NEW$ & VIEW$ (19 AUGUST 2013)

EARNINGS WATCH

We now have Q2 reports from 446 of the S&P 500 companies. Based on S&P data, the beat rate slipped again to 65.2% while the miss rate rose to 27.3%. Interestingly and worryingly, only 3 sectors had a higher beat rate than the average: Health Care (76.9%), Financials (70.4%) and IT (71.9%). The other 7 sectors had a beat rate of 59.7%, down from 62.3% in Q1 and an average of 61.7% in the 3 previous quarters.

Factset notes that 92 companies have preannounced Q3, 81.5% negative. That compares with 94 preannouncements at the same time after Q1 with 79.8% negative and 95 preannouncements after Q4’12 with 75.8% negative. Of the 92 recent preannouncements, 49 were in the 3 sectors with the highest beat rates in Q2 and 40 (81.6%) were negative.

Q2’13 earnings are now estimated at $26.38, up 3.7% YoY. Trailing 12-month operating earnings would thus reach $99.30, up 1.0% from their level after Q1 and barely exceeding the last 18 months tight range of $97.40-$98.69.

Q3 estimates are $27.14, up 13% YoY while Q4 is seen jumping a whopping 26% YoY. Analysts are not meaningfully reducing their second half forecasts even though revenues are up a slow 3.4% YoY and trailing 4-quarter margins have plateaued during the last 12 months. They are obviously counting (hoping?) on a recovery from the weak Q3 and Q4’12 margins but even a return to 2011 margins would not boost earnings anywhere near their forecasts unless revenues really take off. I calculate that assuming quarterly margins return to their 2012 peak levels on a 5% increase in revenues, operating profits would rise 12% in Q3 and 13.5% in Q4. These apparently optimum conditions would take full year EPS to $105.30, nearly 3% lower than current expectations of $108.41.

Adding to the risk, it should be noted that only Financials recorded a meaningful increase in margins in Q2 (14.8% vs 12.4% last year). Ex-Financials, S&P calculates that earnings grew only 1.1% as margins declined from 9.2% last year to 8.9%. Trailing 4Q margins ex-Financials have been in a downtrend since Q3’11, dropping steadily from 9% to 8.6% during this 2-year period.

Hmmm…

And here’s something that won’t help:

Productivity Growth Comes To A Halt

Cape crusader
Ratio is too negative, says Jeremy Siegel

Jeremy Siegel adds his support to my views on the Shiller P/E and profit margins in today’s FT:

(…) I believe the Cape ratio’s overly pessimistic predictions are based on biased earnings data. Changes in the accounting standards in the 1990s forced companies to charge large write-offs when assets they hold fall in price, but when assets rise in price they do not boost earnings unless the asset is sold. This change in earnings patterns is evident when comparing the cyclical behaviour of Standard and Poor’s earnings series with the after-tax profit series published in the National Income and Product Accounts (NIPA). (…)

Downward biased S&P earnings send average 10-year earnings down and bias the Cape ratio upward. In fact, when NIPA profits are substituted for S&P reported earnings in the Cape model, the current market shows no overvaluation.

On the above, Prof. Siegel omits another important flaw of the current CAPE reading: most of the companies that recorded humongous losses in 2008-09 are no longer in the index. As I wrote in The Shiller P/E: Alas, A Useless Friend:

This is like assessing a baseball team’s current batting line-up using 10-year data that includes the dismal stats of now deceased players. How useful is that?

On profit margins:

A second argument used by bears is that the profit margins (the ratio of earnings to sales) of US companies are at unsustainably high levels and are likely to fall. Indeed, in 2012 profit margins of S&P 500 companies (based on operating income) reached 8.9 per cent, well above the long-term average of 7.2 per cent.

But David Bianco, chief equity strategist at Deutsche Bank, has shown that most of the margin expansion over the past 15 years has come from two factors: the increased proportion of foreign profits, which have higher margins because of lower corporate tax rates; and the increased weight of the technology sector in the S&P 500 index, a sector that usually carries the highest profit margins.

Higher profit margins also result from stronger balance sheets. The Federal Reserve reports that since 1996, the ratio of corporate liquid assets to short-term liabilities has nearly doubled, and the proportion of credit market debt that is long term has increased to almost 80 per cent from about 50 per cent. This means many companies have locked in the recent record low interest rates and will be much less sensitive to any future increase in rates, keeping margins high. (…)

Economists Trim 2013 GDP Growth Forecasts

The third-quarter survey of 41 forecasters done by the Federal Reserve Bank of Philadelphia shows the consensus view on gross domestic product expects growth of 1.5% for all of this year, down significantly from 2.0% expected when the survey was last done in May.

Part of the downward revision reflects the refiguring of historical GDP reported last month by the Commerce Department. But the economists in the Philadelphia Fed survey also expect the second half of 2013 will be less robust than they expected three months ago. The median forecast thinks real GDP will grow 2.2% this quarter and 2.3% in the fourth quarter, down from 2.3% and 2.7%, respectively.

For 2014, forecasters expect real GDP to grow 2.6%, down from 2.8% projected in May.

Asia Faces Higher Borrowing Costs

Low rates have been a significant motor of Asia’s developing economies. Now, rising U.S. rates are making it harder for Asian issuers to raise funds cheaply.

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Debt loads in emerging Asia—measured as total public and private borrowing as a percentage of gross domestic product—rose to 155% in mid-2012 from 133% in 2008, according to McKinsey Global Institute, a unit of consulting firm McKinsey & Co.

Thai Economy Slows Sharply

Thailand’s economy entered a technical recession in the three months through June as China’s slowing growth and weak demand in the U.S. continued to weigh on exports, adding to signs of woes across Asia.

Thai gross domestic product, the broadest measure of economic activity, contracted 0.3% on a seasonally adjusted basis from the first quarter. GDP was 1.7% lower in the first three months of 2013 compared with the previous period.

The planning agency downgraded its full-year growth forecast to between 3.8% and 4.3% from a previous range of 4.2% t0 5.2%.

Thai exports fell 1.4% on quarter, driven lower by weak overseas sales to China, Thailand’s largest market, as well as the U.S. and Europe. Private consumption was 1.9% lower on quarter as the government phased out a tax-rebate program. The nation’s current account swung from a $1.3 billion surplus in the first quarter to a $5.1 billion deficit in the second quarter as exports slumped.

India fails to prevent fresh falls for the rupee

Currency hits new record low despite government measures

 

India and Indonesia appeared trapped in a race to the bottom on Monday, as both the rupee and the rupiah fell sharply against the US dollar, prompting a sell-off in equities.

The Indian rupee continued its relentless decline, hitting the latest in a series of all-time lows against the US dollar and dashing hopes the government had succeeded in calming the country’s unsettled financial markets. (…)

Like India, Indonesia relies on foreign capital to fund its deficits. But global investors have been pulling back from emerging markets since May, amid expectations the US could soon start reversing its ultra-loose monetary policy. (…)

The fresh currency falls also increased pressure on the debt markets. Yields on India’s 10-year debt spiked above 9 per cent for the first time since late 2011, while Jakarta’s cost of borrowing jumped 18 basis points to the highest level since March 2011. (…)

From FT Alphaville:

That’s the Jakarta Composite down more than 5.5 per cent at pixel time on Monday, anyway.

U.S. Manufacturers Regain Footing

After a decade of losing ground to China and other export powerhouses, U.S. manufacturers are finally showing signs of regaining their competitive edge.

(…) In a report for release Tuesday, BCG says rising exports and “reshoring” of production to the U.S. from China “could create 2.5 million to five million American factory and service jobs associated with increased manufacturing” by 2020. That, BCG says, could reduce the unemployment rate, currently 7.4%, by as much as two to three percentage points.

The overall U.S. trade deficit, meanwhile, narrowed recently, as new shale-drilling technologies have sharply boosted domestic energy production.

At present, about 12 million Americans are directly employed by manufacturers, down from nearly 17 million two decades ago. (…)

The U.S. accounted for 11% of global exports of manufactured goods in 2011, down from 19% in 2000, Mr. Preeg said. During the same period, China’s share rocketed to nearly 21% from 7%, and the European Union slipped to 20% from 22%.

China’s performance has cooled recently. U.S. exports of manufacturing goods to China surged 19% to $19.9 billion in the second quarter, Mr. Preeg said, but that is about one-fifth of China’s manufacturing exports to the U.S. (…)

Meanwhile, China no longer relies heavily on labor-cost advantages to get a leg up on other countries. As wages rise, China has shifted to more exports of higher-tech items, including telecommunications equipment, computers and scientific instruments, Mr. Preeg said. Only about 15% of China’s manufacturing exports are in labor-intensive industries, such as textiles or shoes, he said.

Value of US fuel exports soars
Petroleum and coal top growth rankings at $110.2bn

(…) According to Census bureau export data reviewed by the FT, the value of petroleum and coal exports more than doubled from $51.5bn in the year to June 2010 to $110.2bn in the year to June 2013. This placed it at the top of the rankings of export growth.

Oil and gas exports were second, with a 68.3 per cent increase over the same period but based on smaller nominal values. Primary metals and livestock exports have also experienced strong export growth under Mr Obama, well above the average 32.7 per cent for all commodities. (…)

China’s House Prices Spark Concern

[image](…) Prices rose an average 6.7% year-over-year in July, up from 6.1% in June, calculations by The Wall Street Journal based on official data released Sunday showed. On a month-to-month basis, the increase in prices moderated slightly. (…)

New home prices in major cities like Beijing, Shanghai and Guangzhou showed the largest gains in July. Export hub Guangzhou in China’s southeast recorded the largest year-over-year gain among the 70 cities tracked—a 17.2% increase. On a sequential basis, the increase in prices moderated—up 0.68% month-to-month in July, down from 0.78% in June, calculations showed.

Pointing up  China’s Xi Embraces Mao as He Tightens Grip

 

(…) It isn’t just Mr. Xi’s rhetoric that has taken on a Maoist tinge in recent months. He has borrowed from Mao’s tactical playbook, launching a “rectification” campaign to purify the Communist Party, while tightening limits on discussion of ideas such as democracy, rule of law and enforcement of the constitution.

Mr. Xi’s apparent lurch to the left comes as Chinese authorities prepare for the coming trial of Bo Xilai, the former party rising star who led a Maoist revival movement until his dramatic downfall last year. Two of Mr. Bo’s lawyers said they expected the trial where he faces corruption charges to take place next week. Before he was detained, Mr. Bo rejected allegations of corruption.

The Chinese president’s Maoist leanings have dismayed many advocates of political reform, who hoped that Mr. Bo’s downfall signaled a repudiation of his autocratic leadership style and might lead to a strengthening of the rule of law and other limits on party power.

But Mr. Xi’s recent record has delighted and emboldened many former Bo supporters who advocate stronger, centralized leadership as the solution to the country’s problems. (…)

Mr. Xi’s use of Maoist imagery, rhetoric and strategy sets him apart from his two predecessors—who both emphasized collective leadership—and suggests to many party insiders that he won’t pursue meaningful political reform during the 10 years he is expected to stay in power. (…)

The new Chinese leadership has also ordered officials to combat the spread of “seven serious problems” including universal values, press freedom, civil society and judicial independence.

At the same time, state media have published a series of attacks on civil society and “constitutionalism”—the idea that the party’s power be limited by China’s existing constitution. (…)

Mr. Xi’s attitude toward political reform is a critical issue in China today because the country may be entering a prolonged period of slower economic growth and mounting public discontent over environmental problems, patchy public services and widespread corruption. (…)

On the political front, however, Mr. Xi has shown no sign of considering even limited liberalization, party insiders say. “Xi is really starting to show his true colors,” said one childhood friend who recalls Mr. Xi spending hours reading books on Marxist and Maoist theory as a teenager. “I think this is just the beginning.” (…)

Yet rather than losing faith in one-party rule, both Mr. Xi and Mr. Bo had worked harder than many contemporaries to prove their allegiance to Mao as young men, and had been left with a heightened sense of how to get ahead in Chinese politics.

“Their thinking is quite similar: They have the same Maoist education, the same red family background, and the same experiences growing up,” said Zhang Lifan, a historian whose father was a senior official. “When they face a problem, they revert quickly to Maoist thinking.” (…)

Ninja  Russia Moves to Restrict Imports if Ukraine Signs EU Deal

Russia is moving to clamp down on imports from Ukraine if its ex-Soviet neighbor signs a landmark free-trade and political-association deal with the European Union, a senior adviser to President Vladimir Putin said.

The comments Sunday by Sergei Glazyev, a senior economic advisor to Mr. Putin, signal a more forceful approach by the Kremlin to the potential deal, which could anchor Ukraine, for centuries ruled from Moscow, more firmly in the West. Moscow is urging Ukraine, a Texas-sized country sandwiched between Russia and the EU, to join a rival trade bloc that it is forming with other former Soviet republics.

Russia last week began tougher checks at the border that Ukrainian exporters said stalled shipments and caused serious financial losses.

Mr. Glazyev said Sunday that those checks were “preventative measures” in preparation for changes in customs procedures if Ukraine signs the EU pact. (…)

A post on Swedish Foreign Minister Carl Bildt’s Twitter blog Thursday said it would be “very serious” if Russia was starting a “silent trade war against Ukraine to block its relations with the EU.”

SENTIMENT WATCH

U.S. Stocks Beat BRICs by Most Ever on Emerging Flight

Almost $95 billion was poured into exchange-traded funds of American shares this year, while developing-nation ETFs saw withdrawals of $8.4 billion, according to data compiled by Bloomberg. The Standard & Poor’s 500 Index (SPX) trades at 16 times profit, 70 percent more than the MSCI Emerging Markets Index. A measure of historical price swings indicates the U.S. market is the calmest in more than six years compared with shares from China, Brazil, India and Russia.

Cash is draining from emerging-market ETFs and flowing into U.S. stock funds at the fastest rate on record as bulls say an unprecedented third year of higher earnings growth will support the S&P 500 even as the Federal Reserve begins to remove stimulus. Developing-nation investors say the ETFs will lure more cash after equity valuations reached a four-year low. (…)

The last time U.S. shares traded at such a premium and volatility versus emerging-markets was similar to now, was in June 2004, when the Fed started to raise interest rates from a 45-year low of 1 percent. Emerging markets rallied 29 percentage points more than the S&P 500 in the next 12 months, according to Bloomberg data. (…)

 

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