, the fourth consecutive decline. Nonoil import prices are down 1.0% compared to a year ago. In June 2012, those prices were rising at a 0.6% annual rate.

Pointing up  Glitches Pump Up Gasoline Futures

August reformulated gasoline blendstock, or RBOB, settled 9.61 cents, or 3.2%, higher at $3.1175 a gallon on the New York Mercantile Exchange, the highest settlement for the contract since March 18. Analysts say the rally likely portends higher prices at the pump in the coming weeks.

Despite the recent rally, the U.S. is brimming with spare gasoline, due largely to weak demand. U.S. gasoline inventories now stand at 221 million barrels, their highest level for this time of year since 2001, according to the Energy Information Administration. However, supplies have fallen in recent weeks, whittling down the sizeable surplus.

Already, pump prices have been rising. On Friday, they rose 3.2 cents a gallon to average $3.55 a gallon nationwide, according to auto club AAA. That’s the biggest one-day rise in five months and comes on the heels of this week’s steep rise in oil prices. Mr. Lipow on Friday estimated that pump prices could rise another 10 cents a gallon over the next seven to 10 days.

Well, according to Gasbuddy.com, gas is now $3.62/g. The last time WTI was $105, gas prices nearly hit $4.00. In fact, crude is now 6% above its summer 2012 peak of $99 but gas prices are 5% lower.image

That’s because Brent remains below its year ago level. But for how long?

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Control retail sales (sales excluding autos, gasoline and building material stores, i.e. the portion of retail sales that goes directly into GDP consumption calculations) cratered last year when gas prices spiked from $3.40 to $3.85.

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Also consider these recent revisions, not incorporated in the above chart:

Nominal personal consumption expenditure increased by 0.3% m-o-m in May, in line with consensus expectations. In real terms, consumer spending inched up by a relatively healthy 0.2%. However, the 0.1% monthly rise published initially for April was revised to a 0.1% drop. And this came in addition to the sharp downward revision for Q1 that was published in late June as a part of the GDP report. (Pictet)

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The end result is quite spectacular and shows that consumption growth is on a softer trend than previously thought. Growth in consumer spending in Q1 was revised from 3.4% to 2.6% earlier this week and, with yesterday’s data in hand, we can now calculate that it settled at a soft 1.4% annualised between Q1 and April- May, whereas before the more recent data were published, the pace of increase in consumption between Q1 and April had been measured at 2.3% annualised.

Hmmm…The revised consumption data are a better reflection of the tight financial conditions of the average American following the expiry of the payroll tax cuts.

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Too bad my fishing season is over!

Embarrassed smile  Restaurants Shift to Part-Time

U.S. restaurants added jobs at a much higher pace in the spring, but many say they are replacing full-time jobs with part-time positions, concerned about the new health-care law.

Restaurants and bars have been adding an average of 50,000 jobs monthly since April—about double the rate from 2012. (…)  Overall, leisure-and-hospitality establishments hired more workers than any other industry in June, accounting for 75,000 of the 195,000 jobs added last month, according to the most recent Labor Department report (…).

Views differ on exactly what is driving the hospitality industry’s pickup. (…) But a number of restaurants and other low-wage employers say they are increasing their staffs by hiring more part-time workers to reduce reliance on full-timers before the health-care law takes effect. (…)

For the entire U.S. workforce, employers have added far more part-time employees in 2013—averaging 93,000 a month, seasonally adjusted—than full-time workers, which have averaged 22,000. Last year the reverse was true, with employers adding 31,000 part-time workers monthly, compared with 171,000 full-time ones.

The Affordable Care Act requires employers with 50 or more full-time equivalent workers to offer affordable insurance to employees working 30 or more hours a week or face fines. Some companies have said the requirement could increase their costs significantly, although others have played down the potential hit. (…)

The administration says the law ultimately will help businesses by allowing them to pool risk with other smaller businesses in order to get more competitive rates. (…)

Well, business owners are voting with there feet now, never mind the “ultimate help” from the ACA. The delay announced won’t change the trend. Companies only got a full year to learn to operate with more part-timers.

Banks Are Cautious Even as Profits Rise

J.P. Morgan and Wells Fargo, two of the nation’s largest banks reported better-than-expected profits, but warned that mortgage lending could drop if interest rates stay elevated.

[image]The results from J.P. Morgan Chase & Co. and Wells Fargo & Co. show how even the biggest banks are struggling to overcome lackluster loan demand, a sluggish U.S. economy and a slew of new regulations that are crimping profits.

[image]Both banks exceeded Wall Street estimates, largely because they are scaling back the amount of money they have set aside to cover future losses. Net interest income–the revenue generated from the bank’s loans and other assets, minus their costs–was down at both banks.

J.P. Morgan reported net income of $6.5 billion, or $1.60 a share, versus $4.96 billion, or $1.21 a share, a year earlier. Revenue on a managed basis, which excludes the impact of credit-card securitizations, jumped 13% to $26 billion, beating the estimates of analysts polled by Thomson Reuters.

Wells Fargo reported net income of $5.52 billion, compared with year-earlier income of $4.62 billion. Per-share earnings were 98 cents versus 82 cents a year earlier. Revenue was roughly flat at $21.38 billion. Analysts polled by Thomson Reuters expected per-share earnings of 93 cents on revenue of $21.22 billion. (…)

J.P. Morgan Chief Financial Officer Marianne Lake told analysts Friday that mortgage refinance volumes could drop substantially if interest rates remain unchanged or rise, saying “the market could be reduced by an estimated 30% to 40%” during the second half of the year.

For the second quarter, J.P. Morgan’s mortgage income dipped 14% compared with the same quarter a year earlier.

Wells Fargo Chief Financial Officer Timothy Sloan also warned that refinancings of existing mortgages will decline. Mortgage banking income at the San Francisco lender decreased 3% from the year-ago period. Wells Fargo has a 22% share of U.S. mortgage originations, more than any other lender. (…)

Both banks highlighted several positive signals from consumers and businesses. Average loan balances in J.P. Morgan’s commercial banking unit were $131.6 billion, up 11% from a year earlier and up about 2% from the prior quarter, indicating companies are taking on more credit to fund inventory. Commercial banking recorded a profit of $621 million, down 8% from a year earlier but up 4% from the first quarter.

At Wells Fargo total loans were up 6% amid stronger demand for certain types of loans, specifically in auto loans and credit card growth. Auto-loan originations, for example, were up 9% from the year earlier period to $7.1 billion. Credit card balances were up 9% from the year earlier period. (…)

Change That J.P. Morgan, Wells Can Believe In

Quarterly results from the two big banks show a silver lining to the shift upward in interest rates.

(…) the move higher in rates should take some pressure off net-interest margins. J.P. Morgan said its margin declined to 2.2% from 2.37% the prior quarter, driven in part by higher cash balances. The bank expects the margin to be flat in the second half, though.

And higher rates should, eventually, benefit both the margin and net-interest income. At J.P. Morgan, the rise since May in the 10-year Treasury yield to levels above 2.5% should add about $700 million to net-interest income in 2014.

The benefit would be even greater if rates on shorter-dated instruments also were to rise. But even small gains help. J.P. Morgan has seen its core net-interest income, which came in at $9.5 billion in the second quarter, fall in five of the past six quarters.

The biggest potential benefit of rising rates, albeit one that may take time to materialize, is if they are accurately reflecting an improved economic outlook that translates into loan growth.

J.P. Morgan, Wells and other banks are well-positioned to take advantage of that, given continued increases in deposits. This, coupled with the continued reluctance of companies and consumers to borrow more, has led net loan-to-deposit ratios to keep falling. At J.P. Morgan, this was 59% in the second quarter, compared with 63% a year earlier; at Wells, the ratio fell to 77% from nearly 82%.

US banks: loan strangers
Without lending more, JPMorgan has increased deposits by about 10%

(…) While loan growth has been lacklustre at JPMorgan, it and its rival have increased deposits by about 10 per cent each during the past year. If the economy continues to strengthen and consumers gain confidence, demand for loans should improve, allowing these banks to deploy some of that cash at improving rates. Even if that remains some time off, there is hope that reserve releases can continue to boost the bottom line. The risk is that a jump in interest rates throws borrowers back into duress or squelches the housing market. But if rates rise gently with the economy, it could be a pretty good time to be a bank again.

Here’s the chart courtesy of ZeroHedge:

 

SLOW AND SLOWER

Chinese economy slows to 7.5% growth
Government at risk of missing target for 2013

(…) Virtually every dimension of the Chinese economy registered weaker performance in the second quarter. Industrial output edged down to 8.9 per cent growth year on year in June, from 9.3 per cent in May. Fixed-asset investment slowed to 20.1 per cent growth in year-to-date terms, from 20.6 per cent in May. Exports fell in June for the first time in more than a year. (…)

Quarter-on-quarter growth edged up from 1.6 per cent in the first three months of the year to 1.7 per cent in the second quarter. Retail sales staged a small rebound, climbing to 13.3 per cent growth year on year in June, from 12.8 per cent in May, though they remained well below last year’s pace for the first half as a whole.

A breakdown of the overall growth numbers also showed differing fortunes for different parts of the economy. The services sector expanded 8.3 per cent, while the industrial sector grew 7.6 per cent. (…)

China GDP(FT Data)

From the WSJ:

The deceleration is particularly hard on commodities producers—the biggest beneficiaries of China’s boom. A Standard & Poor’s study of more than 90 of China’s biggest companies found they will cut total capital expenditures this year for the first time in at least a decade. Investments in factories, assembly lines, smelters and telecommunications links tend to create big demand for raw materials that China imports.

China Is Slow and Unbalanced

The payoff for slower growth in China is meant to be a more balanced economy with consumption playing a greater role. So far, though, China’s economy is stuttering without much sign of the hoped for rebalancing.

(…) But the consumption picture is less rosy than June’s data suggest. For starters, the top-line retail sales figure was mostly boosted by higher prices, not more consumption. Moreover, retail-sales growth of 12.7% in the first half of 2013 is actually down from 15.2% growth for all of last year. The National Bureau of Statistics estimates that consumption accounted for 45.2% of GDP growth in the first half of 2013, compared with 51.8% in 2012. In other words, the economy’s not only slowing, it is also getting more off-kilter.

There are good reasons for this. In particular, household-income growth is slowing along with the broader economy. Urban disposable income in China rose 6.5% in the first half, down from 9.6% in 2012.

Beijing’s efforts to get China spending will take much more time. Public pensions and health-insurance benefits remain too low to persuade people to reduce rainy-day savings. The government has promised to increase returns on bank deposits and loosen restrictions on the capacity of migrant workers to access social welfare in cities, but so far, this is mostly policy hot air rather than concrete action.

Meanwhile, China has now recorded five straight quarters of growth below the 8% level the country’s previous leaders set as their unofficial minimum acceptable growth rate for the economy. So far, the new leadership is holding firm on its plan to let growth slow if it benefits the country in the long run. But the shift to a more consumption-led economy seems some way off.

China GDP components

(FT Data)

China Real-Estate Sector Posts Strong Growth

Total property investment in China in the first half of the year rose 20.3% compared with a year earlier to 3.68 trillion yuan ($599.3 billion), according to data released on Monday by the National Bureau of Statistics. That is marginally slower than the 20.6% growth in the first five months of the year.

The statistics bureau doesn’t give data for individual months. Confused smile

Residential and commercial property sales totaled 3.34 trillion yuan in the January-June period, up 43.2% over a year earlier. Sales totaled 2.59 trillion yuan in the five months ended May, up 52.8%.

Construction starts by area in the first half rose 3.8% from a year earlier to 959.01 million square meters. They were up 1% at 736.13 million square meters in the January-May period.

Chinese export downturn accelerates

Trade data provided further signs that China’s economic slowdown gathered pace in June. Official data confirmed signals from the PMI surveys that exports are falling, while a drop in imports also indicated that domestic demand is weakening.

Official trade data showed exports down 3.1% on a year ago in June. That compared with a 1.0% rise in May and was the worst reading since October 2009. The deterioration in the official data comes after Markit’s HSBC manufacturing PMI data showed exports to have fallen for a third successive month in June, dropping at the fastest rate since March 2009.

The trade data also showed imports down 0.7% on a year ago in June after a 0.3% decline in May. These were the first back-to-back declines since October 2009. Falling imports are an indication that demand
has weakened in the domestic economy of mainland China. This corresponds with PMI data which showed the domestic-oriented services economy going through a soft-patch, with new business growth more or less stalling, registering the weakest growth since the services PMI survey was started in late-2005.

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Pointing up By the way, here’s the most reliable chart on China, courtesy of Pictet:

The Li Keqiang index, a proxy for GDP growth based on three components (railway freight, bank loans and electricity consumption) shows the Chinese economy is now running close to 6% growth compared to the official 7.5% GDP growth target for 2013.

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On today’s Q2 GDP numbers, you may want to read FT Alphaville’s post on the “numbers” (Some observations and oddities in China’s Q2 GDP). I find this part most interesting:

(…) nominal GDP growth decelerated much more sharply from 9.6% in Q1 to 8%, as the deflator increased just 0.5% yoy (1.7% yoy in Q1). We find this deflator somewhat too low given the monthly inflation data published over the quarter. In comparison, Q4 2009 had much lower CPI, similar PPI, lower export price inflation and higher import price inflation, but yet the GDP deflator was significantly higher at 1.4% yoy.

Pictet not only has good charts, it also has good wisdom:

The Chinese equity market has corrected sharply down, and is now trading at 7.8 forward P/E which corresponds to 1.5 standard deviation below the longterm average. China is now one of the cheapest markets in Asia ex Japan. The worst of the impact on corporates in the form of increased financing costs in a context of slower growth is yet to come. In this context, we do not see any significant short term catalyst for the Chinese equity market, which remains unattractive.

The Chinese authorities will remain committed to preventing defaults in the financial sector and a risky sharp deleveraging in the corporate sector which means it is unlikely the government can boost the economy. China’s economy has become more vulnerable. The unremitting slowdown in growth reveals how China’s economic model has been running out of steam just when the proliferation of ‘shadow banking’ in the country is heightening the vulnerability of the financial system as a whole.

A positive outcome for the Chinese economy is that the government may stick to its “no stimulus” approach while adopting more prudent monetary policy which would allow for an orderly deleveraging. More importantly, it could also pave the way for the structural reforms China needs to transition towards an exports-driven economic model that is less reliant on investment and more sustainable.

The FT Lex column is also not short on wisdom:

Granted Chinese companies look cheap. Three of China’s big four banks, which make up over a sixth of the weight of the Hang Seng index by market capitalisation, trade below book value. Bank of China now trades at 0.7 times book. But like China’s GDP figures, book values could be revised down many times yet.

GOOD READ: Asia Is Reaching a Turning Point by Blackstone’s Byron Wein:

I spent almost two weeks in Asia in June and in some ways it was an eye-opener.  In past years there was a sense of optimism everywhere you went.  Now you get a feeling of uncertainty touched by apprehension. (…)

E-Zone IP Dips in May

Eurozone manufacturing production in May fell by 0.4% after rising by 1% in April. The output of consumer durables fell sharply, by 2.3%, posting a second drop in a row, a drop of 1.9%. Capital goods output fell by 1.5% in May. That reversed a stronger 2.5% increase in April. Nondurables output rose by 0.6%, rising for the second month in a row. Intermediate goods output accelerated its continuing modest advance rising by 0.4% in May.

Fingers crossed  Despite the setback in May manufacturing output is on an accelerating path. After falling 1.6% over 12 months it is expanding at a 2.6% annual rate over six months and at a 3.7% annual rate over three.

Sad smile  Business Confidence Declines in Survey

Businesses around the world became more gloomy about their prospects in June, an indication that they are unlikely to increase their investment spending and hiring.

Of 11,000 manufacturers and services providers in 17 countries surveyed between June 12 and 26, the proportion expecting an increase in activity over the coming 12 months exceeded the proportion expecting a decline by 30 percentage points—down from 39 percentage points in February, data-analysis firm Markit said. (…)

Markit said the decline in business confidence was most notable in the U.S. and China, with smaller declines recorded in the euro zone and Japan.

“The deterioration in business optimism in the U.S. suggests the pace of economic growth is slowing sharply compared to that seen earlier in the year and calls into question the ability of the economy to continue generating jobs at anything like the pace seen in recent months,” said Chris Williamson, chief economist at Markit. “Any thoughts of an imminent tapering of the Fed’s stimulus are looking premature on this basis.” (…)

Within the euro zone, Markit said there were signs of rising business optimism in some countries that have been at the forefront of the currency area’s fiscal and banking crises, notably Spain and Ireland. But it said confidence was low in Germany and France, the two largest national economies to use the euro.

Red heart  GOOD READ # 2: Actually, a MUST READ: Neils Jensen’ Much Ado about Nothing

EARNINGS WATCH

Factset notes that:

Of the 30 companies that have reported earnings to date for the quarter, 73% have reported earnings above estimates. This percentage is equal to the average of 73% recorded over the past four years. However, only 47% of companies have reported sales above estimates. This percentage is well below the average of 58% recorded over the past four years. If 47% is the final percentage, it will mark the fourth time in the last five quarters that the percentage of companies reporting revenue above estimates finished below 50%.

The blended earnings growth rate for the S&P 500 overall for Q2 2013 is 0.6% this week, slightly above last week’s growth rate of 0.5%. Upside earnings surprises reported by JPMorgan Chase (+11%) and Wells Fargo (+6%) more than offset small downward revisions to estimates for companies in the Energy sector during the week.

Be aware that 70 S&P 500 companies will report this week. Based on the JPM and WFC beats, the tone should be positive:

The Financials sector will be a focus sector for the market during the upcoming week because the sector has the most companies (22) scheduled to release earnings and because the sector is reporting the highest earnings growth of all ten sectors at 18.7%. The sector is reporting a year-over-year increase in earnings of $7.5 billion ($47.8 billion for Q2 2013 compared to $40.2 billion in Q2 2012) for the quarter.

Laughing out loud  INVESTING IS GETTING SIMPLER! (Click to enlarge). Via Greed & Fear (Tks Gary).

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