NEW$ & VIEW$ (8 OCTOBER 2013)

Small Businesses Skeptical About Future; Optimism Dips

The Optimism Index was basically unchanged, giving up two-tenths of a
point, statistical noise. The only interesting change in the components was
an 8 point deterioration in expectations for business conditions over the
next six months.

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U.S. Consumers Falling Behind on Bills after Years of Improvement

Consumer delinquency rates rose for the first time in two years in the second quarter, possibly showing that the broad household deleveraging seen since the recession concluded in 2009 may be coming to an end.

The American Bankers Association’s composite delinquency ratio, which tracks eight types of debt including auto and home-equity loans, increased to 1.76% in the second quarter from 1.70% the prior period. Similarly, the delinquency rate on credit cards issued by banks inched up 0.1 percentage point to 2.42%. (…)

Consumer delinquency rates peaked near the end of the recession when many Americans were out of work. The composite index reached 3.35% in the second quarter of 2009. (…)

Delinquency rates are now well below historic levels. Bank credit-card delinquency is 37% below its 15-year average, the association said. (…)

A Federal Reserve report Monday showed consumers’ credit-card balances declined for the third consecutive month in August but total debt increased thanks to increased auto lending and student loans. (…)

THAT SHOULD HELP…

(WSJ)

…EVENTUALLY, because it ain’t helping just yet

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The back-to-school season has been weak throughout with chain store sales barely ahead of inflation. Does not bode well for Thanksgiving and Christmas. And now this:

Weekly Drop in U.S. Economic Confidence Largest Since ’08

Gallup Economic Confidence Index -- Weekly Averages, January 2008-October 6, 2013

German Factory Orders Unexpectedly Fall on Weak Recovery

Orders, adjusted for seasonal swings and inflation, dropped 0.3 percent from July, when they fell a revised 1.9 percent, the Economy Ministry said today in an e-mailed statement. Economists forecast an increase of 1.1 percent in August, according to the median of 40 estimates in a Bloomberg News survey. Orders climbed 3.1 percent from a year ago, when adjusted for the number of working days.

Domestic factory orders rose 2.2 percent in August from the previous month, while foreign demand fell 2.1 percent, today’s report showed. Basic-goods orders increased 0.5 percent from July, while demand for consumer goods dropped 0.4 percent. Investment-goods orders decreased 0.7 percent, with domestic demand rising 4.7 percent and orders from the euro area declining 9.2 percent.

German Exports Increased in August on Euro-Area Recovery

Exports, adjusted for working days and seasonal changes, increased 1 percent from July, when they decreased a revised 0.8 percent, the Federal Statistics Office in Wiesbaden said today. Economists forecast a gain of 1.1 percent, according to the median of 16 estimates in a Bloomberg News survey. Imports rose 0.4 percent from July.

EARNINGS WATCH

From Thomson Reuters:

A total of 21 companies have already reported Q3 earnings. Of these, 62% exceeded their consensus analyst earnings estimates. This is slightly below the 63% that beat estimates in a typical full earnings season and the 67% that beat in a typical earnings “preseason”.

Pointing up Historically, when a higher-than-average percentage of companies beat their estimates in the preseason, more companies than average beat their estimates throughout the full earnings season 70% of the time, and vice versa. This suggests that third-quarter earnings results are unlikely to exceed expectations at an abnormally high rate. However, the fact that the preseason beat rate is very close to the average suggests that results will probably not be much worse than average either.

Exhibit 2. S&P 500: Earnings Estimate Beat Rates, Preseason and Final
ER_1007_2
Source: Thomson Reuters I/B/E/S

36 Years Of Over-Optimistic Earnings Growth

Since 1976, Morgan Stanley shows the average consensus EPS growth rate trajectory among the consensus… doesn’t seem to be so “accurate”…

But it remains assured that this time will be different if we look ahead yet again…

Charts: Morgan Stanley (via ZeroHedge)

Hence the use of trailing earnings.

SENTIMENT WATCH

 

What Happened The Last 2 Times IPOs Were Outperforming The Market By This Much?

When the momentum chasing public greatly rotates to the IPO-du-jour, it would appear that bad things happen in the market. The last two times Bloomberg’s IPO index doubled the market’s performance (in 2007 and again in 2011) it seems it marked a euphoric top. Of course, based on 1998/99’s IPO performance there is plenty more room to run since this time is different. Nevertheless, the volume of coverage allotted to this IPO or that IPO (and not just Twitter) is awfully reminiscent of the go-go days of yore (and we all know how that ends) – though you’ll never be the bag-holder again right?

100% Interactive Brokers Margin Hike

The massive outperformance of the smallest and most trashy companies over the past year, month, week, day etc… stalled this afternoon. No news; no macro data; no change in the situation in DC. So what was it? We suspect the answer lies in the all-time record levels of margin that we recently discussed holding up the US equity market. Interactive Brokers, it would appear, have seen the light and over the next week or so will be increasing maintenance margin to 100% – effectively squeezing the leveraged momentum chasing muppets out of the market (or at the very least halving their risk-taking abilities).

As we warned previously,

Margin Debt still contrarian bearish

Using closing basis monthly data, peaks in NYSE margin debt preceded peaks in the S&P 500 in 2007 and 2000. The March 2000 peak in NYSE margin debt of $278.5m preceded the August 2000 monthly closing price peak in the S&P 500 at 1517.68. The July 2007 margin debt peak of $381.4m preceded the October 2007 monthly closing price peak of 1549.38 for the S&P 500. Margin debt reached a record high of $384.4m in April and the S&P 500 continued to rally into July, August, and September. This is a similar set up to 2007 and 2000.

LOW QUALITY STOCKS OUTPERFORMING

Société Générale’s quant team screens equity markets with well-­known value investment filters.

Despite the weakness in the latter part of last month, equity markets enjoyed one of their best Septembers on record. Low quality companies led the market showing strong returns in all regions and with double-­digit returns in the Eurozone and Japan.

Companies with weak balance sheets, as defined using the Merton model, were up 10% on a global basis in September, outperforming the market by 3.5% and outperforming companies with good balance sheets by 5.3%. The performance was wider in the Eurozone and Japan where low quality companies outperformed high quality by 8.9% and 9.9% respectively. Our second quality factor, the Piotroski model, showed similar performance with low quality outperforming as much as 5% in the Eurozone and 18% in Japan!

Nerd smile As a result of the strong market performance, we see a further reduction in the number of names that pass our screens. We can now find only 21 deep value and 25 quality income names, so a total of 46 companies down from 53 last month and 200 names a year ago!

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Hmmm…

ITALY

Credit Suisse: “Il Cavaliere’s Final Bow

Is Italy ready for life without Silvio Berlusconi? After dominating Italian politics for the past two decades, even as he faced scandals and corruption allegations that would have sunk most political careers, the former prime minister’s influence appears to be on the wane. His failed attempt to topple Prime Minister Enrico Letta’s government last week, after several key members of his own party threatened to revolt, was a serious blow to the billionaire media mogul’s image as a political force. (…)

So far, the reaction to the latest political upheaval on financial markets has been relatively subdued, suggesting investors have either grown accustomed to Italian political turmoil or that they’re focused on the glimmer of order emerging from the chaos of recent weeks. (…)

Still, the political uncertainty has become an unwanted distraction at a difficult point for Italy, as the country seems to be on the verge of recovery from the longest recession since World War II. Relentless bickering between the left- and right-wing coalition partners have hampered efforts to reverse eight consecutive quarters of economic contraction and tackle the country’s public debt of more than €2 trillion and record-high youth unemployment.

Credit Suisse analysts have said that though the Italian economy will contract about 1.7 percent in 2013, next year could see positive growth of 0.7 percent. That’s nothing to write home about, but after such a long period of negative numbers, it would be a welcome change. The analysts also noted that the government has started to pay €40 billion in long-outstanding bills to its own contractors, which should provide a boost to small and medium-sized businesses. But political uncertainty, they noted, is a definite risk to that relatively rosy forecast. (…)

Gavekal explains Italy’s paradox:

(…) One paradox is that the renewed political instability implies automatic fiscal tightening. If, for instance, new elections were called, the government would be on “automatic pilot”: meaning the multi-year fiscal consolidation program that the previous technocratic government put in place would continue.

This should be set against another interesting paradox. When Mario
Monti was chosen to form a technical government in November 2011,
everyone in Europe cheered the replacement of the buffoon by the
reformer—but rating agencies continued to downgrade Italy by several
notches as the economy slid into recession amid fiscal tightening. Italy’s
political uncertainties have risen dangerously since February’s elections,
but the economy has gotten stronger. Consumer and business confidence
has rebounded, and the latest consensus estimates show Italy should run a current account surplus of 0.7% of GDP this year, and a fiscal deficit of 3-3.5% of GDP.

This is much improved from the current account deficit of 3.5%, and fiscal deficit of 4-4.5% of GDP, when Monti came into power. In other words, Italy’s twin deficits are considerably lower today (below -3% of GDP) than they were in 2011 (almost -8% of GDP). Italy’s average
(or five-year) bond yield stood Friday at 3.25%, well below 6% at the end
of 2011. The main determinants of fiscal stability – growth, interest rates,
the primary surplus, etc – are thus incomparably improved. That is why
neither investors nor even the International Monetary Fund really want to see Italy commit to further belt-tightening.

Pointing up  Still, given the return of political chaos, the risks of a new rating
downgrade cannot be overlooked, as public debt is high (130% of GDP)
and still rising. Standard and Poor’s could downgrade Italy closer to junk
status. But the lesser known Canadian agency DBRS holds a more
important key. Among the four reference agencies used by the ECB in its
refinancing operations, DBRS has the highest rating of A– for Italy. Since
the ECB takes the best rating of the four, this allows Italian banks to pay the same rate as German banks on its collateral. If DBRS downgrades Italy, as it did just after the February elections, then the haircut on a 5-year Italian bond would rise from 1.5% to 9%, with a large impact on Italian banks, and thus on other parts of the euro financial markets.

With such uncertainties, we think that Italy will continue to
underperform on credit markets (vs. Spain in particular), as it has done
since the February elections. A contagion effect is also possible if markets
are too literal in their reading of the euro rhetoric that Berlusconi is likely
going to use in the coming weeks, infuriated as he is about the looming
decadenza vote.

OECD: Low Skills to Hamper Spain, Italy

In the most extensive report on skill levels across a wide range of countries to date, the OECD found that workers in Spain and Italy are the least skilled among 24 developed countries.

(…) Both economies have suffered from a loss of competitiveness over the last decade, resulting in large trade deficits and high levels of borrowing. In order to return to strong growth while generating trade surpluses and paying off their debts, their competitive position will have to improve.

But according to the OECD, Italy ranks bottom, and Spain second-to-last among the 24 countries in literacy skills. Over one in five adults in both countries can’t read as well as a 10-year-old child would be expected to in most education systems. In a ranking of numeracy skills, the positions are reversed, with Spain bottom, and Italy second-to-last. That means one in three adults have only the most basic numeracy skills, a fate shared by their U.S. counterparts. (…)

Italy faces an even greater challenge. Not only does it have fewer highly-skilled workers than most other economies, it also uses them badly—or in the case of many highly-skilled women, not at all. (…)

Young Americans Fare Poorly on Skills

U.S. baby boomers held their own against workers’ skills in other industrial nations but younger people fell behind their peers, according to a study, painting a gloomy picture of the nation’s competitiveness and education system.

The study, conducted by the Organization for Economic Cooperation and Development, tested 166,000 of people ages 16 to 65 and found that Americans ranked 16 out of 23 industrialized countries in literacy and 21 out of 23 in numeracy. Both those tests have been given periodically and while U.S. results have held steady for literacy, they have dropped for numeracy. In a new test of “problem solving in technology rich environments,” the U.S. ranked 17 out of 19. (…)

The results show a marked drop in competitiveness of U.S. workers of younger generations vis a vis their peers. U.S. workers aged 45 to 65 outperformed the international average on the literacy scale against others their age, but workers aged 16 to 34 trail the average of their global counterparts. On the numeracy exam, only the oldest cohort of baby boomers, ages 55 to 65, matched the international average, while everyone younger lagged behind their peers—in some cases by significant margins.

In most cases, younger American employees outperformed their older co-workers—but their skills were weaker compared with those of other young people in OECD countries. By contrast, some countries are improving with each generation. Koreans aged 55 to 65 ranked in the bottom three against their peers in other countries. But Koreans aged 16-24 were second only to the Japanese.

The results show that the U.S. has lost the edge it held over the rest of the industrial world over the course of baby boomers’ work lives, said Joseph Fuller, a senior lecturer at Harvard Business School who studies competitiveness. “We had a lead and we blew it,” he said, adding that the generation of workers who have fallen behind their peers would have a difficult time catching up. (…)

Americans with the most cerebral jobs—those that demanded high levels of literacy, numeracy and problem-solving skills—fared the best against the rest of the world. The potential problem lies in the growing complexity of traditional middle-class jobs in fields like manufacturing and health care. Workers unable to grow into those jobs will lose their positions or be stranded with stagnant wages. The result: an economy that continues to bifurcate. (…)

By contrast, Japanese workers are the most skilled in the 24-nation survey, but don’t fully employ many of those skills, particularly because they are denied the opportunity to use their problem solving abilities in what the OECD calls a “technology environment.” The OECD attributes that to the relative inflexibility of Japan’s jobs markets. It does suggest that if Japan were able to fully use its workers skills, it could generate higher rates of economic growth, having long stagnated.

 

NEW$ & VIEW$ (30 SEPTEMBER 2013)

Back from Europe, up quite early with much in the news. I strongly encourage you to read this post through the end. There is much to consider, especially on the earnings side, while most economies are showing poor momentum, if any.

Government Heads Toward Shutdown

The nation braced for a partial shutdown of the federal government, as time for Congress to pass a budget before a Monday midnight deadline grew perilously short and lawmakers gave no signs Sunday they were moving toward a resolution.

(…) The stalemate was a monument to problems that have increasingly gripped U.S. politics, especially over the last three years of divided government. The growing polarization of the parties, a diminished willingness to compromise on spending and an epidemic of brinkmanship have made it more difficult for Congress to address even the most routine budgeting questions.

Mr. Obama and other Democrats have said that agreeing to GOP demands now would invite Republicans to press for more in the future, with each fiscal deadline. Next up is a battle over terms for raising the nation’s borrowing limit, which the Treasury says must be approved by mid-October. Most economists predict that the financial consequences of failing to raise the debt limit would be greater than a government shutdown. (…)

Uncertainty Poses Threat to Recovery

(…) “American businesses have this mentality where no one wants to make a decision because you have no idea what’s lurking around the corner,” said Jeremy Flack, president of Flack Steel, a Cleveland steel distributor. “Government needs to make us feel more solid about the state of affairs, and they’re doing the exact opposite.”

Flack Steel’s business took a hit from all three crises in 2011 and 2012. “You can watch our earnings evaporate three months after each event,” Mr. Flack said. “Our customers start pulling back their business” in the weeks around every fiscal deadline in Washington. (…)

Sinking Feeling

Fiscal warfare can harm the economy directly and indirectly. Cutting government services—either temporarily in a shutdown, or permanently through spending reductions—can disrupt a broad range of commerce and hit American workers and businesses tied to the public sector. Indirectly, the annoyance from disruptions alongside the threat of damage to markets and the economy can dent confidence and weigh on corporate planning. (…)

In August, one benchmark of economic confidence registered its first decline in six months. The Equipment Leasing and Finance Association’s index of new business was down 11% from July—and 7% from August 2012.

The drop in the index, which measures leasing and financing activity for commercial equipment used in technology, health care, energy and other sectors, is due to waning confidence, said Adam Warner, president of Key Equipment Finance, the Colorado-based arm of financial-services firm KeyCorp.

Instead of stepping up their leasing, businesses are postponing commitments. “They are thinking,‘Let’s push this off and see what’s going to happen,. Is the economy going into a tailspin because of a possible government shutdown?'” Mr. Warner said.

Such retrenchment ripples through the broader economy and can be a bellwether for the labor market. “When a business is acquiring equipment, chances are you are going to be hiring someone to operate that equipment,” Mr. Warner said. “When we see a fall in that activity, typically there is going to be less employment.”

Italy Makes Final Bid To Save Government Prime Minister Letta launched a last-ditch effort to rescue his government from collapse after Silvio Berlusconi pulled support for the government, plunging Italy into a fresh political crisis.

image(…) Italy’s political chaos, which inflamed the euro-zone crisis two years ago, could be the biggest test so far of Europe’s defenses against a revival of the financial panic that has afflicted the region in recent years. This time, faith in the European Central Bank’s promise to safeguard stability is so strong that many political leaders and economists believe a full-blown run on Italy’s bond market is unlikely.

If Mr. Letta loses Wednesday’s vote, Mr. Napolitano, who has opposed calling new elections, has signaled he would try to piece together Italy’s fourth government in two years, either headed by Mr. Letta or another figure. But that attempt is likely to take weeks. (…)

The government crisis now threatens to thwart the recovery of the Italian economy, which is badly in need of reforms to help pull it out of a two-year recession and create jobs. While Mr. Letta passed some modest measures, his five-month government has been largely paralyzed by infighting. (…)

Meanwhile, the absence of a government could actually lower Italy’s budget deficit and bring it closer to the European Union-mandated limit of 3% of gross domestic product. That would happen because of existing measures that were to be scrapped, including an unpopular property tax on primary residences, a scheduled increase in the value-added tax rate and a tax amnesty for the gaming industry would remain on the books, bringing in more than €3 billion in revenue.

Even if Italy survives this latest political upheaval without reigniting bond-market turmoil, its current travails betray deeper problems that threaten Italy’s longer-term solvency and ability to prosper inside the euro zone. Italy’s political class has struggled to deal with the underlying causes of the country’s malaise, including a loss of international competitiveness and the stagnant productivity of its business sector that began well before the European financial crisis of recent years.

The economy’s meager growth rates have pushed up the national debt to over 130% of gross domestic product. The level of debt could become critical if investors conclude that Italy’s long-term growth prospects are so poor that the debt will rise endlessly. Unlike other crisis-hit countries such as Spain and Greece, Italy has yet to implement major economic overhauls or to push down labor and other business costs to levels that would make its industries more competitive abroad.

Companies Holding Lots More Cash

U.S. nonfinancial companies has $1.8 trillion in cash on their books at the end of the second quarter, according to the Federal Reserve’s quarterly “flow of funds” report (now known formally as the “Financial Accounts of the United States”). (…)

The sharp rise in holdings of hard cash doesn’t appear to reflect a broader caution among executives. The $1.8 trillion in liquid assets — the line item most people are referring to when they talk about “corporate cash” — accounted for 5.4% of all assets held by nonfinancial corporations in the second quarter, down from 6% in 2009 and pretty much flat for the past two years. (…)

U.S. Personal Income Gain Leads Personal Consumption Higher

 

Personal income in August matched expectations and increased 0.4% (3.7% y/y) following a 0.2% July rise, revised from 0.1%. An improved 0.4% increase (3.5% y/y) in wage & salaries followed a 0.3% July decline. (…) Disposable personal income increased 0.5% (2.8% y/y) and inflation adjusted take-home pay rose 0.3% (1.6% y/y).

Personal consumption expenditures improved 0.3% (3.2% y/y) last month after a 0.2% rise in July, revised from 0.1%. The gain also matched expectations. Spending on durable goods jumped 0.5% (5.9% y/y) as motor vehicle purchases gained 1.1% (7.7% y/y). Home furnishings purchases rose 0.2% (4.4% y/y) with the strength in home buying; but spending on apparel fell 0.5% (+2.2% y/y). (…)  Adjusted for price changes, personal consumption rose 0.2% (2.0% y/y).

The personal savings rate moved up to 4.6% but remained down slightly from 4.9% twelve months earlier.

The PCE chain price index inched 0.1% higher (1.2% y/y) in August and matched the July rise. Durable goods prices again fell 0.3% (-1.9% y/y) while prices for nondurables rose 0.2% (0.4% y/y). Services prices increased 0.2% (1.9% y/y). Less food & energy, the chain price index rose 0.2% (1.2% y/y).

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Nominal spending matched income growth since June at 1.1% or 4.4% annualized. In rwal terms, personal expenditures are up 0.5% during the last 3 months or 2.0% annualized.

Fingers crossed  Gasoline Prices Stall Out

Prices for gasoline on the New York Mercantile Exchange have fallen roughly 11% in September as supplies reached their highest level in three years and the peak summer driving season ended. (…)

“We have plenty of supplies and low levels of demand. The fundamental picture isn’t pretty,” said Addison Armstrong, senior director of market research at Tradition Energy, an energy-investment adviser in Stamford, Conn. (…)

In the U.S. retail market, the price of regular gasoline averaged $3.42 a gallon on Friday, a decline of 13 cents from a month earlier and down 38 cents from a year before, according to AAA. (…)

 Tighter Mortgage Standards Stalling Recovery

(…) The paper was written by Jim Parrott, a former housing advisor in the Obama White House who is now a senior fellow at the Urban Institute, a left-leaning think tank, and Mark Zandi, chief economist of Moody’s Analytics.

The clearest sign of tighter credit standards are seen in average credit scores, which in June stood nearly 50 points above their pre-housing bubble levels. Credit scores are not only higher, but they also understate the quality of recent borrowers, who have earned these scores during a much tougher environment. In the early 2000s, borrowers had an easier time building their credit because unemployment was low and home prices were rising. In other words, a 750 credit score coming out of the financial crisis counts for more it did ten years ago.

Easing lending standards to return credit scores to pre-bubble levels would boost home sales by around 450,000 units and new single-family home construction by around 275,000 units, according to estimates from Zandi. (…)

Parrott and Zandi concede there’s little evidence that credit is tighter based on either average loan-to-value ratios and debt-to-income ratios. But they say there are other problems, particularly around banks’ verification of borrowers incomes, scrutiny of appraisals, and other factors that have led to a tighter credit box. (…)

The problem is that Fannie, Freddie and the [Federal Housing Administration] have stepped up their put-backs in ways that lenders cannot address adequately through better underwriting or pricing. This includes disagreements over judgment calls made by lenders or their agents; changes in circumstances occurring after the underwriting process has been completed; small mistakes that bear little relation to either the credit risk or the subsequent default; and inconsistent interpretations of the rules.

The upshot is that because lenders can’t predict how they could be penalized, they’ve chosen to lend less. This last point is the most important, the authors said, because it’s the one where policymakers can exercise the most control.

But the problem is difficult to solve because it’s not as easy as changing specific lending criteria. As it is, banks are putting in place standards that go beyond those required by Fannie, Freddie or the FHA. What’s needed instead, the authors argue, is better clarity around when banks could be forced to take back loans. Regulators overseeing those housing entities, they write, “must embrace the challenge with a good deal more urgency” than they have so far.

Mexico struggles to stem faltering growth Tepid US recovery and catastrophic floods weigh on GDP

(…) Though there have been some newly encouraging signs – such as a boost in retail sales in July for the third month running and promising economic activity data that could help rev up growth – the Ingrid and Manuel storms that battered both coastlines simultaneously will only deepen Mexico’s sudden slowdown in gross domestic product growth.

The storms, which killed at least 147 people and caused an estimated $6bn in damage, are likely to trim another 0.1 per cent off 2013 growth, bringing this year’s official forecast to 1.7 per cent, Luis Videgaray, finance secretary, has concluded. That is less than half the 3.5 per cent predicted last December when Mr Peña Nieto took office and Mexico was the region’s success story.

With government aid already expected to exhaust a 12.5bn peso ($950m) emergency fund, some economists consider even the lower growth target too generous.

TAPER WATCH

Fed May Not Start Taper Until January

(…) “We’re not on a pre-set course,”Charles Evans, president of theFederal Reserve Bank of Chicago told reporters on the sidelines of a monetary policy conference in Oslo. He said the Fed’s decision to start reducing its $85 billion in monthly bond purchases “could be in October, it could be in December, but it also could be at the January meeting.”

Mr. Evans was among ten central bank officials who have expressed a wide range of views on the program since their most recent policy meeting September 17-18. (…)

EUROPE NOT OUT OF THE WOOD JUST YET

German August Retail Sales Rose While Missing Estimates

Sales adjusted for inflation and seasonal swings increased 0.5 percent from July, when they fell a revised 0.2 percent, the Federal Statistics Office in Wiesbaden said today. Sales advanced 0.3 percent from a year earlier.

Renewed decline in eurozone retail sales in September

Retail PMI® data from Markit showed a renewed decline in eurozone retail sales in September. The Markit Eurozone Retail PMI eased below neutrality to 48.6, having signalled the first increase in sales in nearly two years in August. The average PMI reading for Q3 (49.5) was nevertheless the best since Q2 2011.

The overall drop in retail sales mainly reflected a fresh contraction in France following two months of growth, and an ongoing decline in Italy. Encouragingly, the fall in Italian retail sales was the slowest in two years. German retail sales rose at the weakest rate in four months.

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Euro-Area September Inflation Slows More Than Forecast on Energy

Consumer prices rose an annual 1.1 percent after a 1.3 percent increase in August, the European Union’s statistics office in Luxembourg said in a preliminary estimate today. The median forecast in a Bloomberg News survey of 34 economists was for 1.2 percent growth. The core inflation rate, which excludes volatile food and energy costs, was 1 percent.

Siemens Targets 15,000 Job Cuts

Siemens AG, the German industrial giant, said Sunday that it will have cut a total of about 15,000 jobs world-wide by the end of the next business year, defining for the first time the scope of the reductions it plans under a two-year restructuring program aimed at boosting profits.

Jobs eliminated during the business year that ends Monday account for about half the total. Another roughly 7,500 jobs will be cut in the new business year, which begins on Oct. 1, a company spokesman said. (…)

Spain Outlines Austere 2014 Budget

Government ministries will get on average 4.7% less funds to spend next year, the budget minister says with eyes on an economic recovery.

The Spanish government outlined an austere 2014 budget that includes further cuts in spending by its ministries and a salary freeze for public employees despite the country’s emergence from recession.

The budget highlights the huge imbalances created by five years of economic crisis: Spain will set aside €36.6 billion ($49.5 billion) to service its fast-rising pile of public debt, €2 billion more than it will spend on the 13 government ministries.

And it is pledging about €31 billion for welfare and entitlements, up almost 20% from last year. That includes unemployment benefits for the more than a quarter of the working population that is registered as out of work. (…)

Spain will keep public sector wages frozen for a fourth straight year, while pensions will grow by a meager 0.25% next year.

On Friday the government raised its estimate for gross domestic product growth next year to 0.7% from an April estimate of 0.5%. It said private consumption, which has been depressed since Spain’s massive housing bubble burst in late 2007, will grow marginally next year and exports will keep growing at a robust pace.

Finance Minister Luis de Guindos said he expects the economy to start adding jobs in the second half of next year. (…)

Medvedev Warns on Economy

Prime Minister Dmitry Medvedev renewed calls for Russia to end state dominance of the economy and take steps to boost smaller firms to avoid an economic “abyss.”

(…) In a commentary for the country’s leading business daily Vedomosti and a keynote address to an investment forum Friday, Mr. Medvedev presented the gloomiest picture of Russia’s challenges by a top official since its economy started slowing a year and a half ago.

“We are at a crossroads,” he said in the newspaper article. “Russia may continue to move slowly with a close to zero economic growth, or make a leap forward. The latter is risky, but the former is…even more dangerous; it’s a path to the abyss.”

The government last month cut its growth forecast for this year to 1.8%, far below that over-5% expansion called for by President Vladimir Putin. Russia’s economy grew at 7.2% per year from 2000 to the peak of the global financial crisis in 2009, fueled by huge oil and gas revenues.

Mr. Medvedev said the economy could no longer rely on state investments and spending for growth. (…)

In the article and the speech, Mr. Medvedev called for more security for investors by strengthening the rule of law, without mentioning the word “corruption,” which many investors call one the main Russia’s problems.

Mr. Medvedev noted that the state budget and state-controlled companies were the main drivers of the growth in recent years, calling for steps to help small- and medium-size companies grow.

“Amid slowing economic growth we must ensure that the state is not taking up unreasonably large role in the economy,” he said.

Jump in output hints at S Korean recovery
Industrial production at nine-month high

 

New figures from Korea’s National Statistical Office showed output jump 1.8 per cent in August, pulling up the year-over-year gain to 3.3 per cent from 0.9 per cent in July.

HSBC called the figures “particularly impressive” in light of recent strikes in the auto industry and argued the data is indicative of resiliency that could fuel a broader rebound:

Korea is well poised for meaningful recovery towards year-end. But while economic activity is still below potential, the Bank of Korea will likely maintain an accommodative stance. We expect rates to stay on hold at 2.50% on 10 October.

EARNINGS WATCH

[image]Now that the dreaded September is past, keep your fingers crossed for another month. Over and above all the political farces, Q3 earnings season officially begins shortly.

High Time for Profits to Catch Up to Stock Prices

(…) earnings growth has been in the mid-to-low single digits since the middle of 2012. The third quarter is seen registering 3.5% growth, according to S&P. Earnings grew by 3.8% in the second quarter. (…)

Here’s the latest Factset:

  • The estimated earnings growth rate for Q3 2013 is 3.2%. The Financials sector is
    predicted to report the highest earnings growth for the quarter, while the Health Care sector is predicted to report the lowest earnings growth for the quarter.
  • Earnings Revisions: On June 30, the earnings growth rate for Q3 2013 was 6.5%. All ten sectors have recorded a decline in expected earnings growth over this time frame, led by the Materials sector.
  • Earnings Guidance: For Q3 2013, 89 companies have issued negative EPS guidance and 19 companies have issued positive EPS guidance. As a result, 82% (89 out of 108) of the companies that have issued EPS guidance for the third quarter
    have issued negative EPS guidance. This percentage is consistent with the percentage recorded in the previous quarter at this time (81%), but well above the 5-year average of 62%.
  • Earnings Scorecard: Of the 17 companies that have reported earnings to date for Q3 2013, 12 have reported earnings above the mean estimate and 11 have reported revenue above the mean estimate.

Over the course of the third quarter, analysts have lowered earnings estimates for companies in the S&P500 for the quarter. The Q3 bottom- up EPS estimate has dropped 2.6% (to $26.94 from $27.65) since June 30.

During the past year (4 quarters), the average decline in the EPS estimate during the quarter has been 4.4%. During the past five years (20 quarters), the average decline in the EPS estimate during the quarter has been 6.4%. During the past ten years, (40 quarters), the average decline in the EPS estimate during the quarter has been 4.2%.

Thus, the decline in the EPS estimate recorded during the course of the Q3 2013 quarter was lower than the trailing 1-year, 5-year, and 10-year averages. In fact, the decline in the bottom-up EPS during the third quarter was the lowest since Q1 2011 (-0.7%).

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Just kidding  Please, keep reading:

More than $1bn has been wiped off earnings estimates for Wall Street’s five biggest banks in the past month on growing fears of a sharp decline in trading revenues coupled with increased legal costs.

JPMorgan Chase has borne the brunt of forecast cuts, with consensus estimates of net income down $526m to just under $5bn. Its growing legal bills alone are expected to add $2bn in costs when it kicks off the banks’ earnings season on October 11.

But the depressed forecasts have extended to all banks with big fixed income trading operations, after several warnings of slow activity throughout the last three months. Hopes of a final trading flurry in the last few weeks of the quarter have been dashed, with fixed income trading revenues particularly hurt. (…)

Analysts reduced their expectation of net income by $210m for Citigroup, $128m at Bank of America, $123m at Goldman Sachs and $97m at Morgan Stanley, according to Bloomberg data. Those forecasts strip out the distorting effect of an accounting rule that forces companies to take profits or losses from changes in the value of their own debt.

Pointing up  Here’s the punch line from Factset:

The Financials sector is projected to have the highest earnings growth rate (9.3%) of any sector for the third consecutive quarter. It is also expected to be the largest contributor to earnings growth for the entire index. If the Financials sector is excluded, the earnings growth rate for the S&P 500 falls to 1.9%.

At the company level, Bank of America and Morgan Stanley are the key drivers of growth in the sector, due in part to comparisons to weak earnings in the third quarter of 2012. The mean EPS estimate for Bank of America is $0.20, relative to year-ago EPS of $0.00. The mean EPS estimate for Morgan Stanley is $0.44, compared to year-ago EPS of -$0.55. If both of these companies are excluded, the growth rate for the sector would fall to -0.4%.

Hmmm…

THE U.S. ENERGY GAME CHANGER

I have posted a lot about that. The revolution is happening but it is a zero sum game. From the losers side:

Eon chief warns of US energy advantage
Comments fuel concerns heavy industry will abandon EU

The head of Germany’s largest utility has warned it will be years before Europe can hope to counter the US’s growing advantage in energy costs and predicts that the disparity will meanwhile lead heavy industry to abandon the continent.

Johannes Teyssen, chief executive of Eon, said there were no obvious options for Europe to narrow the US advantage – whether by drilling for shale gas, importing more liquefied natural gas or importing inexpensive US supplies.

“There is a competitive advantage for America that we cannot prevent, at least for some time,” Mr Teyssen told the Financial Times. He said it was “a dream” for politicians to suggest otherwise. “It will take years and long years of innovation before we can start to shrink it,” he added.

Mr Teyssen’s comments will add to growing concerns in Europe that high energy prices are encouraging manufacturers such as chemicals companies to shift investments across the Atlantic, where the shale bonanza has reduced natural gas costs to between a quarter and a third of those in the EU. (…)

“The price difference is unnerving some companies and deciding their investments,” Mr Teyssen said, adding that the US advantage was “getting so big we cannot allow it to continue”.

Even if Europe put aside its environmental concerns and decided to pursue natural gas fracking, it would take at least five years to develop such an industry, he predicted. Instead, he said, the continent was more likely to benefit if China and Australia pushed ahead with the technology because it would free up gas from Qatar and other world suppliers. (…)

 

NEW$ & VIEW$ (26 SEPTEMBER 2013)

Durable-Goods Orders Tick Up

Orders for long-lasting manufactured goods inched ahead in August, suggesting businesses and consumers are holding back on big purchases amid slow economic growth and an uncertain outlook.

Total orders for durable goods rose 0.1% to a seasonally adjusted $224.92 billion in August, the Commerce Department said Wednesday.  Durable-goods orders dropped 8.1% in July, lower than the 7.4% decline initially reported. Economists had forecast a 0.6% drop from the prior month. (…)

A key gauge of business investment—nondefense capital-goods orders, excluding aircraft—increased 1.5% from the prior month, retracing some of the prior month’s 3.3% drop. So far this calendar year, business investment is up 4% compared with the same period in 2012. (…)

Markit has a different, less buoyant view:

Orders for US-made durable goods rose 13.7% on a year ago in August, the largest annual increase since December 2011. However, orders were up just 0.1% compared with July; a month in which orders slumped 8.1%. The quarterly rate of growth has consequently weakened, registering an increase of just 3.0% in the three months to August, down from 5.6% in the three months to July and 6.6% in the second quarter.

Excluding volatile transportation goods, the picture is somewhat bleaker. Orders fell for a second month running in August, down 0.1% after a 0.5% fall in July. Over the latest three months, orders for durables other than transport goods were up just 1.2%. By comparison, these orders were rising at a quarterly rate of 3.2% at the start of the year.

Growth is likely to have weakened again in September. Markit’s manufacturing PMI survey showed growth of new orders slowing sharply to a five-month low in September. The lack of demand also hit job creation, which slumped to one of the lowest seen since the height of the financial crisis four years ago.

Both the official data and the survey evidence therefore point to a renewed slowing of growth in the manufacturing economy after a brief pick-up earlier in the summer. Fed policymakers will be further worried that the pace of recovery for the US economy has taken a step back since earlier in the year, when robust growth made a strong case for policy to start being tapered.

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Deja Vu for Wal-Mart

Shares of Wal-Mart (WMT) as well as the broader market just took a new leg lower this afternoon after a Bloomberg story hit the wires suggesting that based on emails the company obtained, WMT is cutting orders to suppliers due to higher inventories.  

If this story sounds familiar, that is because it is.  Back on February 15th, the S&P 500 saw a 50 bps decline intraday after another Bloomberg story hit the wires quoting an executive saying that same store sales were off to their worst start in seven years.  Here’s a link to that story.  As shown in the chart below, following the prior Bloomberg story, the S&P 500 regained nearly all of its declines by the end of the day.

So how did Wal-Mart (WMT) perform following the February article?  As shown below, you couldn’t have picked a better buying point.

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The S&P 500 digested the negative WMT news a bit differently back in February.  While the market bounced back intraday in the immediate aftermath, we did see a decline over the next week before ultimately surging higher in late February and early March.

Ergo: we should all rush out and buy WMT or the whole market for that matter.

But maybe WMT was right after all. Sales have been very slow since last Christmas.

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It could well be that the slow consumer demand has made merchants worried that their inventories might be too high coming into the holiday season. If I have to bet on street economists or on Wal-Mart for a sense of what’s really happening, I’ll take WMT anytime.

Keep that chart in sight:

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Careful out there!

 

U.S. Running Out of Cash More Quickly

The government is closer to running out of money to pay its bills than previously thought, the Treasury Department warned, clarifying the fiscal deadlines confronting Congress.

ClosedTreasury Secretary Jacob Lew said the government would be left with just $30 billion cash on hand “no later” than Oct. 17, and the Congressional Budget Office predicted these funds would be used up between Oct. 22 and Oct. 31 if legislation isn’t enacted to raise the ceiling on government borrowing.

That little cash could make it difficult, if not impossible, for the government to pay the roughly $55 billion in Social Security, Medicare and military payments due Nov. 1. (…)

The Bipartisan Policy Center, a group founded by lawmakers from both parties to forge consensus, has estimated that the government would be unable to pay 32% of its bills in the first month if the debt ceiling isn’t raised in time.

Congress has raised or suspended the debt ceiling five times during President Barack Obama’s tenure. Among those instances, the White House and Republicans brokered an agreement after a bitter debate in August 2011 that put spending restraints in place through 2021. And early this year, Congress agreed to suspend the debt ceiling for several months in exchange for an agreement that both the House and Senate would pass budget resolutions.

The suspended debt ceiling expired in May, and the Treasury has been using emergency steps since then to buy itself more time. Treasury had estimated that by mid-October it would have $50 billion remaining to pay government bills, but it lowered that estimate on Wednesday.

Investors Brush Aside Washington Brinkmanship Washington is in for another ugly battle on the budget and debt ceiling, but markets haven’t exhibited much anxiety at the moment.

(…) Pimco’s Mr. Crescenzi said fiscal impasse was one of the reasons why the Federal Reserve decided not to cut back bond buying last week. The Fed’s decision has sooth fears over rising interest rates, sending benchmark 10-year Treasury yield lower and encouraging buying in stocks.

The 10-year Treasury note yielded 2.643% recently, near a six-week low. The yield earlier this month briefly rose above 3%. (…)

From Credit Suisse:

Credit Suisse strategists have also estimated exactly when markets will run out of patience with the situation. “Markets…are not likely to get much beyond October 10 without pricing for some potential mishap,” they wrote. As of now, the path to a political solution remains unclear, and if politicians follow the same script they did in 2011, they will only act at the very last minute – prolonging the collective panic attack as long as possible. President Barack Obama is taking a hands-off approach to the problem this time around, saying that it is up to Congress to come up with a plan. That’s a very different tack than the public courtship that took place in 2011, when even a well-publicized 18 holes of golf with House Speaker John Boehner, R-Ohio, followed by a meeting at the White House, ultimately failed to lead to a deal.

There’s a needle of good news in that haystack of Washington dysfunction: Credit Suisse’s strategists noted that House Republicans appear willing to have separate debates over the budget and the debt ceiling this time around. That’s important, because it decreases the possibility that the GOP will insist on further budget cuts before agreeing to increase the debt limit. As the strategists noted, the government has already made significant cuts in discretionary spending over the last three years, leaving only entitlement programs such as Medicaid, Medicare and Social Security with any room to yield spending cuts of any significant size. The problem is that changes – especially cuts – to these popular programs are a political minefield for politicians of either party. Still, the strategists think that some small changes may be possible, such as changing the formula by which benefit levels increase each year.

For now, the country — nay, the world — can only hope that a potential compromise is in the offing. But that hope assumes that a conversation is even happening in the first place. With only a month to go before the U.S. runs out of spare cash once again, the Wall Street Journal reported Tuesday that no known talks are going on in Congress around the debt ceiling issue. Get the antacid ready, investors. This fall, it may well come in handy.

Government Closure Would Hurt More Now Than in 1995

As we careen toward a possible shutdown of most of the U.S. federal government, it’s worth looking back at the last time this happened during the combined four-week span from November 14 to November 19, 1995 and from December 16, 1995 to January 6, 1996. Real federal government spending shrank 12% annualized in the fourth quarter of 1995, carving 0.9 percentage points from GDP growth.

But growth slowed only moderately and remained healthy at 2.9% in that quarter because of broad strength in the domestic and external economy. Yet, private-sector payrolls still weakened. Stocks wobbled initially before turning higher, while Treasuries firmed. With the economy on softer ground this time amid sequestration and much higher rates of unemployment and foreclosure, the consequences could be more severe—especially for workers. Congress might want to consider this since most of their jobs are up for renewal next November. (BMO)

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Prices of New Homes Start to Level Out

Prices of new homes, which have risen at double-digit rates in the past year, are starting to level out, the latest evidence that builders are backing away from aggressive increases.

(…) Contracts for sales of new homes remained relatively brisk in August, rising 7.9% when compared to the previous month, to a seasonally adjusted annual rate of 421,000 units, according to data released Wednesday by the U.S. Census Bureau. But the average sale price registered $318,900 in August, roughly on par with the July figure of $318,500 and up 4.4% from August 2012, according to Census release.

Industry executives said the sales data, which are highly volatile from month to month, are masking a slowdown that began over a month ago and is starting to show up in builders’ financial reports.

National builder Hovnanian Enterprises Inc. said this month that it dialed back prices in August after being too “aggressive” with increases in some markets this year. Lennar Corp. said Tuesday that it is using incentives such as down-payment assistance to bolster slow sales in some markets. Texas builder Castle Rock Communities recently started offering more incentives to spur sales after its 12% increase in prices this year deterred some buyers.

Much of the sales falloff has occurred in the Western U.S., where average new-home prices increased 15.7% in the second quarter from a year earlier to $363,300, Census data show. Meanwhile, August sales in that region declined 21% from a year earlier. (…) “And we have seen that trend continue into September, as well,” he said.

Household Wealth Hits Peak

Rebounding home prices and a rising stock market helped boost household wealth by more than $1.3 trillion in the second quarter of this year, Federal Reserve data showed Wednesday. The gain marked the seventh consecutive quarterly increase and pushed household net worth—the value of homes, stocks and other assets minus debts and other liabilities—to $74.8 trillion, an all-time high. Adjusting for inflation, net worth is about 4% below its peak, meaning households have made back about 80% of what they lost during the bust.

Households’ net worth rose about 6% in the first two quarters of 2013, and have likely increased further in the past few months. Stock prices and real-estate values have continued to advance with the Standard & Poor’s 500-stock index up 5% since the end of the second quarter.

(…)  The Fed’s figures showed that the value of corporate equities and mutual funds owned by households rose nearly $300 billion, while the value of real estate owned by households climbed about $525 billion. Americans also have more equity in their homes. A measure of owners’ equity in household real estate as a percentage of household real estate holdings hit 49.8% from 48.1% a quarter earlier.

Household Net Worth: The ’’Real’’ Story

 

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French Budget Relies on Tax Rises

The government unveiled a 2014 budget that still relies on tax increases, threatening to further dent household spending power and President François Hollande’s record low popularity.

(…) net new taxes are still set to increase by €3 billion, with households shouldering the greatest burden, including an increase in the sales tax. (…)

French companies and households have been hit hard by a steady increase in taxation since Mr. Hollande was elected 16 months ago. He introduced more than €7 billion ($9.3 billion) of fresh taxes after coming to power and another €20 billion in the 2013 budget, in a bid to restore France’s public finances and rein in its budget deficit.

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The government went to great lengths Wednesday to stress it is undertaking more spending cuts than tax increases and detailed €15 billion in savings. But the effort to constrain spending is focused more on fighting an automatic increase in expenditure that would otherwise have happened, rather than a net decrease in outlays. For example, at the level of the central state, the €9 billion of savings cut the nominal level of spending by €1.5 billion next year compared with this year.

Overall spending will still rise 0.4% in 2014, even if that is below the 2% annual increase between 2002 and 2012, Budget Minister Bernard Cazeneuve said at a parliamentary hearing. Such efforts to control spending will have more potency if economic growth picks up.

 

NEW$ & VIEW$ (25 SEPTEMBER 2013)

Richmond Fed Manufacturing: Activity Was Flat In September

(…) the manufacturing composite declined sharply from last month’s interim high of 14. Because of the highly volatile nature of this index, I like to include a 3-month moving average to facilitate the identification of trends, now at 1.0, which is close to no growth.

Click to View

U.S. Home Prices Climb  U.S. home prices rose by their fastest pace in more than seven years during July, though there were some signs of a moderation in some regions, according to a widely watched index released Tuesday.

[image]Prices in 20 major U.S. cities increased 12.4% in July compared to the same month last year, according to the Standard & Poor’s/Case-Shiller index. (…)

Tuesday’s report hinted at a possible slowdown in the rate at which prices are going up. While all 20 cities tracked by the Case-Shiller index gained in July, the pace at which prices rose slowed in 15 cities. (…)

Home prices rose 1.8% in July from June. While that was slower than the month-over-month increases in the previous three months, prices tend to rise fastest in the spring, and they typically peak in June. July’s gain was still the largest for that month since the Case-Shiller index began its count in 2000.

Remember the CS index is a 3-m m.a.

REAL WORLD, USA:

  • U.S.: Transmission of monetary policy hits a snag (NBF Financial)

The transmission of U.S. monetary policy seems to have hit a snag recently: since early July, commercial & industrial loans and closed end
residential loans of U.S. commercial banks have been either flat (C&I) or contracting (residential). For both categories, as today’s Hot Chart shows, this is the worst picture in three years.

In our view, the performance of C&I loans is disturbing because it suggests tepid investment by small and medium-sized businesses, which tend to be the main contributors to job creation. In other words, businesses seem somewhat concerned about the outlook. The first uncertainty that comes to mind, of course, is the folly of U.S. politicians threatening once again to shut down the government. Forecasts that  called for an acceleration of U.S. economic growth in the final quarter of the year now seem at risk.

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  • Weekly Chain Store sales stay weak

Data is up to last weekend. Sales are showing no signs of a meaningful upturn

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Recovery in France remains unconvincing
Less positive signals suggest economy continues to struggle

CHINESE CONFUSION:  China Beige Book Shows Slowdown, Opposite Official Data

China’s economy slowed this quarter as growth in manufacturing and transportation weakened in contrast with official signs of an expansion pickup, a private survey showed.

Increases in business-investment and real estate revenue also slowed, while service industries picked up and employees became tougher to find, the survey from New York-based China Beige Book International said yesterday. The report is based on responses from 2,000 people from Aug. 12 to Sept. 4 as well as 32 in-depth interviews conducted later in September.

The quarterly report, which began last year and is modeled on the U.S. Federal Reserve’s Beige Book business survey, diverges from government figures showing faster factory-output gains in July and August that have spurred analysts from Citigroup Inc. to Deutsche Bank AG to raise expansion estimates. Nomura Holdings Inc. is among banks skeptical that any rebound will be sustained next year.

The results “show the conventional wisdom of a renewed, strong economic expansion in China to be seriously flawed,” China Beige Book President Leland Miller and Craig Charney, research and polling director, said in a statement.

The data “reveal weakening gains in profits, revenues, wages, employment and prices, all showing slipping growth on-quarter — no disaster, but certainly not the powerful expansion suggested by the consensus narrative.” (…)

The first China Beige Book, from the second quarter of 2012, said the economy was picking up, a few months ahead of official data indicating a rebound. This year’s second-quarter report showed expansion slowing across the country and a decline in companies taking out loans.

The latest survey said 47 percent of manufacturers reported revenue gains, down 6 percentage points from the second-quarter survey. Growth in export orders was “stable” for the U.S. and Europe and “off a bit” in Asia and developing nations outside of Asia.

In transportation, including shippers, 51 percent of respondents said revenue rose, down 18 percentage points. Fifty-three percent of a broader sample of businesses said investment rose, a 4-point decline. Service revenue rose for 57 percent of respondents, up 3 points.

The survey said bank-loan gains ebbed and borrowing costs declined while companies used non-bank channels more often. Forty-six percent of bankers said loans rose, down 14 percentage points from the prior survey, and there was a 20-point drop in the share expecting credit availability to ease in six months. The mean interest rate on all new loans fell 47 basis points to 6.63 percent, China Beige Book said.

So-called shadow lenders’ share of financing rose to 29 percent of loans in the third quarter, up 5 percentage points, the survey said.

Not all the China data showing a rebound have come from government sources. A report Sept. 23 from HSBC Holdings Plc and Markit Economics showed manufacturing strengthened more than estimated this month, mirroring an August increase in a similar government-produced index. (…)

AMERICAN CONFUSION:
 
  • Two Fed Officials Stay Put on Bond Buys

    Two Fed officials sounded doubtful about cutting back on the central bank’s $85 billion-a-month bond-buying program at their next policy meeting next month.

Pointing up  GOOD READ: WAKING UP IRAN AND EGYPT

Very interesting op-ed by Thomas Friedman in the International Herald Tribune.

(…) Two huge new forces have muscled their way into the center of both Egyptian and Iranian politics, and they will bust open their old tired duopolies.

The first newcomer is Mother Nature. Do not mess with Mother Nature. Iran’s population in 1979 when the Islamic Revolution occurred was 37 million; today it’s 75 million. Egypt’s was 40 million; today it’s 85 million. The stresses from more people, climate change and decades of environmental abuse in both countries can no longer be ignored or bought off.

On July 9, Iran’s former agriculture minister, Issa Kalantari, an adviser to Iran’s new president, Hassan Rouhani, spoke to this reality in the Ghanoon newspaper: “Our main problem that threatens us, that is more dangerous than Israel, America or political fighting, is the issue of living in Iran,” said Kalantari. “It is that the Iranian plateau is becoming uninhabitable. … Groundwater has decreased and a negative water balance is widespread, and no one is thinking about this.”

He continued: “I am deeply worried about the future generations. … If this situation is not reformed, in 30 years Iran will be a ghost town. Even if there is precipitation in the desert, there will be no yield, because the area for groundwater will be dried and water will remain at ground level and evaporate.” Kalantari added: “All the bodies of natural water in Iran are drying up: Lake Urumieh, Bakhtegan, Tashak, Parishan and others.” Kalantari concluded that the “deserts in Iran are spreading, and I am warning you that South Alborz and East Zagros will be uninhabitable and people will have to migrate. But where? Easily I can say that of the 75 million people in Iran, 45 million will have uncertain circumstances. … If we start this very day to address this, it will take 12 to 15 years to balance.”

In Egypt, soil compaction and rising sea levels have already led to saltwater intrusion in the Nile Delta; overfishing and overdevelopment are threatening the Red Sea ecosystem, and unregulated and unsustainable agricultural practices in poorer districts, plus more extreme temperatures, are contributing to erosion and desertification. The World Bank estimates that environmental degradation is costing Egypt 5 percent of gross domestic product annually.

But just as Mother Nature is demanding better governance from above in both countries, an emergent and empowered middle class, which first reared its head with the 2009 Green revolution in Iran and the 2011 Tahrir revolution in Egypt, is doing so from below. A government that just provides “order” alone in either country simply won’t cut it anymore. Order, drift and decay were tolerable when populations were smaller, the environment not so degraded, the climate less volatile, and citizens less technologically empowered and connected.

Both countries today need “order-plus” — an order that enables dynamism and resilience, and that can be built only on the rule of law, innovation, political and religious pluralism, and greater freedoms. It requires political and economic institutions that are inclusive and “sustainable,” in both senses of that word. Neither country can afford the old line that Hosni Mubarak used for so many years when addressing American leaders: “After me comes the flood, so you’d better put up with my stale, plodding but stable leadership, otherwise you’ll get the Muslim Brotherhood.”

That is so 1970s. As Karim Sadjadpour, an Iran expert at the Carnegie Endowment, puts it: In the Middle East today “it’s no longer ‘After me, the flood’ — Après moi, le déluge — but ‘After me, the drought.’ ” Syria’s revolution came on the heels of the worst drought in its modern history, to which the government failed to respond.

Iran’s Islamic leadership seems to realize that it cannot keep asking its people to put up with crushing economic sanctions to preserve a nuclear weapons option. Mother Nature and Iran’s emergent middle classes require much better governance, integrated with the world. That’s why Iran is seeking a nuclear deal now with Washington.

And that’s why two of the most interesting leaders to watch today are President Rouhani of Iran and Egypt’s new military strongman, Gen. Abdul Fattah el-Sisi. Both men rose up in the old order, but both men were brought into the top leadership by the will of their emergent middle classes and newly empowered citizens, and neither man will be able to maintain order without reforming the systems that produced them — making them more sustainable and inclusive. They have no choice: too many people, too little oil, too little soil.

And pay attention: What Mother Nature and these newly empowered citizens have in common is that they can both set off a wave — a tsunami — that can overwhelm their systems at any moment, and you’ll never see it coming.

 

NEW$ & VIEW$ (17 SEPTEMBER 2013)

Still travelling. Pardon the interruptions.

Industrial production rebounds in August, led by manufacturing

In August, the US industrial sector showed its largest monthly production gain since February, with output rising 0.4% during the month, according to the Federal Reserve. The increase is a big relief after production was unchanged in July, which had marked a
disappointingly weak start to the third quarter.

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The data on goods production were even more encouraging – a 0.7% gain during August more than reversed a 0.4% drop in July. The turnaround was largely due to the autos sector, which reported a surge
in production after a slump one month previously. However, broad-based gains were seen in almost all the major manufacturing sectors, with the exceptions of chemicals and basic metals.

The less-volatile quarterly growth rate picked up to 0.3% in the three
months to August compared with a 0.1% drop in manufacturing output in the three months to June.

The Fed also published data on capacity utilisation, which showed capacity running 2.4% below its long run average. Such excess capacity is good news for inflation, as it means the industrial sector has room to
grow before demand exceeds supply, which often leads to the build-up of inflationary pressures.

(…) However, when viewed alongside last week’s disappointing retail sales data, it is likely that the pace of economic growth will have slowed compared to the 2.5% annualised pace seen in the second quarter.

US retail sales growth disappoints in August, but unlikely to deter Fed tapering

Retail sales rose 0.2% in August against expectations of a 0.4% rise. Core sales (excluding autos, building materials and gasoline), also rose 0.2%, lower than expectations of a 0.3% rise and down from 0.5% in July.
With the latest rise building on a 0.4% increase in July, it looks like retail sales will help drive economic growth again in the third quarter, though it seems unlikely that the contribution will be as large as the 0.9% rise in
sales had in the second quarter.

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Haver Analytics adds:

There were also sizable gains in August at furniture stores, up 0.9% (+4.9% y/y), electronics & appliance stores, up 0.8% (+3.1% y/y) and miscellaneous stores, up 1.0% (+4.2% y/y). So several durable goods sectors had firm performances in the latest period. At the same time, building materials, supplies and hardware sales retreated 0.9% (+7.6% y/y) following their 1.8% surge in July.

Markit continues:

The message from the various official data that are available is therefore that the economy continued to grow in the third quarter, but that growth is likely to have slipped from the 2.5% annualized pace seen in the second quarter.

Although weaker than expected, the retail data are unlikely to stop the Fed starting to withdraw its stimulus at next week’s FOMC meeting. However, the Fed is most likely to make only a small but symbolic reduction to the stimulus programme, perhaps reducing the asset purchases by $5bn per month, due to the fragility of the upturn. Importantly, any tapering is likely to be accompanied by a statement of reassurance that any further tightening of policy will be carefully considered to ensure it does not set back the recovery.

Ghost  BloombergBriefs: The Economy’s Sub-Two Percent Tipping Point

There’s a little known rule of thumb in the economics world: when the annual growth rate of key U.S. indicators falls below 2 percent, the economy slides into recession in the next 12 months. Real GDP growth was an annual 1.6 percent in the second quarter. It was last at 2 percent in the fourth quarter 2012, down from 3.1 percent in the third. In addition, real disposable personal incomes (0.8 percent), and real consumer spending (1.7 percent) flash warning signs. With GDP,
they possess exceptional recession-predicting abilities.

The reason is simple: like riding a bike, if you don’t pedal, you tip over.

(…)Another rarely-cited statistic with excellent predictive qualities is the pace of real final sales of domestic product, which measures the level of goods produced in the economy that are actually sold rather than placed in inventory. The current 12-month pace is 1.6 percent. Alternatively,
some economists look to the level of final sales to domestic purchases,
which represents GDP less net exports and inventories.

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These two indicators are often seen by Wall Street economists as preferred measures since they pertain to domestic demand, not what is produced or stockpiled. The year-on-year change in real final sales to domestic purchases is 1.5 percent.

(…) The more meaningful household-sensitive component — revolving
credit — contracted by an annualized 2.6 percent in July following a 5.2 percent decline in the previous month. During the last 12 months, revolving credit advanced 0.8 percent — essentially the same pace
it has held since early 2012. (…)

Retail sales at general merchandise stores — the second largest category of retail sales behind motor vehicles and parts — fell 0.2 percent month-on-month in August and 0.3 percent from August 2012. These are all signs of a consumer led slowdown.

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ShopperTrak Forecasts a Weak Holiday

ShopperTrak, which measures store traffic in 60,000 locations world-wide and crunches other data to come up with its forecast, expects retail sales in November and December to rise by 2.4% from a year earlier, less than the 3% increase in 2012 and below the gains of around 4% in 2011 and 2010.

Early forecasts are often well off the mark, and ShopperTrak’s forecasts have tended to undershoot actual Commerce Department data. But ShopperTrak’s projection echoes weak back-to-school results from some retailers and a tepid showing for retail sales last month. Consumers remain cautious despite improvements in hiring and the housing market. (…)

ShopperTrak predicted a 2.5% increase in retail sales in 2012, while the actual increase was 3%, based on sales of general merchandise, apparel and accessories, furniture and other categories as measured by the Commerce Department. In 2011 the prediction was for a 3% increase, while the actual rise came in at 4%.

Producer Prices Rise 0.3%

But core prices, which exclude volatile energy and food components, were flat, marking the first time since October that category failed to rise.

Compared with a year ago, overall prices were up 1.4%, the smallest year-over-year increase since April. Core prices were up 1.1% from a year ago.

Eurozone employment downturn eases sharply in second quarter

Employment in the eurozone continued to fall in the second quarter, but the rate of decline eased markedly, adding to hopes that the region is on a recovery path.

Employment in the eurozone fell 0.1% in the second quarter, according to Eurostat, taking the total down to 145 million, its lowest since the final quarter of 2005. Employment has fallen continually over the past two years as the region moved back into recession in 2011. However, the rate at which employment is falling has eased significantly. The 0.1% drop in the second quarter compares with a 0.4% fall in the first quarter and a 0.3% decline in the final three months of last year. That equates to 33,000 jobs being lost per month in the second quarter compared to more than 200,000 in the first quarter.

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PMI survey data also suggest that the rate of job losses has eased further in the third quarter so far: an average composite employment index reading of 48.5 compares with an average of 47.3 in the second quarter.

Looking at the four largest economies, employment edged up by 0.1% in Germany in the three months to June, but was flat in France. Spain and Italy both saw the rate of decline ease to -0.5% and -0.3% respectively, down from -1.0% and -1.2% in the first quarter. Elsewhere, the Netherlands saw the rate of decline pick up to -0.4%, but employment rose in Ireland (+0.5%), Austria (+0.2%), Portugal (+0.8%) and
even Greece (+0.1%).

The recent cut in employment took place despite GDP rising 0.3% over the same period. However, comparing employment changes with GDP highlights how, since the financial crisis, jobs have been cut at a significantly faster rate than the pre-crisis relationship between GDP and employment would suggest, pointing to a steep improvement in labour productivity over this period.

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Auto  Lightning  Europe August Car Sales Drop as Demand Lowest on Record

Registrations dropped 4.9 percent to 686,957 vehicles from 722,458 cars a year earlier, the Brussels-based European Automobile Manufacturers’ Association, or ACEA, said today in a statement. Eight-month sales declined 5.2 percent to 8.14 million autos.

The European car market rose 4.9 percent in July to 1.02 million vehicles. The gain was the second this year, following a 1.7 percent increase in April that marked the first growth in European car sales in 19 months. The trade group releases July and August sales figures simultaneously each September.

Registrations in the past two months were affected by differences in the number of business days versus 2012, with one more in July and one less in August, the ACEA said today.  (…)

Four of Europe’s five biggest automotive markets shrank last month. Deliveries in top-ranked Germany dropped 5.5 percent to 214,044 vehicles. That compared with a 2.1 percent increase in July. The U.K. market, the region’s second biggest, expanded 11 percent to 65,937 cars in August. (…)

Record Saudi oil output fills supply gap Saudi pumps out more crude than at any time since the 1970s

(…) The trigger for the jump in Gulf production has been huge disruption to supplies from Libya, where striking workers and militias have reduced exports from about 1m b/d to merely a trickle. Saudi Arabia has responded by pushing output to 10.2m barrels a day in August, according to the International Energy Agency, the most in IEA records. The country is now reaping more than $1bn a day in export revenues.

The UAE and Kuwait have also both set records for output this summer, at about 2.8 mb/d. In August the three large Gulf producers met 17.1 per cent of global demand. In thirty years of IEA data, their share has not topped 18 per cent. (…)

The IEA estimates that even when producing at current levels, Saudi Arabia still has more than 2mb/d of spare production capacity. Ali-al Naimi, the kingdom’s oil minister, emphasised again last week Riyadh’s willingness to meet any demand.

But that appears to have required a subtle shift in policy. Saudi Arabia has been slowly bringing online its giant offshore Manifa oilfield, which should eventually be able to produce 900,000 b/d.

Riyadh had originally planned to send Manifa output to a domestic refinery, while throttling back production at some of its other fields in order to prolong their lives. That would have made less oil available to the global market. But the IEA thinks that has not happened. (…)

By factoring in Manifa output, the IEA has raised its estimate of Saudi output capacity by more than 500,000 b/d this year, to 12.5 mb/d. That provides some buffer to the market, and means the IEA is hopeful that the current tightness in the oil market will ease over the next few months, as refineries are shut for maintenance.

Within the Gulf, though, Saudi Arabia’s ability to bring on new production at will appears to be an exception. The UAE has pushed back its target for increasing production capacity to 3.5m b/d to 2020, from 2017. Kuwait is still targeting 4m b/d by 2020, but is struggling to overcome rapid decline rates from its existing fields.

Both countries are currently pumping near their maximum capacity, according to the IEA. Qatar, meanwhile, has seen output fall slightly in recent years. (…0

Mexico to speed up infrastructure spending
President’s pledge is an attempt to revive sluggish economic growth

Mexican president Enrique Peña Nieto, under fire over tax proposals that herald pain for the middle class, has promised to accelerate spending of 27bn pesos ($2bn) on infrastructure, kick-starting access to credits and boosting the housing industry.

The move is an attempt to revive sluggish economic growth before the end of the year, and reveals the government’s concern with the economy’s sudden deflation. It grew just 1.5 per cent in the first half after shrinking 0.7 per cent in the second quarter, and official estimates of modest 1.8 per cent growth this year are looking optimistic at best.

 Canadian Home Sales Jump

Existing home sales across Canada rose 2.8% in August from July—and surged by 11.1% from a year ago—as real-estate activity ramped back up in most major cities, the country’s real-estate trade group said Monday.

 

Canada Household Debt Hits Record High

Canadian household debt hit a record high in the second quarter as consumers continued to take out mortgages. Net worth, meanwhile, rose 3%.

Canadian household debt, deemed by policymakers as the biggest domestic risk facing the Canadian economy, rose to a record high in the second quarter of 2013 as consumers continued to take out mortgages, albeit at slower pace compared to the same year-ago period, Statistics Canada said Friday.

The data agency said the ratio of household credit-market debt to disposable income hit 163.37% in the April-to-June period, up from the 162.10% level recorded in the first quarter.

According to the figures, Canadians borrowed 25.9 billion Canadian dollars ($25.1 billion) from financial institutions in the three-month period, with mortgages accounting for nearly 70% of that total. However, the amount of mortgages issued to Canadians in the second quarter totaled C$18.24 billion, down from C$21.85 billion a year earlier.

Credit-market debt — which includes mortgages, lines of credit and other loans — totaled roughly C$1.72 trillion at the end of June, for a quarter-over-quarter increase of 1.6%.

Meanwhile, Canadian net worth rose 3.1% in quarter to C$7.31 trillion, or C$207,300 on a per-capita basis.

Sweden’s economy shrinks in Q2
Transport sector helps industrial output grow in Hungary

Final figures for April to June showed that the economy shrank 0.2 per cent quarter on quarter . It was still 0.1 per cent bigger than it was in the second quarter of 2012. Gross fixed capital formation fell 3 per cent year on year, exports fell 2.3 per cent and imports dropped 1.1 per cent. However, household consumption did increase 1.9 per cent and government consumption rose 2 per cent.

Hungary: Industrial output increased 2.5 per cent year on year in July, aided by a strong performance in the transport sector, which increased 12.9 per cent. A 4.9 per cent increase in food production also helped, though the electronics sector struggled. New orders were up 5.9 per cent year on year, after two months of contractions and total orders surged 9.1 per cent.

 

NEW$ & VIEW$ (4 SEPTEMBER 2013)

GLOBAL GROWTH?

Rising demand adds to evidence world growth is picking up

Global manufacturing growth edges higher

The growth rate of the global manufacturing sector continued to edge higher in August. Although the overall pace of expansion remained only moderate at best, it was nonetheless the fastest signalled since June 2011.

At 51.7 in August, up from 50.8 in July, the JPMorgan Global Manufacturing PMI™ – a composite index* produced by JPMorgan and Markit in association with ISM and IFPSM – signalled growth for the eighth month running.

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Manufacturing production rose for the tenth successive month, with the rate of growth accelerating to the highest since January. The main drag came from broad-based weakness in a number of emerging markets, with India, Taiwan, South Korea, Indonesia, Vietnam and Brazil were among the countries to report lower output volumes.

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US manufacturers reported a slowdown in production growth to a ten-month low in August, which offset some of the momentum gained through a return to growth in China and faster expansions in Japan and the UK. The rate of increase in UK manufacturing output surged to its highest since 1994 and in Japan hit a two-and-a-half year high. The recovery in the euro area also gained traction.

Pointing up The rate of growth in global manufacturing new orders rose to a 30-month high in August. The acceleration was also firmer than that seen for production, raising the possibility that output may continue to rise in the months ahead. Moreover, the ratio of new orders to stocks of finished goods – which acts as a bellwether for the near-term trend in output – also hit a 30-month high. Holdings of pre- and postproduction inventories both fell over the month.

Manufacturing employment ticked higher in August. The latest data point to a slight increase in payroll numbers, with job creation reported by the US, Japan, the UK, Canada, Mexico, India, Taiwan, Turkey, Vietnam, Poland, Czech Republic and Ireland.

August saw average input prices rise at the fastest pace since January. On a regional basis, rates of increase accelerated in Asia and eased slightly in North America. Cost inflation was recorded for the first time in seven months in the European Union.

Euro-Zone Recovery Broadens

Data provider Markit said its poll of executives in euro-zone services and manufacturing companies showed the highest reading for business activity in over two years. The composite purchasing managers index rose to 51.5 in August from 50.5 in July. (…)

Wednesday’s survey results suggest growth, albeit still modest, is spreading to some of the bloc’s weaker countries, said Chris Williams, Markit’s chief economist.

“The euro-zone recovery is looking increasingly broad-based, with more sectors and more countries emerging from recession,” he said.

What’s Behind Manufacturing’s Rebound?

(…) From all of which, a couple of themes seem to be emerging. One, the euro zone looks to be bottoming out. Two, China and Germany are once again proving to be the engines driving other economies. And three, the U.S. seems to be offering support, but without being a significant driver of global growth.

The question now is how sustainable and strong are these boosts likely to be. There’s every reason to believe that although the euro zone is getting a little better, it’s still a long way from health. Car sales remain weak across major euro-zone markets, with France, Italy and Spain reporting big year-on-year declines in the summer. This squares with data showing household credit continues to contract across the single currency area.

German manufacturers are likely to be sucking in regional manufactured imports–components and the like. But a lot of this is likely to be re-exported. The International Monetary Fund continues to point to strong German current-account surpluses for the coming years. If its euro-zone neighbors aren’t importing because their economies are too weak, this implies exports elsewhere.

China has been a strong source of demand for German manufactured goods. Chinese manufacturers seem to be benefiting from recent government efforts to restimulate their economy, as well as from restocking.

So as long as Chinese stimulus continues, the global economy will look better. (…)

image(BloombergBriefs)

Volume of retail trade up by 0.1% in euro area

Core retail sales declined 0.4% in July after a 0.6% drop in June and a combined 1.8% gain in April-May which itself followed a 1.4% decline in Feb-March. Very volatile. In total, however, core sales are down 0.6% during the last 6 months.

Confused smile German retail sales declined 1.4% in July after a 0.8% drop in June. German sales are off 2.2% since February. France sales jumped 2.0% in July after a 1.4% decline in June. They are up 2.0% since February. Should we believe these stats?

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Why are German retail sales so soft? The FT may have the answer in this article (Germany’s gold standard jobs record masks hidden flaws).

(…) But the German “jobwunder” has come at a cost – the big increase in low paid, precarious types of employment such as part-time work, temporary contracts, so-called “minijobs” and outsourcing. (…)

The number of temporary workers in Germany has almost trebled in Germany over the past 10 years to about 822,000, according to the Federal Employment Agency.

Meanwhile, more than 7.4m Germans have a ‘minijob’ – a relatively new type of German contract that permits an employee to earn up to €450 a month tax free.

Popular with middle class housewives and students, minijobs have become widespread in service industries such as retail, hotels and restaurants.

However, for the majority of recipients, the minijob is their primary form of employment and hourly wages can be extremely low.

Minijobbers are commonly unable to set aside enough money for retirement and minijobs also have not proved the stepping stone to regular employment that many had hoped. (…)

Rings an American bell?

Weekly chain store sales remain slow in the U.S. indicating a pretty sluggish back-to-school season. The 4-week moving average is up 2.2% as of August 31.

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ISI’s consumer surveys, including homebuilders, continue soft.

Mortgage applications rise first time in four weeks: MBA

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, rose 1.3 percent in the week ended August 30, after sliding 2.5 percent the prior week. (…)

The refinance index rose 2.4 percent last week. (…)

Pointing up The gauge of loan requests for home purchases, a leading indicator of home sales, fared worse, dipping 0.4 percent. (…)

(CalculatedRisk)

Smile  U.S. small business borrowing rises to six-year high

The Thomson Reuters/PayNet Small Business Lending Index, which measures the volume of financing to small companies, rose 11 percent in July to 117.7, the highest level since August 2007. (…)

Pointing up Historically, PayNet’s lending index has correlated to overall economic growth one or two quarters in the future.

The stronger reading in July, up 12 percent from a year earlier, came as the Federal Reserve signaled it is prepared to begin reducing its massive stimulus program as soon as this month. (…)

Because small companies typically take out loans to buy new tools, factories and equipment, more borrowing could signal more hiring ahead. (…)

Low financial stress at small businesses, with more of them paying back loans on time, could also bode well for future borrowing.

Delinquencies of 31 to 180 days fell in July to an all-time low of 1.48 percent of all loans made, according to the Thomson Reuters/PayNet Small Business Delinquency Index.

Accounts overdue as a percentage of all loans have fallen steadily since rising as high as 4.73 percent in August 2009.

Support for U.S. Strike on Syria Builds

Obama’s drive to build support for an attack against Syria gained significant momentum. Leaders of a Senate committee reached agreement on a resolution authorizing military strikes against Syria that adds restrictions.

SENTIMENT WATCH: CHANGING MARKET NARRATIVES

John Hussman has been a very vocal and much quoted bear all along this bull market. His latest weekly note seems to warn of a possible change in his narrative:

(…) One result of this discipline is that even though I expect that the present cycle will be completed by a market loss on the order of 40-55%, conditions can certainly emerge over the course of this cycle that could warrant a more constructive stance than we have presently, though possibly less extended than we’d like. The most likely constructive opportunity would emerge from a moderate retreat in market valuations, ideally to “oversold” conditions from an intermediate-term perspective, coupled with an early firming in measures of market internals. Though larger cyclical risks here will probably make some line of defense important in any event, our outlook certainly has room to be more constructive as conditions change. We would expect such opportunities regardless of whether bull or bear market outcomes unfold ahead.

Light bulb  “A New Way to Deal With Telemarketing Calls,” (The Freakonomics Blog)http://bit.ly/145XehQ

A man in the U.K. is charging telemarketers for calling him. From BBC News:

A man targeted by marketing companies is making money from cold calls with his own higher-rate phone number.

In November 2011 Lee Beaumont paid £10 plus VAT to set up his personal 0871 line – so to call him now costs 10p, from which he receives 7p.

The Leeds businessman told BBC Radio 4′s You and Yours programme that the line had so far made £300.

Phone Pay Plus, which regulates premium numbers, said it strongly discouraged people from adopting the idea.

 

NEW$ & VIEW$ (3 SEPTEMBER 2013)

DRIVING BLIND (Continued)

When I was managing money, after our group had discussed and explored all economic scenarios based on available data, we often concluded with the wishful expression “next month things will be clearer”. We kept repeating it month after month…

What we got last week:

  • Q2 GDP

Thumbs up The U.S. economy entered the second half of the year on firmer footing than previously estimated, with stronger growth, an uptick in corporate profits and consumers feeling better amid a rebound in housing. (WSJ)

The good news is, the U.S. economy grew more than initially expected a month ago. The first stab at the Q2 real GDP on July 31st was 1.7% a.r. Then the trade numbers came out and wow, the view changed and it looked like GDP grew in the neighborhood of 2½% a.r. Then, as the
days went by, more data on inventories and consumer spending caused estimates to be trimmed, leaving consensus and us at around 2.2%-to-2.3% for the second quarter. Now, gentle reader, it looks like we should’ve stuck with the trade data as real GDP did rise 2.5% a.r. in Q2, the largest increase in nearly one year. That and the fact that consumer spending wasn’t revised at all (still 1.8% a.r.) is encouraging. Exports were revised up nicely, and inventories added more to the bottom line. (BMO Capital)

A 2.5% growth is not particularly impressive, but when one takes into account (a) the fiscal drag of lower government spending and higher payroll taxes and (b) the financial drag of retaining revenues to rebuild private balance sheets, the results are beating expectations. Moreover, it is interesting to note that the current recovery has come about despite a declining trend in the velocity of money. (Palos Management)

Curb your enthusiasm:

Thumbs down The latest GDP update shows the current data point is lower than the onset of all recessions except the one that started in January 1980. (Doug Short)

Click to View

Thumbs down But domestic final sales, which strip away swings in the trade deficit and inventories, actually were revised slightly lower, to a 1.9% annual pace from 2%. Over the past 12 months, domestic final sales are up 1.5%, which is more in line with GDP year-on-year growth of 1.6% per annum. (WSJ)

Thumbs down We get a similarly weak picture in the YoY Real Final Sales (which excludes changes in private inventories). (Doug Short):

Click to View

Notice how current levels are indicative of recessionary conditions. (Note to Ian M.: thanks for the heads up on the ZH post. Doug’s chart is just so much better)

  • JULY CONSUMER DATA

Thumbs down July Consumer Spending Up 0.1% Americans spent more cautiously in July as income growth slowed, signaling a potential risk for the economic recovery in the second half of the year.

Overall incomes improved slightly, but wages and salaries fell 0.3%, pushed down by federal spending cuts that spurred furloughs across the government. Government wages were reduced by $7.7 billion in July and $700 million in June due to the furloughs, the report said.

The weak growth of overall spending was partly due to falling demand for durable goods. The category fell 0.2% in July after rising 0.9% in June, marking the first decline since March.

Real disposable income was up 0.8% YoY and is really not growing enough to sustain the recent spending trends…

Click to View

…unless the consumer keeps dissaving. Bold call!

Click to View

Doug Short continues:

As the chart above illustrates, the US savings rate had generally declined since the early 1980s, a trend no doubt supported by the psychology of the secular bull market from 1982 to 2000. After stabilizing for a couple of years following the Tech Crash, a new surge in asset-growth confidence from residential real estate was probably a factor in that trough in 2005. But in 2008 the Financial Crisis reversed the trend … for a while.

Doug is absolutely right. Savings are the residual of income minus spending. When people borrowed against their house to pay for their third car and new boat, the savings rate collapsed, a phenomenon unlikely to be repeated for quite a while.

Thumbs down Several economists lowered their growth estimates for the third quarter after Friday’s weak report, which offered the first major gauge of consumer spending in the third quarter. The forecasting firm Macroeconomic Advisers now expects a 1.6% annualized growth rate, down two-tenths of a percentage point from its earlier estimate. Barclays economists lowered their estimate 0.3 percentage point, also to 1.6%. (WSJ)

Snail  What about August? Weekly chain store sales have been on the weak side so far (to Aug.24). Slow back-to-school sales generally herald sluggish Christmas sales.

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Wait, wait:

Note: The automakers will report August vehicle sales on Wednesday, Sept 4th.
From Kelley Blue Book: Crossovers, Pickup Trucks Lift August Sales Nearly 14 Percent, According To Kelley Blue Book

In August, new light-vehicle sales, including fleet, are expected to hit 1,460,000 units, up 13.6 percent from August 2012 and up 11.0 percent from July 2013.
The seasonally adjusted annual rate (SAAR) for August 2013 is estimated to be 15.6 million, up from 14.5 million in August 2012 and down from 15.8 million in July 2013.

Press Release: J.D. Power and LMC Automotive Report: August New-Vehicle Sales Reach Highest Level in Seven Years

With consistency in the fleet environment, total light-vehicle sales in August 2013 are also expected to increase by 12 percent from August 2012 to 1,495,400. Fleet sales are expected to account for 15 percent of total sales, with volume of 225,000 units.
PIN and LMC data show total sales reaching a 16 million unit SAAR in August, which is the highest since November 2007, with actual unit sales the highest since May 2007.

From TrueCar: August 2013 New Car Sales Expected to Be Up 14.4 Percent According to TrueCar; August 2013 SAAR at 15.75M, Highest August SAAR since 2007

For August 2013, new light vehicle sales in the U.S. (including fleet) is expected to be 1,464,214 units, up 14.4 percent from August 2012 and up 11.8% percent from July 2013 (on an unadjusted basis).
The August 2013 forecast translates into a Seasonally Adjusted Annualized Rate (“SAAR”) of 15.75 million new car sales

The analyst consensus is for sales of 15.8 million SAAR in August.

July sales were 15.7M annualized.

After a six-month stretch where the headline index saw some extremely volatile month to month swings, the Chicago PMI has settled down over the last two months with back to back increases of 0.7 points.  To top things off, the headline reading also came in right in line with forecasts.

Thumbs up New orders at 57.2 from July’s 53.9. Impressive!

Thumbs up Overall prices rose just 0.1% in July from June, according to the Fed’s preferred inflation gauge, the Commerce Department’s price index for personal consumption expenditures, released Friday. Core prices, which exclude volatile food and energy costs, also nudged up 0.1%. Both rose at a slower pace than in June. Compared with a year earlier, overall prices were up 1.4% while core prices rose 1.2%. (WSJ)

In effect, the U.S. economy looks like a building seemingly pretty solid from the outside but actually resting on weak foundations.

Fingers crossed And while the charts above showing that current readings on YoY growth in GDP and final sales generally reflect recessionary conditions, the Conference Board’s LEI charts keep hopes alive (more great Doug Short charts):

Click to View

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It may well be that the YoY change in key GDP numbers were unusually distorted by the “temporary” sequester. In fact, quarterly trends are not indicative of a coming recession . Last 3 quarters:

  • GDP: 0.1%, 1.1%, 2.5%;
  • Final sales of domestic product: 2.2%, 0.2%, 1.0%;
  • Final sales to domestic purchasers: 1.4%, 0.5%, 1.9%.
  • These while federal government spending was: –13.9%, –8.4%, –1.6%.

Palos’ Hubert Marleau:

We have noticed that the private sector has started to slightly lower its preference for cash and equivalents. Should the trend in the velocity of money turn upwards as theory would suggest, the US economy would certainly gather steam. It would either bring about an increase in growth or inflation or both. Given the existing slack in the economy, it is more likely to first have an increase in growth than inflation. This leads us to believe that the Fed is about to reduce its bond-buying program this Fall.

Confused? Pity the FOMC in a couple of weeks. But don’t worry, it will be clearer next month…Winking smile

GLOBAL GROWTH THE NEW NARRATIVE?

WHAT TO DO NOW?

Wait, wait:

Thumbs up (…)Yet investors aren’t exactly dumping their riskiest, priciest bets, notes Justin Walters of Bespoke Investment Group, who divided the 500-stock benchmark into 10 groups of 50 stocks based on various criteria. He found, for instance, that the 50 stocks with the richest price/earnings valuations had declined just 3.4%, the least among the 10 deciles. The 50 stocks paying no dividend lost just 3.9%, versus 4.9% for the 50 proffering the most generous yields. Heavily shorted stocks outperformed. Says Walters: “This is the type of relative performance you would see during a market rally, and not a market decline.”

Individuals also seem to be doing more of the selling, and the 50 stocks most heavily held by institutions fell just 3.5%, versus 4.9% for the 50 with the least institutional ownership. Bulls are rethinking their infatuation with U.S. exposure: The 50 stocks with the most foreign revenues fell just 3.2%, versus 5.2% for those with the most U.S. sales. Meanwhile, economically sensitive sectors continue to hold up. More than half of all industrials, materials and technology stocks hovered above their 50-day averages—a feat managed by less than 15% in the utilities and consumer-staples camps. (Barron’s)

Thumbs up expandFall Market Forecast Looks Sunny  With the economy growing and earnings on the rise, stocks could head higher in coming months. Market strategists like technology and industrials, but not utilities. Who’s afraid of the Fed?

The market, as represented by the Standard & Poor’s 500, has risen 14.5% year-to-date, and Wall Street’s investment strategists see more gains ahead both this year and next.

Barron’s recently checked in with 10 Street seers, whose consensus view is that the S&P will reach 1700 by year-end, 4% above Friday’s close. If these prognosticators are right, the market will log a 19% gain for the full year, compared with last year’s 13.4% advance. Unperturbed by rumblings of rising interest rates or another budget brawl in Washington, some strategists see the S&P hitting 2000 or more in 18 to 24 months. (…)

The S&P currently trades for 14 times the next 12 months’ estimated earnings, up from 13 times earnings at the end of last year. That’s not dirt-cheap, but nor is it rich; the market historically has averaged a P/E of 15 times future earnings, and much more in the past 20 years.

For the record, the average and median P/E on trailing earnings have been 13.3 since 1927, 1945 and 1983 (13.5 actually). Referring to the past 20 years is, shall I say, irrational exuberance. But let the sunshine in:

Corporate-earnings growth, stalled around 5% in the year’s first half, hasn’t been a big driver of stock-market gains this year. But that could change, the strategists say, as profit growth accelerates sharply in the fourth quarter. Our forecasters look for stronger growth in U.S. gross domestic product to boost company-earnings growth to 8% toward year end. The strategists expect full-year S&P earnings to total $107.85, rising to $116.50 next year. (As usual, the consensus view of industry analysts is higher, with estimates of $110 for this year and $123 for 2014.)

Obviously, the strategists are not confused about the economy. Sun SunSun

Thumbs up The bull case

 

(…) Knight says consumers have “hung in,” with annual spending growth of almost 2%, despite paltry wage gains and the expiration of the 2% Bush payroll tax cut early this year. Businesses continue to hire new workers at a steady but not stellar rate of 150,000 to 200,000 per month. The fiscal head winds caused by sequestration and government contraction could ease as the government’s automatic spending reductions are lapped early in 2014, he says.

Auth looks for investment and capital expenditures to pick up, and notes the U.S. housing market has worked through excess inventory. Rising home prices will add to the wealth effect, and nonresidential construction—which hasn’t moved yet—will increase, he says. Commercial rents are stabilizing, and in prime markets such as New York City, they are rising. That is a prelude to greater construction activity, he says.

In the past, construction accounted for 9% of GDP, but it has contributed only 5.5% in the past few years. Construction is “where all the missing middle-class jobs are,” Auth says.

And the “Earnings Math”

With many companies in the S&P 500 reporting near-peak profit margins, “you need sales to come through” to propel earnings growth, Goldman’s Kostin adds.

Barclay’s Knapp is looking for S&P revenue to grow at a rate of up to 5% in the second half, possibly more than doubling the year-to-date growth rate. The drivers, he says, will be higher capital expenditures, steady consumer spending, and continued strength in the U.S. housing industry. Steady growth globally also will help.

Wait, wait,

For more, and better earnings math, read the “EARNINGS WATCH” segment of my Aug. 5 New$ & View$.

For good measure, Barron’s cites a few negatives for its thorough readers:

(…) the litany of negatives, including the widespread expectation of the Federal Reserve’s taper of its $85 billion-a-month bond-buying program, which threatens to stall the housing recovery; weaker-than-expected data, especially on the part of consumers’ income and buying; the potential for renewed upheavals in Europe once the Sept. 22 German elections are safely out of the way, including the recognition that Greece will likely need a third bailout; and the resumption of U.S. fiscal follies, including the need to pass a continuing resolution to keep the federal government from shutting down when the new fiscal year starts on Oct. 1; and yet another debt-ceiling fight when the Treasury reaches its borrowing limit in mid-October.

And add to that we’re heading into historically the worst month for stocks,  one frequently marked by currency and other financial crises (which seem to be brewing in the emerging markets), and there’s the potential for a September to remember. Or maybe one the bulls might want to forget, especially if things heat up in the Middle East.

(Bespoke Investment)

SPEAKING OF EARNINGS

99% of S&P 500 companies have reported Q2:

  • Q2 EPS are $26.36, up 3.7% YoY.
  • Trailing 12 months EPS are $99.28, up 0.9% from 3 months ago and +0.6% YoY.
  • Estimates are now $27.04 (+12.7% YoY) for Q3 and $29.04 (+25.4%) for Q4. These estimates have essentially stopped declining in recent weeks (again, see the “EARNINGS WATCH” segment of my Aug. 5 New$ & View$ before buying these estimates).

Thomson/Reuters says that there have been 105 pre-announcements for Q3: 88 negative and 17 positive. During the past month, we have had 28 pre-announcements for Q3, 27 of which were negative. By comparison, at the same time after the Q1 earnings season, there had also been 28 pre-announcements, 24 of which were negative. Post the Q4’12 season, again comparing similar periods, we had 54 pre-announcements, 41 of which were negative.

Another way to look at pre-announcements, one month prior the end of the quarter, 78.2% of pre-announcements were negative for Q1’13, 80.6% for Q2 and 83.8% for Q3.

NoteSummer has come and passed
The innocent can never last
wake me up when September ends
(Green Day)

The objective Rule of 20 barometer, based on trailing earnings and inflation, closed August 9% undervalued from its 1787 fair value. Downside from the current level of 1633 to the Rule of 20 P/E of 16 (trailing P/E of 14 + 2% inflation)  -15% (1390). We hit these levels during the mid-2010 and mid-2012 retreats.

image

Technically, the S&P 500 Index is now at its 100 day m.a. (1640), a level that held in June, and downside to its 200 day m.a., last touched in December 2012, is 4.5% (1563). At that level, the upside potential would be roughly in line with the downside risk, providing a more attractive investment proposition. Importantly, both moving averages are still positively sloped, as is the 50 day m.a. for that matter.

  • Patience is bitter, but its fruit is sweet. (Aristotle)
  • Patience is power.
    Patience is not an absence of action;
    rather it is “timing”
    it waits on the right time to act,
    for the right principles
    and in the right way
    . (Fulton J. Sheen)

Just kidding  The Seven Deadly Sins of Investing Financial crisis be damned—investors are still making the same mistakes the always have. Here are their biggest blunders and how to avoid them.

Lust: Chasing Recent Performance The belief investors feel that recent performance will dictate future performance—known as “recency bias” in psychology—is one of the biggest investor pitfalls, experts say. (…)

Pride: Being Overconfident (…) Investors, especially ones new to the game, frequently believe they know far more than they actually do about a particular investment, say psychologists and financial advisers. (…)

Sloth: Overlooking Costs Investors often just don’t pay attention to details. (…) “The expenses are much more predictive of future performance because there’s so much randomness in past performance,” he says.

Envy: Wanting to Join the Club  (…) The desire to be part of an exclusive offering often drives people to throw money into an investment that doesn’t fit into the overall goals of their portfolio, against their better judgment.

Wrath: Failing to Admit Failure People hate to lose money. (…) Loss aversion, as it is called by psychologists, isn’t hard to spot. (…)

Gluttony: Living for Today Let’s face it: (…) Fifty-seven percent of U.S. workers surveyed by the Employee Benefit Research Institute earlier this year reported less than $25,000 in total household savings and investments, not counting their house or defined-benefit retirement plans. The lack of preparedness has led experts to deem it a crisis. (…)

Greed: Following the Herd (…) To battle the fear that inevitably comes with a market decline or other adverse events, financial advisers say it is crucial that investors have a detailed portfolio plan that they stick with regardless of short-term events. The plan should outline investors’ targeted holdings in bonds, stocks and other investments, and be based on their retirement goals. (…)

Don’t think investment pros are immune from the above. BTW:

According to JPMorgan’s strategists, nearly three out of five fund managers are trailing their benchmarks this year, including 32% who lag behind by 2.5 percentage points or more.

THIS PART IS EVEN BETTER:

 

Pointing up Lessons From an Investing Giant

Filings with the SEC in March and again this month show the extraordinary gumption of Charlie Munger, Warren Buffett’s business partner and vice chairman of Berkshire Hathaway.

Mr. Munger, who will turn 90 years old next Jan. 1, is a model for individual investors who wonder how they can possibly beat the professionals at their own game. The pros have more information than you, and their trading machines are faster. But you still have an edge over them—so long as you play a different game by your own, more sensible rules.

You can be patient; the pros can’t. You don’t have to be part of the herd; they do. Above all, you can be brave; they almost never are.

What makes Mr. Munger a model for individual investors?

In the first quarter of 2009, during the most desperate days of the financial crisis, Mr. Munger took 71% of the cash at Daily Journal, a small publishing company he chairs, and poured it into the bank stocks that so many other investors were fleeing. By March 31, 2009, his bet already had gained 60%. With other purchases he made later, Mr. Munger invested $49.7 million into stocks and bonds that today are worth $128.4 million, according to financial statements Daily Journal filed on Aug. 20.

At Daily Journal’s annual meeting in February, Mr. Munger discussed the move briefly. According to an online transcript and an attendee, Alexander Rubalcava of Los Angeles-based Rubalcava Capital Management, Mr. Munger said “we behaved pretty sensibly” by moving boldly out of cash when stock prices got “ridiculously low.”

The Daily Journal investment wasn’t the only bold move Mr. Munger made during the crisis. (…)

Where does Mr. Munger get his gumption?

In the late 1980s, he recalled in a magazine interview, a guest at a dinner party asked him, “Tell me, what one quality accounts for your enormous success?”

Punch Mr. Munger’s reply: “I’m rational. That’s the answer. I’m rational.”

Trained as a meteorologist at the California Institute of Technology, Mr. Munger thinks in terms of probabilities Light bulb rather than certainties, say those who know him well. (…) Decades of voracious reading in history, science, biography and psychology have made him an acute diagnostician of human folly.

“Charlie has such a deep sense of stoicism,” says a long time friend, Christopher Davis, chairman of New York-based fund manager Davis Advisors. “He seems to be able to invert emotions, becoming uninterested when other people are euphoric and then deeply engaged when others are uncertain or fearful.”

Mr. Munger favors what he calls “sitting on your a—,” regardless of what the investing crowd is doing, until a good investment finally materializes.

In the panic that typically produces such an opportunity, Mr. Munger ruminates. If he likes what he sees, he pounces.

“Charlie knows exactly what he thinks, and the fact that other people don’t agree has no impact on him,” says his friend John Frank, managing principal at Oaktree Capital Management in Los Angeles. “He doesn’t get confused about the difference between an emotional feeling and an intellectual understanding.”

Many money managers spend their days in meetings, riffling through emails, staring at stock-quote machines with financial television flickering in the background, while they obsess about beating the market. Mr. Munger and Mr. Buffett, on the other hand, “sit in a quiet room and read and think and talk to people on the phone,” says Shane Parrish, a money manager who edits Farnam Street, a compelling blog about decision making.

Pointing up “By organizing their lives to tune out distractions and make fewer decisions,” he adds, Mr. Munger and Mr. Buffett “have tilted their odds toward making better decisions.” (…)

Mr. Buffett declined to comment other than to say, “Charlie is indeed rational.”

This unsolicited and unpaid advertising was presented to you by New$-to-Use Winking smile.

This is what NTU attempts to help us do. Be well informed with relevant, unbiased info, think rationally and independently, and act rationally based on sound probabilities.
 
PICK YOUR CORRELATION!

John Mauldin “hates” this market. His latest weekly note, always a good read, shares his “reasons to head for the sidelines”. One of these is this chart with these comments:

One of the first market aphorisms I learned was that copper is the metal with a PhD in economics. While you can get into a great deal of trouble regarding that as a short-term trading axiom, it is definitely a longer-term truth. Copper is a metal that is closely associated with construction, industrial development and production, and consumer spending. One can argue that the price of copper is falling today because of a fundamental increase in supply, but for those of us of a certain age, the following chart is nervous-making. Unless the long-term correlation has disappeared, the data would indicate that either the price of copper needs to rise or the market is likely to fall.

image

Something inside me screeched when I read “Unless the long-term correlation has disappeared”. John is younger than me so his “long term” must differ. Here’s my “long term” which does not correlate copper with equity prices very well (sorry, I do not have John’s means to quickly combine both series on the same chart but the time frames are the same).

Copperimage

image

John’s long term seems to begin with China and QEs. It likely includes a lot of hype in copper which is now deflating thanks to China’s slowdown and the coming tapering. My sense is that copper prices, and those of most other commodities, are on their way back to their real long term trend which is dismal and little (!) correlated with other asset classes (chart from SoGen).  image_thumb[1]

One day, I will explain why I essentially never invest in commodity-related stuff but the chart above provides a good starting point.

Copper Rally Loses Steam as China Demand Falters

 

(…) One leading indicator of waning appetite is that stocks at metal at warehouses in Shanghai have stabilized around 400,000 tons after falling from as high as a million tons earlier this year. Manufacturers are easing up on using stocks after robust buying over the past few months depleted inventories, according to the manager of a warehouse who declined to be named as he isn’t authorized to speak to the media. (…)

Another sign is that the premium for copper in China is falling, which analysts say also bodes badly for futures. (…)

“We’re not very bullish on copper prices going forward,” said Liu Jiang, a purchasing manager at a Zhejiang-based power-cable maker that supplies China State Grid Corp., the world’s biggest utility. He sees demand from power cable producers, which account for half of copper consumption in China, remaining flat until the end of the year after a flurry of activity in the first half.

Mr. Liu said his company’s order books have been thin since July, as some urban infrastructure projects have ended, with most of the orders placed and filled in the first half.

Investment in power grids rose 19% in the first six months from the same period a year earlier to 165.9 billion yuan ($27.1 billion), far exceeding the 4% growth target set by China State Grid. That means there is little room for growth from the power sector for the rest of the year, according to Yang Changhua, chief copper analyst at state-owned metals consultancy Beijing Antaike.

“We’re unlikely to see any surprise in copper demand from China this year,” Mr. Yang said. (…)

Plus, a potential glut from rising copper supply may also add to the metal’s woes, says Barclays, who forecasts prices will fall in the fourth quarter. The U.K.-based investment bank estimates there will be a 418,000-ton global copper surplus in the second half of this year compared with a 307,000-ton market deficit in the first half. (…)

Chinese Home Prices Outpace Construction

Chinese home prices climbed 8.6% in August from last year and soared in major cities, but didn’t lift construction, or the wider economy.

Prices nationwide climbed 8.6% year-over-year in August and soared in major cities, according to data provider China Real Estate Index System on Monday. Housing prices are up 22.5% year-over-year in Beijing, CREIS said. In Guangzhou, the rate is 24.2%. Other cities are seeing more modest increases, with prices in Shanghai up 7.7%

(…) developers are sitting on a large amount of unsold inventory. With builders preferring to pare down their existing supply rather than take on new projects, housing starts are returning to life only sluggishly—up 7.1% in the first seven months of the year, according to the government. Sales rose 27.1% to 547.3 million square meters over the same period. (…)

The backlog in unsold housing is formidable. At the end of 2012, China had more than 4 billion square meters of residential property under construction, enough to satisfy demand for more than four years without a single new project started. The bloated inventory is the result of China’s last go-round with slowing growth, in 2009. To recharge the economy, Beijing unleashed bank lending and loosened its controls on the property sector. Sales and construction soared. (…)

image
 
 
ONLY IN CHINA!
Surprised smile Chinese workers lock out US bosses

Cooper Tire factory hit by tri-national $2.5bn M&A dispute

Chinese factory workers in eastern Shandong province have turned a traditional management weapon – the lockout – back on their American bosses, by denying them access to a tyre plant at the centre of a controversial $2.5bn cross-border deal.

The sustained Chinese industrial action that erupted in June after the deal was announced is the first to target a major offshore acquisition involving two foreign companies, and exposes a new risk for multinationals operating in China with local partners.

Ohio-based Cooper Tire, which has accepted a buyout offer from India’s Apollo Tyres, admitted for the first time on Friday that workers at its joint venture with the Chengshan Group had taken “disruptive actions”. These included “denying access to certain representatives of the company and withholding certain business and financial information”. (…)

Unlike most other high-profile disputes between foreign manufacturers and Chinese workers, Cooper’s Shandong employees are not demanding higher wages.

The workers have instead complained they were not adequately consulted over Apollo’s offer for Cooper. They also fear the deal will burden their prospective Indian owner with too much debt and result in a clash of corporate cultures.

GOOD QUOTE

Kerry praised the support of France—”our oldest ally,” which supported the new United States in the Revolutionary War against Britain—in a pointed barb following the vote by the House of Commons. That, of course, also was the reverse of those nations’ stances regarding the U.S. invasion in Iraq, for which former Prime Minister Tony Blair was a vociferous supporter and France was opposed. Left hug Martini glass Right hug

Note Oh, I get by with a little help from my friends
Mmm, I get high with a little help from my friends
Mmm, gonna try with a little help from my friends

 

NEW$ & VIEW$ (30 AUGUST 2013)

This is a long post but I think well worth reading during the long week-end.

 

Second-Quarter GDP Revised Upward

The U.S. economy entered the second half of the year on firmer footing than previously estimated, with stronger growth, an uptick in corporate profits and consumers feeling better amid a rebound in housing.

[image]Strong exports, improved business investment and solid consumer spending helped U.S. gross domestic product grow at a 2.5% rate in the second quarter, the Commerce Department said Thursday. That marked a significant improvement both from the first three months of the year, when the economy grew at a 1.1% annual rate, and from the government’s earlier, preliminary estimate of second-quarter growth of 1.7%. The latest report means U.S. per capita economic output has finally—four years after the end of the recession—returned to the pre-crisis peak it reached in late 2007.

BMO Capital offers a good summary:

The good news is, the U.S. economy grew more than initially expected a month ago. The first stab at the Q2 real GDP on July 31st was 1.7% a.r. Then the trade numbers came out and wow, the view changed and it looked like GDP grew in the neighborhood of 2½% a.r. Then, as the
days went by, more data on inventories and consumer spending caused estimates to be trimmed, leaving consensus and us at around 2.2%-to-2.3% for the second quarter. Now, gentle reader, it looks like we should’ve stuck with the trade data as real GDP did rise 2.5% a.r. in Q2, the largest increase in nearly one year. That and the fact that consumer spending wasn’t revised at all (still 1.8% a.r.) is encouraging. Exports were revised up nicely, and inventories added more to the bottom line.

But perhaps the biggest surprise was the huge swing in nonresidential investment in structures (factories, buildings, etc)—initially pegged at 6.8% and is now looking like 16.1%. One should, perhaps, regard this with some skepticism, particularly as private nonresidential construction spending has been soft over the past year. Offsetting all of these pluses was a larger-than-estimated drop in government spending.

But aside from the stronger headline, underlying demand isn’t what I’d describe as … fabulous. It’s alright, but not fab. Final domestic demand (GDP excluding inventories and net exports) was trimmed to +1.9% a.r. from +2.0% but this also takes into account government cutbacks. Private final sales (GDP excluding inventories, net exports  and government) was unchanged at 2.6%, which is not fabulous but still decent.

Doug Short illustrates the difference between “fabulous” and “alright”. Quite a step down from a 3.3% cruising speed to 1.8%.

image

The only thing not revised up was consumer spending, 70% of the economy. There, the downshifts were from 5.5% in the late 1990’s to 3-4% in the mid-2000’s to the current 2% pace.

image

But that is in spite a real disposable income per capita no longer growing. How long can a 2% spending pace be sustained without income growth?

image

image

In the second half of 2012, consumer spending got support from a sharp drop in gas prices. Ain’t happening just yet.image

Could that help? Saudi Arabia Set to Pump 10.5M Barrels of Crude a Day

Saudi Arabia is set to pump 10.5 million barrels a day of crude in the third quarter, a million bpd increment over the second quarter and its highest quarterly level of production ever, leading U.S. energy consultancy PIRA said. (…)

“This is the tightest physical balance on the world oil market I’ve seen for a long time.” PIRA reported its estimate to clients earlier this week.

Libyan oil output has fallen from 1.4 million bpd to just 250,000 bpd after protesters shut oilfields. (…)

Ross said about 400,000 bpd of the incremental supply would go to feed domestic Saudi power usage during peak summer demand for air conditioning. (…)

U.S. Prepares for Solo Strike Against Syria

The Obama administration laid the groundwork for unilateral military action, a shift officials said reflected the U.K.’s abrupt decision not to participate and concerns Bashar al-Assad was using the delays to disperse military assets.

France ready for Syria strike without UK
Hollande to discuss next move with Obama
 

Hmmm…

This morning:

Consumer Spending in U.S. Increase Less Than Forecast as Income Gains Slow

Consumer purchases, which account for about 70 percent of the economy, rose 0.1 percent after a revised 0.6 percent increase the prior month that was larger than previously estimated, the Commerce Department reported today in Washington.

Sad smile Adjusting consumer spending for inflation, purchases were unchanged in July compared with a 0.2 percent increase the previous month, according to today’s report.

The Commerce Department’s price index tied to spending, a gauge tracked by Federal Reserve policy makers, increased 1.4 percent in July from the same period in 2012. The core price measure, which excludes volatile food and energy categories, rose 1.2 percent from July 2012.

U.S. HOUSING COOLING?

Bidding Wars Continue to Tumble as Housing Market Rebalances

Competition in the US residential real estate market dropped for the fourth consecutive month in July, underscoring the market’s overall trend towards balance. Nationally, the percentage of offers written by Redfin agents that faced multiple bids fell to 63.3 percent in July, down from 68.6 percent in June, and 75.7 percent at the peak in March.image

The slide in competition reflects multiple factors that are beginning to erode sellers’ market dominance across the nation:

Buyer Fatigue: First and foremost, Redfin agents report that buyers in the nation’s most competitive markets are growing weary. (…)

Budgets: The combined effect of rising prices and mortgage rates continues to price buyers out of the market, reducing competition for available inventory. Nationally, the median home price per square foot for single-family homes was up 18.7 percent in July from the year before and average weekly 30-year fixed mortgage rates in July were up about one percentage point from May. For a $250,000 mortgage, this jump in prices and mortgage rates translates to a rise in mortgage payments of more than $300 per month.image

Growing Inventory: Rising prices and mortgage rates are also driving homeowners to list their homes in greater numbers, which is boosting options for buyers. As of June, the number of single-family homes for sale in Redfin markets was up 7.8 percent from March and the national months of supply of inventory grew from 2.7 in May to 3 in June. Some homeowners who were underwater on their mortgages are becoming more confident that their homes can fetch a fair price and are deciding to list. Furthermore, our agents in San Francisco and Chicago report that mortgage rates are also leading homeowners to list. Homeowners, too, want to capitalize on historically low rates and move up before rates increase further. (…)

Further Cooling on Tap for Autumn: Looking forward, we expect that bidding wars will continue to cool slightly during the autumn months. The real estate market was atypically hot during autumn of 2012 because buyers were rushing to lock in low mortgage rates once home prices stabilized. Now that rates are higher, home prices continue to rise, and more inventory is coming available, buyers are likely to battle for homes less often.(…)

EUROTURN?

 

Euro-Zone Adds 15,000 Jobs

The number of people unemployed in the euro zone fell in July for the second month in a row, adding to tentative signs that a modest recovery under way in the currency bloc’s economy is starting to erode its sky-high levels of joblessness.

Eurostat said the annual rate of consumer-price inflation fell to 1.3% in August from 1.6% in July, putting it considerably below the central bank’s target area of a little below 2%.

Sad smile  German Retail Sales Unexpectedly Drop in Sign of Uneven Recovery

German retail sales unexpectedly fell for a second month in July, signaling an uneven recovery in Europe’s largest economy.

Sales adjusted for inflation and seasonal swings dropped 1.4 percent from June, when they declined 0.8 percent, the Federal Statistics Office in Wiesbaden said today. Economists predicted an increase of 0.6 percent, according to the median of 27 estimates in a Bloomberg News survey. Sales climbed 2.3 percent from a year earlier.

These are big drops!

Fingers crossed Eurozone sales rise marginally in August

Retail sales in the eurozone rose for the first time in nearly two years in August, Markit’s retail PMI® data showed. The value of retail sales increased since July, albeit only marginally. Employment at retailers also rose slightly following a 16-month sequence of decline. National differences in sales trends remained, however, as Germany registered further strong growth, France achieved a back-to-back modest rise and Italy posted an ongoing sharp decline.

image

Germany’s retail sector continued to drive the overall increase in eurozone retail sales. Sales rose on a monthly basis for the fourth successive survey, the longest sequence of growth in 17 months.
Moreover, the rate of expansion was little-changed from July’s two-and-a-half year high.

Retail sales in France rose for the second month running in August, and at the strongest rate since October 2011. Prior to July, sales had fallen for a survey-record 15-month period.

Italy remained the weak link in the eurozone retail recovery mid-way through Q3. Sales fell for the thirtieth successive month, and the rate of
contraction remained sharp despite easing since July.

image

Retail sales in the eurozone continued to decline on an annual basis. That said, the rate of contraction eased to the slowest since October 2011. A further sign of the nascent recovery in the eurozone retail sector was a rise in employment in August. This mainly reflected recruitment at German retailers, while retail employment in France stabilised following a prolonged period of cuts and Italian retailers shed staff at the slowest rate since August 2010.

Pointing up imageAverage purchase prices paid by retailers for new goods rose at a sharper rate in August. By product sector, food & drink again posted the steepest rate of inflation, followed by clothing & footwear. Among the three national retail sectors covered, Germany posted the steepest increase in average input costs. Meanwhile, gross margins across the eurozone retail sector declined at the slowest rate since April 2011.

Note that the retail PMI is barely above 50 and has shown a very high volatility in recent years. The German engine remains fairly sound but the Italian and French engines remain unreliable. See below on France.

DOUCE FRANCE from BloomberBriefs:

President Francois Hollande’s pension reforms will probably fail to eliminate the pension deficit or make the French economy more
competitive. France’s government spends the most in the euro area relative to its GDP and has the third-highest labor costs.

People under the age of 40 will have to work beyond 62 to earn a full
pension. Contributions by both workers and employers will increase by
0.3 percentage point in 2017, though the government will cut other payroll charges in an effort to contain labor costs. The pension system is still likely to have a deficit of 13.6 billion euros in 2020, instead of 20.7 billion euros, even if all the announced measures are adopted, according to the French pension council.

The proportion of population over the age of 65 is forecast to climb to 18
percent next year from 17.1 percent in 2012. France has the third-highest
share of labor costs allocated to employers’ social contributions, according to Eurostat, at 34.2 percent, compared with 21 percent in Spain. The nation is ranked the 21st most competitive economy in the world, compared with sixth for Germany, according to the Global Competitiveness Index.

image

The government may be forced to introduce additional spending cuts and
tax increases to meet its commitment to balance the budget by 2017. It is
likely to miss the target of narrowing the deficit to 3.7 percent of GDP this
year from 4.5 percent, having abandoned the original target of 3 percent.
France has failed to balance its budget since 1974, and the shortfall has
averaged 3.9 percent of GDP over the last decade.

image

The government claims two-thirds of its austerity measures will come
from changes to the tax system this year, with 20 billion euros in tax
increases planned, compared with 10 billion euros in spending cuts. Taxes
accounted for 45.9 percent of GDP in 2011, compared with a euro-area
average of 40.8 percent. Public spending in France amounts to 57 percent
of GDP, the highest level in the euro region.

Red heart EPSILON THEORY: CENTRAL BANK COMPETENCE OR LACK THEREOF

U.S. equity markets have done well recently against flattening earnings, stable inflation rates and higher interest rates. Rising investors confidence has translated into absolute P/E ratios that are 10% above their historical mean and Rule of 20 readings that are unfavourable from a risk/reward ratio standpoint.

Earnings expectations for Q3 and Q4 look increasingly vulnerable. Can confidence stay high enough to offset “natural”, more dependable forces?

Ben Hunt’s latest note is highly relevant here:

(…) The shift in perceptions of Fed competence is being driven by opinion leaders’ public statements questioning the Fed’s communication policy. Here’s the critical point from an Epsilon Theory perspective: these public statements are not questioning the content of Fed communications; they are questioning the USE of communications as a policy instrument in and of itself. In exactly the same way that a magician immediately becomes much less impressive once you know how he does his trick, so is the Fed much less impressive once you start focusing on HOW policy is being communicated rather than WHAT policy is being implemented.

For example, this past Saturday Jean-Pierre Landau, a former Deputy Governor of the Bank of France and currently in residence at Princeton’s Woodrow Wilson School, presented a paper at Jackson Hole focused on the systemic risks of the massive liquidity sloshing around courtesy of the world’s central banks. For the most part it’s a typical academic paper in the European mold, finding a solution to systemic risks in even greater supra-national government controls over capital flows, leverage, and risk taking.  But here’s the interesting point:

Pointing upZero interest rates make risk taking cheap; forward guidance makes it free, by eliminating all roll over risk on short term funding positions. … Forward guidance brings the cost of leverage to zero, and creates strong incentives to increase and overextend exposures. This makes financial intermediaries very sensitive to “news”, whatever they are.”

Landau is saying that the very act of forward guidance, while well-intentioned, is counter-productive if your goal is long-term systemic stability. There is an inevitable shock when that forward guidance shifts, and that shock is magnified because you’ve trained the market to rely so heavily on forward guidance, both in its risk-taking behavior (more leverage) and its reaction behavior (more sensitivity to “news”). This argument was picked up by the WSJ (“Did Fed’s Forward Guidance Backfire?”) over the weekend, and it continues to get a lot of play. It’s an argument I’ve made extensively in Epsilon Theory, particularly in “2 Fast 2 Furious.”

Landau’s paper is probably the most public example of this meta-critique of the Fed, but I don’t think it’s been the most powerful. Highly influential opinion leaders such as David Zervos and John Mauldin have recently written in their inimitable styles about the Fed’s use of words and speeches as an attempt at misdirection, as an ultimately misguided effort to hide or sugarcoat actual policy. FOMC members themselves are starting to question the Fed’s reliance on communications as a policy instrument, as evidenced by the minutes released last week. Combine all this with the growing media focus on the “battle” between Yellen and Summers for the Fed Chair – a focus which will create policy disagreements between the candidates in the public’s perception even if no such disagreements exist in reality – and you have a recipe for accelerating weakness in perception of Fed competence.

The shift in perception of non-Fed central bank competence, especially of Emerging Market central banks, is even more pronounced. Actually, “competence” is the wrong word to use here. The growing Narrative is that Emerging Market central banks are powerless, not incompetent. The academic foundation here was made in a paper by Helene Rey of the London Business School, also presented at Jackson Hole, where the nutshell argument is that global financial cycles are creatures of Fed policy … period, end of story. Not only is every other country just along for the ride, but Emerging Markets are kidding themselves if they think that their plight matters one whit to the US and the Fed.

Just as malcontents with the exercise of Fed communication policy may be found within the FOMC itself, you don’t have to look any further than Emerging Market central bankers and finance ministers themselves for outspoken statements protesting their own impotence. Agustin Carstens, Mexico’s equivalent to Ben Bernanke, gave a speech on the “massive carry trade strategies” caused by ZIRP and pleaded for more Fed sensitivity to their capital flow risks. Interesting how the Fed is to blame now that the cash is flowing out, but it was Mexico’s wonderful growth profile to credit when the cash was flowing in. South Africa’s finance minister, Pravin Gordhan, gave an interview to the FT from Jackson Hole where he bemoaned the “inability to find coherent and cohesive responses across the globe to ensure that we reduce the volatility in currencies in particular, but also in sentiment” now that the Fed is talking about a Taper. Christine Lagarde got into the act, of course, calling on the world to build “further lines of defense” even as she noted that the IMF would (gulp!) have to stand in the breach as the Fed left the field. To paraphrase Job: the Fed gave, and the Fed hath taken away; blessed be the name of the Fed.

I’ll have a LOT more to say about all this in the weeks and months to come, but I thought it would be useful to highlight these shifts in Narrative structure in real-time as I am seeing them. Informational inflection points in the market’s most powerful Narratives are happening right now, and this is what will drive markets for the foreseeable future.

Right on cue:

India’s Central Bank Governor Concedes to Missteps

It is rare for officials to admit that their policies have been less than perfect, but India’s central bank governor Duvvuri Subbarao did just that late Thursday, in his last public speech as head of the Reserve Bank of India.

Mr. Subbarao, whose five-year term as RBI governor ends Sept. 4, said the bank could have done a better job of explaining the intentions behind the various steps it has taken in the last three months to support India’s declining currency.

“There has been criticism that the Reserve Bank’s policy measures have been confusing and betray a lack of resolve to curb exchange-rate volatility,” Mr. Subbarao said at a lecture in Mumbai. He said that the RBI is unequivocally committed to curbing volatility in the rupee. “I admit that we could have communicated the rationale of our measures more effectively,” he added.

Ghost Über-bear Albert Edwards will scare you even more, courtesy of ZeroHedge:

(…) The fabulously entertaining Zero Hedge website keeps running the charts showing that the evolution of bond yields and equity markets this year resembles closely what happened in 1987 (see below). Now we should all take these comparisons with a pinch of salt, but what if…

I remember the 1987 crash well. I was working at Bank America Investment Management as an economist/strategist at the time. Of course, the immediate trigger for the equity crash was the fear of US recession caused by the fear that the US would have to hike rates sharply to defend the dollar. Those fears were triggered by Germany raising rates at a time when the G6 had recently agreed to stabilise the US dollar at the February 1987 Louvre Accord, after two years of sanctioned dollar weakness. Investors got into a tizzy about recession, jumping many steps ahead of the game. But, in the wake of a run-up in US bond yields that year, equities were richly priced and so very vulnerable to recession fears, however unfounded. And then the machines took over. That couldn’t possibly happen again, or could it?

Therein lies one of the key lessons I learnt in my 30 years in the markets. Pointing up It is not just to try to predict what will happen, but to second-guess what the markets fear might happen. Indeed a recession did not ensue and the 1987 crash turned into a tremendous buying opportunity.

Edwards then links with the EM debacle:

But another shoe will surely drop soon. China has gone off the radar in the last month, as the data have firmed, but it is set to return centre stage. Our China economist Wei Yao, thinks “this sudden turn-around is similar to that during Q4 2012, when the multi-quarter deceleration trend reversed shortly after the policy stance shifted to “cautious” easing. But that growth pick-up did not last for more than one quarter.” A continued slowdown in credit growth will strangle the current buoyancy of house price inflation (see charts below), with property sales growth having already peaked. Wei expects the Chinese data to relapse in Q4.

“Many people are writing about a Chinese credit crunch and banking crisis. I disagree. The authorities will have a choice as to whether to accept such a crunch or devalue and launch a new credit cycle to keep the balls in the air once again. Devaluation is the preferred option…..So the (recent) spike in SHIBOR was not a tremor indicating the earthquake of a banking crisis, but a tremor of a forthcoming RMB devaluation.” That will be the biggest domino of all to fall. And, as with the 1987 crash, markets will react to the fear of the devaluation and the deflation it will bring to the west, rather than the event itself. (…)

The emerging markets “story” has once again been exposed as a pyramid of piffle. The EM edifice has come crashing down as their underlying balance of payments weaknesses have been exposed first by the yen’s slide and then by the threat of Fed tightening. China has flipflopped from berating Bernanke for too much QE in 2010 to warning about the negative impact of tapering on emerging markets! It is a mystery to me why anyone, apart from the activists that seem to inhabit western central banks, thinks QE could be the solution to the problems of the global economy. But in temporarily papering over the cracks, they have allowed those cracks to become immeasurably deep crevasses. At the risk of being called a crackpot again, I repeat my forecasts of 450 for the S&P, sub-1% US 10y yields and gold above $10,000. Ghost

Indian Growth Slows to Four-Year Low as Rupee Drop Dims Outlook

Gross domestic product rose 4.4 percent in the three months through June from a year earlier, compared with 4.8 percent in the prior quarter, the Statistics Ministry said in New Delhi today. The median of 44 estimates in a Bloomberg News survey was for a 4.7 percent gain.

Emerging Markets Raise Rates

Indonesia raised its benchmark rate by half a percentage point on Thursday, one day after a half-point increase by Brazil and a week after a rate increase by Turkey. Other developing economies are under mounting pressure to tighten credit to support their weakening currencies. Brazil’s central bank hinted at further increases to come.

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(…) The value of India’s rupee has fallen by a fifth against the U.S. dollar since the beginning of May. The Reserve Bank of India’s initial response was to stop easing monetary policy, holding benchmark interest rates steady in June and July. When the rupee kept falling, the RBI limited the amount of money banks could borrow from it.

Investors saw that as effectively raising interest rates, at a time when India’s economy was growing at its slowest pace in a decade. Bonds and stocks sold off after the RBI’s steps. Yields on both short- and long-term rupee bonds jumped.

Some analysts say the incoming Indian central-bank governor may have no choice but to raise interest rates sharply, much as Fed Chairman Paul Volcker did in the U.S. in the 1980s.

South Africa is in a similar bind. Authorities want to halt declines in its currency, which has lost nearly a quarter of its value against the dollar over the past year but are reluctant to smother already weak growth.

Inflation reached an annual rate of 6.3% in July, but when South African central-bank officials meet to discuss rates again next month, they will be loath to raise rates in an economy struggling to meet forecasts for 2% growth this year, analysts say.

Some investors worry that they could see a repeat of the Asian financial crisis of 1997-98, or the stampede out of emerging-market currencies a decade later in 2008. But there are reasons to believe it won’t be that bad.

Pointing up Most emerging-market currencies today are allowed to float, so central-bank officials don’t have to defend a fixed exchange rate as they did during the Asian crisis. The government debt levels of countries like Indonesia, India and Brazil aren’t particularly high and are denominated mainly in local currency.

Not just in the U.S.: Elections Complicate Economic Decisions for India,Indonesia Upcoming elections in India and Indonesia, two of the countries hardest hit by the selloff in emerging-market assets, are making it more difficult to make the tough decisions both countries need.

Pointing up  Ft Alphaville has a great post on the EM situation:

From a recent Citi presentation, a chart stressing the potential risk of negative-feedback loops in the options available to those emerging market countries now trying to stem capital outflows and defend their currencies:

The chart makes an important point and is self-explanatory, but it isn’t comprehensive.

Notably excluded is the imposition of capital controls on outflows, which thus far have been mostly resisted with the exception of some limited measures in India. (…)

Also unmentioned is the option to lobby the central banks of developed countries, encouraging them not to tighten policy too quickly. This option appears to have been pursued with some vigour at Jackson Hole last weekend, but probably won’t carry much weight at the next FOMC meeting.

So the immediate options, at least those of a sweeping nature, are unattractive. And the possibility that emerging market central banks and governments will overreact and excessively tighten policy is a singular concern. (…)

But the broader issue is that it remains quite difficult to gauge the severity of the year’s EM currency and asset selloff — and to know whether it is more attributable to an acute market crisis versus a more fundamental economic shift.

Among the various possible causes normally cited are the Fed’s talk of tapering; the unwinding of carry trades; Chinese rebalancing; the pass-through effects of this rebalancing on commodity-exporters (Australia, South Africa, various countries in South America); the end of the commodity super-cycle generally; the limits to growth in countries that procrastinated on necessary structural changes; continued sluggishness by developed-country consumers; and dwindling investor patience with widening current account and budget deficits.

The causes aren’t mutually exclusive, of course, and some influence the others in various ways.

It’s also tough to know, at least for the inexpert or non-obsessive follower of international economics, how prepared the affected countries are to handle it.

The current situation — has it reached the level of “crisis” yet? — inevitably will have a similar feel to the crises of the 1990s given the reversal of hot money flows, the threat from speculators attacking various currencies, and even the involvement of some of the same countries. But so much is different, and most of the differences are positive.

As our colleagues David Pilling and Josh Noble wrote in Wednesday’s FT:

Back then, many countries had fixed exchange rates and their companies were heavily exposed to foreign debt. As currencies came under pressure, central banks desperately spent reserves to defend them. When the peg finally broke, currencies collapsed and companies’ foreign-denominated debts soared.

Thailand, Indonesia and South Korea had to seek help from the International Monetary Fund. Partly as a result of now largely discredited IMF austerity packages, they subsequently plunged into deep recession. Indonesia, the worst affected, lost 13.5 per cent of GDP in a single year. Suharto, the dictator, was toppled.

Today the picture is very different. Asian economies have flexible exchange rates, much higher reserves and sounder banking systems. India, for example, has reserves to cover seven months of imports compared with only about three weeks when it had its own “come-to-IMF” moment in 1991.

Nor, this time around, has India’s central bank wasted much firepower on defending the currency. Instead, it has largely allowed the rupee to slide. A weaker currency should boost exports and slow imports, closing the current account deficit automatically.

And so it might, hopefully without much lasting damage. We would also note the still-favourable growth differentials between developed and emerging market countries, which didn’t exist in the 1990s.

Admittedly this doesn’t preclude a new crisis or crises of a different flavour, and do read the full FT piece for the thoughts of more-pessimistic commentators, with careful attention to the points of Ruchir Sharma. Still, for the moment the problems seem at least endurable, if not actively manageable.

And although these countries’ immediate choices are regrettably limited, there is also a more hopeful longer-term story that can be told about this year’s events.

It’s mainly about how (some of) the lessons of the 1990s and the recent developed-world financial crisis have been heeded. In addition to the ability of emerging market currencies to respond to market forces, the relevant Asian countries also better understand the need for multi-lateral coordination and support during crises.

Furthermore, as economists from Standard Chartered explained, it’s likely that investors have become more discerning about the details of countries’ external funding problems. The economists looked at the short-term external debt situations for India, Indonesia, and Thailand — the three countries involved running a current account deficit — and found that “in all three cases the vast majority of the debt due within one year does not come with serious financing risk”.

More broadly, we’ve been especially interested in tracking the continued expansion of local-currency debt and capital markets, where tremendous progress has been made in the last decade and a half, especially in sovereign and corporate bond markets.

They’re important for a few reasons.

Companies in emerging markets find it easier to borrow in their own currencies, and are better able to hedge their debt if they rely on imports denominated in foreign currencies. Currency swings therefore become less threatening. (…)

Emerging market governments with sophisticated capital markets also have less need to build up massive stores of foreign currency reserves, a process that exacerbated the unnatural problem of global imbalances in the decade prior to the crisis of 2008 — when too much capital flowed from developing countries to developed countries rather than the other way round.

And of course, robust local-currency debt and equity markets, when accompanied by sound governance practices, reduce the dependence on foreign bank lenders and lead to a more diversified base of stakeholders. (…)

International trade and capital flows collapsed after the financial crisis of 2008. Within Europe the balkanisation of financial markets has mostly remained in place. But as both Citi’s presentation and a helpful McKinsey report explain in detail, by 2012 capital inflows to emerging markets had returned nearly to their pre-crisis levels.

These inflows returned, however, mainly in the form of foreign direct investment and investments via capital markets rather than bank lending.

Foreign direct investment is already considered to be a more stable kind of inflow. And the progress in developing local-currency capital markets also indicates that the growth in portfolio flows will be less worrying in the future, if certainly not yet.

These were favourable trends. Despite the present slowdown, in time they are likely to resume course given the disproportionately shallower financial markets in developing countries.

Investors in local-currency emerging market debt have been shellacked this year, and clearly the FX markets are spooked. Maybe the selloff will accelerate and new balance of payments crises really are imminent. We don’t know: much depends on policy still being decided, especially given the recent introduction of heightened geopolitical risks. We certainly don’t mean to dismiss the possibility of a terrible outcome, especially for an individual country.

Fingers crossed For now, however, the problems appear both different in nature and smaller in scale, and unlikely to spread uncontrollably. If we’re right about that, then a plausible explanation is that the lessons of the 1990s haven’t gone entirely ignored. And if a number of emerging market countries are about to enter a grinding period of slower growth and structural adjustments, or to experience new financial strains, at least they do so better prepared. (…)

Japan inflation highest in five years
Weaker yen pushes up cost of fuel and electricity

Consumer price inflation in Japan rose to an annual rate of 0.7 per cent in July, its highest level in almost five years, as the effects of a weaker yen pushed up the cost of fuel and electricity.

Excluding fresh food, the all-items index rose by 0.7 per cent from a year earlier and by 0.1 per cent from June.

But excluding the cost of energy from the calculation brings the yearly CPI to minus 0.1 per cent. The prices of items such as housing, furniture, medical care and culture and recreation all fell from a year earlier, while charges for fuel, light and water rose by 6.4 per cent.

Other data released on Friday morning were positive. The jobless rate dropped to 3.8 per cent, from 3.9 per cent in June, while industrial production rose by 1.6 per cent on a yearly basis and 3.2 per cent on the previous month.

Household spending edged up 0.1 per cent from a year earlier, from a 0.4 per cent fall in June.

Signs of Japanese Investment Uptick Investment by Japanese companies has been a laggard in the nation’s economic recovery. But things could be turning, data showed Friday.

Industrial production jumped 3.2% on month in July, reversing a 3.1% downturn in June.

The government was keen to point out that much of the production seems to show companies are spending more on increasing production.

The output of capital goods, which includes machinery, was at its highest level on a seasonally-adjusted basis since May 2012, a Japanese official said. The official also pointed toward big jumps in the output of goods such as steam turbines and equipment used in the plastics industry – tentative signs that companies are investing in increasing capacity. (…)

Other data today added to a sense that companies’ optimism is returning. Japan’s Purchasing Managers’ Index rebounded to 52.2 in August from 50.7 in July. That’s not far off a high of 52.3 in June. New orders, a sign of renewed corporate activity, were strong.

Have a good one!