NEW$ & VIEW$ (27 JANUARY 2014)

Emerging markets turmoil intensifies
Turkish central bank calls emergency meeting to tackle falling lira

The emerging markets sell-off intensified on Monday with stocks heading for their worst day in almost six months even before Latin American bourses opened, and currencies weakened further until the Turkish central bank prompted speculation it might raise rates by calling an emergency meeting. (…)

The FTSE Emerging Markets index was 1.4 per cent down in early afternoon London trading on Monday – and is more than 6.2 per cent weaker for the year. Hong Kong’s stock market fell 2.1 per cent, Taiwan’s tumbled 1.6 per cent and Indonesia’s dropped 2.6 per cent. (…)

U.S. Markets Tumble as Fear Spreads

U.S. stocks tumbled Friday to their biggest loss in more than seven months, extending a global selloff that investors fear signals turmoil to come as financial markets adjust to a pullback in central-bank stimulus.

The Dow Jones Industrial Average fell 318.24 points, or 2%, to 15879.11. The Stoxx Europe 600 lost 2.39%, and Germany’s DAX, down 2.48%, had its sharpest fall in months. The Nikkei also fell 1.94%.

While those drops were dramatic, much of the pain of investors’ readjustment is landing on developing economies, from Brazil and India to Thailand and South Africa. (…)

Friday’s swoon was notable for its breadth—nearly all major equity markets were in the red. In foreign-exchange markets, the selloff began with currencies such as the South African rand and Turkish lira that have been viewed as vulnerable because of sluggish domestic growth. But it soon spread to currencies of countries with relatively solid fundamentals, such as Mexico’s peso and South Korea’s won. Currencies also slid in Eastern Europe. (…)

WHAT NOW?

When equity markets foray into not-so-cheap territory, investors get nervous and edgy, ready to jump ship at the first alarm bell, justified or not. Even more so if the Fed is off the gas pedal. Argentina, South Africa and Turkey cannot wag the U.S. economic dog, but they can wag its financial dog for a while. Here’s Ben Hunt’s take on this latest EM rout:

For 20+ years there has been a coherent growth story around Emerging Markets, where the label “Emerging Market” had real meaning within a common knowledge perspective. Today .. not so much. Today the story is that it was easy money from the Fed that drove global growth, EM or otherwise. Today the story is that Emerging Markets are just the levered beneficiaries or victims of Fed monetary policy, no different than anyone else.

In my note, (It Was Barzini All Along), I’m not asking whether the growth rate in this EM country or that EM country will meet expectations, or whether the currency in this EM country or that EM country will come under more or less pressure. I’m asking if the WHY of EM growth and currency valuation has changed. The WHY is the dominant Narrative of a market, the set of tectonic plates on which investment terra firma rests. When any WHY is questioned and challenged – as it certainly is in the case of EM markets today – you get a tremor. But if the WHY changes you get an earthquake.

What are the investments that such an earthquake would challenge? You don’t want to be short the yen if this earthquake hits. You don’t want to be long growth or anything that’s geared to global growth, like energy or commodities. You don’t want to be overweight equities and underweight bonds. You don’t want to be overweight Europe. There .. did I cover one of your favorite investment themes? Bet I did. You can run from EM’s with US equities, but with S&P 500 earnings driven by non-US revenues you cannot hide. If you think that your dividend-paying large-cap US equities are immune to what happens in China and Brazil and Turkey .. well, good luck with that. My point is not to sell everything and run for the hills. My point is that your risk antennae should be quivering, too.

The U.S. “investment terra firma”, for now, is in Q4 earnings:

EARNINGS WATCH

Factset gives us a good rundown after the first quarter:

Overall, 123 companies have reported earnings to date for the third quarter. Of these 123 companies, 68% have reported actual EPS above the mean EPS estimate and 32% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year (71%) average and the 4-year (73%) average.

Note that S&P’s tally shows 66% beats and 24% misses.

In aggregate, companies are reporting earnings that are 2.7% above expectations. This surprise percentage is below the 1-year (3.3%) average and the 4-year (5.8%) average. Companies in the Information Technology (+6.6%) are reporting the largest upside aggregate differences between actual earnings and estimated earnings. On the other hand, companies in the Industrials (+0.7%) sector are reporting the smallest upside aggregate differences between actual earnings and estimated earnings.

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In terms of revenues, 67% of companies have reported actual sales above estimated sales and 33% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the average percentage recorded over the last four quarters (54%) and above the average percentage recorded over the previous four years (59%).

In aggregate, companies are reporting sales that are 0.7% above expectations. This percentage is above the 1-year (0.4%) average and above the 4-year (0.6%) average.

The blended earnings growth rate for Q4 2013 of 6.4% is slightly above the estimate of 6.3% at the end of the quarter (December 31). Four of the  sectors have recorded an increase in earnings growth during this time frame, led by the Information Technology (to 5.9% from 3.3%) sector. Five of the ten sectors have seen a decline in earnings growth since the end of the quarter, led by the Energy (to -10.9% from -8.0%) and Consumer Discretionary (to 3.7% from 6.2%) sectors.

The Financials sector has the highest earnings growth rate (23.5%) of all ten sectors. It is also the largest contributor to earnings growth for the entire index. If the Financials sector is excluded, the earnings growth rate for the S&P 500 falls to 3.1%.

Other than Energy and Consumer Discretionary, the earnings season is going pretty smooth so far.

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In fact, earnings estimates for Q4’13 have been rising in recent weeks from their low point of $28.14 on Jan. 9 to their current $28.77, a not insignificant 2.2% creep up. As a result, trailing 12 months EPS would reach $107.82 after Q4.

But there is this new variable:

Multinationals Start Warning on Q1 Currency Impacts

As currencies in emerging markets tumbled this week, Procter & Gamble Co. and Stanley Black & Decker Inc. warned investors Friday their earnings could take a hit. (…)

Procter & Gamble’s cautioned investors that foreign-exchange swings in the fourth quarter shaved 11 cents a share off earnings, which came in at $1.18 a share. And there’s not much, the company can do to offset the damage, said Jon Moeller, chief financial officer, according to a transcript of a conference call provided by FactSet.

(…) And though the company is still looking for ways to hedge financially, much of its currency woes stem from countries like Egypt, Venezuela, Argentina and Ukraine, “where there really isn’t a financial hedging option.” And even in countries where hedging is possible, “the cost of forward hedging gets pretty prohibitive.” (…)

Stanley Black & Decker CFO Donald Allan said currencies, including the Canadian dollar, Brazilian real and Argentine peso, dragged down earnings and would continue to do so this year. While the euro showed strength over the course of 2013, he said the Canadian dollar fell 11% against the dollar last year, the real lost 15% and the peso plunged 40%.

“We saw about $60 million of negative currency effects in 2013, primarily in the back half of the year,” Mr. Allen said on a conference call. “We would expect a very similar number to occur in the first half of the 2014, which would equate to about a 30-cent negative to in [earnings per share].”

The toolmaker reiterated its guidance for earnings of 2014 earnings of $5.18 to $5.38.

That said, Factset finds little panic among companies, so far:

Q1 Guidance: At this point in time, 25 companies in the index have issued EPS guidance for the first quarter. Of these 25 companies, 18 have issued negative EPS guidance and 7 have issued positive EPS guidance. Thus, the
percentage of companies issuing negative EPS guidance to date for the first quarter is 72% (18 out of 25). This percentage is above the 5-year average of 64%, but below the percentage at this same point in time for Q4 2013 (86%).

Nine of the 18 companies with negative guidance are in IT, 5 in Consumer Disc. and 3 in Health Care.

Analysts are paring down their expectations for Q1 however:

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Using S&P numbers, Q1’14 estimates are now $28.30, down 0.6% from their level of 2 weeks ago. Trailing 12-month EPS would thus reach $110.35, up 2.3% from their expected Q4’13 level. Full year 2014 estimates have been shaved 0.3% to $121.09, up 12.3% YoY.

For the third time since 2009, the S&P 500 Index failed to cross the “20” line on the Rule of 20 barometer. If it were to retreat to the 15-16 Rule of 20 P/E range like it did in 2010 and 2012, the S&P 500 Index would decline to between 1435 (another -20%) and 1540 (-14%), assuming inflation is 1.7%. Given the current state of the world economy (good in the U.S., better in Europe and OK in China), it seems doubtful that we would revisit such deep undervaluation territory. Central banks would no doubt intervene and keep the financial heroin plentiful.

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Given that trailing earnings remain in an uptrend and that inflation is stable, my sense is that the still rising 200-day (1700) moving average will hold the rout to another 5%. The Rule of 20 P/E would then be 17.5, right in the middle of the 15 (deep undervalue) and the 20 (fair value) range. In both the 2010 and 2012 corrections, the Rule of 20 Fair Index Value (yellow line on chart) was declining as inflation picked up temporarily, conditions not currently present.

Also consider that for most global investors, the U.S. must currently be seen as the only trustworthy terra firma from economic, financial and political points of view.

That said, volatility and caution will likely remain for a while. Furthermore, as Lance Roberts’ chart shows, investors are highly leveraged at this time, pretty dangerous if the rout continues.  image

I see no rush to step back in following my Jan. 13 post TAPERING…EQUITIES.

Moody’s Affirms France Rating

The ratings firm, which rates France Aa1, said it kept the negative outlook due to continuing reduced competitiveness in the nation’s economy, as well as the risk of further deterioration in the financial strength of the government.

“Although the French government has introduced or announced a number of measures intended to address these competitiveness and growth issues, the implementation and efficacy of these policy initiatives are complicated by the persistence of long-standing rigidities in labor, goods and services markets as well as the social and political tensions the government is facing,” Moody’s said. (…)

France’s fiscal policy flexibility is limited, which, together with the policy challenges noted above, imply a continued risk of missing fiscal targets,” the firm added. (…)

Markit adds that France official data overstate the reality:

image[A recent Markit] analysis suggests France official GDP data may have overstated growth in the French economy since 2012.

A divergence between the PMI and GDP has been evident since the third quarter of 2012. (…) Up to the third quarter of 2013 (the latest available data point), GDP has risen 0.3%. This growth has helped bring the French economy to within 0.2% of its precrisis peak reached in the first quarter of 2008.

However, the PMI has painted a far weaker picture of the French economy. The composite PMI, which is a GDP-weighted average of the PMI surveys’ manufacturing and services output measures, has been below 50 (thereby signalling falling output) in every month since March 2012 with the exceptions of September and October 2013. Furthermore, the rates of decline signalled by the PMI have been strong over much of this period – exceeding those seen in the prior survey history with the exception of the height of the financial crisis in 2008-9.

Importantly, much of this discrepancy can be accounted for by the fact that PMIs only cover private sector activity. The output of the government sector, which accounts for 25% of GDP, has grown 2.1%
since the second quarter of 2012. Excluding the government sector, GDP is in fact 0.2% lower than the second quarter of 2012 and still some 3.2% below its pre-crisis peak. Stripping out government spend brings the GDP data more into line with the PMI. (…)

The recent (weaker) trends signalled by the PMI survey are confirmed by INSEE’s own surveys of manufacturing and services. (…) Chart 4, which plots the INSEE survey results against growth of non-government GDP, adds confirmation to the PMI message that the official data may have overstated growth in recent quarters. (…)

The PMI exhibits a much higher correlation with official data than both INSEE and Banque de France surveys, whether we look at manufacturing, services or a weighted combination of the two sectors. The track record of the surveys therefore adds weight to the suggestion that the GDP data have been overstating the health of the economy since mid-2012.

imageThe possible overstatement of economic growth by the official data and Banque de France surveys is also something which is indicated by the employment data. Chart 7 shows that a clear divergence between the
official data on output and employment has become evident. Between mid-2012 and mid-2013, nongovernment GDP was flat but private sector
employment dropped by 153k (0.9%). To put this in context, the fall in employment was the steepest seen over such a period in recent history (since 1999) with the exception of the height of the 2008-9 financial crisis.

Rather than concluding that the French economy has undergone a period of rapid productivity growth, it is possible that the fall in employment over this period is another indication that GDP data have overstated output. To investigate this more closely, we look at the survey data on employment. Here we can see that the survey that has corresponded most closely with the upbeat GDP data over the past two years – namely the Banque de France survey – appears to have overstated employment growth.

Importantly, the PMI survey data on employment have not diverged from the official data. The PMI has in fact exhibited a correlation of some 89% with private sector employment excluding agriculture since the survey data were first available in 1998, outperforming the INSEE and Banque de France surveys. (…)

European banks have 84 billion euro capital shortfall, OECD estimates: report

European banks have a combined capital shortfall of about 84 billion euros ($115 billion), German weekly WirtschaftsWoche reported, citing a new study by the Organisation for Economic Cooperation and Development (OECD).

French bank Credit Agricole has the deepest capital shortfall at 31.5 billion euros, while Deutsche Bank and Commerzbank have gaps of 19 billion and 7.7 billion respectively, the magazine reported in a pre-release of its Monday publication. (…)

Confused smile STRANGE QUOTES

Marc Faber: What I recommend to clients and what I do with my own portfolio aren’t always the same. (…) About 20% of my net worth is in gold. I don’t even value it in my portfolio. What goes down, I don’t value. (…) I recommend the Market Vectors Junior Gold Miners ETF [GDXJ], although I don’t own it. I own physical gold because the old system will implode. Those who own paper assets are doomed. (Barron’s)

 

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