NEW$ & VIEW$ (13 FEBRUARY 2014)

Note: BEARNOBULL.COM also published: LADIES’ TURN (II)

SOFT PATCH WATCH
 
USDA Projects U.S. Net Farm Income to Decline 27% in 2014 Federal forecasters expect U.S. farm income to decline 26.6% to $95.8 billion this year due to a sharp drop in corn and soybean prices.
Falling Property Values Hint at Trouble on the Farm Plummeting prices for corn and soybeans are weighing on land values and threatening a yearslong boom for U.S. growers.

(…) From 2009 to mid-2013, average prices for agricultural land in the U.S. rose by half, while in Iowa, Nebraska and some other Midwest farm states, prices more than doubled, according to U.S. Department of Agriculture data from last August. That helped fuel economic prosperity across the Farm Belt while stoking fears about a possible bubble.

Now there is mounting evidence the boom is fizzling out. Farmland prices in Iowa fell 3% over the second half of last year, and those in Nebraska fell 1%, according to estimates from the Farm Credit Services of America, an Omaha, Neb., lender that calculates weighted averages based on land quality. Reports from U.S. Federal Reserve Banks across the Midwest late last year showed prices flattening or slipping from the previous quarter. A monthly survey of Midwestern lenders by Omaha-based Creighton University in January found the outlook for farmland and ranchland prices was the weakest in more than four years.

Despite the falling property values, agricultural analysts say a repeat of past farm-belt collapses is unlikely. Farmer income is expected to remain strong and debt levels are low, according to USDA figures.

But prices have plunged for corn, a key U.S. crop. After rising to all-time highs in 2012—driven by growing demand and tight supply because of a historic drought—prices for the biggest U.S. crop dropped 40% last year, thanks to a record harvest of 14 billion bushels. The Federal Reserve warned in January that corn prices, then around $4.28 a bushel, won’t cover farmers’ anticipated cost of raising the crop this year. Prices have since climbed to about $4.40 a bushel, compared with about $8.31 in August 2012.

Soybeans, the nation’s No. 2 crop, have also lost value. Meanwhile, with the Fed scaling back its stimulus efforts, buyers of U.S. farmland face the prospect of higher interest rates after years of cheap borrowing.

The shifts have forced farmers to recalculate the value of productive land. (…) Falling land prices could cause economic ripples, curbing farmers’ ability to borrow money to buy new acreage, crop supplies or machinery. (…) A pullback in farmers’ spending could curtail construction of grain bins and livestock facilities as well as purchases of new machinery. Tractor company Deere & Co. predicted Wednesday that sales of farm equipment in the U.S. and Canada this year would decline 5% to 10% from 2013.(…)

The economic picture in the Farm Belt is expected to worsen. The USDA forecast Tuesday that U.S. farm incomes will dive 27% this year from 2013, to $95.8 billion, which would be the lowest level since 2010. Last year’s total was the highest since 1973 on an inflation-adjusted basis, but the continued slump in grain prices is expected to this year outweigh the benefits of having more corn and soybeans to sell. Still, even with the expected decline, the USDA reckons incomes will remain $8 billion above the previous 10-year average.

Michael Duffy, professor of economics at Iowa State University in Ames, Iowa, projects lower income for farmers could drive the price of farmland down 20% to 25% over the next several years. (…)

Southland Home Sales Drop in January; Price Picture Mixed

Southern California logged its lowest January home sales in three years as buyers continued to wrestle with a tight inventory of homes for sale, a fussy mortgage market and the highest prices in years. The median price paid for a home dipped from December – a normal seasonal decline – but remained 18 percent higher than January last year, a real estate information service reported.

A total of 14,471 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties last month. That was down 21.4 percent from 18,415 in December, and down 9.9 percent from 16,058 sales in January 2013, according to San Diego-based DataQuick. (…)

Last month’s Southland sales were 17.3 percent below the average number of sales – 17,493 – in the month of January since 1988. Sales haven’t been above average for any particular month in more than seven years. January sales have ranged from a low of 9,983 in January 2008 to a high of 26,083 in January 2004.

“The economy is growing, but Southland home sales have fallen on a year-over-year basis for four consecutive months now and remain well below average. Why? We’re still putting a lot of the blame on the low inventory. But mortgage availability, the rise in interest rates and higher home prices matter, too,” said John Walsh, DataQuick president.

“Two of the bigger questions hanging over the housing market right now are,‘How much pent-up demand is left out there?’ and, ‘Will inventory skyrocket this year as more owners take advantage of the price run-up?’” Walsh continued. “Unfortunately, we’ll probably have to wait until spring for the answers. When it comes to statistical trends, January and February are atypical months that haven’t proven to be predictive over the years.” (…)

China auto market growth slows sharply in January

Growth in China’s auto market slowed to 6 percent in January, a third of the rate seen in December, partly weighed down by sluggish sales of commercial vehicles likes trucks and buses.

The relatively slow growth in the world’s biggest auto market was also due to the week-long Chinese New Year holiday, or Spring Festival, starting at the end of January that resulted in fewer working days compared with 2013, analysts said. Most dealers close during the holiday, which fell in February last year.

The China Association of Automobile Manufacturers (CAAM) said on Thursday passenger vehicle sales rose 7 percent from a year earlier while commercial vehicle sales, which make up around 15 percent of the entire auto market, were virtually flat.(…)

The overall market grew 17.9 percent in December last year and ended the 2013 year with a growth rate of 13.9 percent. (…)

OIL

IEA Cuts Emerging-Market Demand Forecast

In its closely watched monthly oil market report, the International Energy Agency, which represents some of the world’s largest oil consumers, said it trimmed its oil-demand forecast for developing countries by 80,000 barrels a day in the first quarter. (…)

Still, the IEA Thursday slightly increased its overall demand forecast for the year by 125,000 barrels a day to 92.6 million barrels a day, citing improving prospects for the U.S. economy. (…)

Oil prices: well managed, behaving well:

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CANADIAN HOUSING
Report warns of excess supply of rental units in Toronto and Vancouver

(…) The large number of condos that are still being built in both of those cities will lead to an excess supply of rental units in the coming years, and will likely cause their condo vacancy rates to rise by 0.3 to 0.4 percentage points, Mr. Tal adds. The shift is significant considering that Toronto and Vancouver boast the lowest overall vacancy rates outside of Alberta. But it will not be enough to derail the housing markets in those cities or cause a sharp drop in rents, Mr. Tal predicts. (…)

Mr. Tal says vacancy rates will probably rise in the coming few years and rent inflation will ease. “But a careful analysis of the magnitude of the projected supply/demand mismatch suggests a much gentler adjustment than feared by many,” he writes.

The Calgary area has a vacancy rate of 1 per cent, and Toronto and Vancouver are each at 1.7 per cent. The majority of Canadian cities, accounting for about 45 per cent of the population, have higher vacancy rates, stretching from 2.5 per cent in Winnipeg to 11.4 per cent in Saint John.

Mr. Tal estimates that the average number of people per rental unit in big cities last year was 2.1, down from 2.4 10 years earlier. The trend toward smaller families and one-person households has raised the demand for rental units by close to 10 per cent during the past decade.

When you add it all up, the picture that emerges is of a market that reached its peak at a national level in 2012, and is now beginning a moderate decline, Mr. Tal says.

Veritas Investment Research analyst Ohad Lederer published a report in November arguing that Toronto’s rental market might be at an inflection point. “We believe recent claims of robust rental market increases should be taken with a grain of salt,” he wrote.

“In one possible scenario, the Toronto rental market may no longer absorb supply as it comes on stream, resulting in lower rents and increasing cash outflows for landlords, who then decide to sell, at first in a trickle and then in a thunderous herd,” he added. “In this scenario, condo prices could drop dramatically, given relatively small unit sizes that do not attract a wide segment of potential buyers and the already weak underlying fundamentals.”

Mr. Tal says the “real challenge for investors down the road won’t be falling rents, but rather higher financing or opportunity costs when mortgage rates eventually rise.”

EARNINGS WATCH

S&P updated its earnings score sheet as of Feb. 10 with 358 (79%) S&P 500 companies having reported Q4 results. The beat rate is 66% and the miss rate 23.5%, in line with Q3’13 results. Beat rates are particularly high in IT (76%) and Financials (72%). Excluding these two sectors, the beat rate drops to 61.8%, down from 64.4% in Q3.

Q4’13 operating EPS are now seen reaching $28.70, down $0.53 in the last 10 days. Trailing 12 months EPS would thus total $107.75, up 5.4% from their level after Q3’13 and up 11.3% YoY. Revenues are up 5.7% YoY in Q4, bringing operating margins to a new record of 9.85%.

We have had 18 additional reports in the last 3 days. With 84% of the S&P 500 market-cap in, the picture is almost complete. RBC Capital does an excellent job monitoring and analysing earnings. Total revenues are up 2.2% (+2.4% ex-Financials) and EPS are up 7.8% (4.6%). Where it gets interesting is in the breakdown between domestically and globally oriented companies (ex-Fin) which are roughly 50-50 in the Index. RBC calculates that domestic companies revenues grew 4.4% in Q4’13 vs 2.1% for global companies. Domestic profits grew 10.3% vs 4.3% for global companies.

Back to S&P numbers: estimates for Q1’14 are fairly stable at $28.01, up 8.7% YoY and only $0.12 lower than 10 days ago.

With trailing 12m EPS reasonably solidly set at $107.75 (only about 100 companies to be tallied), the Rule of 20 sets fair value at 1972 (20 minus core CPI of 1.7% = Rule of 20 P/E of 18.3 x 107.75, January CPI will be released Feb. 20). Fair value is thus 8.3% above current level.

Equity markets had a brief 5.8% setback in recent weeks (U.S. growth scare and EM rout) but are now realizing that earnings are still rising, inflation remains subdued, interest rates are kept excessively low and the financial heroin keeps flowing albeit at a somewhat reduced rate. Note how the Rule of 20 Fair Value (yellow line on chart) has spiked thanks to rising trailing earnings.

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Downside? 1715 on the rising 200 day m.a., which is also 17.5x on the Rule of 20 P/E (half way between 15-20), some 6% below current levels. Trailing 12m EPS could rise another 2% to $110 after Q1’14.

So 8-10% upside to fair value, 6% downside to fundamental and technical resistance. Not bad. Yet, there is this soft patch risk. How soft a patch? How soft Europe? How bad China? Dunno, but watching carefully. Today’s earnings headlines are nothing to reassure:

    Europe MSCI Revenues Remain Downbeat

    The forward revenues of the EMU MSCI is also falling, and has been doing so at a faster pace recently, suggesting that the region may be especially hard hit by weaker growth among emerging economies. The only good news is that the forward profit margin seems to have bottomed early last year and is recovering slowly.

    Punch FT’S GAVYN DAVIES (A dose of humility from the central banks)

    (…)  past week, we have had major statements of intent from Janet Yellen, the new US Federal Reserve chairwoman; from the European Central Bank; and from the Bank of England. After multiple hours of fuzzy guidance about forward guidance, the clarity of previous years about the global policy stance has become much more murky. Central banks are no longer as obviously friendly to risk assets as they once were – but they have not become outright enemies, and they are unlikely to do so while they are concerned that price and wage inflation will remain too low for a protracted period.

    It is now quite difficult to generalise about what central bankers think. However, a few of the necessary pieces of the jigsaw puzzle slotted into place in the past week.

    The first point to make about Ms Yellen is that she has declared herself to be the agent of continuity not the harbinger of a significant regime shift at the Fed. (…)Economists at the Fed, like the Congressional Budget Office, have been moving towards supply-side pessimism, implying that more of the post-2008 output losses are now thought to be permanent. Ms Yellen said on Tuesday that she was not sure how much of the decline in the labour participation rate could be reversed. Her uncertainty about this scarcely supports dramatic policy action either way.

    There are also signs of supply-side pessimism at other central banks.

    The BoE’s latest Inflation Report has reduced productivity growth projections, and says that the amount of spare capacity in the economy is only 1-1.5 per cent of GDP, despite the fact that the level of GDP is still below the 2008 peak. To the extent that its latest phase of forward guidance is decipherable, the BoE seems to be eager to reassure markets that the bank rate will rise very gradually, and to a low end point, but it does not fully eliminate the possibility that the first UK interest rate rise will come this year.

    The ECB also has a pessimistic view of the supply side, which explains why it does not see any urgent need for a big monetary policy change as inflation drops towards zero. That does not mean it will refuse to cut interest rates into negative territory next month. My interpretation of the supposedly “neutral” steer from Mario Draghi’s press conference on Thursday last week is that the ECB president said only that more information would be needed before action would be taken. That information would come in the form of the ECBs inflation forecast for 2016, which would be published earlier than usual.

    A sensible guess at that forecast can be made, given that it will depend on market forward rates for oil prices, which are falling. JPMorgan reckons the likely forecast for eurozone inflation in 2016 will be 1.5 per cent, compared with 1.2 per cent in 2015. That seems to offer Mr Draghi enough evidence of a prolonged period of exceptionally low inflation, which is what he needs to get the German Bundesbank to support action. But it does not point to a threat of outright deflation, without which ECB balance sheet expansion looks improbable. Mr Draghi went out of his way to differentiate between these two different states of the economy last week.

    Pointing up If the central banks are becoming more pessimistic about the supply side, this could spell danger for markets that have perhaps already priced in a strong medium-term recovery in GDP towards previous trends. Without the prospect of this GDP recovery, the high share of profits in current GDP could start to pose problems, especially if the central banks are expected to raise short rates within a year or two. Regardless of the path for short rates, asset purchases are petering out everywhere except in Japan, and Chinese liquidity withdrawal is adversely affecting Asian monetary conditions.

    Yet the prospect of genuinely hostile central banks for markets still seems some way off. Above all else, policy committees seem highly uncertain about the right path for interest rates now that asset purchases are ending. But there is an emerging degree of consensus that global inflation, notably wage inflation, remains inconsistent with their mandates.

    The Romers wrote: “Central bankers should have a balance of humility and hubris.” At present, they seem to be leaning towards humility about what they know and can achieve. In an environment of unavoidable doubts about the labour market constraints that they are facing, it seems that they will let wage inflation increasingly act as the judge and jury for the stance of policy. Their latest refrain is that inflation will return to target, but only over a prolonged period, and that wage inflation will be the crucial signal.

    Only when wage inflation starts to rise should markets really start to worry.

    So, our central bankers are quietly acknowledging that labour supply may be lower than previously thought. That has been my point in recent months. In the same FT today:

    German companies court older workers Labour shortages force employers to offer incentives

    (…) “German companies are facing a labour shortage. It is difficult for them to get competent, highly skilled employees,” said Nils Stieglitz, professor of strategic management at Frankfurt School of Finance and Management. “One way to compensate is to extend the lifetime of their employees.”

    As a consequence, Prof Stieglitz said, pressure was mounting on German employers to offer a better work-life balance to retain older employees. (…)

    As governments across Europe have pushed through plans to raise retirement ages, Germany, the continent’s strongest economy, has taken a step in the opposite direction.

    The country recently unveiled draft legislation to lower the retirement age to 63 for workers such as Mr Brockmann who have contributed to the system for 45 years.

    The government estimates that, each year, about 200,000 workers will be able to retire early under this legislation – a proposal that will cost €60bn between its planned introduction in July and 2020.

    The remainder of the workforce will be required to keep to the current retirement age, which is being raised from 65 to 67. (…)

    The plan has also been criticised by German business leaders, who have had to work hard in recent years to hang on to older employees.(…)

    Germany’s working-age population is expected to fall 7 per cent by 2025, according to projections from the United Nations Population Division, in part because German women have been having too few babies for more than 40 years.(…)

    Finally, my suspicions on January’s U.S. employment report are shared by David Rosenberg:

    It’s ‘as if 100,000 service-sector jobs went missing,’ Rosenberg says

    David Rosenberg, chief economist and strategist of Gluskin Sheff, says the weakness in the data came on the services side of the ledger — which doesn’t make sense to him when looking at both the ISM and ADP surveys. The employment component of the ISM services index was a strong 56.4% in January, and ADP said 160,000 private-sector services jobs were created during the month. “It’s as if 100K service sector jobs went missing in the payroll report,” he said.

    (In the chart, the blue bar represents what the Labor Department says of private-sector services employment, and the red bar is ADP’s tally.)

    He said the headline number “did not pass the proverbial sniff test,” and that the strong showing of the household survey is closer to the mark and more consistent with what actually is going on in the economy.

     

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