NEW$ & VIEW$ (4 NOVEMBER 2013)

DRIVING BLIND

We had two important U.S. stats last week: the manufacturing PMIs and car sales. Draw  your own conclusions:

The PMIs:

The Institute for Supply Management’s index of industrial activity edged up from 56.2 in September to 56.4 in October, reaching its highest level since April 2011.

The components of the ISM index were somewhat mixed. New orders and new export orders grew faster, while production and employment grew at slower paces compared with the previous month. Prices also increased at a slower pace. But economists still cheered.

(Bespoke Investment)

High five  Wait, wait: Markit’s U.S. PMI report

indicated “only modest improvement in business conditions”, “output growth weakest for over four years“, and “new orders increasing at the slowest pace since April.”

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Car sales:

The seasonally adjusted annual sales pace for October was 15.2 million vehicles, up from 14.4 million a year ago but down from August and September’s pace, said researcher Autodata Corp.

High five  In reality, car sales are not showing any momentum (next 2 charts from CalculatedRisk):

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High five  A longer term chart suggests that car sales are at a cyclical peak if we consider the early 2000s sales levels abnormally high (internet and housing bubbles, mortgage refis):

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This RBC Capital chart shows that even boosted incentives fail to propel sales lately. Can incentives get much higher?

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So, taper or no taper?

HELP COMING?

Oil-Market Bears Are Out in Force The oil market bears are out in force today.

(…) According to Morgan Stanley’s analysis, the structure of the Brent market “is at its weakest point for this time of year since 2010,” and they point out that of the things currently keeping oil prices high—a weaker dollar, the aforementioned Middle Eastern instability and the wide difference between the U.S. and North Sea benchmark prices—all appear more likely to improve than get worse.

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Fingers crossed  Gas prices have dropped 12% since July. They are 7% lower than at this time last year and in line with prices last Christmas. Welcome additional pocket money at this crucial time…image

…because income growth is very very slow.

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THAT’S NOT HELPING
 
US public investment at lowest since 1947
Republicans stymie Obama push for more spending

(…) Gross capital investment by the public sector has dropped to just 3.6 per cent of US output compared with a postwar average of 5 per cent, according to figures compiled by the Financial Times, as austerity bites in the world’s largest economy.

US public investment is at its lowest percentage share of GDP since post-WW2 demobilisation

Construction projects have taken the early hit as budgets come under pressure, with state and local government building fewer schools and highways

Emerging economies show diverging fortunes Brazil’s industrial production misses forecasts, fiscal deficit widens

Industrial production rose 0.7 per cent seasonally adjusted in September, government statistics agency IBGE said. The figure missed expectations for a 1.2 per cent rise, underscoring one of the myriad economic issues the country is facing.

World-Wide Factory Activity, by Country

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China manufacturers squeezed as costs rise
Wage rises and renminbi strength weigh on companies

(…) On top of the stronger Chinese currency, wages in the Pearl River Delta are climbing at double-digit rates each year as factories compete for workers in a tight labour market.

Sean Mahon, managing director of an Irish company called Brandwell that owns several accessory brands and has been coming to the Canton Fair for 20 years, says his suppliers charge 20 per cent more each year for the 3,000 products – everything from umbrellas to underwear – that he sources. (…)

China Industrial Activity Weakening

CEBM’s October survey results indicate that aggregate demand has stabilized, but remains weak. The CEBM Industrial Sales vs. Expectations Index decreased from -4.9% in September to -8.1% in October, suggesting that the industrial activity has again weakened.

Investment was sluggish, while real estate and automobile sectors outperformed. Steel sales dropped substantially relative to the past two months’ sales volume, implying that the investment rebound observed over the past several months is losing steam. Automobile and residential home sales growth exceeded expectations.

In general, external demand was stable in October, but consumption remained weak. Freight forwarding agents reported positive shipment growth due to fee adjustments and shipments being delayed from September. However, absolute shipment volume M/M in October, as well as Y/Y growth, was flat. In consumer sectors, home appliance sales outperformed other products, but, overall, consumer demand remained weak.

Looking forward into November, the forward-looking CEBM Industrial Expectations Index (SA) decreased to -7.7% in November from -7.4% in October, suggesting enterprises have weaker expectations toward next month’s sales demand.

EARNINGS WATCH

S&P updated its data as of Oct. 31 with 356 company results in. The beat rate rose to 69% from 67% the previous week. Beat rates are highest in IT (85%) and Consumer Discretionary (73%) and weakest in Consumer Staples (54%) and Utilities (59%). Factset calculates that

In aggregate, companies are reporting earnings that are 1.4% above expectations. Over the last four quarters on average, actual earnings have surpassed estimates by 3.7%. Over the past four years on average, actual earnings have surpassed estimates by 6.5%. If 1.4% is the final surprise percentage for the quarter, it will mark the lowest surprise percentage since Q4 2008 (-62%).

Q3 earnings are now expected at $26.77, down from $26.94 the previous week and from $26.81 on Sept. 30. It is curious to see good beat rates but flat earnings vs expectations. That could mean that misses are more significant than beats.

At this stage of Q3 2013 earnings season, 79 companies in the index have issued EPS guidance for the fourth quarter. Of these 79 companies, 66 have issued negative EPS guidance and 13 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the fourth quarter is 84% (66 out of 79). This percentage is well above the 5-year average of 63%.

But the average of the last 3 quarters is 79.5% at the same stage, not terribly different considering the small sample.

Q4 estimates keep being tweaked downward. They are now $28.38 compared with $28.52 on Oct. 24 and $28.89 on Sept. 30. Nothing major, so far. In fact, according to Factset

the decline in the bottom-up EPS estimate recorded during the course of the first month (October) of the fourth quarter was lower than the trailing 1-year, 5-year, and 10-year averages.

Money  US bank securities portfolios back in black  Reversal of fortunes as Treasuries rally

Big US banks have seen billions of dollars of losses on their vast portfolios of securities reversed following the recent rally in the price of Treasuries and other assets.

Data released by the Federal Reserve on Friday showed unrealised gains in these portfolios had recovered to $8bn after plummeting into negative territory from June to September, when worries that the central bank might taper its bond-buying programme caused investors to sell securities including US government debt.

Profits on big banks’ securities portfolios plummeted from almost $40bn at the beginning of the year as the yield on the benchmark 10-year Treasury spiked to 3 per cent. The yield on the Treasury note has fallen back to 2.6 per cent in recent weeks, helping to push banks’ securities portfolios back into black.

The recovery will come as a relief to bank executives who had worried that the paper losses, which reached more than $10bn in early September, would translate into lower regulatory capital ratios under new Basel III proposals. (…)

The central bank revealed last week that it would include a sharp rise in interest rates when it next “stress tests” the largest US banks, suggesting it is concerned about rate risk in the financial system.

SENTIMENT WATCH

Europe Stocks Hit Five-Year High

Investors Return to IPOs in Force

Investors are stampeding into initial public offerings at the fastest clip since the financial crisis, fueling a frenzy in the shares of newly listed companies that echoes the technology-stock craze of the late 1990s.

October was the busiest month for U.S.-listed IPOs since 2007, with 33 companies raising more than $12 billion. The coming week is slated to bring a dozen more initial offerings, including Thursday’s expected $1.6 billion stock sale by Twitter Inc., the biggest Internet IPO since Facebook Inc. FB -0.91% ‘s $16 billion sale in May 2012.

The 190 U.S.-listed IPOs this year have raised $49.2 billion, more than the $45 billion raised by the 132 deals during the same period in 2012. (…)

Many of these companies aren’t profitable. But investors increasingly are willing to roll the dice, particularly on technology firms that they say have the potential to “disrupt” the industry. (…)

So far this year, 61% of companies selling U.S.-listed IPOs have lost money in the 12 months preceding their debuts, according to Jay Ritter, professor of finance at the University of Florida. That is the highest percentage since 2000, the year the Nasdaq Composite Index roared to its all-time high of 5048.62. The index closed Friday at 3922.04.

Investors this year are putting a higher value on debut companies’ revenue than at any time since the crisis. The median IPO this year has been priced at five times the past 12 months’ sales, according to Mr. Ritter. That is the highest mark since 2007, when the median ratio was more than six times.

Companies holding their IPOs in the U.S. this year have posted an average 30% gain in share price, according to Dealogic. That compares with a 23.5% advance in the S&P 500 index.

Many IPOs this year have raised funds to pay back debt to private-equity owners rather than to invest in corporate expansion, a use of funds that many observers say is more likely to lead to stronger performance. Thinking smile So far this year, 41% of U.S.-listed IPOs have been of private equity-backed firms, according to Dealogic. (…)

In 1999 and 2000, the median IPO company was valued at more than 25 times past-year sales, according to Mr. Ritter. Many had revenue of less than $50 million. This year, fewer than 40% of IPOs fall into that category.

And so far this year, 3% of the 190 U.S.-listed IPOs have doubled in their first trading day. That compares with 22% of the 536 U.S. debuts in 1999. (…)

Three charts from The Short Side of Long

  • Most bullish newsletter sentiment since 2011 market top

  • Managers are holding extreme net long exposure towards stocks

  • Retail investor cash levels are now at extreme lows

Italy’s economic woes pose existential threat to euro zone

(…) I have lived in Italy for six years and have never seen its citizens worry so much about their children, whether those children are kids, university students or young adults starting families. There is no work, or work so beneath their skill levels they can barely muster the enthusiasm to get out of bed in the morning.

Every young Italian I know is leaving the country, or wants to. The U.S., Canadian and British consulates in Rome are seeing a surge in work-visa applications from desperate Italians.

Statistics released on Thursday confirm that Italy suffers a hellish employment problem. The overall jobless rate ticked up in September to 12.5 per cent, the highest since the records began in 1977. The youth jobless rate also rose, to 40.4 per cent, approaching Greek levels.

Even as the rest of the euro zone emerges from the economic crypt, Italy alone continues to dig its grave, tragically unaware of Warren Buffett’s maxim: “The most important thing to do if you find yourself in a hole is to stop digging.”

Besides being a textbook case for relentless wealth destruction, Italy poses an existential threat to the euro zone. Forget Greece; its economy is the size of a corner store compared with Italy. Italy is a Group of Eight country. Its economy is bigger than Canada’s. It is the euro zone’s third-largest player and second-biggest manufacturer, after Germany. If Italy goes down, the euro zone is finished.

This may sound like newspaper columnist hyperbole. It is not. Only a few days ago, the eminently sober-minded Joerg Asmussen, the German economist who sits on the executive committee of the European Central Bank, said this in a speech in Milan: “The future of the euro area will not be decided in Paris or Berlin, or in Frankfurt or Brussels. It will be decided in Rome.” (…)

A recent article on the London School of Economics website by Roberto Orsi, a professor at the University of Tokyo, was refreshingly brutal in its analysis of Italy. He called it “the perfect showcase of a country which has managed to sink from a condition of prosperous industrial country just two decades ago to a condition of unchallenged economic desertification, total demographic mismanagement, rampant ‘thirdworldization,’ plummeting cultural production and complete political-constitutional chaos.”

Evidence that he is not exaggerating comes from the youth diaspora. Writing this week in The New York Times, Corriere della Sera newspaper columnist Beppe Severgnini noted that 400,000 university graduates have left Italy in the last decade.About 60,000 Italians flee Italy every year, most of them with university degrees. You can’t blame them.

Italy needs an economic revolution, pronto. What’s happening now – a slow-motion suicide – is still a suicide. (…)

 

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