NEW$ & VIEW$ (21 NOVEMBER 2013)

Sales Brighten Holiday Mood

The government’s main gauge of retail sales, encompassing spending on everything from cars to drinks at bars, rose a healthy 0.4% from September, despite the partial government shutdown that sent consumer confidence tumbling early in the month. Sales climbed in most categories, with gains in big-ticket items as well as daily purchases such as groceries. (…)

Wednesday’s report showed some clear pockets of strength: Sales of cars rose at the fastest pace since the early summer. Sales in electronics and appliance stores also rose robustly. Stores selling sporting goods, books, and music items saw business grow at the fastest pace in more than a year.

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High five Let’s not get carried away. Car sales have been slowing sequentially lately and are near their past cyclical peaks if we consider the early 2000s sales levels abnormally high (internet and housing bubbles, mortgage refis) (next 2 charts from CalculatedRisk):

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Meanwhile, core sales ex-cars remain on the weak side as this Doug Short chart shows:

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Consumer Prices Ease Amid Lower Fuel Costs

The consumer-price index rose only 1% in October from the same month last year, the smallest 12-month increase since October 2009, the Labor Department said Wednesday. Core prices, which exclude volatile food and energy costs, rose 1.7% from a year ago, similar to the modest gains seen in recent months. The Fed targets an annual inflation rate of 2%.

Prices fell 0.1% last month from September, the first drop since April. Core prices increased 0.1%.

Last month, the overall decrease reflected gasoline prices, which were down 2.9% for the month. (Chart from Haver Analytics)

High five Let’s not get carried away. Core inflation remains surprisingly resilient given the weakness of the economy and the large output gap. On a YoY basis, core CPI is stuck within 1.6% and 1.8% and the Cleveland Fed median CPI just won’t slip below 2.0%. Looking at monthly trends, core CPI has slowed to 0.1% over the last 3 months from 0.2% in the previous 3 months. Yet, the median CPI only slowed to 0.1% MoM last month after a long string of 0.2% monthly gains. The inflation jury is still out.

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Pointing up No Renaissance for U.S. Factory Workers as Pay Stagnates

(…) The average hourly wage in U.S. manufacturing was $24.56 in October, 1.9 percent more than the $24.10 for all wage earners. In May 2009, the premium for factory jobs was 3.9 percent. Weighing on wages are two-tier compensation systems under which employees starting out earn less than their more experienced peers did, and factory-job growth in the South.

Since the U.S. recession ended in June 2009, for example, Tennessee has added more than 18,000 manufacturing jobs, while New Jersey lost 17,000. Factory workers in Tennessee earned an average of $54,758 annually in 2012, almost 10 percent less than national levels and trailing the $76,038 of their New Jersey counterparts, according to the Bureau of Labor Statistics. (…)

Some of the states where factory jobs are growing the fastest are among the least unionized. In 2012, 4.6 percent of South Carolina workers were represented by unions, as did 6.8 percent of Texans, according to the U.S. Bureau of Labor Statistics. New York, the most-unionized, was at 24.9 percent.

Assembly workers at Boeing’s nonunion plant in North Charleston, South Carolina, earn an average of $17 an hour, compared with $27.65 for the more-experienced Machinists-represented workforce at the company’s wide-body jet plant in Everett, Washington, said Bryan Corliss, a union spokesman. (…)

In Michigan, which leads the U.S. with 119,200 factory jobs added since June 2009, automakers are paying lower wage rates to new hires under the United Auto Workers’ 2007 contracts. New UAW workers were originally paidas little as $14.78 when the contract was ratified in 2011, which is about half the $28 an hour for legacy workers. Wages for some of those lower-paid employees have since risen to about $19 an hour and the legacy rate hasn’t increased. (…)

General Electric Co. says it has added about 2,500 production jobs since 2010 at its home-appliance plant in Louisville, Kentucky. Under an accord with the union local, new hires make $14 an hour assembling refrigerators and washing machines, compared with a starting wage of about $22 for those who began before 2005. While CEO Jeffrey Immelt has said GE could have sent work on new products to China, it instead invested $1 billion in its appliance business in the U.S. after the agreement was reached.

The company is also moving work to lower-wage states. In Fort Edward, New York, GE plans to dismiss about 175 employees earning an average of $29.03 an hour and shift production of electrical capacitors to Clearwater, Florida. Workers there can earn about $12 an hour, according to the United Electrical, Radio and Machine Workers of America, which represents the New York employees. (…)

Existing Home Sales Fall 3.2%

Sales of previously owned homes slipped for the second consecutive month in October, the latest sign that increased interest rates are cooling the housing recovery.

Existing-home sales declined 3.2% in October to a seasonally adjusted annual rate of 5.12 million, the National Association of Realtors said Wednesday. The results marked the slowest sales pace since June.

The federal government shutdown last month pushed some transactions into November, Realtors economist Lawrence Yun said. The Realtors group reported that 13% of closings in October were delayed either because buyers couldn’t obtain a government-backed loan or the Internal Revenue Service couldn’t verify income.

The number of homes for sale declined 1.8% from a month earlier to 2.13 million at the end of October. The inventory level represents a five-month supply at the current sales pace. Economists consider a six-month supply a healthy level.

Americans Recover Home Equity at Record Pace

The number of Americans who owe more on their mortgages than their homes are worth fell at the fastest pace on record in the third quarter as prices rose, a sign supply shortages may ease as more owners are able to sell.

The percentage of homes with mortgages that had negative equity dropped to 21 percent from 23.8 percent in the second quarter, according to a report today from Seattle-based Zillow Inc. The share of owners with at least 20 percent equity climbed to 60.8 percent from 58.1 percent, making it easier for them to list properties and buy a new place. (…)

Fingers crossed“The pent-up demand from people who now have enough equity to sell their homes will help next year,” said Lawler, president of Lawler Economic & Housing Consulting LLC in Leesburg, Virginia. “We’ll see the effect during the spring selling season. Not a lot of people put their homes on the market during the holidays.” (…)

About 10.8 million homeowners were underwater on their mortgages in the third quarter, down from 12.2 million in the second quarter, Zillow said. About 20 million people had negative equity or less than 20 percent equity, down from 21.5 million in the prior three months. Las Vegas, Atlanta, and Orlando, Florida, led major metropolitan areas with the highest rates of borrowers with less than 20 percent equity. (…)

DRIVING BLIND, TOWARDS THE WALL

Fed Casts About for Bond-Buy Endgame

Federal Reserve officials, mindful of a still-fragile economy, are laboring to devise a strategy to avoid another round of market turmoil when they pull back on one of their signature easy-money programs.

Minutes of the Oct. 29-30 policy meeting, released Wednesday, showed officials continued to look toward ending the bond-buying program “in coming months.” But they spent hours game-planning how to handle unexpected developments and tailoring a message to the public to soften the impact of the program’s end. (…)

Fed officials are hoping their policies will play out like this: The economy will improve enough in the months ahead to justify pulling back on the program, which has been in place since last year and has boosted the central bank’s bondholdings to more than $3.5 trillion. After the program ends, they will continue to hold short-term interest rates near zero as the unemployment rate—which was 7.3% last month—slowly declines over the next few years. (…)

One scenario getting increased attention at the Fed: What if the job market doesn’t improve according to plan and the bond program becomes ineffective for addressing the economy’s woes? The minutes showed their solution might be to replace the program with some other form of monetary stimulus. That could include a stronger commitment to keep short-term interest rates low far into the future, a communications strategy known as “forward guidance.”

Top Fed officials have been signaling in recent weeks that their emphasis is shifting away from the controversial bond-buying program and toward these verbal commitments to keep rates down. (…)

Punch The reality is that, do what you want, say what you want, market rates are market rates.

Millennials Wary of Borrowing, Struggling With Debt Management

Young people are becoming warier of borrowing — but they’re also getting worse at paying bills.

(…) Total debt among young adults actually dropped in the last decade to the lowest level in 15 years, separate government data show, with fewer young adults carrying credit-card balances and one in five not having any debt at all.

And yet, Millennials appear to be running into more trouble when paying their bills — whether on credit cards, auto loans, or student loans.

Millennial borrowers are late on debt payments roughly as much as older Gen-X borrowers, Experian’s data show. Millennials also use a high share of their potential borrowing capacity on cards, just like Gen-Xers, meaning they’re as likely to max out on cards.

Since Millennials tend to have fewer assets than Gen-Xers and other generations, as well as shorter credit histories, they end up with the worst average credit score — 628 — of any demographic group.

Pointing upMillennials have “the worst credit habits,” and are “struggling the most with debt management,” Experian said in a report.

(…) A study by the Federal Reserve Bank of New York recently suggested high student-loan balances may have encouraged young adults to reduce their credit-card balances between 2005 and 2012.

Other young adults may be less willing to take risksin a weak economy, whether by splurging on furniture for a new apartment, moving geographically or starting businesses — things that often require debt.

What Experian’s data suggest is that the Millennials who are in fact borrowing are struggling to do so responsibly, at least partly because of the nation’s 7.3% jobless rate, sub-3% growth and $1 trillion student-loan tab — all things that are weighing disproportionately on young people, especially those without college degrees.

As the Journal reported last week, the share of student-loan balances that were 90 or more days overdue in the third quarter rose to 11.8% from 10.9%, even as late payments on other debts dropped. While the incidence of late payments on Millennials’ overall debts isn’t alarming yet, it’s big enough to drag down their credit scores, Experian said. (…)

Thumbs up Thumbs down TIME TO BE SENTIMENTAL?

In December 2010, I wrote INVESTOR SENTIMENT SURVEYS: DON’T BE TOO SENTIMENTAL!, warning people not to give much weight to bullish sentiment readings:

I have analyzed 30 years of data plotting the II bull-bear % difference against the DJ Total Stock Market Index of 5000 US stocks. Extreme readings are above +/-25%. However, I have easily identified 11 periods when the “contrary” indicator rose to cross the extreme +30% level which were followed by strongly rising markets. Obviously not useful on that side of the ledger. (…)

Overall, never mind the extreme positives, they are essentially useless. The extreme negatives (bullish) are few but generally very good although some require patience and staying power.

My analysis was based on relative bullishness, bulls minus bears like in the chart below, but Barclays here takes another angle looking at the absolute level of bears:

According to the US Investors’ Intelligence Survey there are currently 40% more bulls than bears. At the end of August, the same survey indicated just 13.4% more bulls that bears. Global equities have rallied by 9% since then. Other measures also confirm this bullish hue, but none have displayed anything close to the relationship that the Investors’ Intelligence Survey has had recently with forward returns.

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Here’s the more interesting part:

Closer examination reveals that the reading on “bearishness” has a better contrarian relationship with subsequent forward returns. Currently only 16% of respondents describe themselves as “bears”. Since the beginning of 2009, when there have been less than 18% bears, the market has been lower six months later on each occasion. Given that the period since 2009 has been a strong bull market, sentiment extremes have provided a good “call” on the market.

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GOOD READ: ASSESSING THE PARTY’S DECISIONS

CLSA’s Andy Rothman is one of the most astute analyst living in China:

China’s leaders have issued strong statements in support of private enterprise and the rights of migrant workers and farmers which, if implemented effectively, will facilitate continued economic growth and social stability.  By announcing relaxation of the one-child policy and the abolishment of ‘re-education through labor’, the Party acknowledged it needs to curb human rights abuses and re-establish trust.  The creation of new groups to coordinate economic and national security policy signal that Xi Jinping has quickly consolidated his power as Party chief, raising the odds that the decisions announced Friday will be implemented quickly.

The brief, initial communique issued when the Party Plenum closed last Tuesday was dense, obtuse and packed with outdated political slogans.  But the more detailed ‘decision document’ published Friday was, for a Communist Party report, unusually clear, particularly in its support for private enterprise and markets.

Strong support for entrepreneurs

The most important signal from the Party leadership was strong support for the private sector and markets. Private firms already account for 80% of urban employment and 90% of new job creation, as well as two-thirds of investment in China, so improving the operating environment for entrepreneurs is key to our relatively positive outlook for the country’s economic future.  Friday’s document did not disappoint in this respect.

Although the Party still cannot rise to the challenge of actually using the Chinese characters for ‘private’ sector’, continuing to refer to it as ‘non-public’, they did pledge to ‘unwaveringly encourage, support and guide the development of the non-public economy’, and declared that ‘property rights in the non-public economy may equally [with the state sector] not be violated.’

In Friday’s document, the Party said it would ‘reduce central government management over micro-level matters to the broadest extent’, called for an end to ‘excessive government intervention’, and said that ‘resource allocation [should be] based on market principles, market prices and market competition.’  The world’s largest Communist Party declared that ‘property rights are the core of ownership systems’, and called for ‘fair competition, free consumer choice, autonomous consumption, [and] free circulation of products and production factors.’  The document also says China will ‘accelerate pricing reform of natural resources’ to ‘completely reflect market supply and demand’, as well as the costs of environmental damage.

The Party also pledged to reduce red tape and administrative hurdles to doing business.  Zhang Mao, the head of the State Administration for Industry and Commerce, explained that ‘registering a business will become much more convenient in the near future.’  And Miao Wei, minister for industry and information technology, announced that implementation of the plenum decision would lead his agency to eliminate at least 30% of administrative approval procedures by the end of 2015.

Friday’s document called for better protection of intellectual property rights, as well as the ‘lawful rights and interests of investors, especially small and mid-sized investors.’  The Party said it would create a ‘marketized withdrawal system where the fittest survive’, and a better bankruptcy process.

Party leaders did say that public ownership would remain ‘dominant’, but they clearly didn’t mean it.  Repeating this language, especially in light of the fact that private firms are already dominant, is, in our view, just a rhetorical bone thrown to officials whose political or financial fortunes are tied to state-owned enterprises. (…)

 

The Party did, however, raise the share of SOE income that has to be paid into the national security fund to 30% by 2020, up from 10-20% now.

In what may be a warning that serious SOE reform is likely down the road, the Party did call for the elimination of ‘all sorts of sector monopolies, and an end to ‘preferential policies . . . local protection . . . monopolies and unfair competition.’

Hukou reform coming

If the most important message from the plenum is renewed support for the private sector, a close second is the decision to reform the hukou, or household registration system.  This is important because there are more than 230m urban residents without an urban hukou, accounting for one-third of the entire urban population.

According to the official news agency, Xinhua, ‘Friday’s document promised to gradually allow eligible rural migrants to become official city residents, accelerate reform in the hukou system to fully remove restrictions in towns and small cities, gradually ease restriction in mid-sized cities, setting reasonable conditions for settling in big cities while strictly controlling the population in megacities.’ (…)

Hukou reform will be expensive, but the Party has no choice but to provide migrant workers and their families with equal access to education, health care and other urban social services.  In cases where local governments cannot afford these services, the central government will transfer the necessary funds.  Hukou reform will be rolled out gradually, and in our view:

Will reduce the risk of social instability from the 234m people living in cities who face de jure discrimination on a daily basis, particularly in eligibility for social services.

May increase the supply of migrant workers in cities at a time when the overall labour force is shrinking.

Should improve consumption by strengthening the social safety net for migrants, which will increase transfer payments and reduce precautionary savings.

Should result in higher productivity in manufacturing and construction by reducing worker turnover, and by creating a better-educated workforce. (…)

The one-child policy will be relaxed by ‘implementation of a policy where it is permitted to have two children if either a husband or a wife is an only child,’ a change from the current rules which require both the husband and wife to be only-children in order to qualify to have a second child.

Wang Peian, the deputy director of the national health and family planning committee, said that the Party will allow each province to decide when to switch to the new policy, but Friday’s announcement, in our view, spells the rapid end of the one-child policy.

Wang Feng, one of China’s leading demographers, told us over the weekend that Friday’s announcement was a ‘decisive turning point.’  But he also reminded us that in a May CLSA U report, he explained why ending the one-child policy is likely to result in a temporary uptick in the number of births, but is unlikely to change the longer-term trend towards a lower fertility rate.  The current fertility rate of 1.5 could drop even lower in the future, closer to Japan and South Korea’s 1.3, as the pressures of modern life lead Chinese couples to have smaller families. (…)

Xi consolidates power

The plenum decided to create two new groups within the government, a National Security Council and the Leading Small Group for the Comprehensive Deepening of Reform.  This signals that Party chief Xi Jinping has quickly and effectively consolidated his political power, far beyond, apparently, what his predecessor Hu Jintao was able to achieve.  This bodes well for Xi’s ability to implement the reform decisions announced Friday. (…)

 

NEW$ & VIEW$ (19 NOVEMBER 2013)

EU Car Sales Maintain Growth

New car registrations in the European Union rose in October from a year earlier, the latest in a series of indications that Europe’s long auto-sales slump may be moderating.

The data, released Tuesday, marked the first time year-to-year demand for new cars has risen for two consecutive months since September 2011.

High five  But underscoring the still-daunting challenges faced by European auto makers, the October figures were lower than registrations a month earlier, and represented the second-lowest number of vehicles registered during October since 2003. During the first 10 months of the year, EU new car registrations fell 3.1% from the year-earlier period.

October new car registrations, a proxy for sales, rose 4.7% from a year earlier to 1.00 million vehicles, compared with 5.4% growth to 1.16 million in September.

Demand was supported by all major European markets, with registrations up 2.3% in Germany, 2.6% in France, 4.0% in the U.K. and 34% in Spain. The exception was Italy, where registrations fell 5.6% from a year earlier. (…)

Punch  The WSJ article failed to mention that Spain had its fourth cash-for-clunkers program last month.

Home Builders’ Confidence Eases a Bit

The National Association of Home Builders, an industry trade group, said Monday its monthly housing-market index stood at 54 in November, matching a downwardly revised figure for October. The figure measures builder confidence in the market for newly built, single-family homes.

Readings above 50 indicate that more builders view conditions as good than poor, and the index crossed that threshold in June for the first time since April 2006. At the height of the building bubble, readings were in the high 60s and low 70s. (…)

The figure hit 58 in August and has been falling since. (…) In recent weeks, mortgage rates have started to rise, with the average rate for a 30-year fixed-rate mortgage at 4.35% as of Nov. 14, according to Freddie Mac. That is the highest rate in eight weeks, though rates remain near historic lows. (…) (Charts from CalculatedRisk and Bespoke Investment)

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HOLIDAY SPENDING WATCH

(…) With shoppers expected to visit fewer stores this holiday, sales are projected to advance 2.4 percent, the smallest increase since the year the recession ended, according to ShopperTrak, a Chicago-based researcher. Sales from Black Friday through Cyber Monday are projected to rise 2.2 percent year-over-year, researcher IBISWorld said yesterday. (…)

“The consumer is more deal-driven than ever,” Ken Perkins, president of researcher Retail Metrics LLC, wrote in a Nov. 14 note. “Discretionary dollars for holiday spending are limited for the large pool of lower- and moderate-income consumers due to lack of wage gains this year coupled with the increased payroll tax.” (…)

The six-fewer shopping days this year also could make the chains “push the promotional ‘panic button’ earlier than needed, putting their margins at risk,” they said. (…)

The National Retail Federation, a Washington-based trade group, is more upbeat than ShopperTrak. It has forecast that U.S. retail sales may increase 3.9 percent during the holiday season. That increase would be slightly higher than last year’s 3.5 percent gain. (…)

  • Best Buy warns promotions could hurt holiday quarter margins
  • Amazon’s Toys Cheaper Than Wal-Mart Online
  • Amazon.com Inc. (AMZN)’s toy prices were lower than those available online from Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT) last week as retailers seek to attract shoppers heading into the crucial holiday selling season.

    Amazon’s prices, excluding those from its third-party sellers, were 3 percent lower on average than Wal-Mart’s on a basket of 87 toys, according to a study conducted by Bloomberg Industries on Nov. 14. Including the Marketplace vendors, which use Amazon’s platform to sell their own products, the pool of comparable goods expanded to 115, and Wal-Mart was cheaper by 1.2 percent, on average.

    The pricing battle may help determine which retailers win consumers’ toy purchases during the holiday season. Sales in November and December account for 20 percent to 40 percent of U.S. retailers’ annual revenue, according to the National Retail Federation. (…)

    Wal-Mart’s prices were 2.4 percent lower than at Target, 5 percent less than Sears Holdings Corp. (SHLD)’s Kmart and 7.2 percent lower than Toys “R” Us Inc., according to the study.

  • Chain store sales rose 0.1% last week and the 4-week m.a. is up 2.3% YoY.

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Worldwide business confidence lifts from post-crisis low

The 13th Markit global survey of business expectations for the year ahead, covering 11,000 companies, indicated that firms have become more upbeat about their business prospects since the post-crisis low seen mid-year, resulting in higher expectations about employment and investment. However, optimism remains well below the highs seen earlier in the recovery, indicating that global economic growth is likely to remain subdued in the coming year.

The number of companies expecting their business activity levels to rise in the next 12 months outnumbered those anticipating a decline by +33%, up from +30% in June but below the +39% reading seen in February.

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Improving prospects for the developed world contrasted with still-low levels of confidence about the year ahead in the emerging markets.
Among the developed world, the upturn in confidence was led by the UK, where the outlook is the brightest seen since the survey began in early-2009. Optimism also improved in the eurozone, hitting its highest since mid-2011, notably improving in the ‘periphery’, with Spain and Italy reporting a higher degree of optimism than Germany and France, the latter seeing the weakest positive sentiment.

In the United States, business confidence about the year ahead was the second–lowest seen since the financial crisis, up only slightly on the low seen in June but above the global average. Optimism edged up slightly in both manufacturing and services but remained subdued. Companies again fretted about the impact of the ongoing uncertainty surrounding the government budget.

Worries about the outlook meant employment intentions were only marginally higher than the survey low seen in June, though capex plans recovered to a slightly greater extent.

In Japan, optimism remained weak, and slipped compared to mid-year, suggesting companies are unconvinced that the recent growth spurt is turning into a sustainable and robust upturn, in many cases harbouring concerns about growth prospects in other Asian countries, especially China. However, price pressures are set to improve, with input costs and output charges both rising at slightly faster rates.

Prospects among the four largest emerging markets remained unchanged on the post-crisis low seen in the mid-year survey. Both India and Russia saw optimism slide, while China’s outlook failed to improve on the low seen in the summer. Only Brazil saw business sentiment improve, reaching a new post-crisis high, buoyed by optimism about the positive impact of the soccer World Cup and Olympics.

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High five  Corporate Results Expose Lack of Confidence

Investors sifting through third-quarter financial results should be a bit nervous about the future growth of the U.S. economy.

Though corporate profits were higher overall, companies slashed their spending on factories, equipment and other performance-enhancing investments by 16% from year-earlier levels, according to an analysis by REL Consultancy for The Wall Street Journal.

Instead of putting money to work in their operations, companies gave more of it back to shareholders in the form of buybacks and dividends.

Weakness in emerging markets and strong currency headwinds also were common themes in the quarterly results. (…)

Almost 90% of the companies that have given financial forecasts for the final quarter of the year have prompted Wall Street analysts to lower their numbers. Only a dozen companies have painted rosier pictures, according to data tracker FactSet.

“Companies are reluctant to raise the bar,” said John Butters, senior earnings analyst at FactSet. “We’re not really seeing a huge increase in companies turning negative, but the number of companies giving positive guidance is almost half of what we’ve seen lately.”

A broad range of companies scaled back capital spending plans during the quarter, including Honeywell Inc., Corning Inc., Yahoo Inc., Cliffs Natural Resources Inc. and McDonald’s Corp. (…)

To be sure, earnings continued to be strong in the third quarter. With more than 90% of companies in the S&P 500 index having posted results for the quarter, blended earnings were up 3.5% from a year earlier, and profit remained in record territory, according to FactSet. (…)

Profit margins, at 9.6%, were near records, thanks to cost cutting, automation and lower commodity prices. But revenue growth was a tepid 2.9% from a year earlier. (…)

The lack of confidence is part of the reason why U.S. companies were on pace to have more than $1.144 trillion in cash at the end of the quarter, making it the fourth quarterly record in a row, according to S&P Dow Jones Indices. (…)

Corporate buybacks totaled $103 billion in the quarter, an increase of 12% from the second quarter, excluding Apple’s record $16 billion buyback in the spring, according to FactSet. (…)

Companies also announced a combined 2.5% increase in dividend payments, which now total almost $75.5 billion for the quarter, according to FactSet. (…)

Another prominent trend in third-quarter results was the harm caused by the dollar’s strength against the currencies of several major U.S. trading partners, including Japan, Brazil and India.

The dollar has climbed between 11% and 20% against the currencies of those three countries, making U.S.-made goods more expensive there. (…)

OECD Warns of U.S. Threat to Global Recovery

The uncertain future of U.S. fiscal and central bank policies poses a growing risk to a global economic recovery that has already been weakened by a slowdown in growth in many developing economies, the Organization for Economic Co-operation and Development said Tuesday.

In its twice-yearly Economic Outlook report, the Paris-based research body said the U.S. debt ceiling should be abolished, and replaced by “a credible long-term budgetary consolidation plan with solid political support.”

The report marks a significant shift in the OECD’s focus of concern, which in recent years has been centered on the euro zone’s attempts to tackle its fiscal and banking crises. While the OECD remains worried about the euro zone’s frailties, the most immediate threats to the global recovery now appear to come from the U.S.

The OECD said a series of events has undermined confidence and stability in recent months, including the “surprisingly strong” reaction by investors to the possibility that the Federal Reserve will soon start to reduce its asset-purchase program. That led to related concerns about developing economies, and was followed by a “potentially catastrophic” crisis precipitated by negotiations over the U.S. debt ceiling.

“These events underline the prominence of negative scenarios and risks that the recovery could again be derailed,” OECD chief economist Pier Carlo Padoan said.

The heightened risks from the U.S. are in addition to continued ones from a fragile euro-zone banking sector and Japan’s fiscal situation, the OECD said.

The warnings came as the OECD forecast only a modest economic recovery through 2015. The combined economies of the 34 members of the OECD will grow 1.2% this year, before accelerating to 2.3% in 2014 and 2.7% in 2015, according to its forecasts.

Growth rates between developed economies will continue to differ markedly with the euro zone contracting 0.4% this year before growing 1% next year, while the U.S. will grow 1.7% and 2.9% over the same periods.

The twice-yearly economic outlook is slightly weaker than in May, mainly because of an expected slowdown in some large developing economies that partly reflects their vulnerability to capital outflows when the Federal Reserve does eventually start to reduce its stimulus program.

“The turmoil following the tapering discussions in mid-year has revealed how sensitive some emerging market economies are to U.S. monetary policy,” the OECD said.

The OECD cut its 2014 growth forecast for Brazil to 2.2% from 3.5% in May, its forecast for India to 4.7% from 6.7%, and its forecast for Indonesia to 5.6% from 6.2%. It cut its growth forecast for China more modestly to 8.2% from 8.4%, still leaving it above that of many other economies.

The research body said the weaker growth outlook for some developing economies was more deeply rooted in “long-standing structural impediments that had been hidden by abundant capital inflows.” Solutions to those problems vary from country to country, but generally developing economies need more formal and efficient labor markets and stronger, market-based financial systems, Mr. Padoan said.

Largely as a result of its more downbeat assessment of the outlook for large developing economies, the OECD cut its forecast for global gross domestic product growth by around 0.5 percentage points this year and next to 2.7% and 3.6%, respectively. (…)

But not to worry:

Mohamed El-Erian
Yellen shows Fed remains risk markets’ best friend

(…) and not by choice but by necessity.

This is music to the ears of investors conditioned to position their portfolios to gain from steadfast central bank liquidity support, especially in the US. But with Wall Street having already reflected this in asset prices, and with the benefits for Main Street continuing to disappoint, investors may well need an increasingly differentiated approach if they are to continue to benefit from the “central bank put”. (…)

Ms Yellen left no doubt that she is committed to maintaining the Fed’s current approach – one that places asset markets front and centre in the transmission mechanism linking Fed actions to policy objectives.

Positioning for the impact of Fed policy rather than fundamentals has been a winning strategy for investors – not only in the immediate aftermath of the 2008 global financial crisis, but also in the past three years during which the Fed has pivoted from normalising markets to pursuing much more ambitious macroeconomic objectives. But they now need to be increasingly mindful of the level of prices and the associated (and growing) number of disconnects that the Fed is underwriting.

This year’s impressive performance of risk assets (including the 21 per cent year-to-date increase in the MSCI world equity index as of Friday, powered in particular by US stocks) contrasts with a global economy still stuck in third gear. (…)

Fed policy fuels wealth-led growth
Still no sign of a real economic recovery

(…) Ms Yellen’s remarks, prepared for her confirmation hearings last week, contained no hint of tapering. That underscores the Fed’s obsessive fear of the negative wealth effect of any slowdown in asset purchases and a move towards higher interest rates. Five years after the meltdown, it is clear the Fed’s quantitative easing is not about a real economic recovery, it is only about generating the liquidity that gives rise to asset inflation and wealth-led growth. Or super wealthy people-led growth since wages and incomes for the rest of us are not rising at all. (…)

BUBBLE WATCH

Stocks Are Way, Way Overvalued: GMO

As U.S. stocks sit in record territory, money managers at GMO – never a bunch to shy away from bold calls – are warning that the market is significantly overvalued.

As U.S. stocks sit in record territory, money managers at GMO – never a bunch to shy away from bold calls – are warning that the market is significantly overvalued.

In a report titled ”Breaking News! U.S. Equity Market Overvalued!“, Ben Inker, head of the asset allocation group at GMO, comes out with some eye-popping numbers. He argues that the S&P 500′s fair value is 1100, about 40% below Monday’s closing level, and the expected return is -1.3% a year, after inflation, for the next seven years.

Small-cap valuations, he writes, are even more elevated. (…)

Mr. Inker’s call came after comments by billionaire investor Carl Icahn, who told a conference sponsored by Reuters that he was “very cautious” on the stock market and could see a “big drop” because earnings at many companies have been goosed by low borrowing costs rather than strong management. (…)

GMO’s calls are widely watched in part because the firm’s money managers don’t have a reputation for being perma-bulls or perma-bears. Mr. Grantham was early in predicting the financial crisis and then reversed course before markets started rebounding in 2009. He has also advocated investing in timber and high-quality dividend-paying stocks. (…)

Here’s the conclusion to Mr. Inker’s rather downbeat analysis:

“We don’t consider non-U.S. equity markets a screaming buy. But as value managers listening for any assets, anywhere, that are screaming to be bought, the world currently sounds a deathly quiet place. The hoarse whisper of “buy me” coming from European and emerging equities (as well as the polite cough for attention coming from U.S. high quality stocks) comes through loud and clear. “

Hmmm… U.S. equities 40% overvalued and still willing to buy equities. I wouldn’t.

But others are also trumpeting Euro equities:

Europe Stocks Seem Cheap

As U.S. stocks push to record highs, more U.S. money managers are looking for better opportunities across the pond.

The big rally in U.S. stocks has pushed valuations higher than those of European shares. Meanwhile, sentiment is rising that Europe has gotten past the worst of its debt crisis, and some say the European Central Bank appears to be on a path for more easing of monetary policy, both of which augur for more room to run in European stocks.

Unlike the S&P 500, which is well into record territory, the Stoxx Europe 600 stock index hasn’t recovered to its precrisis peak. The S&P 500 has risen 26% this year while the Stoxx Europe 600 is up 16%.

Aren’t you convinced by this great analysis?

What about these mundane facts?

  • U.S. P/Es have exceeded Euro P/Es by an average of 10% over the last 25 years. In fact, the U.S. premium is at its low point of the past 14 years.
  • US trailing EPS are some 20% above their 2007 peak, whilst in Europe they are some 25% below.
  • U.S. profit margins are higher than Euro margins.
  • The U.S. economy keeps growing faster than that of the Eurozone.
  • U.S. inflation is higher than that of the Eurozone.
  • The U.S. government is more efficient than that of the Eurozone, which speaks volume about the latter.
  • The Fed is also more efficient than the ECB.

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These reasons amply justify higher multiples for American companies.

This is not to deny the possibility that Eurozone profits could rise faster than U.S. profits in the next few years. In fact, this is a key argument for many strategists. The hurdles are significant, however. Slow domestic growth, a strong euro, low inflation and very liberal labour laws are big impediments to profit margins. Don’t simply extrapolate America’s margin expansion. Expectations for rising margins in Europe have remained elusive so far.

image image

A case in point: the following is especially true in Europe:

Just kidding  Business taxes fall more heavily on labor.

Companies around the world are paying more in employment taxes than in profit taxes, the FT reports. Labor taxes accounted for 32% of the average total tax rate paid by midsize businesses in 2004, but now account for almost 38% of the rate, compared with slightly more than 37% for profit taxes. Mary Monfries, tax partner of PwC, said the shift is a world-wide trend, “with governments lowering profit taxes to encourage investment and entrepreneurship. Getting the right tax mix is a hard call. Lower profit taxes can drive growth which brings employment, whilst lower employment taxes can ease the cost of hiring.”

Fed Official Says Big Banks Need Higher Capital Levels Very large banks that rely on broker-dealer operations need to hold higher levels of capital to reduce the risk to the broader financial system, Federal Reserve Bank of Boston President Eric Rosengren said.

European banks are also in a worse situation.

Now you know the essentials. All the best.  Winking smile

 

NEW$ & VIEW$ (12 NOVEMBER 2013)

THE AMERICAN PROBLEM

Job Gap Widens in Uneven Recovery

America’s jobs recovery is proceeding on two separate tracks—a pattern that is persisting far longer than after past economic rebounds and lately has been growing worse.

(…) Youth unemployment, for example, nearly always improves after recessions more slowly than that of prime-age workers, those between 25 and 54. Following the 2001 recession, it took six months for the gap between the youth and prime-age unemployment rates to return to its long-run average. After the early 1990s recession, it took 30 months. This time, it has been 52 months, and the gap has hardly narrowed.

For those with decent jobs, wages are rising, albeit slowly, and job security is the strongest it has been since before the recession. Many families have paid down debts and are seeing the value of assets, from homes to stocks, rebound strongly.

But many others—the young, the less educated and particularly the unemployed—are experiencing hardly any recovery at all. Hiring remains weak, and the jobs that are available are disproportionately low-paying and often part-time. Wage growth is nearly nonexistent, in part because with so many people still looking for jobs, workers have little bargaining power.

Wage growth has moved on two tracks

The two-track nature of the recovery helps explain why the four-year-old upturn still doesn’t feel like one to many Americans. Higher earners are spending on cars, electronics and luxury items, boosting profits for the companies that make and sell such goods. But much of the rest of the economy remains stuck: Companies won’t hire or raise pay without more demand, and consumers can’t spend more without faster hiring and fatter paychecks. (…)

‘Rural America’ slow to recover
Net job growth near zero, say data

Employment growth in the US’s sparsely populated heartland has stagnated since the economy began to recover in 2010, according to official data that underscore the weakening economic power of rural America.

The data, from this year’s US Department of Agriculture’s Rural America at a Glance report, show that while employment in both urban and rural areas fell by 5 per cent during the 2007-09 recession and recovered by a similar level in 2010, their prospects have since diverged. Since the start of 2011, net job growth in non-metropolitan areas has been near zero, while it has averaged 1.4 per cent annually in metropolitan areas.

The report notes that rural job growth stagnation has coincided with the first-ever recorded net population decline in those regions, driven by a drop in the number of new migrants moving in. This means the unemployment rate in rural regions has not risen, since fewer people are seeking work.

Population loss has meant fewer jobs as demand for goods and services falls, which in turn encourages those with higher skills to move away. (…)

In summary (chart from Doug Short):

Click to View
 

Fingers crossed About 1-in-4 U.S. Pumps Selling Gas Below $3

Americans are seeing the lowest pump prices for gasoline since February 2011, AAA says.

Gas prices dropped 6.6 cent per gallon the past week to $3.186, which is down 25.3 cents from a year earlier.

That’s a 7.4% drop YoY! Right before Christmas. Chain store sales rose 1.2% last week, boosting the 4-week moving average to +2.1% YoY.

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Expiring US jobless benefits fuel concern
The scheme launched in 2008 is due to run out

(…) Unless Congress takes action to renew it again, about 1.3m long-term unemployed would see their benefits halted at the end of the year, and a further 850,000 would be denied access to the benefits in the first three months of next year, according to a report from the National Employment Law Project, an advocacy group. (…)

Federal assistance for the long-term unemployed was launched in 2008, during the last recession, and renewed until the end of this year. Michael Feroli, a senior economist at JPMorgan Chase, has estimated that the expiry of the federal jobless benefits would trim about 0.4 percentage points off annualised gross domestic product growth in the first quarter of next year. This is roughly equivalent to estimates of the hit to US output produced by last month’s US government shutdown. (…)

Sad smile  Small Businesses Optimism Takes a Tumble

Fall arrived literally this month, as small business optimism dropped from 93.9 to 91.6, largely due to a precipitous decline in hiring plans and expectations for future smal -business conditions. Of the ten Index components, seven turned negative, falling a total of 27 percentage points. The stalemate in early October over funding the government as well as the failed “launch” of the Obamacare website left 68% of owners feeling that the current period is a bad time to expand; 37% of those owners identified the political climate in Washington as the culprit—a record high level.

Small business optimism report data through October 2013

 

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Fingers crossed OECD: Global Growth to Pick Up

Economic growth is set to pick up in the euro zone, China and the U.K., while remaining sluggish in India, Brazil and Russia.

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Punch  LE PROBLÈME FRANÇAIS (from Reuters’ AlphaNow):

COTW_1111

Rating the Euro Zone’s Progress

Many euro-zone indicators have taken on a more promising outlook in recent months. Credit ratings firms are beginning to reflect that.

The direction of travel can be more important than where on the journey you are. That’s particularly true of the euro zone and the credit ratings assigned to its member states. November’s actions—a downgrade for France and improvements in outlooks for Spain and Portugal—send some key signals. The euro zone is undergoing adjustment, although not all its members are yet on the right track.

France’s downgrade to double-A by Standard & Poor’s might look like the most important action, but isn’t. French bond yields hardly reacted; strategists at Royal Bank of Scotland told investors to “ignore” the cut. That is quite right; France faces no immediate threat that should cause bond yields to spike higher.

Still, the rationale is cause for long-term worry: France is falling behind. “French exporters appear to continue to be losing market share to those European competitors whose governments have more effectively loosened the structural rigidities in their economies,” S&P warned. The European Commission last week forecast that net exports would contribute just 0.1 percentage point to French growth of 0.9% in 2014 and be a slight drag on growth in 2015. France’s government still hasn’t found the right policy direction to regain competitiveness.

More significant was Fitch’s decision to raise Spain’s rating outlook to stable from negative, the first of the major ratings firms to do so. Spain won plaudits for its fiscal and structural reforms, and the move to surplus in its current account. That is an important turnaround: Spain was on the front line of the crisis just 18 months ago.

Most interesting of all was Moody‘s move to a stable outlook from negative on Portugal. Moody’s is becoming rapidly less bearish on the euro zone. At the start of September, it had just two euro-zone sovereigns with a stable outlook; now there are six. The big move for Moody’s would be to shift Spain back to a stable outlook. The decision on Portugal provided a glint of hope, with Moody’s highlighting the benefit of a recovery in Spain, its key trading partner.

Ratings are often dismissed as backward-looking, and downgrades or upgrades are frequently priced in long before they actually happen. But outlooks can provide new information to the market. That is where investors should look for signposts.

IEA warns of future oil supply crunch
Concerns rise as Gulf states delay investment due to US shale revolution

(…) Mr Birol was speaking as the Paris-based IEA unveiled its annual outlook for the energy market. Its 2012 forecast that the US would be a net oil exporter by 2030 helped bring shale oil production to global attention. But this year the organisation downplayed the significance of US production growth, with Mr Birol calling shale “a surge, rather than revolution”.

The IEA still expects US oil output to reduce the world’s dependence on Middle Eastern oil in the near term: it now forecasts that the US will displace Saudi Arabia as the world’s biggest oil producer in 2015, two years earlier than it had estimated just 12 months ago.

But it expects US light tight oil production, which includes shale, to peak in 2020 and decline thereafter, even as global demand continues to grow to 101m barrels a day by 2035, from around 90m b/d today.

Outside the US, light tight oil production is only expected to contribute 1.5m b/d of supplies by 2035, as countries such as Russia and China make limited progress towards unlocking their shale reserves.

That will leave the market once more dependent on crude from the Opec oil cartel, of which Gulf producers are key members. (…)

But the IEA expects domestic demand in the Middle East to hit 10m b/d by 2035 – equal to China’s current consumption – thanks to subsidies for petrol and electricity, even as foreign demand for Gulf oil increases.

Mr Birol said the Gulf states needed to invest significantly now to meet rising demand after 2020, because projects take several years to begin producing. But he said he was concerned Gulf countries were misinterpreting the impact of rising US shale production. (…)

Gulf producers have taken a cautious approach to investment in recent years, in the face of fast growing US output. Saudi Arabia does not plan to increase its oil production capacity in the next 30 years, as new sources of supply, from US shale to Canadian oil sands, fill the demand gap.

The UAE is reported to have pushed back its target for raising production capacity to 3.5m b/d to 2020 from 2017, while Kuwait is struggling to overcome rapid decline rates from its existing fields. (…)

SENTIMENT WATCH

Charles Schwab’s Liz Ann Sonders posted this good Ned Davis chart, although her bullishness dictated her to write that sentiment was “a bit” stretched.

Sentiment does look a bit stretched in the short-term, with both the Ned Davis Crowd Sentiment Poll and SentimenTrader’s Smart Money/Dumb Money Confidence Poll showing elevated (extreme) levels of optimism. Investor sentiment shoots higher

Since 1995, being in such a “bit stretched” territory has not been profitable, on average:Screen Shot 2013-11-07 at 4.21.29 PM

This next chart, posted by ZeroHedge, is nothing to help sentiment get less stretched.

Note however that the latest tally from S&P reveals that estimates for Q3 have turned up to $27.02 ($26.77 last week) while the forecast for Q4 is now $28.23 ($28.38 last week).

 

NEW$ & VIEW$ (11 NOVEMBER 2013)

DRIVING BLIND

 

Jobs Strength Puts Fed on Hot Seat

The U.S. job market showed surprising resilience in October, rekindling debate about whether the economy is strong enough for the Federal Reserve to rein in its signature easy-money program.

The Labor Department reported that U.S. employers added 204,000 jobs last month, defying expectations for weaker hiring amid the shutdown and a debt-ceiling fight that knocked down consumer and business confidence.

Among the most encouraging revelations in the jobs report were upward revisions to government estimates of job growth in August and September, before the government shutdown, easing worries about a renewed slowdown in the labor market.

The 204,000 jump in nonfarm payrolls came on top of upward revisions of 60,000 for the two previous months.

With the revisions, the trend in job creation looks notably better than it did just a few weeks ago. The latest report showed that payroll employment grew by an average of just less than 202,000 jobs per month in the past three months. The previous jobs report, released Oct. 22, showed job growth had averaged 143,000 per month over the prior three-month period.

See the impact before and after the revisions. The “summer lull” was shallower and employment growth could be turning up:

image  image

However,

The latest figures included a number of statistical quirks that will likely lead Fed officials to be even more cautious than usual about inferring too much from a single month’s jobs report. For example, the timing of the delayed monthly hiring survey might have skewed the data.

And these peculiar stats:

Retail boom coming to a store near you?

Pointing up CalculatedRisk writes that according to the BLS, retailers hired seasonal workers in October at the highest level since 1999. This may have to do with these announcements posted here on Oct. 1st.:

Amazon to Hire 70,000 Workers For Holiday Selling Season

Amazon plans to hire 70,000 seasonal workers for its U.S. warehouse network this year, a 40% increase that points to the company’s upbeat expectations about the holiday selling season. (…)

Wal-Mart, for instance, said this week it will add about 55,000 seasonal workers this year and Kohl’s Corp. is targeting 50,000. Target Corp.’s estimated 70,000 in seasonal hires is 20% lower than last year, the company said, reflecting the desire by employees to log more hours at work.

Punch But, out there, in Real-Land, this is what’s happening:

Personal spending, a broad measure of consumer outlays on items from refrigerators to health care, rose 0.2% in September from a month earlier, the Commerce Department said Friday. While that was in line with economists’ forecast of a 0.2% increase and matched the average rise over the July-through-September period, it is still a tepid reading when taken in broader context.

This is in nominal dollars. In real terms, growth is +0.1% for the month and +0.3% over 3 months. While the rolling 3-month real expenditures are still showing 1.8% YoY growth, the annualized growth rate over the last 3 and 6 months has been a tepid 1.2%.

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Here’s the trend in PDI and “department store type merchandise” sales. Hard to see any reason for retailers’ enthusiasm.image

Confused smile More quirks:

The weirdness was in the household survey, which showed a 735,000 plunge in employment, mainly 507,000 workers who were kept home by the federal government’s partial shutdown. But private employment was down 9,000, while the Bureau of Labor Statistics counted a massive exodus of 720,000 folks from the workforce.

Accordingly, the six-month average through October now comes to an increase of 174,000, basically the same as the six-month average through September of 173,000.

From the GDP report:

Consumer spending rose at an annualised rate of just 1.5%, down from 1.8% in the second quarter and 2.3% in the first three months of the year. The increase was the smallest for just over three years and considerably
below the 3.6% average seen in the 15 years prior to the financial crisis.

 

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In a nutshell, the BLS reports a surge in jobs thanks largely to accelerating retail employment that is not supported by actual trends in consumer expenditures nor by their ability to spend.

Fingers crossed POTENTIAL SAVIOR:image

But there is also this:

October Housing Traffic Weakest In Two Years On “Broad-Based” Housing Market Slowdown

In case the world needed any additional proof that the latest housing bubble (not our words, Fitch’s) was on its last legs, it came earlier today from Credit Suisse’ Dan Oppenheim who in his monthly survey of real estate agents observed that October was “another weak month” for traffic, with “pricing power fading as sluggish demand persists.” (…)

Oppenheim notes that the “weakness was again broad-based, and particularly acute in Seattle, Orlando, Baltimore and Sacramento…. Our buyer traffic index fell to 28 in October from 36 in September, indicating weaker levels below agents’ expectations (any reading below 50). This is the lowest level since September 2011.”

Other notable findings:

  • The Price appreciation is continuing to moderate: while many markets saw home prices rising if at a far slower pace, 7 of the 40 markets saw sequential declines (vs. no markets seeing declines in each of the past 8 months). Agents also noted increased use of incentives. Tight inventory levels remain supportive, but are being outweighed by lower demand.
  • Longer time needed to sell: it took longer to sell a home in October as our time to sell index dropped to 42 from 57 (below a neutral 50). This is  typically a negative indicator for near-term home price trends.

Nonetheless:

U.S. Stocks Rise as Jobs Data Offset Fed Stimulus Concern

U.S. stocks rose, pushing the Dow Jones Industrial Average to a record close, as a better-than-forecast jobs report added to signs growth is strong enough for the economy to withstand a stimulus reduction.

Nerd smile  Ray Dalio warns, echoing one of my points in Blind Thrust:

Ray Dalio’s Bridgewater On The Fed’s Dilemma: “We’re Worried That There’s No Gas Left In The QE Tank”

(…) As shown in the charts below, the marginal effects of wealth increases on economic activity have been declining significantly. The Fed’s dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing. If it were targeting asset prices, it would tighten monetary policy to curtail the emerging bubble, whereas if it were targeting economic conditions, it would have a slight easing bias. In other words, 1) the Fed is faced with a difficult choice, and 2) it is losing its effectiveness.

We expect this limit to worsen. As the Fed pushes asset prices higher and prospective asset returns lower, and cash yields can’t decline, the spread between the prospective returns of risky assets and those of safe assets (i.e. risk premia) will shrink at the same time as the riskiness of risky assets will not decline, changing the reward-to-risk ratio in a way that will make it more difficult to push asset prices higher and create a wealth effect.

Said differently, at higher prices and lower expected returns the compensation for taking risk will be too small to get investors to bid prices up and drive prospective returns down further. If that were to happen, it would become difficult for the Fed to produce much more of a wealth effect. If that were the case at the same time as the trickling down of the wealth effect to spending continues to diminish, which seems likely, the Fed’s power to affect the economy would be greatly reduced. (…)

The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up, in that interest rates are at zero and US asset prices have been driven up to levels that imply very low levels of returns relative to the risk, so there is very little ability to stimulate from here if needed.  So the Fed will either need to accept that outcome, or come up with new ideas to stimulate conditions.

We think the question around the effectiveness of continued QE (and not the tapering, which gets all the headlines) is the big deal. Given the way the Fed has said it will act, any tapering will be in response to changes in US conditions, and any deterioration that occurs because of the Fed pulling back would just be met by a reacceleration of that stimulation.  So the degree and pace of tapering will for the most part be a reflection and not a driver of conditions, and won’t matter that much.  What will matter much more is the efficacy of Fed stimulation going forward. 

In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.

Elsewhere:

S&P Cuts France’s Credit Rating

The firm cut France’s rating by one notch to double-A, sharply criticizing the president’s strategy for repairing the economy.

“We believe the French government’s reforms to taxation, as well as to product, services, and labor markets, will not substantially raise France’s medium-term growth prospects,” S&P said. “Furthermore, we believe lower economic growth is constraining the government’s ability to consolidate public finances.”

S&P’s is the third downgrade of France by a major ratings firm since Mr. Hollande was elected. (…)

The political situation leaves the government with little room to raise taxes, S&P said. On the spending side, the agency said the government’s current steps and future plans to cut spending will have only a modest impact, leaving the country with limited levers to reduce its deficit.

Smile with tongue out  French Credit Swaps Fall as Investors Shun Debt Downgrade

The cost of insuring against a French default fell to the lowest in more than three years, as investors ignored a sovereign-credit rating downgrade by Standard & Poor’s.

Credit-default swaps on France fell for a sixth day, declining 1 basis point to about 51 basis points at 1:45 p.m. That would be the lowest closing price since April 20, 2010. The contracts have fallen from 219 basis points on Jan. 13, 2012 when France lost its top rating at S&P.

“You need to ignore the S&P downgrade of France,” saidHarvinder Sian, fixed-income strategist at Royal Bank of Scotland Group Plc in London. “It is behind the market.”

Surprise Jump in China Exports

Exports rebounded sharply in October from a September slump as demand improved in the U.S. and Europe, a potentially positive sign for the global economic outlook.

Exports in October were up 5.6% from a year earlier, after registering a 0.3% fall in September. The median forecast of economists surveyed by The Wall Street Journal was for an expansion of just 1.5%.

The news from China follows reports of a strong October performance from South Korea’s exports, up 7.3% from a year earlier, and suggests the recovery in the U.S. and elsewhere, though slow, is feeding through into increased demand for Asia’s export machine.

Shipments from China to the European Union were up 12.7% from a year earlier, while those to the U.S. were up 8.1%. But exports to Japan lagged behind, against a background of continued political tensions and a weakening of the Japanese yen.

China’s good export performance is even more striking given that last year’s figures were widely thought to have been overreported, so that growth looks weaker by comparison. Excluding that effect, real export growth could be as high as 7.6%, Mr. Kuijs estimated.

Imports to China also showed strength in October, up 7.6% from a year earlier, accelerating a bit from September’s 7.4% pace.

Surprised smile  China Auto Sales Climb at Fastest Pace in Nine Months

Wholesale deliveries of cars, multipurpose and sport utility vehicles rose 24 percent to 1.61 million units in October, according to the state-backed China Association of Automobile Manufacturers today. That compares with the median estimate of 1.5 million units by three analysts surveyed by Bloomberg News. (…)

Total sales of vehicles, including buses and trucks, rose 20 percent to 1.93 million units last month, the association said. In the first 10 months of the year, 17.8 million vehicles were delivered, with 14.5 million being automobiles.

Commercial vehicles sales increased 7.4 percent in the first 10 months of the year to 3.36 million units.

China inflation hits eight-month high amid tightening fear

China’s Inflation Picks Up

The consumer price index rose to 3.2% on a year-on-year basis in October, up from 3.1% in September. The rise was largely due to mounting food prices, which climbed 6.5%, and rising rents, according to government data released on Saturday. But it was still well within the government’s ceiling of 3.5% for the year.

Producer prices were down 1.5% year on year after moderating to a fall of 1.3% in September. This was the 20th month in a row of falling factory prices.

On a month-on-month basis, prices were even less of a concern, gaining only 0.1%.

CPI/non-food rose 1.6% YoY (same as September and vs. 1.7% a year ago), and was +0.3% MoM (+0.4% in September). Last 2 months annualized: +4.3%.

Data also showed China’s factory output rose 10.3% YoY in October. Fixed-asset investment, a key driver of economic growth, climbed 20.1% in the first 10 months. Real estate investment growth rose 19.2%, while property sales rose 32.3%.

Power production rode 8.4% YoY in October, compared to 8.2% in September and 6.4% a year earlier.

Retail sales were up 13.3%. Nominal retail sales growth has been stable at about 13% YoY for the past five months.

INFLATION/DEFLATION

Central Banks Renew Reflation Push as Prices Weaken

A day after the European Central Bank unexpectedly halved its benchmark interest rate to a record-low 0.25 percent and Peru cut its main rate for the first time in four years, the Czech central bank yesterday intervened in currency markets. The Reserve Bank of Australiayesterday left open the chance of cheaper borrowing costs by forecasting below-trend economic growth. (…)

Other central banks also held their fire this week. The Bank of England on Nov. 7 kept its benchmark at 0.5 percent and its bond purchase program at 375 billion pounds ($600 billion).

Malaysia held its main rate at 3 percent for a 15th straight meeting to support economic growth, rather than take on inflation that reached a 20-month high in September.

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The Economist agrees (tks Jean):

The perils of falling inflation In both America and Europe central bankers should be pushing prices upwards

(…) The most obvious danger of too-low inflation is the risk of slipping into outright deflation, when prices persistently fall. As Japan’s experience shows, deflation is both deeply damaging and hard to escape in weak economies with high debts. Since loans are fixed in nominal terms, falling wages and prices increase the burden of paying them. And once people expect prices to keep falling, they put off buying things, weakening the economy further. There is a real danger that this may happen in southern Europe. Greece’s consumer prices are now falling, as are Spain’s if you exclude the effect of one-off tax increases. (…)

Race to Bottom Resumes as Central Bankers Ease Anew

The European Central Bank cut its key rate last week in a decision some investors say was intended in part to curb the euro after it soared to the strongest since 2011. The same day, Czech policy makers said they were intervening in the currency market for the first time in 11 years to weaken the koruna. New Zealand said it may delay rate increases to temper its dollar, and Australia warned the Aussie is “uncomfortably high.”

Canada’s housing market teeters precariously
Analysts warn nation is on verge of ‘prolonged correction’

(…) Alongside Norway and New Zealand, Canada’s overvalued property sector is most vulnerable to a price correction, according to a recent OECD report. It is especially at risk if borrowing costs rise or income growth slows.

In its latest monetary policy report, the Bank of Canada, the nation’s central bank, noted: “The elevated level of household debt and stretched valuations in some segments of the housing market remain an important downside risk to the Canadian economy.”

The riskiest mortgages are guaranteed by taxpayers through the Canada Mortgage and Housing Corporation, somewhat insulating the financial sector from the sort of meltdown endured by Wall Street in 2007 and 2008. But a collapse in home sales and prices would be a serious blow to consumer spending and the construction industry that employs 7 per cent of Canada’s workforce. (…)

Household debt has risen to 163 per cent of disposable income, according to Statistics Canada, while separate data show a quarter of Canadian households spend at least 30 per cent of their income on housing. This is close to the 1996 record when mortgage rates were substantially higher.

On a price-to-rent basis, which measures the profitability of owning a house, Canada’s house prices are more than 60 per cent higher than their long-term average, the OECD says. (…)

EARNINGS WATCH

From various aggregators:

  • Bloomberg:

Among 449 S&P 500 companies that have announced results during the earnings season, 75 percent beat analysts’ estimates for profits, data compiled by Bloomberg show. Growth in fourth-quarter earnings will accelerate to 6.2 percent from 4.7 percent in the previous three months, analysts’ projections show.

  • Thomson Reuters:
  • Third quarter earnings are expected to grow 5.5% over Q3 2012. Excluding JPM, the earnings growth estimate is 8.2%.
  • Of the 447 companies in the S&P 500 that have reported earnings to date for Q3 2013, 68% have reported earnings above analyst expectations. This is higher than the long-term average of 63% and is above the average over the past four quarters of 66%.
  • 53% of companies have reported Q3 2013 revenue above analyst expectations. This is lower than the long-term average of 61% and higher than the average over the past four quarters of 51%.
  • For Q4 2013, there have been 78 negative EPS preannouncements issued by S&P 500 corporations compared to 8 positive EPS preannouncements. By dividing 78 by 8, one arrives at an N/P ratio of 9.8 for the S&P 500 Index. If it persists, this will be the most negative guidance sentiment on record.
  • Zacks:

Total earnings for the 440  S&P 500 companies that have reported results already, as of Thursday morning November 7th, are up +4.6% from the same period last year, with 65.7% beating earnings expectations with a median surprise of +2.6%. Total revenues for these companies are up +2.9%, with 51.4% beating revenue expectations with a median surprise of +0.1%.

The charts below show how the results from these 440 companies compare to what these same companies reported in Q2 and the average for the last 4 quarters. The earnings and revenue growth rates, which looked materially weaker in the earlier phase of the Q3 reporting cycle, have improved.

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


The composite earnings growth rate for Q3, combining the results from the 440 that have come out with the 60 still to come, currently remains at +4.6% on +2.9% higher revenues. This will be the best earnings growth rate of 2013 thus far, though expectations are for even stronger growth in Q4.

We may not have had much growth in recent quarters, but the expectation is for material growth acceleration in Q4 and beyond. The chart below shows total earnings growth on a trailing 4-quarter basis. The +3.1% growth rate in the chart means that total earnings in the four quarters through 2013 2Q were up by that much from the four quarters through 2012 2Q. As you can see, the expectation is for strong uptrend in the growth momentum from Q4 onwards.

Guidance has been overwhelmingly negative over the last few quarters and is not much different in Q3 either, a few notable exceptions aside.

Given this backdrop, estimates for Q4 will most likely come down quite a bit in the coming weeks. And with the market expecting the Fed to wait till early next year to start Tapering its QE program, investors may shrug this coming period of negative estimate revisions, just like they have been doing for more than a year now.

SENTIMENT WATCH

 

Stocks Regain Broad Appeal

Mom-and-pop investors are returning to stocks, but their renewed optimism is considered by many professionals to be a warning sign, thanks to a long history of Main Street arriving late to market rallies.

(…) “Frankly, from 2009 until recently, I wanted to stay very conservative,” said Chris Rouk, a technology sales manager in Irvine, Calif. Now, he said, “I want to get more aggressive.” (…)

More investors are saying they are bullish about the stock market, according to the latest poll from the American Association of Individual Investors, which found that 45% of individuals are bullish on stocks, above the long-term average of 39%. Last month, the same survey said the number of investors who said they were bearish on stocks fell to the lowest level since the first week of 2012. (…)

Flurry of Stock, Bond Issuance Is a Danger Sign for Markets

Just as financial markets were recovering from the Washington turmoil, a new danger signal has started blinking, in the form of a flood of stock and bond issues.

So far this year, U.S. companies have put out $51 billion in first-time stock issues, known as initial public offerings or IPOs, based on data from Dealogic. That is the most since $63 billion in the same period of 2000, the year bubbles in tech stocks and IPOs both popped.

Follow-on offerings by already public companies have been even larger, surpassing $155 billion this year. That is the most for the first 10-plus months of any year in Dealogic’s records, which start in 1995.

It isn’t just stock. U.S. corporate-bond issues have exceeded $911 billion, also the most in Dealogic’s database. Developing-country corporate-bond issues have surpassed $802 billion, just shy of the $819 billion in the same period last year, the highest ever. (…)

Small stocks with weak finances are outperforming bigger, safer stocks. And the risky payment-in-kind bond, which can pay interest in new bonds rather than money, is popular again. (…)

 

NEW$ & VIEW$ (5 NOVEMBER 2013)

WEAK HALLOWEEN SALES

Weekly sales declined 0.6% last week, and the 4-week m.a. is down for the 12th consecutive week (+1.6% YoY).

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Nobody should be surprised as BloombergBriefs explains:

(…) the pace of per capita disposable personal income was 2 percent for the 12 months ended in August. This equates to a 1.8 percent increase in GAFO retail sales, which represents sales at stores that sell merchandise traditionally sold in department stores.

Credit conditions are similarly poor and indicative of a consumer reluctant to spend. During August, the pace of revolving credit (credit cards) contracted at an annualized 1.2 percent — the third consecutive monthly drop.

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TAPER WATCH

Three Fed Policy Voters Signal Prolonged Easing to Stoke Growth

“Monetary policy in the United States is likely to remain highly accommodative for some time,” Fed Governor Jerome Powell said yesterday in a speech in San Francisco. Boston Fed President Eric Rosengren backed further easing to “achieve full employment within a reasonable forecast horizon,” while James Bullard of the St. Louis Fed said in an interview on CNBC he wants the Fed to “meet our goals,” singling out inflation.

And now this: Fed’s Bullard: Need to see “tangible evidence” inflation moving back towards 2% before Taper
Is the Fed getting worried about deflation?

SAME SURVEY DATA, SEVERAL ACCOUNTS:

Domestic banks are making loans more readily available, easing lending policies to businesses as competition stiffens and relaxing standards on mortgages as demand for home loans cools, a Federal Reserve survey shows.

“Banks eased their lending policies for commercial and industrial loans” as well as standards on prime residential mortgage loans in the third quarter, the central bank said in its survey of senior loan officers released today in Washington. The share of banks relaxing mortgage standards was described as “modest.”

Banks reported “on net, weaker demand for prime and nontraditional mortgage loans” while demand for business loans “experienced little change,” according to the report. For other types of lending to consumers, banks “did not substantially change standards or terms.”

(…) Nearly 80% of banks said their credit standards for mortgages remained basically unchanged from July through September, according to a quarterly Fed survey of bank loan officers released Monday. Only about 15% of banks said their standards for mortgages have eased somewhat. (…)

More than 40% of banks said they saw a lower volume of mortgage applications since the spring, prior to the increase in mortgage rates. About a third of banks said demand was about the same or stronger.

(…) “Very few banks” reduced fees, lowered the minimum required down payments or accepted borrowers with lower credit scores, the report said. Several banks also reduced staff allocated to processing mortgage applications. (…)

Separately, very few banks said they have changed lending standards for approving credit cards or auto loans. Only about a quarter of banks saw stronger demand for auto loans since the spring.

But increased competition has driven some banks to loosen their commercial and industrial lending standards, the report said. Banks said they have experienced little change in demand for those loans.

  • Easing Loan Standards No Match for Higher Rates  (BMO)

More U.S. banks eased lending standards in Q3 but higher mortgage rates still resulted in weaker demand for residential mortgages. This could point a further slowing in home sales in the fourth quarter

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However,  banks are loosening standards for commercial real estate loans and demand is rising (charts via CalculatedRisk)

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EU Lowers Euro-Area Growth Outlook as Debt Crisis Lingers

Gross domestic product in the 17-nation currency bloc will rise by 1.1 percent in 2014, less than the 1.2 percent forecast in May, the Brussels-based European Commission said today. Unemployment, now at its highest rate since the euro was introduced, will be 12.2 percent in 2014, higher than the 12.1 percent predicted six months ago. (…)

Next year’s projected return to growth will come after the euro-area economy contracts an estimated 0.4 percent in 2013, the commission said in today’s report. That follows a decline in GDP of 0.7 percent in 2012, the first time output has fallen in two consecutive years since the introduction of Europe’s single currency in 1999.

Signs of a fragile recovery in 2014 disguise a north-south divide in the euro area, in which the economies of Germany, Belgium, Estonia and Ireland are predicted to gain momentum next year, while Spain, Greece, Italy and Portugal are projected to experience much weaker growth rates. The exceptions are Finland and the Netherlands, whose growth figures now lag behind their northern neighbors.

Italy’s finance minister warns on euro
ECB urged to ease monetary policy

Italy’s finance minister has warned of the risks of a strengthening euro to Europe’s fragile recovery, urging the European Central Bank to ease monetary policy to help the continent’s small and medium enterprises.

 

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Li Says China Needs 7.2% Expansion to Maintain Job Growth

Expansion at that pace would create 10 million jobs a year to maintain the urban registered jobless rate at about 4 percent, Li said in an Oct. 21 speech to the All-China Federation of Trade Unions published yesterday on its website. China’s growth has entered a stage of medium-to-high speed, meaning about 7.5 percent or above 7 percent, Li said.

Kellogg to Cut 7% of Workforce by 2017

Kellogg Co. said Monday that it will cut about 2,000 jobs, or 7% of its global workforce, over the next four years as part of a billion-dollar cost-cutting plan.

“We do see weaker top-line growth than we expected as some of our categories remain challenging,” Chief Executive John Bryant said in an interview, citing cereal in the U.S. as one of those segments.

 

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. (…)

 

NEW$ & VIEW$ (22 OCTOBER 2013)

WEEKLY CHAIN STORE SALES

Sales rose 1.4% last week. The 4-week moving average declined for the 10th consecutive week however and is +1.6% YoY. Last year, sales remained weak until early December and recovered somewhat during the final 3 weeks, possibly due to a sharp decline in gas prices. Will we witness the same this year?

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Demand is flat while U.S. supply is rising (chart from Doug Short):

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HOUSING WATCH

U.S. Existing Home Sales and Prices Move Lower

Sales of existing homes declined 1.9% (+10.7% y/y) last month to 5.290 million (AR). The drop followed no-change during August revised from a 1.7% rise, according to the National Association of Realtors. Consensus expectations had been for 5.30 million sales. Sales of existing single-family homes alone fell 1.5% to 4.680 million (+10.9% y/y).

The median price of an existing home fell to $199,200. The decline was the third straight down month and left prices at the lowest level since April. The peak was $230,300 in July 2006.

Sales performance was mixed during September. The greatest m/m decline occurred in the Midwest with a 5.3% shortfall (+12.6% y/y). Next was the Northeast which posted a 2.8% sales drop (+15.0% y/y. In the South, sales fell 1.4% m/m (+9.9% y/y) but sales in the West improved 1.6% (7.8% y/y).

The supply of homes on the market was roughly unchanged at 5.0 months of sales, down from a high of 11.9 months in July of 2010. The actual number of homes on the market increased 1.8% y/y last month. That started to reverse a 21.1% decline during all of last year and a 23.2% drop in 2011.

Listed inventory, now up YoY (+1.8%), typically declines a little in September. Listings are creeping up.

image(CalculatedRisk)

Sales of homes priced above $500,000 (10% of the market) jumped 37.2% YoY, while sales of homes under $250,000 (60% of the market) are up only 6.3% YoY. First-time buyers (normally 40-45%) accounted for 28% of September sales, down from 32%
last year. More examples of the two-speed economy: that of the top 1% is in high gear while the remaining 99% are in neutral at best.

CalculatedRisk notes:

The NAR reported total sales were up 10.7% from September 2012, but conventional sales are probably up close to 25% from September 2012, and distressed sales down.  The NAR reported (from a survey):

Distressed homes – foreclosures and short sales – accounted for 14 percent of September sales, up from 12 percent in August, which was the lowest share since monthly tracking began in October 2008; they were 24 percent in September 2012.

Although this survey isn’t perfect, if total sales were up 10.7% from September 2012, and distressed sales declined to 14% of total sales (14% of 5.29 million) from 24% (24% of 4.78 million in September 2012), this suggests conventional sales were up sharply year-over-year – a good sign.

China Housing Prices Rise Faster

(…) Prices were up from a year earlier for the ninth consecutive month, data released Tuesday by the National Bureau of Statistics showed, with the pace accelerating for the eighth consecutive month. As in August, prices were up in 69 of the 70 cities in September, despite nearly four years of controls on the property market. Month-on-month price increases moderated slightly. In August, prices were up from a month earlier in 66 cities. (…)

The average increase from a year earlier accelerated to 8.19%, from 7.48% in August and 6.70% in July, calculations by The Wall Street Journal showed. The average rise from a month earlier in September was 0.67%, moderating from 0.79% in August. (…)

In particular, there have been steady increases in home prices in tier-one cities—Beijing, Shanghai, Shenzhen and Guangzhou—which offer the best jobs and schools and so attract home buyers from the rest of the country. And the pace of increase accelerated in all four cities last month: Average home prices in Beijing were up 16% from a year earlier, beating August’s 14.9%. In Guangzhou, the pace increased to 20% from 18.8%; in Shanghai, to 17% from 15.4%; and in Shenzhen, to 19.7% from 18.1%. (…)

Soaring London House Prices Fuel Concerns

Home sellers in London raised their asking prices by 10% during early October, adding to concerns that the U.K. capital may be on the verge of a fresh property bubble.

The average asking price for a London home advertised via online real estate agency Rightmove’s website surged by £50,484 ($81,617) to a record-high £544,232 in October. By contrast, house prices rose between 1% and 4% in most of England and Wales, falling in two regions.

Asia’s housing bubbles put UK in shade

(…) Property prices in Hong Kong rose by 19.1 per cent year-on-year in Q2, and those in Taiwan swelled by 15.4 per cent, according to Knight Frank’s global pricing index. House prices in Shanghai and Beijing look pretty heady, too, growing at 14.8 per cent. Look at a longer time frame and there is evidence of a boom:

Source: Capital Economics

The fast pace of price rises, in comparison to incomes, indicates that Hong Kong and Taiwan are going through a bubble, according to Capital Economics. The Chinese story is more complicated (more of this later).

Hong Kong’s house prices have more than doubled in under five years. (…) Gareth Leather of Capital Economics thinks prices are over-valued by at least 40 per cent, and even bigger falls are possible. House prices in Taiwan’s capital, Taipei, are over-valued to a similar degree. But there need not be a crash like the US 2007 housing bust. Leather writes:

Housing construction in Hong Kong and Taiwan accounts for a relatively small share of GDP compared to the US on the eve of the global financial crisis. Meanwhile, banks in Hong Kong and Taiwan have required much bigger down-payments […] If property prices fall sharply, the damage to local banks should be limited.

In China’s larger Tier I cities, house prices are high: the move from countryside to city means housing demand outstrips supply. But the reverse is true elsewhere: in over 200 small cities – which make up more than half of total property sales – there is a downward pressure on pricing. This explains why China’s average house prices rose about 5 per cent year-on-year in Q2:

Source: GK Dragonomics

Supply now exceeds demand in a number of small Chinese cities. Easy money and government subsidies after 2009 pushed up the supply of housing in small prefectural-level cities. But the demand has not kept up, as rural dwellers often cannot afford to move, according to Rosealea Yao of GK Dragonomics. “We are more worried more about falling prices in small cities than high prices in big cities,” she writes. (…)

Bundesbank warns of property bubble Report fuels concern on impact of loose ECB monetary policy

The Bundesbank has warned that apartment prices in Germany’s biggest cities could be overvalued by as much as 20 per cent, stepping up its concern about a real estate boom in the powerhouse of the European economy.

The warning will feed into German concern that the European Central Bank’s monetary policy is far too loose for the country. The bank’s main refinancing rate is 0.5 per cent, a record low.

It also adds to signs that international investors are fuelling rising property prices around the world. The trend reflects the lack of opportunities investors regard as a safe haven and low returns for traditional asset classes such as bonds and stocks.

Rapid price rises have particularly affected the seven largest cities in Germany, the central bank said on Monday, although the value of houses had risen at a more moderate pace. Flats in Berlin, Munich, Hamburg, Cologne, Frankfurt, Stuttgart and Düsseldorf had, on average, seen prices rise more than 25 per cent since 2010.

“After the real estate bubbles in the US and several European house markets burst, the German property market, which had been quiet for many years, became more attractive to international investors,” the Bundesbank said in its monthly report for October. (…)

Asian cities such as Hong Kong and Singapore have imposed new taxes on foreign buyers in an attempt to limit the effect on their housing markets. Prices of the most expensive homes are now above their pre-crash highs in Hong Kong, according to data from estate agent Knight Frank. (…)

The property market trend is unusual in Germany, a nation of home renters with historically slumbering property markets, and is in sharp contrast to the rest of the eurozone, where house prices are near seven-year lows following property slumps in Spain, Ireland and the Netherlands. (…)

“In the short term, the [upward] price pressure will not ease,” the Bundesbank said. But it was “not very likely that the price structure on real estate markets currently represents a serious macroeconomic risk. The observed price movements are an expression of delayed increases in supply.”

However, “the empirical evidence shows there is no substantial overvaluation of the German residential property market as a whole”, the central bank said. (…)

THE AMERICAN ENERGY REVOLUTION STARTING TO BITE:

Eni chief warns on impact of shale gas
Energy intensive industries drawn to US from Europe over prices

Paolo Scaroni, chief executive of the Italian oil and gas group, warned that European economies face a long-term structural challenge of competing with industrial operators in the US, which now enjoy far cheaper gas and electricity prices than those prevailing across the EU.

“Why would anyone invest in anything energy intensive [in Europe] rather than go to Texas, where the cost of electricity is half and gas a third, on top of all the other favourable factors,” he said on Monday. “We have seen clients moving investment from Europe to the US.”

Speaking at the Financial Times Global Shale Energy Summit, Mr Scaroni said the start-up of exports of liquefied shale gas from the US to European markets, combined with other global supplies coming on stream, could see European gas prices moderating from a predicted $10-$11 per million British Thermal Unit (mBTU) to $8 in the coming years.

However, he said the differential would still leave Europe disadvantaged. “Is $8 per unit enough to compete with the US? I think that it isn’t enough.” (…)

 

NEW$ & VIEW$ (15 OCTOBER 2013)

Senate Nears Deal on Debt, Shutdown

Top Senate leaders said they were within striking distance of an agreement to reopen the government and defuse a looming debt crisis just days before the U.S. could run out of money to pay its bills.

The latest proposal would reopen the government at current spending levels until Jan. 15 and extend the federal borrowing limit until early February, according to aides familiar with the talks. Lawmakers also would begin longer-term negotiations on the budget, with the task of reaching an agreement by Dec. 13. (…)

Still, a deal would mark a major breakthrough in the impasse that has gripped Washington for weeks, shutting federal agencies and threatening the government with a debt default. (Cartoon by Mike Flugennock)

This is the new definition of a “major breakthrough”?

Storm cloud  Here’s a real breakthrough!:

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Chain store sales have been weak for a while, +2.0-2.3% YoY since mid-summer, but the 4-week moving average slipped to +1.5% last week, breaking through 1.5% for the first time since February 2010.

Commercial-Property Loans Rise

(…) As of June 30, U.S. banks had $991.2 billion in total commercial real-estate loans, up 3.3% from a year earlier, according to research firm SNL Financial.

J.P. Morgan Chase JPM +0.38% & Co. on Friday reported that outstanding commercial-real-estate loans rose to $61.5 billion in the third quarter, a 12% increase from a year earlier. “The commercial-real-estate business continues to grow strongly,” J.P. Morgan Chief Financial Officer Marianne Lake said during a conference call with analysts, noting loans have increased “every month for the last 13 months.” (…)

Last year’s 2.4% rise in total commercial real-estate loans to $972.7 billion was the first growth in four years, according to SNL. Analysts said the lending rebound, still in its early stages, is being fueled largely by one area: apartment projects. The boom could start to peter out as the single-family housing market recovers, but for now banks are eager to keep lending. (…)

EARNINGS WATCH

Early report from Factset:

With 6% of the companies in the S&P 500 reporting actual results, the percentage of companies reporting earnings above estimates is below the four-year average, and the percentage of companies reporting revenues above estimates is also below the four-year average.

Overall, 31 companies have reported earnings to date for the third quarter. Of these 31 companies, 61% have reported actual EPS above the mean EPS estimate and 39% have reported actual EPS below the mean EPS estimate. Over the past four quarters on average, 70% of companies have reported actual EPS above the mean EPS estimate. Over the past four years on average, 73% of companies have reported actual EPS above the mean EPS estimate.

In terms of revenues, 52% of companies have reported actual sales above estimated sales and 48% have reported actual sales below estimated sales. The percentage of companies beating sales estimates is above the percentage recorded over the last four quarters (48%), but below the average over the previous four years (58%).

In aggregate, companies are reporting sales that are 0.4% below expectations. Over the previous four quarters on average, actual sales have exceeded estimates by 0.4%. Over the previous four years on
average, actual sales have exceeded estimates by 0.7%.

Heading into the start of the peak weeks of the Q3 2013 earnings season, 110 companies in the index have issued EPS guidance for the third quarter. Of these 110 companies, 91 have issued negative EPS guidance and 19 have issued positive EPS guidance.

If 91 is the final number of companies issuing negative EPS guidance for the quarter, it will mark the highest number of companies issuing negative EPS guidance since FactSet began tracking guidance data in 2006. The current record is 88, which was recorded in Q2 2013.

If 19 is the final number of companies issuing positive EPS guidance, it will mark the lowest number of companies issuing positive EPS guidance
for a quarter. The current record is 22, which was also recorded in Q2 2013.

The percentage of companies issuing negative EPS guidance is 83% (91 out of 110). If this is the final percentage for the quarter, it will mark the highest percentage of companies issuing negative EPS guidance for a quarter since FactSet began tracking the data in 2006.

Call me  If you missed it, I recommend that you read yesterday’s New$ & View$’ EARNINGS WATCH segment.

HOUSING WATCH

Home Sales, Prices Slowing in Bust-and-Boom Markets

(…) Phoenix: Investor purchases fell to 20% of sales in September, down from 29% a year earlier, and purchases by nine major institutional investors dropped to 110 sales, down 72% from 398 sales one year ago. Just four of the nine investors bought homes in September, compared with all nine one year ago. Second home purchases dropped by 23%, but purchases by owner-occupants increased by 21%, according to the Arizona Multiple Listing Service.

There were 2.5% fewer homes sold in September compared with a year earlier, even as the number of homes for sale increased by 9.4% over that span, according to the Arizona MLS. (…)  Distressed sales were down 59% from a year earlier.

Sacramento: The number of homes that sold in September fell by 6.8% from a year earlier, and the number that went under contract fell by 3.6%. Listings jumped by 40.3%, according to TrendGraphix Inc. Median prices rose by 1.2% from August and by 36.1% from one year earlier.

Las Vegas: The share of homes that sold in cash last month stood at 47.2%, down from 54.8% in August and one year ago, and down from a high of 59.5% in February, according to the Greater Las Vegas Association of Realtors. Many cash buyers tend to be investors.

Home sales were down 1.2% from a year earlier, even though there were more homes for buyers to choose from. The number of single-family homes listed for sale, at 14,659, stood 12.6% below last year’s levels, but the inventory of “non-contigent” listings—homes that don’t have any offers and aren’t under contract—was 60.5% above year-earlier levels. The median sales price in September fell for the first time in 19 months.

(…) “the market is softening tremendously,” said Bryan Lebo, a local real-estate agent. “Buyers are becoming a lot pickier. They’re more patient.”

In some neighborhoods, he says, homes are now selling for 10% less than they were just a few months earlier, and builders are beginning to offer generous incentives, such as home upgrades to buyers and commissions to real-estate agents, in order to stay competitive.

SPAIN EXITING RECESSION ON STRONG EXPORTS (Markit)

Official GDP data released later this month looks set to announce the end of the recession in Spain, in line with PMI data covering the manufacturing and service sectors, which in Q3 posted its highest quarterly average since the current recession began in Q2 2011.

One of the most positive aspects of the recent PMI data has been strong growth of manufacturing exports. New export orders increased at the fastest rate in more than two-and-a-half years in August, and maintained this pace in September. Exports have now risen for five months in a row. (…)

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Spanish firms have been able to take advantage of recent signs of economic improvement in some of their main export markets. PMI data suggest that the eurozone recovery gathered pace at the end of Q3, while the UK posted particularly strong growth. The Export Climate Index for Spain suggests that conditions for exporters have strengthened in three successive months, largely on the back of these improvements.

Monthly export data from the Bank of Spain also highlight the UK as a key source of current growth in external demand, with rises also seen in the eurozone. However, after increasing strongly towards the end of 2012, exports to the US have shown signs of weakness in recent months.

Further evidence of the recent solid performance of exports in Spain can be seen by splitting the PMI data into exporting and non-exporting companies. This shows that manufacturers that export have recorded growth in overall new orders in recent months, while non-exporters have continued to see falling levels of new business as domestic demand in Spain lags behind. (…)

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This over-reliance on external markets is a cause for concern given that economic recoveries in the eurozone and UK are far from assured, and political stalemate in the US has the potential to throw the world economy back into turmoil. It is therefore too early to judge whether the Spanish economy is starting a real recovery or just experiencing another false dawn.

But Spain is not out of the woods just yet (chart from The Economist):

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Nor is Europe for that matter (chart from CLSA):

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Goldman Sachs: The Growing Income Divide in Four Charts How the rich and poor view the economy has diverged to some of the widest levels in years, data from Goldman Sachs’s latest consumer survey shows.

Pointing up  Chris Wood at CLSA (tks Gary):

Meanwhile, a dramatic social development in America is the ever more glaring extremes in terms of the distribution of income. The latest information on this came from a recently published study by economic professor Emmanuel Saez at University of California, Berkeley, based on income tax data published by the IRS (see “Striking it Richer: The Evolution of Top Incomes in the United States”, 3 September 2013 by Emmanuel Saez, UC Berkeley).

The results are startling and have not surprisingly generated media attention. But the findings are worth repeating for those who missed them. The incomes of the top 1% Americans rose by 19.6% in 2012 while the incomes of the bottom 99% of Americans rose by only 1%. As a result, the top 1% accounted for 19.3% of total household income, excluding capital gains, in 2012, the largest share since 1928. While if capital gains are included, the top 1%’s income share has risen from 18.1% in 2009 to 22.5% in 2012 (see Figure 6).

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The above findings provide more evidence that quanto easing is helping the wealthy via asset price appreciation but doing little to improve the overall economy. This is potential politically explosive.