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. (…)

 

CHINA MANUFACTURING PMIs EDGE UP

After adjusting for seasonal factors, including the recent Golden Week holiday, the HSBC Purchasing Managers’ Index™ (PMI™) posted at 50.9 in October, unchanged from the earlier flash reading, and up from 50.2 in September. Though only slight, it was the strongest improvement of operating conditions in China’s manufacturing sector in seven months.

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Output at manufacturing plants in China increased for the third month running in October, and at the quickest pace since April. The expansion of output was accommodated by stronger client demand both at home and abroad, with new orders and new export orders rising at faster rates in October. Furthermore, it was the strongest expansion of new business from abroad in nearly a year, with a number of panellists citing greater demand in the US in particular.

The level of outstanding business at Chinese manufacturers increased solidly in October, and was generally associated with new order growth. Moreover, it was the strongest accumulation of work-in-hand in 31 months. October data signalled a renewed expansion of payroll numbers, as some firms planned to expand output. However, the rate of job creation was only slight.

Increased production requirements led to higher levels of purchasing activity. Furthermore, the rate of increase accelerated since September to a solid pace, with 17% of surveyed firms noting more input buying.
Concurrently, stocks of purchases rose for the first time since January, albeit marginally.

China’s official PMI:

China’s official manufacturing Purchasing Managers’ Index climbed to 51.4 in October from 51.1 the month before, according to the National Bureau of Statistics, marking an 18-month high.

But the data also showed a marked contrast between large and small manufacturers, with the reading for big companies rising to 52.3 while the one for small companies falling to 48.5. (WSJ)

But

(…) the sub-index for new orders dropped to 52.5 from September’s 52.8, while the sub-index for new export orders dropped to 50.4 from 50.7 in September. (FT)

 

CHINA OCTOBER FLASH PMI AT 50.9

  • Flash China Manufacturing PMI™ at 50.9 (50.2 in September). Seven-month high.
  • Flash China Manufacturing Output Index at 51.0 (50.2 in September). Six-month high.

October’s HSBC Flash China Manufacturing PMI rose to a seven-month high of 50.9 on the back of broadbased modest improvements. This implies that China’s growth recovery is becoming consolidated into 4Q
following the bottoming out in 3Q. This momentum is likely to continue in the coming months, creating favorable conditions for speeding up structural reforms.

Good but far from great. New orders are barely above the 50 mark.

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NEW$ & VIEW$ (18 OCTOBER 2013)

PHILLY FED SURVEY POSITIVE

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, edged down from 22.3 in September to 19.8 this month. The index has now been positive for five consecutive months. The percentage of firms reporting increased activity this month (36 percent) was greater than the percentage reporting decreased activity (16 percent).

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The demand for manufactured goods, as measured by the current new orders index, increased 6 points, to 27.5, its highest reading since March 2011. Shipments continued to expand: The index fell 1 point to 20.4, following a 22 point increase last month. The diffusion indexes for inventories, delivery times, and unfilled orders were all positive and higher than last month.

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Labor market indicators showed improvement this month. The current employment index increased 5 points, to 15.4, its highest reading since May 2011. The percentage of firms reporting increases in employment
(23 percent) exceeded the percentage reporting decreases (8 percent).

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With respect to prices received for manufactured goods, 21 percent of firms reported higher prices, and 7 percent reported lower prices. The prices received index increased 2 points, to 14.2.

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HOME BUILDERS SENTIMENT WEAKENS

Wednesday’s release of the NAHB sentiment survey showed that sentiment among homebuilders unexpectedly fell from a revised reading of 57 down to 55. (Bespoke)

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Growth Picks Up in China

China’s growth accelerated in the third quarter, putting to rest for now fears that the world’s No. 2 economy was headed for a sharp slowdown that would rattle world markets.

China’s gross domestic product grew 7.8% from a year earlier, according to data from the National Bureau of Statistics released Friday. That compares with 7.7% in the first quarter and 7.5% in the second. It also matched the median forecast of 18 economists surveyed by The Wall Street Journal.

On a quarter-to-quarter basis, growth rose by 2.2%, suggesting an annualized rate of growth of 9.1%.

China grew at 7.7% year-over-year over the first three quarters of 2013, making it likely that the economy would top the country’s annual growth target of 7.5%.

The FT warns:

But in a sign the rebound may not be sustained in the coming quarters, a raft of monthly data released on Friday by China’s National Statistics Bureau showed growth in industrial activity, retail sales and fixed asset investment slowed slightly in September compared with previous months.

Industrial production in September increased 10.2 per cent from a year earlier, down from a 10.4 per cent rise in August, while fixed asset investment and retail sales both decelerated slightly to grow 20.2 per cent and 13.3 per cent respectively.

Other data from last month, including the closely watched purchasing manager’s index, electricity consumption and exports all disappointed, with exports contracting 0.3 per cent from a year earlier, compared with 6 per cent average growth in the preceding two months.

Consumption accounted for 46% of growth in the first nine months, compared with 56% for investment. Exports subtracted 1.7% from growth.

But CLSA’s Andy Rothman is upbeat:

China remains the world’s best consumer story, with retail, new home and car sales healthy and inflation modest.  Restructuring is well under way, with private firms, not SOEs, driving growth in investment, employment and profits, and with, for the first time, the tertiary sector overtaking secondary as the largest share of GDP.  The government has taken a proactive approach to the trust sector, and overall credit growth continues to cool a bit – – not so much tightening as an effort to normalize credit growth and improve its quality.

We all need to stop obsessing over the GDP growth numbers; Chinese consumers and corporates don’t care about them, and even Party leaders are paying less attention.  We also need to put more emphasis on the base.  For example, if real GDP growth is 7.7% this year, that is a lot slower than 10% a decade ago.  But the economy is 3 times larger than it was back then, so even with a slower growth rate, the incremental increase in GDP is almost 200% bigger this year.

More significantly, for the first time, the tertiary sector (which includes services, retail sales and real estate) now accounts for a slightly larger share of China’s economy (45.5%) than the secondary sector (45.3%) – – clear evidence of rebalancing.  The tertiary sector remains very healthy, growing by 8.4% YoY YTD  (8.1% last year) and outpacing secondary sector (industry and construction) growth, which was 7.8% for the first 3Q (7.9% last year). (…)

More importantly, investment by privately-owned firms has risen at a faster pace than total FAI and investment by SOEs in each of the last 15 months, and in every month except one since March 2010.  Private sector investment rose 22.1% YoY in September, while SOE investment slowed to 14.9%, the slowest pace all year, and further evidence of the absence of a government stimulus.  (Moreover, fiscal spending is up 8.8% YTD, down from 21.1% during the first nine months of last year.) (…)

Real urban income rose 6.8% YoY YTD, up a bit from 6.5% in 1H but down from 9.8% in the first three quarters of last year.  Real rural income followed a similar path, rising 9.6% in the first nine months after 9.2% in 1H and 12.3% in the first three quarters of last year.  We also note that household debt is very low, and is primarily mortgages (with a minimum of 30% down) for primary residences.

It is also important to recognize that, unlike in many developed countries, wages continue to rise rapidly for China’s low-income workers.  Wages for the migrant workers who hold the majority of manufacturing and construction jobs in Chinese cities are up 13% this year.  In our view, strong income growth at the lower end of the pay scale, along with rising government spending on health care and education, is far more important than the wide gulf between rich and poor.

Global Growth Expectations: Too Pessimistic

Bloomberg consensus expectations for real GDP growth next year in the U.S. and in the other major economies have dipped to just 2.6 and 3%, respectively. This represents only a mild acceleration in growth relative to 2013 and is too pessimistic in our view.

global growth expectations

In a recent research piece we highlighted that a global resynchronization in growth is underway: the easing in fiscal drag next year alone will add 0.6 percentage points to growth for the G7, including more than 1.5% in the U.S., according to the latest IMF projection. Moreover, the recent break-out in business confidence shows that ‘animal spirits’ are gradually returning to boardrooms around the world, albeit from depressed levels. From the Tankan survey, to the IFO, to the regional Fed surveys, capital spending plans are being revised up.

And see below on M&A activity.

TAPER WATCH

  • October Unlikely for Fed Tapering The Fed is unlikely to start curtailing its bond buying at its next policy meeting Oct. 29-30, given the uncertainty left by the government shutdown. Officials could act at one of the following two meetings—Dec. 17-18 or Jan. 28-29—but that, too, is uncertain.

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It will be some weeks yet before all of the economic data releases that were postponed during the government shutdown are published. As the shutdown will have severely delayed the collection process for this month, some of October’s reports may not come out until late November. That means the Fed will remain in the dark for a bit longer yet. (…)

Overall, the Fed may not have a complete picture of the economy when it meets on 29th/30th October. And although the statistical agencies will probably have caught up by the Fed meeting scheduled for 17th/18th December, by then the greater uncertainty may come from the respective budget and debt ceiling deadlines of 15th January and 7th February.

Clock  Data release schedules:

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BofA Sees Strong M&A Pipeline Building

“As we head into the last quarter of the year, the [M&A] pipeline looks quite strong,” said Bruce Thompson, BofA’s chief financial officer, in a post-earnings conference call with analysts.

Moody’s concurs:

M&A’s Exceptionally Low Relative to Record High Market Value of US Common Stock

The current pace of mergers and acquisitions (M&A) lags far behind what otherwise might be inferred from the record high market value of US common stock. By way of statistical inference, the value of acquisitions involving US businesses could rise by 40% from its recent yearlong pace if the equity prices merely hold steady. Cheap corporate debt might soon help to fund a sharp upturn by acquisitions provided that potential buyers do not view too many business assets as being dangerously overvalued.

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NEW$ & VIEW$ (17 OCTOBER 2013)

Congress Vote Ends Impasse to Be Revisited in January

After the partisan passions and heated rhetoric, the disruptions of a government shutdown and displays of dysfunction, Congress did what it could have done weeks ago: voted to fund the government and lift the debt limit. (…)

The shutdown shaved 0.6 percentage point from annualized fourth-quarter growth, taking $24 billion out of the economy, S&P said in a statement yesterday. In September, the company forecast a growth rate of about 3 percent.

German Growth Outlook Cut

(…) The institutes said Europe’s largest economy would grow only 0.4% this year and would pick up next year, expanding 1.8%. This marks a lowering of their forecasts from April when they said the German economy would grow 0.8% and 1.9%, respectively.

The official announcement confirms earlier reports in the German media.

“The German economy is on the verge of an upturn driven by domestic demand,” the institutes said. “The improving global economic climate and decreasing uncertainty are fueling investment. Private consumption is benefiting from favorable employment and income prospects,” they said. (…)

Corporate Germany Looks Away From Home

Germany’s biggest companies say they are looking to invest overseas rather than at home in the year ahead, suggesting that low investment in Europe’s biggest economy won’t improve soon.

(…) Lack of sales growth in Germany and Europe, now and in companies’ expectations for coming years, is deterring many corporations from increasing their investment spending in Germany, where capital expenditure has sunk to near-historic lows as a share of gross domestic product.

High production costs—especially high energy prices in Germany compared with the U.S. and some European or emerging economies—and lingering uncertainty about the longer-term cohesion of the euro zone are also commonly cited reasons for holding back on domestic investment. (…)

Most of the companies that responded to The Wall Street Journal survey—all of them nonfinancial companies from among the leading German corporations that make up the DAX-30 stock-market index—say they are aiming to maintain or slightly increase their overall investment in the year ahead. But they are mostly planning to spend money on maintaining rather than significantly upgrading their domestic production facilities.

Only a minority of polled companies listed Germany among their planned investment targets.

The survey’s findings challenge hopes in Germany that investment will take off in coming months, following two years of weakness that has held down Germany’s growth rate. German GDP is projected to increase by about 0.4% this year, due in part to companies’ reluctance to invest. (…)

Meanwhile, foreign companies’ appetite for investing in Germany is also waning. Foreign direct investment in Germany plummeted to €5.1 billion ($6.9 billion) in 2012, from €58.6 billion in 2007, according to data from Germany’s central bank. The decline continued in the first six months of this year, when a mere €800,000 of FDI landed in Germany. (…)

CHINA

Several charts from CEBM Research suggest slow and slower growth in China:
 
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IBM blames China for slide in revenues
Investor disquiet at sixth successive quarter of sales falls sends shares down 6%

Mark Loughridge, chief financial officer, said much of the problem was caused by Chinese state-owned enterprises and other public sector customers pulling back from buying computer hardware as the country’s leaders prepared an economic reform plan. IBM had suffered “enormous reductions on a year-to-year basis in a geography we tend to see [high] growth rates”, he said.

EARNINGS WATCH

Still early (61 companies) but here’s the tally as of yesterday courtesy of RBC Capital:

Beat rates are 34% on revenues and 56% on earnings. Of the 15 Financials that have reported so far (out of 81 total), 40% beat on revenues and 60% on earnings. Ex Financials, the beat rate is 54% so far.

 

NEW$ & VIEW$ (14 OCTOBER 2013)

Democrats in Senate Press New Front in Budget Battle

Lawmakers attempting to avoid a debt default remained at loggerheads and escalated the standoff by reopening the contentious issue of automatic spending cuts.

Capitol Hill at sea(…) Democrats made plain that one of their top priorities was to diminish the next round of across-the-board spending cuts, known as the sequester, due to take effect early next year.

Many Republicans, including Senate Minority Leader Mitch McConnell (R., Ky.), oppose retreating from those cuts. That set up a clash that seemed almost as intense as the one that caused budget talks between House Republicans and President Barack Obama to collapse Friday.

“Total federal spending has now gone down for two years in a row—the first time that’s happened since the Korean War,” Mr. McConnell said Sunday. With the additional sequestration cuts on tap for 2014, the budget limits have produced “the most significant spending reduction in modern history and Senate Republicans will not accept anything that undoes these cuts.” (…)

Confused smile  Lawmakers said they would watch Monday’s opening of financial markets to see whether investors, already jittery, show greater concern. That, in turn, could affect the climate for further negotiations. Crying face

(…) a possible compromise that sources familiar with Senate budget talks said that Mr. Reid floated to Mr. McConnell on Sunday: Continue spending at current levels until mid-December, set up a mechanism for negotiating over the across-the-board cuts and other budget matters for the rest of the year, and extend the debt limit for about six months. It wasn’t immediately clear what Mr. McConnell’s response was.

Thinking smile  Europe Stocks Slip as Stalemate Drags On

U.S. Stock Futures Fall on Debt Concerns

 

EARNINGS WATCH

In case you forgot, we are entering Q3 earnings season with some 161 companies reporting this week including 70 S&P 500 companies.

Earnings rose an estimated 1.4 percent for Standard & Poor’s 500 Index companies last quarter, trailing gains of 3.8 percent in the previous three months and an average 10 percent over 15 years. Analysts have reduced the quarterly estimate by 75 percent since June, according to data compiled by Bloomberg.

The official S&P estimates are now $26.62 for Q3, down 0.8% from the September 30 estimates. Q4 estimates have been shaved a nickel to $28.83. Here’s Zacks Research’s early read:

Total earnings for the 31 S&P 500 companies that have reported results are up +9.8% with 51.6% beating earnings expectations, while total revenues for these companies are up +1.4% and 45.2% are beating top-line expectations.

This is still early going, but the results thus far are weaker than what we have seen for this same group of companies in recent quarters. The +9.8% earnings growth in Q3 for these companies compares to +18.2% in Q2 and the 4-quarter average of +17.8%, while the +1.4% revenue growth is below Q2 and the 4-quarter’s average of +4.2%. The beat ratios are similarly tracking lower.

The weak comparisons are primarily because of the Finance sector. If we exclude results from the Finance sector, the remaining companies that have reported results are tracking better than what those same companies reported in Q2 and the last few quarters. (…)

Ghost  This good analysis should worry you:

Total earnings growth for the remaining 469 companies is barely in the positive relative to the same period last year (+0.1%) and in the negative excluding the Finance sector (-1.1%). The composite earnings growth rate, combining results from the 31 companies that have reported with the 469 still to come, is +0.9% for the S&P 500. (…)

While estimates for Q3 have come down, the same for Q4 and the following quarters have held up fairly well, as the chart below shows.

Part of the strong Q4 growth is a function of easier comparisons, as 2012 Q4 represents the lowest quarterly earnings total for the S&P 500 in the last six quarters, with the comps particularly easy for the Finance sector.

But it’s not all due to easy comparisons, as the expected earnings totals for Q4 represent a new all-time quarterly record. Total earnings for the S&P 500 reached a new record at $259.5 billion in Q2, surpassing Q1’s $255 billion record. But they are expected to reach $269.7 billion in 2013 Q4, with total earnings growth outside of Finance expected at +4.9%.

Pointing up  The evolving outlook for Q4 is perhaps the most important aspect of the Q3 earnings season, more so than Q3 earnings/revenue growth rates and beat ratios. While the overall level of aggregate earnings is in record territory, there isn’t much growth. The longstanding hope in the market has been for earnings growth to eventually ramp up. But the starting point of this expected growth ramp-up keeps getting delayed quarter after quarter. The hope currently is that Q4 will be the starting point of such growth.

Guidance has overwhelmingly been negative over the last few quarters. But if current Q4 expectations have to hold, then we will need to see a change on the guidance front; we need to see more companies either guide higher or reaffirm current consensus expectations.

Anything short of that will result in a replay of the by-now familiar negative estimate revisions trend that we have been seeing in recent quarters. The market didn’t care much as estimates came down in the last few quarters, hoping for better times ahead. Will it do the same this time as well, pushing its hopes of earnings ramp up into 2014? We will find out the answer to that question over the next two months.

Punch  I suggest you also read “Myths about cash” below.

Eurozone production grows 1%
Data are latest sign of recovery in currency bloc

Industrial production in Germany, Europe’s largest economy, grew 1.8 per cent in August, lifting the entire eurozone, while in France, the second-largest economy, it rose by a much slower 0.2 per cent.

However, the most encouraging news came from Portugal and Greece, two of the countries worst affected by the sovereign debt crisis, which recorded robust growth in industrial production. In Portugal it rose 8.2 per cent while in Greece it increased 1 per cent.

I am more concerned by the facts that France’s IP rose only 0.2% after cratering 2.3% in the four months previous and that Italy’s IP declined 0.3% after falling 1.0% in July and 0.8% in the March-June period. These are two heavyweights.

The reality is that Eurozone IP rose 1.0% in August, offsetting July’s 1.0% decline. During the 4 months to June, IP rose 1.5%, thanks primarily to automobile production as IP of durable consumer goods rose 2.3% between March and June and 0.6% in July-August. A very slow grind (full Eurostat report)

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Here’s the YoY trend:

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Housing Affordability Hits Four-Year Low

Housing affordability hit a four-year low in August amid steady gains in home prices during the spring and higher interest rates during the summer.

(…) At prevailing interest rates in August, the mortgage payment on the median priced home stood at $851, or around 16% of the median U.S. income. By contrast, the equivalent mortgage payment one year earlier, at $683, accounted for 13.3% of the median income. (…)

But the affordability figures show unmistakable evidence of how rising interest rates hurt housing affordability in July and August because median prices didn’t rise in those months, even as the average monthly payment went up due to rising rates. The average monthly payment rose from $787 in June to $851 in August — even though median prices fell slightly from June to August.

Monthly payments last stood above $850 in November 2008, and monthly payments as a share of income last stood at 16% in July 2009.

Mortgage rates have declined modestly since August, which means that the 16% figure could be — for this year, at least—the high watermark for the payment-as-a-share-of-income metric. (…)

Home for Sale, With Freebies Home builders, concerned by flagging sales due to rising prices and higher mortgage rates, have boosted cash incentives and materials upgrades in some markets.

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China’s Exports Shrink

(…) Exports fell 0.3% in September compared with the year-ago period, data from the General Administration of Customs showed Saturday. This was sharply down from August’s 7.2% growth and far below economists’ median forecast of a 5.5% expansion.

The drop in exports was broad-based, with volumes to the European Union, Hong Kong and Taiwan dropping. Exports to many developing economies also fell. (…)

The overinvoicing of exports to disguise capital inflows—which started in the second half of last year and lasted into the first half of this year but has since waned—inflated the base in September 2012, said RBS economist Louis Kuijs, adding that actual export growth for September is estimated at about 1.7% in U.S. dollar terms.

(…) Chen Weiqiang, president of Guangdong Xinyi Underwear Group Co., a garment maker in the southern Chinese city of Foshan, said the slowdown in demand for his products hit last year and hasn’t abated.

“I have no obvious feelings that exports are recovering in the garment industry,” he said. “My company can still get orders, but profits are really pathetic due to rising labor costs, and we have actively cut export volume.” (…)

Compared with a year earlier, China’s exports to Hong Kong slipped 4.1%, while exports to Taiwan decreased 8.6% and exports to the European Union fell by 1.1%. However, exports to the U.S. rose 4.2% and to Japan rose 1.3%. (…)

September imports rose 7.4% compared with a year ago, slightly up from the 7% rise in August and beating economists’ median forecast of a roughly 6.8% increase. (…)

China’s crude-oil imports in September surged to 6.27 million barrels a day, surpassing a previous record set in July of 6.17 million barrels a day. September’s crude imports were up 28% when compared with the corresponding month last year. (…)

China inflation at 7-month high, limits room for easing despite export tumble

China’s annual consumer inflation rate rose to a seven-month high of 3.1 percent in September as poor weather drove up food prices, limiting the scope for the central bank to maneuver to support the economy even as exports showed a surprise decline.

The inflation rate was higher than a median forecast of 2.9 percent in a Reuters poll and August’s 2.6 percent, but was still below the official target of 3.5 percent for 2013.

Month-on-month, consumer prices rose 0.8 percent, the National Bureau of Statistics said, bigger than a rise of 0.5 percent expected by economists.

Food prices gained 1.5 percent in September from August due to droughts and floods in some areas, pushing up the CPI by 0.51 percentage points, Yu Qiumei, a senior statistician at the bureau, said in a statement.

In annual terms, food prices jumped 6.1 percent.

Producer prices fell 1.3 percent from a year earlier, a smaller fall than the 1.4 percent expected by the market and the 1.6 percent drop in August.

However, there was some relief to manufacturers struggling to cope with profit-eating price declines, as producer prices rose 0.2 percent from August.

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Inflation in China: veg now, pork later From Nomura via FT Alphaville:

We see a rising risk of CPI inflation sitting above 3.5% for some months in 2014, as pork prices enter the upswing phase of the cycle, given that the ratio of corn prices to pork prices was below the important level of 6x for most of H1 2013 (Figure 10). Historically, pork prices have exhibited long cycles, with upswings preceded by this ratio dropping below 6x. Concerns over inflation will make monetary policy easing unlikely in 2014, because with the benchmark deposit rate at only 3% there is little room to cut rates.

India’s headline inflation at 7-month high, another rate hike seen
 
Gulf oil production hits record
Region defies fears of impact from US shale revolution

(…) Saudi Arabia, Kuwait, the United Arab Emirates and Qatar set aggregate production records in each of the last three months, according to fresh estimates from the International Energy Agency. In September they accounted for 18 per cent of global demand – a level only matched twice in IEA data stretching back to the 1980s. (…)

As a result Gulf states are capturing more of the fast growing Asian market. India imported 44 per cent of its crude from Saudi Arabia, Kuwait, Qatar and the UAE in July, up from 36 per cent in 2011, while China relies on the countries for a quarter of its imports compared to 21 per cent in 2007.

A rapid return to production among other Opec members, for example through a resolution to Iran’s nuclear standoff with the US, could yet leave the Gulf states exposed to the US shale revolution. And some analysts argue that Opec could yet need to discuss production cuts when its oil ministers next meet in Vienna in December.

The record output has provided a windfall for the oil-dependent monarchies. The 16.4m barrels a day produced by the four states during the third quarter was worth more than $150bn at today’s prices of more than $100 a barrel.

The principal beneficiaries have been Saudi Arabia, which has increased output more than 10 per cent since the start of the year to a record of 10.19m b/d in August, and the UAE where the 2.77m b/d produced in September was a record, and 7 per cent higher than at the start of the year. Kuwait has also set a series of production records this year, but Qatar has been unable to raise production significantly.

It also means the region remains crucial to the world’s major powers. The US continues to import almost 60m barrels a month from the Gulf, a number that has actually increased in the last three years even as US imports overall have fallen.

The WSJ digs deeper:

Increasing oil output in the U.S. and Canada are already redirecting global oil flows, but those being hit the hardest are West Africa’s crude-oil producers and the refineries of Western Europe that are suddenly competing with cheap North American products.

The four Gulf kingdoms that dominate OPEC have actually increased their exports to the U.S. over the past three years, the Financial Times reports, taking advantage of Nigeria’s fragile infrastructure and Libya’s political chaos.

Instead, the rise of Asia as a consuming region is having just as big a sway on the flows of money, products and political capital. (…)

A report from the Asian Development Bank anticipates that oil-deficient Asia will have to increase net imports of crude and refined products by more than 10 million barrels a day by 2035, The Wall Street Journal’s Simon Hall reports.

The ADB’s forecast echoes that of the International Energy Agency, which forecasts Southeast Asia’s oil imports will more than double by 2035. This is a region that excludes China, which is just beginning what should be a lengthy stay at the top of the list of the world’s crude-oil importers. (…)

This great shift brings with it new factors—logistical, political and financial—for the oil markets to consider.

Singapore will become a sweet spot for the new trade flows, with the Malacca and Singapore straits joining the Strait of Hormuz as the oil market’s narrow waterways of note, the Journal’s Eric Yep writes. The New York Times pinpoints Fujairah, in the United Arab Emirates, as a products hub to rival Singapore and Rotterdam.

Economically, surging crude-oil imports will put strain on the Asian economies.

The IEA says that spending on net oil imports for the whole region is expected to reach $240 billion, from $77 billion today, and that the $51 billion the region currently spends each year on annual fossil-fuel subsidies should be reorganized to discourage wasteful consumption. (…)

Nerd smile  MYTHS ABOUT CAPEX

Conventional wisdom says that corporate America is flush with cash which it refuses to invest. Sometimes, aggregated data can be misleading. Factset just published an analysis of S&P 500 companies which reveals the true picture:

Cash & short-term investment balances (“cash”) in the S&P 500 (ex-Financials) rose by 13.5% year-over-year and settled at a balance of $1.27 trillion at the end of Q2 2013. The elevated growth in cash partially resulted from 13.3% growth in free cash flows (operating cash flows less capital expenditures) and continued net debt issuance. The $39.4 billion in cash flows represented the twelfth consecutive quarter of cash inflows from net debt issuance.

Index-level, fixed capital expenditures increased by 4.1% in Q2. This marks the second consecutive quarter of single-digit, year-over-year growth following a period when growth averaged 18.5% over eleven quarters. Though seven of the nine sectors under consideration increased year-over-year CapEx spending in Q2, the Energy sector, which represented a third of all spending, reduced CapEx by 0.1% for the second consecutive quarter. Chesapeake Energy’s prior divestments and strategic shift were again the primary reason for the decline—the company’s move to bring spending in line with cash flow continues to be compared against periods of higher investment. In addition, Hess Corp. and Occidental Petroleum also reduced capital expenditures. Hess cited the need for a balance with cash inflows, while Occidental Petroleum cited a need for cost reductions. Hess should also experience reduced capital spending expectations following its close of the multi-billion dollar divestiture of Samara-Nafta ZAO and its Russian oilfield properties in Q2.

S&P 500 companies have thus been growing capex at an 18.5% annual rate for 18 consecutive quarters until a few oil companies decided, because of their own particular situation, to strategically reduce their capex. In spite of this:

Despite a moderation in quarterly capital investment, trailing twelve-month fixed capital expenditures grew 7.5% and reached a new high over the ten-year horizon. This helped the trailing twelve-month ratio of CapEx to sales (0.068) hit an 11% premium to the ratio’s ten-year average. Overall, elevated spending has been a product of aggressive investment in the Energy sector over two and a half years, but, even when excluding the Energy sector, capital expenditures levels relative to sales are in-line with the ten-year average.

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Low capex at the national level may thus have more to do with smaller businesses as this NFIB chart suggests:image

Nerd smile  MYTHS ABOUT CASH

S&P 500 (ex-Financials) cash and marketable securities balances grew 13.5% year-over-year to a balance of $1.27 trillion at the end Q2. In particular, the growth of 15.4% in the Information Technology sector was most significant due to the sector’s enormous cash weight in the
overall index (36.7%). The sequential growth rate for the aggregate cash balance was 3.3%.

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However, 10 companies account for 37% of the cash pile which they have grown 20% in the past year. The remaining 490 companies’ cash grew 10% YoY. Furthermore, only 4 of the S&P’s 9 main sectors had positive free cash flow growth in Q2.

Shareholder distributions in the form of dividends and the repurchase of stock ($164.3 billion) increased 22.3% year-over-year and 23.5% sequentially. On the other hand, Cash inflows from debt issuance were positive ($39.4 billion) for the twelfth straight quarter.

As this next chart shows, average net debt has increased over the last 10 years and all sectors but one currently have higher debt levels than their 10-year average.

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This confirms Moody’s findings shown in my N&V post of October 7: corporate America is getting more leveraged, not cash rich as some aggregated stats make us believe.

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Ghost  The capex and cash myths having been debunked, we can now more objectively assess how the economy would fare in the event of rising interest rates. Capex would slow even more and corporate profits would feel the adverse effect of leverage. And even though the Fed controls short-term rates, it has little control on longer-term market rates it found out in recent months.

 

NEW$ & VIEW$ (3 OCTOBER 2013)

U.S. Showdown Bites Manufacturers Layoffs and Production Disruptions Loom at Firms Tied to U.S. Federal Government Shutdown Hits Military Contractors, Suppliers

The partial shutdown of the federal government is leading to layoffs and production disruptions at defense contractors and some manufacturing companies.

Retailers Weigh Into U.S. Shutdown Debate

The National Retail Federation, an industry trade group, came out with its annual holiday forecast Thursday, predicting sales will grow by a middling 3.9% from the year before to $602.1 billion. Early forecasts are sometimes off the mark, and the industry group warned the results could be worse if Washington doesn’t resolve debates over the budget and raising the debt ceiling.

Holiday sales rose by 3.5% in 2012, falling short of NRF’s initial forecast of 4.1% growth.

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 Fingers crossed Price of Gasoline Drops For 30th Straight Day

 

 

U.S. planned layoffs fall 20 pct in September: Challenger

Employers announced 40,289 layoffs last month, down from 50,462 in August, according to the report from consultants Challenger, Gray & Christmas, Inc.

High five  Still, the September job cuts were up 19 percent from the same month last year. For 2013 so far, employers have announced 387,384 losses, close to the 386,000 seen in the first nine months of last year.

The healthcare sector saw the biggest layoffs, with plans to cut 8,128 employees as health companies faced lower government payments, up from 3,163 in August.

The financial sector saw the next largest number of planned job cuts, with 6,932 in September compared with 3,096 a month earlier.

 China Services Index Increases in Sign of Sustained Rebound

The non-manufacturing purchasing managers’ index rose to 55.4 in September from 53.9 in August, the Beijing-based National Bureau of Statistics and Federation of Logistics and Purchasing said today.

The federation said a gauge of new orders jumped, retail spending grew strongly and a logistics industry index rose.

 Italy’s Letta Survives but Battle Looms

Italian Prime Minister Enrico Letta won the fight to keep his government alive Wednesday. But the bigger battle will be to revive a sclerotic economy that is emerging as a major threat to the euro-zone recovery.

After days of political chaos, Mr. Letta won confidence votes in both houses of parliament when conservative leader Silvio Berlusconi at the last minute abandoned his bid to topple the government. But the near-death of the coalition, just five months after its formation, illustrates the challenges of pursuing an ambitious economic overhaul amid a fragmented and quarrelsome political scene. (…)

“The Italian political system is preoccupied with itself, it has no time for the country,” says a senior European policy maker. (…)

But don’t worry, Mario Draghi will do “whatever it takes” whatever mess they make!

The stakes are high. Italy’s sheer size, dysfunctional politics and faltering economy are a bigger headache for Europe’s crisis managers than even Greece, which represents only 2% of the euro-zone economy, compared with Italy’s 16%.

And the country’s €2 trillion ($2.7 trillion) public debt makes it too big for Europe’s bailout funds to rescue, should Italy ever lose access to bond markets. (…)

Italian GDP is now 9% smaller than at its precrisis peak in late 2007—a worse performance than Spain or Portugal, and second only to Greece for lost economic output.

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Large chunks of Italy’s manufacturing base—the second-largest in Europe after Germany—are in distress. Many of Italy’s signature industries, such as steel, white-goods manufacturing and textiles, are in deep distress. (…)

Italian labor costs today are 30% higher than in Spain, while productivity is 6% lower. So car companies such as Renault and Ford are moving production to Spain. In Greece, costs have fallen so sharply that Unilever has begun producing a new line of low-cost products there for the Greek market. (…)

Over the last five years, Italy attracted an average of just $12 billion of foreign investment a year, compared with $37 billion for France and $66 billion for the U.K.

Euro-Zone Retail Sales Rise

The European Union’s official statistics agency Thursday said sales volumes rose by 0.7% from July, although they were still 0.3% lower than in August 2012.

The figures for July were also revised higher, with Eurostat now estimating that sales volumes rose by 0.5%, having previously calculated they increased by 0.1%.

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High five  The details are not as positive. Core sales volume rose 0.6% MoM in August after dropping 0.1% and 0.8% in the previous two months, leaving core volume down 0.3% between June and August, much weaker than during the March-May period when core sales rose 1.1%. image

To repeat Markit’s Eurozone Retail PMI for September:

Retail PMI® data from Markit showed a renewed decline in eurozone retail sales in September. The Markit Eurozone Retail PMI eased below neutrality to 48.6, having signalled the first increase in sales in nearly two years in August.

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Malls Are Recovering From the Downturn

Large enclosed malls are recovering from the downturn faster than strip shopping centers, a sign that malls are being hurt less by online retailing.

The vacancy rate of U.S. malls in the third quarter declined to 8.2% from 8.3% in the second quarter, according to new statistics released by Reis Inc., a real-estate data firm. Mall vacancy was 8.7% in the third quarter of 2012, said Reis, which tracks the top 77 markets in the U.S.

But the improvement hasn’t been as strong with shopping centers—typically open-air retail strips that face parking lots. The average national vacancy rate for neighborhood and community shopping centers held steady in the third quarter at 10.5% from the previous quarter, down from 10.8% in the third quarter of last year.

The national average asking rent at shopping centers was $19.25 per square foot, up just 1.5% from the recession low of $18.97 in 2011. The average asking rent for malls in the largest 77 U.S. markets rose to $39.77 per square foot in the third quarter, up 1.4% from the same quarter last year, according to Reis Inc.

(…) Mall vacancy rates are now falling partly because there has been little to no new mall development since 2006, Mr. Calanog said. (…)

Reis: Office Vacancy Rate declines slightly in Q3 to 16.9%

Reis reported that the office vacancy rate declined to 16.9% in Q3 from 17.0% in Q2.  This is down from 17.2% in Q3 2012, and down from the cycle peak of 17.6%.
From Reis Senior Economist Ryan Severino:

Vacancies declined by 10 basis points during the third quarter to 16.9%. This is a marginal improvement after last quarter when the vacancy rate did not change. However, since the market began to recover in mid‐2011, the vacancy rate has been unable to decline by more than 10 basis points in any given quarter. While this is technically an improvement versus last quarter, it is nonetheless a weak result. On a year‐over‐year basis, the vacancy rate fell by just 30 basis points, in line with last quarter’s year‐over‐year decline.

On new construction:

Occupied stock increased by 6.652 million SF in the third quarter. … On the construction side, this quarter 4.099 million SF were completed, down from last quarter’s mini‐spike of 8.049 million SF. While last quarter’s bump in construction activity appears to be an aberration, construction activity for office has been slowly if inconsistently trending upward. Year‐to‐date, the market has developed 15.161 million SF. This is almost double the 8.820 million SF that were constructed through the third quarter of last year.

On rents:

Asking and effective rents both grew by 0.3% during the third quarter. This marks the third consecutive quarter in a row with slowing asking and effective rent growth. Though in reality, rental growth rates are so low that the quarter‐to‐quarter differences are rather minor and could simply be idiosyncratic. Nonetheless, asking and effective rents have now risen for twelve consecutive quarters. Yet, the simple truth is that with vacancy remaining elevated at 16.9%, it is far too high to be conducive to much rent growth. At that level of vacancy, landlords have little leverage to either increase face level asking rents or to remove concessions from leases. A meaningful acceleration in rent growth will not be possible until vacancy falls to pre‐recessionary levels.

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U.S. Rises to No. 1 Energy Producer

The U.S. is overtaking Russia as the world’s largest producer of oil and natural gas, a startling shift that is reshaping markets and eroding the clout of traditional energy-rich nations.

[image]The U.S. produced the equivalent of about 22 million barrels a day of oil, natural gas and related fuels in July, according to figures from the EIA and the International Energy Agency. Neither agency has data for Russia’s gas output this year, but Moscow’s forecast for 2013 oil-and-gas production works out to about 21.8 million barrels a day.

U.S. imports of natural gas and crude oil have fallen 32% and 15%, respectively, in the past five years, narrowing the U.S. trade deficit. (…)

The U.S. last year tapped more natural gas than Russia for the first time since 1982, according to data from the International Energy Agency. Russia produced an average of 10.8 million barrels of oil and related fuel a day in the first half of this year. That was about 900,000 barrels a day more than the U.S.—but down from a gap of three million barrels a day a few years ago, according to the IEA. (…)

Saudi Arabia remains the world’s largest supplier of crude oil and related liquids. As of July, Saudi Arabia was pumping 11.7 million barrels a day, according to the IEA. Russia was second, at 10.8 million barrels, while the U.S. was third, at 10.3 million. (…)

U.S. energy producers also are drilling more efficiently and cutting costs in other ways. Some companies have said that the amount of oil and gas produced by shale wells isn’t dropping as fast as predicted.

Ken Hersh, chief executive of NGP Energy Capital Management LLC, a private-equity fund with $13 billion under management, said the immense amounts of oil and gas uncovered in recent years indicate that the U.S. energy boom could last a long time.

“It is not a supply question anymore,” he said. “It is about demand and the cost of production. Those are the two drivers.” (Chart from Ed Yardeni)

SENTIMENT WATCH

One factor S&P Dow Jones indices uses in their stock classifications is an Earnings and Dividend Quality Ranking measurement. The basis for this measurement is to provide investors with a ranking that S&P evaluates based on a company’s stability of earnings and dividend over time. The highest ranking is A and the lowest is D (a company in reorganization).

With this as background S&P has constructed indices based on these rankings. The S&P 500 High Quality Rankings Index consists of stocks with a ranking of A and better. The S&P 500 Low Quality Rankings Index consists of stocks with a ranking of B or lower. The high quality index has a larger weighting in sectors like consumer staples that tend to hold up better in a more defensive or “risk off” market. As the below table shows, this year, the low quality index has outperformed the high quality index by a wide margin.


This pattern of the “risk on” and more cyclical stocks outperforming has continued in the the second half of September, in spite of a down equity market.

(From The Blog of HORAN Capital Advisors)

(…) One characteristic of lower quality stocks is many of them do not pay a dividend. True to form, through the end of the third quarter, the non dividend paying stocks in the S&P 500 Index are outperforming the payers by a wide margin. The return comparison is detailed in the below table.

Nerd smile  Hmmm…Remember, the cream always ends up at the top.

(…) In recent weeks, both Warren Buffett and Carl Icahn warned stocks aren’t cheap. Others are urging investors to move cautiously.

“The opportunity sets aren’t as robust and the margins of safety are smaller,” said David Perkins, who oversees the $1 billion Weitz Value fund at Weitz Investment Management, an Omaha, Neb., value-oriented fund manager that oversees $5 billion.

Mr. Perkins says the firm’s internal readings on the stocks they follow are at their most expensive levels since 2006. He is holding more cash as a result.

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  • It’s right here, sir!

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Hmmm…

GOOD READS

“Character” (Jeffrey Saut, Chief Investment Strategist, Raymond James)

“The true prophet is not he who predicts the future, but he who reads history and reveals the present.”

… Eric Hoffer, American moral and social philosopher

I could almost hear my history teacher espousing Eric Hoffer’s words last week as I was asked by a particularly prescient media type if trust and character would really command a “premium” price/earnings multiple for the stock market? My response was “of course,” and as an example I referred him to a quote from John Pierpont Morgan, who built his family’s fortunes into a colossal financial empire. The referenced verbal exchange took place when an aging J.P. Morgan testified before a House of Representatives’ committee investigating the financial interests of the “House of Morgan.” A tough lawyer named Samuel Untermyer queried him. The conversation went like this:

Untermyer: “Is not commercial credit based primarily upon money or property?”

Morgan: “No sir, the first thing is character.”

Untermyer: “Before money or property?”

Morgan: “Before money or property or anything else. Money cannot buy it … because a man I do not trust could not get money from me on all the bonds in Christendom.”

While Morgan’s language is from an era gone by, the essential insight is as clear today as it was decades ago. I recalled the Morgan/Untermyer exchange as I read Friday’s Wall Street Journal, in particular, “Robbery at J.P Morgan.” The article began, “Government lawyers are backing up the truck again at J.P Morgan Chase (JPM/$52.24/Strong Buy) to extract another haul from the country’s largest bank.” Recall that JPM is one bank that did not need taxpayer assistance during the financial fiasco of 2008, or ever since.

To me that speaks volumes about the character of JPM’s CEO, Jamie Dimon. This lack of government dependence, combined with Mr. Dimon’s remarks about how the Dodd-Frank financial reform act is hurting the economy, is likely what put Mr. Dimon in the government’s crosshairs. This also explains why the government is beating up on JPM again over the “London Whale’s” $6 billion trading loss, even though there were NO public costs.

The irony is that Jamie Dimon is one of the few bank CEOs who avoided the credit excesses. He also, at the pleading of the government, rescued Bear Stearns and Washington Mutual (WaMu). Then-FDIC Chairperson Shelia Bair said, “[The WaMu situation] could have posed significant challenges without a ready buyer. … Some are coming to Washington for help; others are coming to Washington to help.” Now it appears Washington is suing JPM for helping.

I have no doubt about Jamie Dimon’s character. I do, however, doubt the character of some of the folks inside the D.C. Beltway, on both sides of the political equation, who are about to close down the government.

HEALTH SYSTEMS

Compare the US health system to those of the other large high-income countries. The US spends 18 per cent of its gross domestic product on health against 12 per cent in the next highest spender, France. The US public sector spends a higher share of GDP than those of Italy, the UK, Japan and Canada, though many people are left uncovered. US spending per head is almost 100 per cent more than in Canada and 150 per cent more than in the UK. What does the US get in return? Life expectancy at birth is the lowest of these countries, while infant mortality is the highest. Potential years of life lost by people under the age of 70 are also far higher. For males this must be partly due to violent deaths. But it is also true for women. (FT’s Martin Wolf)

Ingram Pinn illustration

 

CHINA OFFICIAL PMI EDGES UP TO 51.1

The official Manufacturing Purchasing Managers’ Index measured 51.1 in September, its highest reading since May 2012, and the third consecutive month of increase.

The September index was barely up from 51.0 in July after posting large gains in July and August.

New exports orders came in at 50.7 in September, from 50.2 in August. The small business sub-index fell to 48.8 from 49.2.