NEW$ & VIEW$ (24 OCTOBER 2013)

Japan says exports almost flat as shipments to Asia slow down

Japan’s government downgraded its assessment of export performance for the second consecutive month in October on slowing shipments to Asia — suggesting external demand may now contribute less to Japan’s growth than initially anticipated.

The government left its overall assessment unchanged, saying the economy is set to recover at a moderate rate as high corporate profits fuel capital expenditure, which then spurs labor demand.

Domestic demand, boosted by increasing public works and consumer spending, has largely driven Japan’s recovery from recession last year, but signs of weakening exports may mean Japan having to rely even more on domestic demand to continue growing.

“Exports are almost flat,” the government said in its report for October. “Exports are expected to pick up in the future, because overseas economies are stable and because the yen has weakened, but we must be mindful of downside risks to overseas economies.”

That assessment marked a further downgrade from last month, when the government noted recent gains in exports had started to slow.

It was also the first time in three years that the government downgraded exports for two consecutive months.

A decline in export volumes due to lower shipments of cars to the United States, India and Southeast Asian countries prompted the downgrade in October.

The government left unchanged its view that industrial output is slowly increasing and that business investment is showing signs of picking up — mainly among non-manufacturers.

On deflation, the government’s view was unchanged from September, saying Japan is approaching an end to deflation as consumer prices, excluding fresh food and energy, were firming up.

LA area Port Traffic in September

On a rolling 12 month basis, inbound traffic was up 0.4% in September compared to the rolling 12 months ending in August.   Outbound traffic decreased slightly compared to August.

ARCHITECTURE BILLINGS RISE IN SEPTEMBER

Showing a steady increase in the demand for design services, the Architecture Billings Index (ABI) continues to accelerate, as it reached its second highest level of the year. As a leading economic indicator of construction activity, the ABI reflects the approximate nine to twelve month lead time between architecture billings and construction spending.

The American Institute of Architects (AIA) reported the September ABI score was 54.3, up from a mark of 53.8 in August. This score reflects an increase in design services (any score above 50 indicates an increase in billings). The new projects inquiry index was 58.6, down from the reading of 63.0 the previous month.

Bank of Canada Drops Bias to Lift 1% Policy Rate

Bank of Canada Governor Stephen Poloz surprised investors by dropping language about the need for future interest rate increases, a move that’s leading to investor speculation about possible rate cuts.

Poloz removed the language, which had been in place for more than a year, citing greater slack in the economy, while keeping his benchmark rate on overnight loans between commercial banks at 1 percent for the 25th consecutive meeting today. The country’s currency and government bond yields fell after the announcement.

The Canadian dollar fell 1 percent to C$1.0385 per U.S. dollar at 4:16 p.m. in Toronto. One dollar buys 96.29 U.S. cents. Government bond yields fell, with the five-year security declining to 1.73 percent from 1.79 percent. (Chart from BMO Capital)

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SENTIMENT WATCH

U.S. Equities: Lift-Off

The short-term resolution to Washington’s folly ignited stocks last week, kicking off what looks to be an equity overshoot phase. Even a soft earnings season is unlikely to derail the budding positive momentum in the broad market: investors may award a ‘free pass’ to the business sector, as uncertainty and modest order book softness is expected given the U.S. government shenanigans.US Equitites - Lift Off

More importantly, lost in the shuffle has been the simultaneous easing in three main reflationary variables.

  • First, the U.S. dollar is drifting lower, reflecting the official nomination of noted policy dove Janet Yellen as the new Fed Chairperson, and the expectation that liquidity settings will remain extremely generous.
  • Second, Treasury yields are moving sideways, digesting this year’s rapid advance. Prospects for another budget battle in the coming months suggest that the Fed may well delay tapering further. Thus, another sudden surge in yields is not imminent.
  • Third, oil prices are easing, reducing a drain on global consumer and business purchasing power, especially in the developing world where weak currencies have exacerbated the impact.

The reflationary push from these three natural economic stabilizers will add to the positive economic momentum that has been slowly but steadily building all year. Our profit model has hooked back up, and capital spending indicators are accelerating, implying that the transition to a self-reinforcing economic expansion remains intact. With reduced fiscal drag next year, growth could surprise on the strong side.

That said:

STRETCHED VALUATIONS

The Rule of 20 valuation barometer is approaching “fair value” which it has not exceeded during his bull market. The risk return ratio is getting unfavourable to investors based on trailing earnings and inflation. Equities do occasionally reach into overvalued territory and sometimes pretty high into it and for extended periods (click on charts to enlarge).

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The Rule of 20 is not a forecasting tool, it is a risk measurement tool enabling investors to objectively measure the potential reward vs the risk of owning equities at any point in time.

Other than the Rule of 20, I also look at some basic absolute valuation parameters on U.S equities. CPMS is a Morningstar software that I have profitably been using since 1985. The charts are not fancy but the data is reliable. The first chart plots Price/Sales for the median U.S. company in the CPMS database (2185 stocks) against net profit margins on the CPMS median.

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The median P/S is at its 20 year peak but so is the median profit margin. The gap between both lines is nearly as wide as it was in 2007, suggesting that expectations are for a continuation of record high margins. In fact, the red dot on the top right corner is the bottom up forecast for margins in 2014, a jump from 8.2% to 10%. Obvious irrational exuberance. Keep in mind that “sales” are barely growing, meaning that the denominator offers little upside to the P/S ratio.

The next chart looks at balance sheet values. It shows Price/Book Value against ROE for the median company in the CPMS universe.

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The median P/B is near its 20 year high but this is not supported by the median ROE, unless you want to buy analyst forecasts for 2014 which see ROEs jumping 200 bps to 12.8% (red dot), a rather heroic achievement in today’s environment. Note that the median ROE has been declining steadily since early 2012!

This is not my definition of “Buy low, sell high”. We are clearly defying gravity here. How lucky to you feel?

EARNINGS WATCH

We now have 181 companies representing 42% of the S&P 500 Index having reported so far. The earnings beat rate is now 61% (56% yesterday) while the revenue beat rate is 28% (unchanged from yesterday) as per RBC Capital’s calculations.

BANKING

Reset Switch: Is the Can Coming to the End of the Road?

From The Institutional Risk Analyst:

We invented an early warning operating bank stress indicator (BSI) in 2004 that was based on what were then the optimistic visions of Basel II and the global economy. (…)

We tracked the comings and goings the U.S. banking industry through the 2008 crisis and subsequent recovery. We started giving speaker presentations on the journey this systemic stress showing how as a whole, the banking industry population today has a stress profile similar to where it was just prior to the 2008 crisis. (…)

Since the beginning of 2013, we’ve seen a number of banks drop from what were steadily improving BSI scores in the A to A+ range back down to F’s. The subset of the population doing this is small but statistically significant enough to warrant us putting the pattern into exception analysis follow up. What reveals so far is that the time has come to recognize asset value degradations.

Some banks look to have carried loans at book value hoping that the economy would improve substantially before rules on revaluation triggered and the clock seems to have run out on the bet. Aggregate 1-4 residential lending on bank balance sheets is still around 14 percent below a beginning of 2008 baseline and current property valuations dictate that the write down process needs to begin recognition. Similar stresses also seem to be manifesting in some banks’ commercial real estate lending books.

(…)  From years of observation, we note that banks typically do their write downs as part of their 4th quarter end of year filings. At the moment we do expect most will survive the pain but do worry a little that the regulatory and counterparty burden on what will be materially weaker institutions could cause secondary effects to a still jittery market. (…)

 

4 thoughts on “NEW$ & VIEW$ (24 OCTOBER 2013)

  1. Stock buy backs seem to have had a large impact on stock prices. The interest rate scare of May/June is over so will the buy backs just continue to offset earnings malaise until we get another scare?

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