NEW$ & VIEW$ (1 NOVEMBER 2013)

Europe Sparks Growth Fears Euro Zone Faces Threat of Too Little Inflation

The latest numbers signal that dangerously low inflation—which Japan struggled with for two decades and the U.S. central bank has labored in recent years to avoid—is at Europe’s front door. (…)

Super-low inflation will persist in Europe, economists warn. Euro-zone unemployment in September matched a record-high 12.2%, which could exert downward pressure on wages and spending. Commercial banks are cutting credit to euro-area businesses, especially in the weaker southern rim. (…)

Deflation is less of a risk in the more prosperous north. Inflation is 1.3% in Germany and close to 2% in Austria and the Netherlands. (…)

In emerging markets the rate is closer to 5% to 6%. It is 2.7% in the U.K., whose central bank—like the Fed—bought large amounts of government bonds to keep borrowing costs low. (…)


Euro Down as ECB Cut Eyed

The euro continued to weaken amid growing expectations that low inflation will push the European Central Bank to cut interest rates, possibly as early as next week.

The single currency dropped 1.1% against the dollar Thursday after data showed that inflation in the euro zone fell to a near four-year low in October. Early Friday, the euro dropped further, fetching $1.3532 from $1.3582 late Thursday in New York.

China Home Prices Jump by Most This Year as Demand Defies Curbs

The average price surged 10.7 percent last month from a year earlier to 10,685 yuan ($1,753) per square meter (10.76 square feet), SouFun Holdings Ltd. (SFUN), the nation’s biggest real estate website owner, said in a statement after a survey of 100 cities. Prices rose 1.24 percent from September, the 17th consecutive month of increases. (…)

Last month’s month-on-month increase widened from September’s 1.07 percent, though the number of cities with gains exceeding 1 percent dropped by five to 29, SouFun said. Housing sales in the first nine months surged 34.5 percent to 4.54 trillion yuan from a year earlier, according to government data released Oct. 18.


Over 75% in the earnings season:

Zacks Research:

(…) when all is said done about the Q3 earnings season, we will have a new quarterly record for total earnings and the quarter’s earnings growth rate will likely be the best thus far this year.

Total earnings for the 355  S&P 500 companies that have reported results already, as of Thursday morning October 31st, are up +4.5% from the same period last year, with 67.3% beating earnings expectations with a median surprise of +2.6%. Total revenues for these companies are up +2.9%, with 49% beating revenue expectations with a median surprise of +0.1%.

The earnings beat ratio looks more normal now than was the case earlier in this reporting cycle. It didn’t make much sense for companies to be struggling to beat earnings expectations following the significant estimate cuts in the run up to the reporting season.

The composite earnings growth rate for Q3, combining the results from the 355 that have come out with the 145 still to come, currently remains at +4.2% on +2.4% higher revenues. It is perhaps reasonable to expect that the final Q3 earnings growth tally will likely be not much different from the +3.4% achieved in Q2.

We may not have had much growth in recent quarters, but the expectation is for strong growth resumption in Q4 and beyond. Estimates for Q4 have started coming down, with the current +8.4% growth pace down from last week’s +9.1%. But as the chart below shows, consensus estimates for Q4 and beyond represent a material acceleration in earnings growth.

Guidance has been overwhelmingly negative over the last few quarters and is not much different thus far in Q3 either, a few notable exceptions aside. (…) Given this backdrop, estimates for Q4 will most likely come down quite a bit in the coming weeks.


Thus far, the third-quarter operating profits and sales of S&P 500 companies have topped expectations. As of September 2013, the consensus expected year-over-year increases of 2.3% and 2.8% for Q3-2013’s S&P 500 operating profits with and excluding the index’s financial company members, respectively. As of October 30, these forecasts had been raised to 4.3% and 3.7%.

Nevertheless, the consensus has pared its projections for each subsequent quarter through the second quarter of 2014. For example, the consensus pared its estimate of Q4-2013’s yearly growth by the operating income of the S&P 500’s nonfinancial companies from September’s 8.3% to a recent 5.9%.


David Einhorn’s latest letter to investors warns:

The game of Earnings Expectation Conflation continues. It’s a bit like limbo – with a twist. Though the bar gets lowered every round, the goal is to make it over the bar, rather than go under it.

Here’s what the current round looks like: At the end of June, third quarter S&P 500 index earnings were expected to grow 6.5%. In July, as actual earnings started to come in and companies lowballed the next quarter’s guidance, index earnings expectations were likewise adjusted lower.

As more companies reported “beat and lower” earnings, market expectations continued to fall to the point where third quarter index earnings growth is now expected to be half of what was forecast in June. Of course, when earnings are announced in October and they “beat” the guidance set in July, everyone will celebrate with cake and ice cream. (Never mind that the earnings are actually in line with the original June predictions, or that they’ve lowballed guidance for next quarter – if anyone noticed that, they wouldn’t be able to move to the next round by lowering the December bar, which is currently set at 13% growth.) As the S&P 500 index has  advanced this year mostly through multiple expansion, the index is no longer cheap, particularly considering that we are now almost half a decade into an economic expansion and earnings growth is unexciting.

Pointing up There is evidence of much more (and increasingly creative) speculative behavior. Some companies have convinced the market to embrace earnings reports that ignore what they must pay employees to show up to work every day, provided the employees accept equity rather than cash. We don’t understand how some investors view this as economically different from the company selling shares into the market and using the proceeds to pay workers.

Then there’s the sizable group of companies (including a number of recent IPOs) that are apparently not subject to conventional valuation methods. Many have no profits and no real plan to make future profits. The market doesn’t seem to mind – in fact, it is hard to fall short of such modest expectations and the prices of these stocks have performed particularly well of late.

Finally, there are the market participants whose investment process appears to be “bet on whatever has made money most recently.” They’ve noticed that stocks with large short-interest ratios have materially outperformed over the last year and they continue to invest accordingly. When “high short interest” becomes a viable stock-picking strategy and conventional valuation methods no longer apply for many stocks, we can’t help but feel a sense of déjà vu. We never expected to find ourselves in an environment like this again, given the savings that were lost when the internet bubble popped.


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