NEW$ & VIEW$ (25 OCTOBER 2013)

Half way into earnings season…(see below)

Mortgage Declines Spread the Pain 

Bank of America, Other Lenders Cut Thousands of Jobs as Refinancing Slows and Bad Loans Shrink

Bank of America Corp. cut about 1,200 mortgage jobs on Thursday, and is aiming to shed another 2,800 such jobs in the fourth quarter, according to people familiar with the matter. The layoffs follow similar moves at Wells Fargo & Co., which cut about 6,200 jobs in its mortgage unit, and Citigroup Inc., which has trimmed about 1,100 jobs. (…)

“As we continue to resolve the needs of customers with delinquent loans, we are reducing the size of the operations that support these specialized programs,” a Bank of America spokesman said. “Additionally, in line with the industry, we are realigning our cost structure in response to lower customer demand for mortgage refinancing.”

Since the last quarter of 2012, the legacy asset-servicing group has seen its staff drop 45% to 32,000, said Ron Sturzenegger, the BofA executive who runs the group. The reduction includes attrition, which is at about 18% to 20%, he said. (…)

Swedish Manufacturers Cut Jobs Appliance manufacturer Electrolux and truck maker Volvo each plan to trim about 2,000, amid continued uneasiness about how quickly European demand will return for a range of big-ticket items.

The companies—with a combined 176,000 workers world-wide—posted lower net profit in the third quarter than the same period a year ago.

The moves in Sweden come as part of a continued wave of retrenchments by major European firms. High costs, weak European markets and the need for organizational restructuring are fueling these actions. (…)

Electrolux said its European operations, especially in Southern Europe, weighed on volumes and earnings in the third quarter. It expects market demand for appliances in Europe to decline by 1% to 2% for the full year of 2013. Electrolux is raising its estimates for market demand in the U.S. to increase by 7% to 9% for the full year of 2013. (…)

The world’s third-largest truck maker by trucks sold said it expects the size of the European heavy-duty truck market to remain unchanged in 2014, as it reported lower third-quarter sales and earnings than expected.

The European truck market has struggled to regain its footing after the 2007 financial crisis led to a nose dive in truck orders. “For a third year in a row we are calling this a flat market,” Volvo’s Chief Executive Olof Persson said in a news conference Friday.

Volvo’s orders in Europe were up 11% in the third quarter from the year-ago period. However, demand was boosted by customers taking the chance to buy trucks with less expensive so-called Euro 5 engines, ahead of the introduction of new emission standards, Euro 6, at year-end. There is concern that weak underlying demand will become evident next year when the pre-buy effect is gone. (…)

Rising Euro Jeopardizes Bloc’s Economy

The rising euro threatens to cool exports and the economy further after business activity in the euro zone already slowed in October.

(…) “The euro is too expensive, too strong and a bit too German,” French Industry Minister Arnaud Montebourg told the French daily Le Parisien this week, as he urged the ECB to take action.

Indeed, pain from the euro’s gains is likely to expose Europe’s North-South divide, hurting companies in Southern Europe with less room to raise prices and cut costs than Germany’s export powerhouses, which tend to sell more premium goods, such as luxury cars and niche engineering products. (…)

From FT Alphaville:

Consider this from Morgan Stanley’s FX team:

EMU-based banks are preparing for the Asset Quality Review, which will reference year-end balance sheets. Ahead of the event, equity weak banks have a high incentive to reduce the asset side of the balance sheet, using proceeds to add to equity positions. Foreign funds stand ready to snap up these assets at discounted prices. In addition, EMU banks’ net foreign asset position has gone up sharply. Exhibit 2 suggests that banks run a EUR600bln foreign assets position not covered by foreign-denominated liabilities, but by EUR-denominated ones. In other words, EMU banks run a EUR600bln EUR foreign-currency long position. Ahead of the AQR banks are likely to reduce this exposure markedly, suggesting the EUR could benefit from repatriation pressure.

Now weigh that against the fact that “EMU’s leading indicators have started rolling over, the French industry minister Montebourg has complained about EUR strength… ECB officials have brought back the idea of cutting the deposit rate thus imposing negative rates” (again), And as Citi point out, the measure of relative economic surprises out of the eurozone and the US headed south in August/September and decoupled from the surging currency pair…

… and do what thou wilt.

Oh! and this rising problem:


Storm cloud  Emerging-Market Bank Lending Conditions Tighten Further

Bank lending conditions in emerging markets have deteriorated to their worst levels in over a year, according to a new industry survey. (…)

Lending conditions in Asian economies are showing the worst degradation, with wholesale funding conditions rapidly decaying, credit standards tightening sharply and demand for loans falling and non-performing loans rising, according to the Institute of International Finance’s quarterly survey. (…)

“This tightening reflects in part banks’ reaction to the capital market volatility over the summer months,” the global banking trade group. (…)

It’s not just Asia. The amount of nonperforming loans are rising across the globe, from Latin America to Africa, the Middle East to Europe. “Bank asset quality continues to deteriorate,” the IIF said.

  • Demand for loans is falling fastest in Latin America, underscoring concerns there about falling investment levels.

Fingers crossed  Putting Fed Taper On Ice Heats Up Emerging Mkts

Now that the Fed taper is indefinitely off, the emerging markets trade is back on. Since its mid-summer lows, the MSCI Emerging markets index has rallied 18%, almost fully clawing back losses sustained over the first six months of the year.

(…) Will the easy money flowing back into emerging markets reignite the credit boom? Or will governments aim to repeat what the Asian economies did after the Asian crisis of the late 1990s and implement policies focused on building exports and foreign currency reserves?

Some hints:


From Bespoke Investment which tallies all NYSE companies:

Just over 600 companies have reported earnings this season, and the average stock that has reported has gained 0.19% on the day of its report.

Zacks Research sees an improving trend in the more recent results:

Total earnings for the 212 (47%) S&P 500 companies that have reported results already, as of Thursday morning October 24th, are up +8.1% from the same period last year, with 67.9% beating earnings expectations with a median surprise of +2.5%. Total revenues for these companies are up +3%, with 42% beating revenue expectations with a median surprise that is barely in the positive.

Unlike Q2, the Finance sector has been less of a growth driver in Q3, with total earnings for the 60.1% of the sector’s total market capitalization that have reported already, up +13.0%. Excluding Finance, total earnings for the S&P 500 that have been reported would be up +6.4% vs. +1.2% for the same companies in Q2.

The charts below show how the results from these 212 companies compare to what these same companies reported in Q2 and the average for the last 4 quarters. The earnings and revenue growth rates which looked materially weaker in the earlier phase of the Q3 reporting cycle have improved.

The earnings beat ratio looks more normal now than was the case last Friday when only 62.6% of the 99 companies that had reported by then were beating expectations. It didn’t make much sense for companies to be struggling to beat earnings expectations following the significant estimate cuts in the run up to the reporting season.

The current above average earnings beat ratio for the 212 S&P 500 companies that have reported already confirms what many of us were suspecting all along – that estimates had fallen enough to make it easy for companies to come ahead of them. We see this quarter after quarter, with about two-thirds of the companies beating earnings expectations – a good illustration of management teams’ tendency to under-promise and over-deliver.

The composite earnings growth rate for Q3, combining the results from the 212 that have come out with the 288 still to come, currently remains at +2.9% on +1.2 higher revenues. It is perhaps reasonable to expect that the final Q3 earnings growth tally will likely be not much different from the +3.4% achieved in Q2.

We may not have had much growth in recent quarters, but the expectation is for strong growth resumption in Q4 and beyond. Estimates for Q4 have started coming down, with the current +9.1% growth pace down from last week’s +9.5%. But as the chart below shows, consensus estimates for Q4 and beyond represent a material acceleration in earnings growth.


Guidance has been overwhelmingly negative over the last few quarters and is not much different thus far in Q3 either, a few notable exceptions aside. (…) Given this backdrop, estimates for Q4 will most likely come down quite a bit in the coming weeks. (…)

RBC Capital’s tally includes yesterday’s results (228 companies or 51% of the Index): 63% beat earnings (61% yesterday), 30% beat revenues (28% yesterday). RBC’s blended Q3 earnings are now seen up 4.6% on 2.0% revenue growth (Zacks sees +2.9% EPS on +1.2% revenues).

If we get 4.6% YoY growth in Q3 EPS, this would mean $25.10 on S&P’s scorecard, well short of the $26.72 currently expected. That said, aggregators each have their own calculation methods.

BloombergBriefs monitors conference calls to “measure” the corporate mood:

The economy has registered no meaningful improvement in conditions; weakness was again the prevailing theme in the latest round of conference calls. A “challenging” environment was mentioned by the majority of companies, particularly those servicing the household sector — restaurants, retail, food, household products. Many noted the state of affairs in the nation’s capital also seemed to be holding back the recovery process.

The Bloomberg Orange Book Sentiment Index for the week ended Oct. 25 was 46.67, a decline from the 48.03 registered during the previous week. It is the 37th consecutive weekly reading below 50, and the lowest reading since December 2012. Sub-50 readings suggest contractionary conditions, while above-50 is indicative of expansion.

Bespoke monitors guidance: Guidance Remains Weak

So far this earnings season, 62.6% of the companies that have reported have beaten earnings estimates.  As shown below, this quarter’s reading is at the moment the highest seen since Q4 2010, but given that there are still more than 1,000 companies left to report, this is far from set in stone. Pointing up  Historically, the earnings beat rate has drifted lower as the reporting period progresses, so our guess would be that it finishes somewhere around the 60% mark.

While the earnings beat rate has been pretty strong, guidance has been weak, which is nothing new to this market.  At the moment, the spread between the percentage of companies raising guidance minus the percentage lowering guidance stands at -5.3 percentage points.  As shown below, if the guidance spread remains in negative territory through the end of earnings season, it will be the ninth consecutive quarter where more companies have lowered guidance than raised guidance.  It has been a long while now since corporate America collectively had a rosy view of the future.


Alan GreenspanAlan Greenspan
‘I couldn’t tell what was really happening’

(…) But tact cannot entirely mask Greenspan’s deep concern that six years after the leverage-fuelled crisis, there is even more debt in the global financial system and even easier money due to quantitative easing. And later he admits that the Fed faces a “brutal” challenge in finding a smooth exit path. “I have preferences for rates which are significantly above where they are,” he observes, admitting that he would “hardly” be tempted to buy long-term bonds at their current rates. “I run my own portfolio and I am not long [ie holding] 30-year bonds.”

But even if Greenspan is wary of criticising quantitative easing, he is more articulate about banking. Most notably, he is increasingly alarmed about the monstrous size of the debt-fuelled western money machine. “There is a very tricky problem we don’t know how to solve or even talk about, which is an inexorable rise in the ratio of finance and financial insurance as a ratio of gross domestic income,” he says. “In the 1940s it was 2 per cent of GDP – now it is up to 8 per cent. But it is a phenomenon not indigenous to the US – it is everywhere. (…)

What also worries Greenspan is that this swelling size has gone hand in hand with rising complexity – and opacity. He now admits that even (or especially) when he was Fed chairman, he struggled to track the development of complex instruments during the credit bubble. “I am not a neophyte – I have been trading derivatives and things and I am a fairly good mathematician,” he observes. “But when I was sitting there at the Fed, I would say, ‘Does anyone know what is going on?’ And the answer was, ‘Only in part’. I would ask someone about synthetic derivatives, say, and I would get detailed analysis. But I couldn’t tell what was really happening.”

This last admission will undoubtedly infuriate critics. Back in 2005 and 2006, Greenspan never acknowledged this uncertainty. On the contrary, he kept insisting that financial innovation was beneficial and fought efforts by other regulators to rein in the more creative credit products emerging from Wall Street. Even today he remains wary of government control; he does not want to impose excessive controls on derivatives, for example.

But what has changed is that he now believes banks should be forced to hold much thicker capital cushions. More surprising, he has come to the conclusion that banks need to be smaller. “I am not in favour of breaking up the banks but if we now have such trouble liquidating them I would very reluctantly say we would be better off breaking up the banks.” He also thinks that finance as a whole needs to be cut down in size. “Is it essential that the division of labour [in our economy] requires an ever increasing amount of financial insight? We need to make sure that the services that non-financial services buy are not just ersatz or waste,” he observes with a wry chuckle. (…)


NEW$ & VIEW$ (2 OCTOBER 2013)

Global PMI rises to 27-month high

The global manufacturing economy saw a modest pace of expansion in September, rounding off its best quarter for just over two years. The ongoing recovery again failed to filter through to the labour market, however, as employment levels were broadly unchanged over the month.

At 51.8 in September, up from 51.6 in August, the JPMorgan Global Manufacturing PMI™ – a composite index* produced by JPMorgan and Markit in association with ISM and IFPSM – edged higher for the third month running to a 27-month peak.


Growth tended to be centred on the developed world, with the UK at the top of the global rankings and expansions also seen in the US, the eurozone, Japan and Canada. Among the emerging markets, China, Brazil and Indonesia stagnated in September. India, Russia and South Korea saw marginal contractions, whereas conditions improved
in Taiwan, Turkey and Vietnam.

Global manufacturing production rose for the eleventh consecutive month in September, with the rate of expansion the sharpest since May 2011. Higher output was supported by improved market conditions, as incoming new business increased for the ninth month running.


There was also positive news for international trade volumes, as new export orders posted the most noteworthy increase since May 2011. The export growth rankings were led by the eurozone nations, with the largest increases reported by Spain, Ireland, Italy and the Netherlands.

September data pointed to a negligible gain in staffing levels, continuing a sequence of near-stagnation in the labour market that has been seen through the year-to-date. Among the largest industrial regions covered by the survey, job creation was seen in the US, the UK, Canada, Taiwan and Turkey.

Cost inflation accelerated slightly during September, hitting a near one-and-a-half year peak. Manufacturer’s pricing power continued its nascent improvement, as average output charges rose slightly for the second straight month.


Global growth? Read on:

Maersk Four Rate Rises Fail to Spread as Demand Falls

The average global rate to ship an FEU fell 7.9 percent to $1,665 for the week ending Sept. 26, the third straight weekly decline, WCI data showed. The drop was led by the Asia-Europe route, with the fee from Shanghai, China’s busiest port, to Rotterdam, Europe’s biggest, falling 19 percent to $1,703. That rate has fallen 41 percent from $2,881 on Aug. 8, the highest in almost a year. (…)

The spot rate to ship a 20-foot equivalent unit, or TEU, to northern Europe from Far East Asia is currently $765 per box, down from $1,501 at the beginning of August, Alphaliner said, citing Shanghai Containerized Freight Index data. It could fall to $500 per TEU in the next few weeks, the Paris-based industry consultant said in an e-mailed note distributed yesterday. (…)

With no potential fundamental catalyst to drive charges higher before the end of the year and capacity growth set to exceed demand at least through 2014, there probably won’t be any sustainable uplift in rates before 2015, Cantor’s Byde said. (…)

Goldman’s Global Leading Indicator Plunges Back To “Slowdown”

Everything looked so good in August. Goldman’s global leading indicator (GLI) “swirlogram” had recovered quickly from a ‘growth scare’ in Q1 and was holding firmly in “expansion” territory. Then reality hit as new-orders-less-inventories worsened, various manufacturing surveys rolled over, industrial metals gave up gains, and Korean exports provided no help. Among the few factors holding up the index from already plunging levels was the Baltic Dry Index (which has collapsed now in the last few days) and Consumer Confidence (which appears to also be rolling over).September’s plunge into “slowdown” for the GLI is the biggest drop in 8 months.


And commodity prices show no upward momentum (chart from Ed Yardeni:

Meanwhile, U.S. PMIs remain positive in September and…


Canada’s manufacturing expansion accelerated to a 15-month high in September, according to the RBC Canadian Manufacturing Purchasing Managers’ Index™ (RBC PMI™).

The seasonally adjusted RBC PMI rose to 54.2 in September, up from 52.1 in August. This indicated further improvement in manufacturing business conditions, with the rate of growth above the series average and the fastest since June 2012.

The RBC PMI found that both output and new order growth accelerated in September. In particular, the latest rise in total new work intakes was strong and the fastest since June 2012. This partly reflected the greatest increase in new export orders for two-and-a-half years. Meanwhile, the rate of job creation also quickened to a 15-month high, as firms hired additional staff to handle increased business activity.

While in Mexico: Total new work intakes rose only slightly over the month, despite an increase in new export orders – the first in five months.


September U.S. Auto Sales Fall 24%

(…) Industry executives said September sales were depressed because the Labor Day weekend occurred early in the month, and many cars sold during sales promotions tied to that weekend were counted in August rather than September.The selling rate for September was 15.28 million, down from an annualized selling pace of 16.09 million vehicles in August.


image(Charts from CalculatedRisk)

Averaging August and September to smooth out the calendar perks, we get 15.68 million vehicles, down from 15.8 in July and in line with previous cyclical peaks if we exclude the bubbled 2000s.


Policy Makers Prepare For Siege

The federal government shutdown showed no signs of breaking, increasing the likelihood it will become entangled in an even larger battle over the Treasury’s ability to pay its bills.

Europe is not out of the wood just yet:

The rise of the currency has contributed to a tightening of monetary conditions. The IMF’s measure of the real effective exchange rate, which is deflated by the consumer price index, has risen to 98.72 from 98.24 over the last quarter and from 94.19 over the last year.

The strengthening of the currency has been accompanied by a rise in the cost of borrowing. Real three-month EUR LIBOR has risen to minus 0.94 percent from minus 2.45 percent over the last 12 months.

A monetary conditions index for the euro area has risen to 97.03 from 95.79 during the same period. The latest reading is 0.7 percent below the 10-year moving average. That compares with the figure having been 2.1 percent below that long-term mean one year ago.

The tightening of monetary conditions has occurred as a Taylor Rule model has called for the opposite to occur. A version of the monetary policy tool, based on coefficients estimated by the Federal Reserve Bank of San Francisco, suggests the main policy rate of the ECB should have been reduced to 0.25 percent from 1 percent during that period.


Loans to non-financial corporations, adjusted for sales and securitization,
fell 2.9 percent year over year in August versus minus 2.8 percent in July. The equivalent figure for households stood at 0.4 percent year over year, unchanged from the previous month.


Worrying About Profit Warnings Companies are cutting their profit forecasts at a record pace. Yet for investors, history shows the sour outlooks aren’t a reason to sell.

The number of companies projecting quarterly earnings results below analysts’ expectations climbed to 89 late last week, according to FactSet, which started tracking guidance data in 2006. The latest figure surpassed the previous records of 88 in the second quarter and 86 in the first quarter.

Earnings warnings have increased every quarter since the second-quarter of 2012, FactSet data show. Yet over that time frame, the S&P 500 has rallied 24%. (…)

“Third quarter earnings are expected to be the same as the second quarter – we will all be disappointed with low profit and sales growth, but in the end, the third quarter will set a new all-time record, beating out the current record set by the second quarter, by about 2%,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. (…)



More Pain Looms for Banks  New troubles are piling up for U.S. banks as they prepare to release third-quarter earnings results amid warnings of weak trading revenue, a sharp decline in mortgage refinancings and rising legal costs.

(…) Analysts reduced revenue estimates for the six largest U.S. banks during the quarter and cut profit estimates for all but Wells Fargo.

Bank of America, which relies heavily on the trading and mortgage businesses, suffered the biggest drop. Analysts have reduced their third-quarter per-share earnings predictions for the Charlotte, N.C., lender by 27% since July 1. (…)

“For a while we thought a light was at the end of the tunnel,” said Gerard Cassidy, a banking analyst with RBC Capital Markets. “It seems to be a Mack truck.” (…)


Weak third-quarter results are expected to accelerate plans for job cuts. Overall employment at the six largest U.S. banks declined by 26,254 jobs, or 2.2%, in the year ended June 30, company filings show. The largest was a 6.6% decline at Bank of America. Wells Fargo was the only gainer over the period, boosting its staff by 3.8%. (…)

Nowhere are banks hurting more than in mortgages. Banks long have braced for a slowdown, but the spike in interest rates this summer brought a yearlong boom to an abrupt end.

“It’s been brutal,” said Michael Menatian, a mortgage banker in West Hartford, Conn. “We were flat-out busy until May. Once rates went up, things went completely dead.” He said he closed around $4 million in loans every month through June, and about $1.5 million a month since then. (…)

J.P. Morgan, Bank of America, Wells Fargo and Citigroup already have cut more than 10,000 mortgage jobs this year, with plans for thousands more to come. J.P. Morgan is accelerating plans to cut as many as 15,000 jobs in its mortgage division by the end of 2014.

All told, the number of employees in the industry will likely shrink by 25% to 30% over the next year, estimates Christine Clifford, president of Access Mortgage Research & Consulting, Inc., a Columbia, Md., mortgage research and consulting firm. (…)

If you missed it, you may want to read the EARNINGS WATCH segment of Monday’s New$ & View$.

Merck to Cut Staff as Industry Trims R&D

Merck said it plans to slash its 81,000-strong workforce by 20% over the next two years, a stark show of the diminishing research-and-development capabilities of some of America’s biggest health companies.

The company also said it would close offices in New Jersey and discontinue some late-stage drug development, all in the service of saving about $2.5 billion annually by 2015. (…)

[image]After acquiring Schering-Plough Corp. for $41 billion in 2009, Merck’s workforce nearly doubled to reach a peak of 100,000. Assuming no new employees are added by 2015, the company’s total head count would fall to 64,800 after the layoffs, or just 17% more than before the merger.

Advancements in the understanding of genetics and biology have increasingly fuelled drug development in recent decades, and many of the most promising new drugs have been aimed at niche disease populations, developed in the labs of biotechnology competitors considered closer to the cutting edge of science. Merck has begun to catch up, most recently with an experimental cancer drug that harnesses the immune system to fight tumor cells. But some former executives worry that the company wasn’t quick enough to adapt and that its declining size mirrors the shrinking ambitions of other large drug makers. (…)

Merck lowered its earnings-per-share guidance to a range of $1.58 to $1.82, from a range of $1.84 to $2.05 previously; the company maintained its projected earnings per share, excluding restructuring items, at a range of $3.45 to $3.55.

Foreign Firms Tap U.S. Gas Boom

The U.S. boom in natural-gas production is luring investment from foreign manufacturers eager to tap a cheap, abundant supply of fuel and feedstocks.

Companies from the U.S. and abroad have invested or are planning to invest billions of dollars through the rest of the decade in plants that would churn out chemicals, fertilizers, plastics, metals and fuel from gas. Many foreign companies, alone or in joint ventures with U.S. partners, are taking advantage of gas that costs a fraction of what it does in Europe or Asia to expand production in the U.S.

Boston Consulting Group estimates that international companies will invest at least $50 billion through the end of the decade on projects that take advantage of low-price natural gas.

Linde AG, a German gas-and-engineering company, recently said it would spend $200 million to build a new air-separation unit in La Porte, Texas, that would provide synthetic gas for the petrochemical industry. The investment “is directly tied to the price and availability of natural gas,” said spokesman Uwe Wolfinger. “Five or seven years ago, this type of investment would have been far more likely elsewhere in the world.” (…)

Energy consulting firm IHS Cera said in a report last month that cheaper gas would kick-start the nation’s chemicals sector over the next dozen years, creating more than 300,000 jobs and driving half a trillion dollars in production through 2025. (…)

Chemicals accounted for one-quarter of the $160.5 billion in inbound foreign-direct investment in the U.S. last year, according to the U.S. Commerce Department. (…)

“If you think about the competitive advantages of an economy, having low-priced energy is about the most important,” Incitec Chief Executive James Fazzino said. Combined with a stable regulatory framework and a trained labor pool, the U.S. “is really the most attractive place in the world to invest,” he said. (…)

The Commerce Department, which for years has sought to help American companies boost exports, has put new emphasis on attracting foreign investment through a program called SelectUSA. (…)

Nomura Sees $690 Billion Flow Into Japan Stocks on Tax Break  (Tks Carl)

Japanese savers are poised to pump $690 billion into stocks to benefit from new tax breaks as the government tries to avert a retirement cash crunch in the nation with the world’s oldest population and lowest interest rates.

The Nippon Individual Savings Account program, which opens for applications tomorrow, will allow individuals to buy 1 million yen ($10,143) a year of risk assets that are exempt from taxes on dividends and capital gains for five years. The plan will draw as much as 68 trillion yen through 2018, with 65 percent of users pulling money out of bank deposits to purchase securities, estimates from Nomura Research Institute show. (…)

Equities made up just 7.9 percent of household assets as of March, compared with 34 percent in the U.S. and 15 percent in the euro zone, the most recent Bank of Japan data show. (…)

There have been other government policies that tried and failed to promote the shift of funds, and NISA is set to join them, said Yasuhiro Yonezawa, professor of finance at Waseda University in Tokyo.

“NISA will have limited impact on the investment attitude of Japanese people,” said Yonezawa. “I doubt they’ll behave rationally when it comes to asset management as they’ve been unresponsive to incentives offered by the government in the past.” (…)

The expiration of another incentive plan for investors at the end of this year will also limit NISA’s impact, according to Ichiro Takamatsu, a fund manager at Bayview Asset Management Co. Levies on dividends and capital gains will return to 20 percent after being cut by half for the past 10 years.

“Individual investors will sell shares toward the end of the year before the tax rate is raised back,” said Takamatsu. “Many are holding unrealized gains due to the Abenomics rally and that will spur profit-taking.” (…)


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%.


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.


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?



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


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.


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.(…)



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.


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.


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.


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.


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.


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.


(…) 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!


NEW$ & VIEW$ (29 AUGUST 2013)

U.S. Pending Home Sales Decline Further

The National Association of Realtors (NAR) reported that pending sales of single-family homes during July declined 1.3% m/m but remained up 6.7% versus July of last year. The monthly decline followed an unrevised 0.4% June slip.

Last month’s sales decline again reflected mixed performance around the country. Home sales in the Northeast fell 6.5% (+3.3% y/y) while sales in the West dropped 4.9% (-0.4% y/y). Also moving 1.0% lower were home sales in the Midwest but they remained up 14.6% y/y. Pending home sales in the South rose 2.6% (7.7% y/y).

BMO Capital:


U.S. foreclosures fall in July from year ago: CoreLogic

There were 49,000 completed foreclosures last month, down from a 65,000 in July of last year, CoreLogic Inc said. There were 53,000 foreclosures in June, down from an originally reported 55,000.

Before the housing market’s downturn in 2007, completed foreclosures averaged 21,000 per month between 2000 and 2006. (…)

There were about 949,000 homes in some stage of foreclosure, down from 1.4 million a year ago. That foreclosure inventory represented 2.4 percent of all mortgaged homes, down from 3.4 percent in July last year.

German Jobless Figures Unexpectedly Rise in Summer Lull

The number of people out of work increased by a seasonally adjusted 7,000 to 2.95 million, the Nuremberg-based Federal Labor Agency said today. Economists predicted a decline by 5,000, according to the median of 25 estimates in a Bloomberg News survey. The adjusted jobless rate stayed at 6.8 percent, near a two-decade low.

Brazil raises rates for fourth time since April
Central bank in drive to tame stubbornly high inflation

imageThe central bank’s monetary policy committee, Copom, raised Brazil’s benchmark Selic rate by 50 basis points to 9 per cent late on Wednesday, the latest increase in a 175 basis point tightening cycle since April.

Indonesia Raises Rates in Unplanned Move to Shore Up Rupiah

The central bank increased the reference rate to 7 percent from 6.5 percent, it said, after a meeting in Jakarta today that came before the next scheduled policy review. It also raised the deposit facility rate by half a point to 5.25 percent, and extended a bilateral swap deal with theBank of Japan valued at $12 billion that will allow the two to borrow from each other’s foreign-exchange reserves.

Indonesia raised the key rate by a combined 75 basis points in June and July before keeping it unchanged at its meeting on Aug. 15 as slowing growth deterred a third consecutive increase. The rupiah’s more-than-5 percent slump in the past two weeks may have pressured the central bank to increase borrowing costs again before a scheduled policy review on Sept. 12.

Philippine economy maintains strong growth
Services led by trade and real estate fuel 7.5% GDP rise

GDP grew 7.5 per cent in the second quarter from a year ago after expanding by a revised 7.7 per cent from the previous period, making it the fourth straight quarter that the economy climbed more than seven per cent, the government National Statistical Coordination Board said. (…)

Though personal consumption spending still accounts for almost 70 per cent of the economy, it contributed less than half of second-quarter GDP growth. Most of the expansion came from government spending, boosted by the May 2013 midterm polls, and investments, particularly public and private construction.

Construction grew by 15.6 per cent in the quarter to June after rising by 30.1 per cent in the previous period, buoyed by government infrastructure projects as well as a boom in high-rise residential condominiums, office towers and other types of housing.

Is The Japanese Consumer Losing Faith?confidence is waning. More data on Friday may underline this trend.

Last week, subdued department store sales set off alarm bells. On Thursday, preliminary retail sales figures brought more bad news, falling 0.3% on year in July. On a seasonally adjusted basis, retail sales were down 1.8% on the previous month, the biggest fall since August 2011.

Oil market: multiple worries
Libya may be bigger threat to oil price than Syria

(…) Syria always has been and always will be a marginal player in the oil market. Before the civil war, it produced about 370,000 barrels of oil equivalent a day; that may have fallen to about 70,000 b/d now. Nor is it a significant transit point. (…)

More troubling is Libya, which produced almost 2 per cent of the world’s total oil and gas output last year. Earlier this year, Libya was boasting that it was almost back to its prewar production level of about 1.6m b/d (of which 1.3m b/d is exported). But strikes and protests have cut its daily oil production to an average of just 500,000 b/d this month. The chaos that has gripped the country since the ousting of Muammer Gaddafi in 2011 now threatens to curtail production indefinitely.

The “War” Effect

How do markets (US equities, Gold, Crude Oil, and the USD) react around US military conflicts…? Citi shows what happened before-and-after the Gulf War, Kosovo, Afghanistan, Iraq, and Libya… and why Syria is arguably more complex than these previous conflicts

Via Citi,

S&P: trades better once conflict begins. This time should be no different.

Gold: falls after start of action. Again should be no different.

Crude: usually falls at or just prior to start of military action.

USD: reverts back to dominant trend. USD weakened post-action in 1991, 2003, 2011 as it was in a bear market. The opposite happened in 1999 and 2001 (USD bull market). This time around USD strength should return once military intervention begins.

One counterpoint: Syria is arguably more complex than these previous conflicts. Military objectives are also not as well defined. Russia and Iran will also weigh in both pre- and post-action. The usual market reaction may be more muted and short-lived because of greater uncertainties.


Links Between Capacity Utilization, Profits and Credit Spreads

From Moody’s:

Though the share of jobs directly linked to goods producing activity has shrunk considerably over time, the percent of industrial capacity in use remains highly correlated with overall profitability, credit spreads, and business debt repayment. In all likelihood, the large amount of economic activity that is indirectly linked to the production of tangible goods helps to explain the still strong correlation between industrial activity and the corporate credit cycle. For example, much service sector activity is derived from the transportation, storage, sale, and maintenance of tangible merchandise. Capacity utilization’s ability to offer useful insight shows that tangible goods still figure prominently in a post-industrial economy. We still consume a lot of things.

(…) Amid sufficient slack, rising rates of capacity utilization often generate percent increases by profits that are a multiple of the accompanying percent increase in business sales. This phenomenon is referred to as operating leverage.

Ordinarily, the bigger is the year-to-year percentage point increase in capacity utilization, the faster is the year-to-year growth rate of profits. For example, when the year-to-year increase by the rate of industrial capacity utilization most recently peaked at the 6.8 percentage points of 2010’s third quarter, the annual growth rate of the moving yearlong sum of profits from current production also crested at 33%. Subsequently, the yearly change of the capacity utilization rate eased to the 0.0 points of 2013’s second quarter and profits growth slowed to 3%. (Figure 1.)


Capacity utilization has declined in each of the last 5 months, from 78.2% in March to 77.6% in July. It has also declined in each of the last 7 cycles.


David Rosenberg recently wrote on the “normal” biz cycle:

I think we are heading into mid-cycle where consumer spending is going
to take the baton from the housing market. This is currently being
delayed by the lagged impact of the early year tax bite and the current
round of sequestering, but next year we should begin to see the impact
of gradually improving job market fundamentals spill into a pickup in
consumer spending growth. This would not just be desirable — it would
be natural. Exports should also take on a leadership role as the
recession in Europe ebbs and Chinese growth stabilizes. The cyclical
outlook in Japan is also constructive as the monetary and fiscal stimulus
has to fully percolate but there is already evidence that the two-decade
experience with deflation is drawing to a close.


The next chapter would then involve capital spending and plant
expansion, and capacity utilization rates and an increasingly obsolete
private sector capital stock will trigger accelerating growth in business
spending, likely by 2015 or perhaps even earlier. Profit growth is slowing and normally that would be an impediment, but there is ample cash on balance sheets and what businesses need is a less clouded policy
outlook, which hopefully will be resolved in the coming year as we get a
new Fed leader, greater clarity on monetary policy and some fiscal
resolution ahead of or following the mid-term elections.

That may be nothing but a hope and prayer, but more fundamentally, productivity growth has stagnated and the best way the corporate sector can reverse the eroding trend and protect margins at the same time will be to move more aggressively to upgrade their operations and facilities — we are coming off the weakest five-year period in the past six decades with regards to growth in capital formation.

Moody’s makes the link between capacity utilization and the high yield market:

Given the capacity utilization rate’s significant correlations with both the high-yield default rate and the delinquency rate of bank C&I loans, it is not surprising that the high-yield bond spread tends to widen as the capacity utilization rate falls. The diminution of cash flows and pricing power that accompanies a lowering of capacity utilization will increase the yield that creditors demand as compensation for default risk. Thus, a narrowing by the high-yield bond spread from its recent 460 bp to its 418 bp median of the previous two economic recoveries will require the fuller use of production capacity. (Figure 6.)

After rising sharply from June 2009’s record 66-year low of 64.0% to February 2013’s current cycle high of 76.5%, the capacity utilization rate of US manufacturers has since eased to July’s 75.8%. An extension of the current credit cycle upturn requires the return of a rising rate of capacity utilization.  (…)


However, U.S. capex are not about to turn up:

An unexpected second monthly decline in nondefense capital goods shipments in July, coupled with weak orders, flags slower business capex in Q3. (BMO Capital)



NEW$ & VIEW$ (28 AUGUST 2013)

Emerging-Market Rout Intensifies

The slide in many emerging-markets currencies and stocks intensified and oil prices climbed farther, as investors continued to worry about a possible U.S. strike against Syria.

The Indian rupee and Turkish lira—no strangers to selloffs since May—fell heavily, even by recent standards. The rupee plunged by 3.3% while the lira sank by 1.7%. Both hit record lows for the second consecutive day.

Syria isn’t a major oil producer, but there are fears that U.S. action could touch off a wider conflict. (…) Crude-oil futures spiked for a second day, with the front-month Brent contract hitting an intraday high of $117.34 a barrel in Asian trade. Recently, ICE Brent was $1.42 higher on the day at $115.78 a barrel. Nymex WTI also gained more than a dollar, to an 18-month high above $110 a barrel. (…)

Oil-producing Russia and Mexico have also seen their currencies slide, signaling that, for now, this is a broad-based wave of market nerves.


The composite index of manufacturing activity rebounded in August, climbing twenty-five points above the July reading to 14. The imagecomponents of that index all rose this month, with the index for shipments jumping to 17 from the previous reading of -15 and the index for new orders moving to 16 from -15. The marker for the number of employees picked up to 6 from July’s reading of 0.

Capacity utilization made a weak comeback, with the index ending the survey period at 3 compared to last month’s index of -9. The gauge for the backlog of orders declined by much less than a month ago, with that index settling at -6 from the previous reading of -24.


The index for the number of employees moved up to 6 in August following a flat reading a month ago. The indicator for the average manufacturing workweek also gained, picking up six points to post a reading of 8. In addition, average wage growth intensified, pushing the index to 13 from July’s reading of 8.


Mortgage applications fall as rates hit 2013 high: MBA

Applications for U.S. home loans fell for a third straight week as average mortgage rates hit their highest level this year, although demand for purchase loans increased, data from an industry group showed on Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, fell 2.5 percent in the week ended August 23, after sliding 4.6 percent the prior week. (…)

The refinance index fell 5.4 percent last week, and the refinance share of total mortgage activity slid to 60 percent, the lowest since April of 2011.

The gauge of loan requests for home purchases, a leading indicator of home sales, held up better, rising 2.4 percent. (…)


U.S. Case-Shiller Home Price Index Increase Eases Again

Home price inflation eased further in June. The seasonally adjusted Case-Shiller 20 City Home Price Index rose 0.9% (12.1% y/y) on a seasonally adjusted basis after a 1.0% May gain. It was the third consecutive month of lessened increase following the 1.9% March jump. The result was to drop the 3-month annualized rate of increase to 15.3% from its record 20.2% recorded in March. Home prices in the narrower 10 city group rose 1.1% in June (11.9% y/y).


More Young Adults Live With Parents

In a report on the status of families, the Census Bureau on Tuesday said 13.6% of Americans ages 25 to 34 were living with their parents in 2012, up slightly from 13.4% in 2011. Though the trend began before the recession, it accelerated sharply during the downturn. In the early 2000s, about 10% of people in this age group lived at home.



Recent surveys by Pew found over 60% of people ages 18 to 34 knew someone who had moved back in with their parents because of the economy, he said, and that four of five people ages 25 to 34 who were living with their parents were satisfied with the arrangement.

The latest findings have important implications for the nation’s housing market and broader recovery, since they suggest fewer young Americans are buying houses, furniture and appliances—purchases that fuel much of the country’s economic growth.

Japan Auto Makers Cut Domestic Production

(…) The across-the-board decline in production suggests that there won’t be an immediate pick up in capital spending in Japan’s auto industry, undermining the efforts of Prime Minister Shinzo Abe to fix one of the weak links in the nation’s economic turnaround.

While Toyota and all other Japanese car makers reported solid quarterly profits in their latest earnings results, the growth is coming from overseas, which has made them reticent about increasing outlays at their domestic facilities.

Euro zone loan slump puts onus on ECB to keep rates low

Lending to the euro zone’s private sector contracted further in July, dragging on the euro zone’s nascent economic recovery and keeping up pressure on the European Central Bank to maintain its expansive monetary policy.

Private sector loans shrank by 1.9 percent from the same month a year ago, ECB data released on Wednesday showed.

A breakdown of the region-wide figure, which matched the lowest reading in a Reuters poll of economists, showed declines were generally steeper on the euro zone’s struggling periphery, adding to evidence that the recovery is uneven. (…)

Adjusted for sales and securitization, the drop in loans to the private sector was 1.4 percent on an annual basis, the biggest on the record.

An ECB survey released in July showed that euro zone banks, facing tougher capital requirements, tightened lending standards for both companies and home loans in the second quarter even though their access to funding eased. (…)


NEW$ & VIEW$ (26 AUGUST 2013)


Surprised smile Rate Shock: Sales of New U.S. Homes Fall on Mortgage Costs

The reading was the weakest since October and was lower than any of the forecasts by 74 economists Bloomberg surveyed.

The median estimate of economists surveyed by Bloomberg called for a decrease to 487,000. Forecasts ranged from 445,000 to 525,000.

The actual number was 394,000.

Disappointed smile The difference between July’s outcome and the average estimate of economists surveyed was 7 times larger the poll’s standard deviation, or the average divergence between what each economist forecast and the mean. That was the biggest surprise since April 2010.

The Commerce Department also marked down readings for each of the previous three months with June’s sales pace revised down to 455,000 from a previously reported 497,000 pace.

New-Home Sales Tumble

New-home sales fell 13.4% from June to an annual pace of 394,000, the Commerce Department said Friday. The drop, the steepest in three years, pushed sales down to the lowest level since October.

Because of how new-home sales are tallied—at the signing of the contract, rather than at the closing—economists said Friday’s data could be evidence that a rise in mortgage rates from the spring is starting to pinch the housing market, a key engine of the U.S. recovery. (…)

The report also showed that June sales were lower than previously estimated, with that month’s figure now at 455,000, compared with an initially reported 497,000.

Even with the decline, sales in July were 6.8% higher than a year ago.

The slower sales pace in part caused inventory to rise and median prices to dip. The median price for a new home slipped 0.5% to $257,200. The number of new homes listed for sale, seasonally adjusted, at the end of July was 171,000. The supply would take 5.2 months to deplete at the current sales pace.

Well, it looks like higher prices and mortgage rates do have an impact after all. Welcome to the real world (see my June 25 Facts & Trends: U.S. Housing A House Of Cards?). The Raymond James housing analyst sums it up:

The 13.4% sequential drop is one of the largest on record – aside from the nearly 34% sequential plunge in May 2010 when the first-time homebuyer tax credit expired. Notably, this report stands in stark contrast to the improving July NAHB homebuilder sentiment index and suggests new home sales have been materially impacted by the recent spike in mortgage rates. While still limited, rising levels of existing home inventory may also be negatively impacting demand for new homes. (…)

Relative to June, sales fell across all four regions, with the breakdown as
follows: Northeast (-5.7%), Midwest (-12.9%), South (-13.4%), and West (-16.1%).

Here’s the “relationship” with the Homebuilders Index which everybody watches. Remember that this index measures builders’ sentiment. I have warned repeatedly that the more objective “traffic index” has been a lot more subdued so far in 2013. (Next two charts courtesy of ZeroHedge)

Yes Virginia, mortgage rates do matter to ordinary people (just about everybody excluding economists and strategists).

Also, keep in mind that 10 year Treasury rates are still rising…which normally translates into higher mortgage rates…

image(Doug Short)

…with a 97% correlation:


More on ordinary folks: Charles Hugh Smith (Of Two Minds) posted several telling charts revealing the reality of the average American:

  • The number of social security beneficiaries jumped 25% (12 million people) to 57 million Americans since 2000 while full time employment declined to 114 million.


  • Less than 59% of Americans have a job.


    • Full time employment is now only 47% of total employment and has stalled at that low level.


  • Social security payments have ballooned exponentially.


  • Here’s how tight it is on main street:


The end result, illustrated by this next Doug Short’s chart, is that median income just made it back to its 2008 peak but real median income remains 7.9% below its 2008 peak which was unchanged from its 2002 level.

Click to View

From Family Dollar Stores’ Q2 conference call:

When we look at the Nielsen data, one thing that’s pretty clear is that our customer is spending less in the overall marketplace. (…) The biggest factor for the additional weakness, in my opinion, is the consumer is just more challenged than we had anticipated. She’s making choices. Things are very tough right now.

Very tough right now! And for quite a while. Who do you think will pay for all the social benefits and government deficits when so few Americans have a job and more and more of those workers have only part-time jobs? This is main street’s reality.

And now this: U.S. Sets Stage For Bigger Syria Role

Nerd smile  Barron’s Randall Forsyth:

So, will the Fed taper its bond purchases in September with housing activity slowing sharply, more bad news from retailers about consumer spending, and global markets cracking? And ahead of another possible debt-ceiling debacle and possible government shutdown on Oct.1?

It wouldn’t be the first policy blunder.

But, bad news can be good news for some:

The massive drop in new home sales will raise an eye-brow (or two) at the September 18 FOMC meeting, and could either delay tapering or result in a tinier taper than the market currently anticipates (a reduction of around $10-15 billion in asset purchases)…unless it’s offset by stronger economic data in the weeks ahead. (BMO)

More Homes for Sale, At Last

imageThe number of new homes for sale at the end of July reached a seasonally adjusted 171,000, an increase of 28,000 from a year earlier, the Commerce Department said Friday. That’s the largest annual gain in supply since November 2006.

Clock Clock Another delay for U.S. decision on Keystone

A decision on the controversial and much-delayed oil sands pipeline to the U.S. Gulf Coast could be pushed into 2014 as a U.S. watchdog examines whether contracts tied to the Keystone XL review process were wrongfully awarded and regulatory safeguards fully adopted.

The U.S. State Department’s Office of Inspector General (OIG) is holding an inquiry into whether it was appropriate for the government to hire Environmental Resources Management, a private contractor selected to conduct an environmental review of TransCanada Corp.’s proposed pipeline. (…)

The State Department does not have to wait for the OIG’s report in order to issue its decision on Keystone XL. Mr. Obama has previously said he will make a call in 2013. (…)

Good read: Currency sell-off: Victor Mallet looks at a tragedy in three acts for emerging markets

India, 1991. Thailand and east Asia, 1997. Russia, 1998. Lehman Brothers, 2008. The eurozone from 2009. And now, perhaps, India and the emerging markets all over again. (…)

The fuse igniting each financial explosion is inevitably different from the one before. Yet the underlying problems over the years are strikingly similar. (…)

First comes complacency, usually generated by years of high economic growth and the feeling that the country’s success must be the result of the values, foresight and deft policy making of those in power and the increasing sophistication of those they govern. (…)

The truth is more banal: the real cause of the expansion that precedes the typical financial crisis is usually a flood of cheap (or relatively cheap) credit, often from abroad. (…)

Phase Two of a financial crisis is the downfall itself. It is the moment when everyone realises the emperor is naked; to put it another way, the tide of easy money recedes for some reason, and suddenly the current account deficits, the poverty of investment returns and the fragility of indebted corporations and the banks that lent to them are exposed to view. (…)

Phase Three is when ministers and central bank governors survey the wreckage of a once-vibrant economy and try to work out how to rebuild it. (…)

The FT’s Lex column seeks to taper EM fears:

(…) After all, not every emerging market has taken a fall. Just look at Argentina, Vietnam, Nigeria and Macedonia as examples. The Buenos Aires main index is up almost a quarter in dollar terms since the start of the year. And in spite of the hysteria over Brazil’s real, the Bovespa stock market index has been rallying since July, as has Russia’s benchmark index. Both are up 8 per cent over the past two months alone. Granted, equity markets in Turkey and Indonesia have fallen by more than a quarter since their peaks this year, but they are at levels seen many times during the past five years. India’s Nifty index has only slipped to its 200-day moving average, where it has been seven times in the past four years.

In any case, as far as price is concerned, emerging market equity valuations are no longer exorbitant. Russia’s Micex index trades on five times expected earnings. It has hovered at this level for the past two years, but remains 25 per cent below its long-term average. The multiple for Brazil’s Bovespa index is 15 times – above its five-year average of 12 times, but it has been to 18 times twice over that period. And with India’s Nifty index trading on 13 times expected earnings it may not be a screaming buy – it fell to 8 times in 2008 – but it is still only half as expensive as it was back in March 2010.

Sure, all bets are off if interest rates in the developed world start rising quickly. The flood of liquidity has been a big driver of emerging market equities since the collapse of Lehman Brothers. But these funds must go somewhere. Asia still has a current account surplus. And the US and Europe remain fragile.

Pointing up  Fed Officials Rebuff Coordination Calls as QE Taper Looms

Federal Reserve officials rebuffed international calls to take the threat of fallout in emerging markets into account when tapering U.S. monetary stimulus.

The risk that the Fed’s trimming of bond buying will hurt economies from India to Turkey by sparking an exodus of cash and higher borrowing costs was a dominant theme at the annual meeting of central bankers and economists in Jackson Hole, Wyoming, that ended Aug. 24.

Emerging-market stocks have lost more than $1 trillion since May, according to data compiled by Bloomberg. That’s the month when Bernanke said the Fed “could take a step down” in its bond purchases. The MSCI Emerging Markets Index has fallen about 12 percent this year, compared with a 13 percent gain in the MSCI gauge of shares in advanced countries.

Such selloffs aren’t an issue for Fed officials who said their sole focus is the U.S. economy as they consider when to start reining in $85 billion of monthly asset purchases that have swelled the central bank’s balance sheet to $3.65 trillion. Even as the Fed officials advised emerging markets to protect themselves, they were pressed by the International Monetary Fund and Mexican central banker Agustin Carstens to spell out their intentions better in the interest of safeguarding global growth.

“You have to remember that we are a legal creature of Congress and that we only have a mandate to concern ourselves with the interest of the United States,” Dennis Lockhart, president of the Atlanta Fed, told Bloomberg Television’s Michael McKee. “Other countries simply have to take that as a reality and adjust to us if that’s something important for their economies.”

Ghost Older folks like me might remember that that was exactly what Germany said in mid-October 1987. Then, it was the U.S. that was asking for more international cooperation and consideration, begging Germany to change its monetary policy in order to help the greenback. After Germany rebuked James Baker, markets realized there was actually little cooperation between central bankers and lost confidence that a solution would soon be found.

“It could get very ugly” in emerging economies as the probability of currency and banking crises grows, said Carmen Reinhart, the co-author of “This Time is Different: Eight Centuries of Financial Folly” and a professor at Harvard University. “Whenever emerging markets have faced rising international interest rates and softening commodity prices, let us not forget that it has not boded well.” (…)

Amid such concerns, IMF Managing Director Christine Lagarde warned that financial market reverberations “may well feed back to where they began.” She proposed “further lines of defense” such as currency swap lines.

“We advocate clarity, proper and well-channeled communications,” Lagarde told Bloomberg Television’s Sara Eisen in an Aug. 23 interview. “The signaling effect matters almost more than the implementation. The signal has to be very clear.”

Her call was echoed by Carstens, who urged the Fed to be more open about its strategy. “What would have the most impact right now would be to have a much better, clearer implementation of the tapering,” he said.

Adapting to advanced countries’ exit strategies is “the most pressing challenge for emerging economies,” Carstens said, noting the “turbulence in financial markets around the world once the tapering talk started.”

“It would be desirable to have monetary policy coordination,” he said. “To have the central banks of advanced economies to go in different directions, can become a source of instability.”


Bad Week for Earnings

While the unofficial end of earnings season came last week when Wal-Mart (WMT) reported, there were still 92 companies that reported this week.  And the results were not very pretty.  There were certainly a few solid reports from companies like Lowe’s (LOW), Best Buy (BBY) and Urban Outfitters (URBN), but the majority of companies that reported this week went down on their report days.  Of the 92 companies that reported, 53 saw their stocks decline on their report days, while just 39 posted gains.  Overall, the average stock that reported this week fell 1.65% on its report day, which is well below the average gain of 0.30% that stocks saw on their report days during the second quarter earnings season.

Forward guidance was notably weak as well.  Of the companies that reported, negative guidance outnumbered lowered guidance by a margin of 4 to 1. 

The above is from Bespoke Investment which tallies all NYSE companies.

The official S&P tally as of Aug. 22. reveals that 65% of the 488 S&P 500 companies having reported beat the estimates and 27% missed. Q2 EPS ended up at $26.36, up 3.7% YoY. Trailing 12-month earnings are now $99.28, up 0.9% from their level after Q1 and +0.6% YoY.

Analysts keep shaving their second half estimates but remain hopelessly optimistic. Q3 earnings are seen at $27.14, up 13% YoY while Q4 earning are estimated at $29.12, up 26% YoY.

Meanwhile, Factset reports that

For Q3 2013, 85 companies have issued negative EPS guidance and 18 companies have issued positive EPS guidance.

The number of preannouncements and the percentage of negatives are both higher than they were for Q1’13 and Q2’13 at the same stage. Actually, since Aug. 2, there have been only 2 positive preannoucements against 24 negative ones.

Bloomberg’s Rich Yamarone’s Orange Book Sentiment Index (a compilation of macroeconomic anecdotes gleaned from comments made by CEOs and CFOs on quarterly earnings conference calls) was 48.47 during the week ended Aug. 23, essentially unchanged from the 48.47 registered during the week ended Aug. 16. The Bloomberg Orange Book Sentiment Index marked its twenty-eighth consecutive week below 50. Sub-50 readings suggest contractionary conditions, while above-50 is indicative of expansion.

 High Profit Margins Point to Stock Pain


Mark Hulbert rehashes the mean-reversion risk. I humbly submit that my June 11 post Margins Calls Can Be Ruinous In Many Ways is a more complete analysis.

Wilted rose  China Rethinks Deals for Resources

(…) China has plowed $226.1 billion into outbound mergers and acquisitions to grab a slice of global resources since 1995, about a quarter of which was in the mining sector, according to data provider Dealogic. But people inside and outside the government say Beijing is taking a more careful look at projects.

“The government still encourages ‘going out,’ ” said Jin Bosong, deputy director of the Ministry of Commerce’s International Trade and Economic Cooperation Research Institute. “But now the emphasis is to make companies ask questions like: ‘Can the project make money?’ ” he said.

Mining projects are high on the list.

(…) Beijing’s barrage of iron-ore asset purchases in the last decade has yielded little. Ore imports from China-controlled global mines currently account for just 2.7% of the country’s total iron-ore imports, far below an official target of 40% set in 2011, according to data from Antaike, a Beijing-based consultancy, in June. (…)


NEW$ & VIEW$ (23 AUGUST 2013)


Flash PMIs hint at improving global manufacturing economy

Flash PMI data from Markit covering the eurozone, China and the US showed an across-the-board improvement in manufacturing business conditions in August. This was for the first time since June 2011 and suggested that the global manufacturing economy has picked up growth momentum.


The Markit-produced HSBC flash manufacturing PMI for China rose sharply in August, up from a near postcrisis low of 47.7 in July to a four-month high of 50.1. Although barely above the no-change level of 50.0, the improvement in the China PMI was significant in signalling an end of a three-month sequence of contraction. The data therefore add to hopes that the Chinese economy reached a low in the second quarter, when GDP growth slowed to 7.5%.

A flash Markit Eurozone PMI reading of 51.3 signalled an improvement in manufacturing business conditions for the second month running in August. An increase in the index from 50.3 in July also pointed to an
acceleration in the pace of growth to the fastest since June 2011. A concomitant improvement in the regions’ services PMI – which registered an upturn in business activity for the first time since January 2012 – left the composite Eurozone PMI at its highest for two years.

Manufacturing growth in the single currency area was led by Germany, where the PMI was the highest for over two years, while the French manufacturing sector more or less stagnated. Particularly encouraging news came from the rest of the region, where business conditions showed the largest monthly improvement since June 2011.

Moving further west, the Markit US manufacturing PMI came in at 53.9 according to the flash August reading, up from 53.7 in July and recording the fastest pace of expansion since March. With the US PMI up for a second successive month from June’s eight-month low, the survey data suggest that the economy has gained momentum again after a spring lull.

The upturns in the flash PMIs for three of the world’s largest manufacturing economies bode well for global growth. The JPMorgan Global Manufacturing PMI signalled that a near-stagnation of the world’s factories in the second quarter continued into July, but the flash data for August suggest that growth could lift higher.

Interestingly, new orders and new export orders were strong in the U.S. and rose marginally in Europe. In China, however, total new orders rose just above 50 but new export orders declined well below 50, meaning that domestic new orders rose strongly. Since exports are only a small part of China’s economy, we might be seeing the beginning of a strengthening in the Big Three economies.

[image]That would be a big surprise. How positive would that be for financial markets? Coming tug-of-war between taper fears, inflation fears and earnings expectations.

For clues as to what might really happen, Nouriel Roubini conveniently just wrote one of his long, rear-view-mirror article for Institutional Investor in which he forecasts that

  • world economic growth will remain anemic for many more years to come;
  • unemployment rates will stay high;
  • inflation will remain subdued for a long time;
  • aggressive monetary policy will continue for a little while longer;
  • long term interest rates in advanced economies will remain low and rise only slowly

If, like me, you have been following Dr. Doom’s crystal ball since 2009, your inclination would be to bet on the other side of Roubini’s trades. Winking smile

(…) The market appears to be accepting that though yields are moving up, they remain low by historical standards and can be better absorbed if seen in conjunction with an improving economic backdrop.

And further evidence of that more optimistic scenario was provided on Thursday, when manufacturing surveys from China to the eurozone and the US came in better than expected. US house prices were also shown to have risen 7.7 per cent in the year to June, while weekly initial jobless claims remain near multiyear lows. (…)

  • German GDP Growth Gains Steam 

    Germany’s economy rebounded sharply in the second quarter from a weak start to the year, gaining steam from a pickup in investment and robust consumption, official data showed.

Gross domestic product swelled 0.7%, corresponding to an annualized rate of 2.9%, the national statistics office said. The figures confirm official estimates issued last week.

That makes Germany the fastest growing of the world’s largest industrialized economies in the second quarter.

(…) some of the activity recorded in the three months to June had been postponed from the first quarter, when a severe cold spell depressed industrial activity and construction.

German GDP data for the second quarter showed a healthy pickup in investment: construction spending jumped 2.6% from the first quarter, “partly due to weather-related catch-up effects,” the office said.

Investment in machinery and equipment increased 0.9% after six consecutive quarters of declines, indicating companies have healthy cash positions or access to favorable financing conditions.

Private consumption in Germany increased 0.5% from the first quarter, supported by low unemployment and rising wages. Public consumption increased 0.6%.

Exports rose 2.2% on the quarter, while imports increased 2.0%. The data is adjusted for inflation and accounts for seasonal swings as well as the number of working days in each quarter.


There is a high level of hope that the housing market will keep lifting the economy. Existing home sales have been stronger lately and expectations are that they will keep rising, boosting prices and pulling along new construction. Charts like this one (CalculatedRisk) feed the hope:

But we forget that the early 2000’s were bubble years. BMO Capital puts things into their proper perspective. Warning: this may deflate some of your expectations.

U.S. Resale Market Feeling Normal Again

The 6.5% jump in existing home sales to more than three-year highs of 5.39 million annualized in July has taken the level above long-term averages, normalized for the growing number of households. This compares with the market for new homes, where sales and starts are both well below normal despite solid gains in the past year. The role of investors, who account for one-in-six resale transactions, likely explains the difference.


Note that first-time buyers were 29% of July sales, unchanged from June, and down from 34% a year ago and the historical norm of 40%. Not a healthy market just yet.

Raymond James adds:

Interestingly, there may be some evidence that the surge of demand from rental-home investors may have begun to wind down, as the NAR reported 16% of homes purchased in July were bought by investors down from 17% last month and 22% in February (the cyclical peak). That said, we note that 31% of all sales in June were still “all-cash” transactions (normally less than 10%), indicating that investors and other affluent households still remain a critical component of current housing demand. With rising home prices, distressed sales continued to dwindle to just 15% of sales (the lowest level on record since tracking began in October 2008).

Listed inventory in July rose by 120,000 units from June to 2.28 million for-sale homes. Total listings are still down 5.0% y/y and months’ supply still registers at a very low 5.1 months (down from 6.3 months last year). Nevertheless, the sequential inventory increase (+5.6%) was larger than typical June-July patterns, as listings are typically flat between June and July (dating back to 1990).

Inventory increases have now exceeded historical patterns in five of the last six months. Given the recent pace of double-digit y/y price increases
in many markets across the country, it’s not terribly surprising that more sellers would begin to emerge.

Consumers Skip Dining for Cars as Sales Slow

Restaurant sales contracted in June and July, even as spending on other discretionary categories such as automobiles and homes grew, a sign some Americans remain budget conscious.

Results at casual-dining establishments fell 3.5 percent last month, following a 2 percent drop in June, according to the Knapp-Track Index. This marked the first two consecutive declines in the monthly index of restaurant sales after the industry was rocked by its worst streak in almost three years between December and February.

Preliminary data suggest that August sales still are weak, though “better than July,” said Malcolm Knapp, a New York-based consultant who created the index and has monitored the industry since 1970.

“Consumers’ priorities change every month based on what they can afford,” Knapp said. Many Americans don’t eat out as often as they would like, and they’ve had to cut back “very begrudgingly” on meals away from home to help subsidize other purchases.

Pointing up Restaurants and retailers have been among the most active employers in recent months.

Leading Index Signals U.S. Growth to Pick Up Into 2014


The Conference Board’s gauge of the outlook for the next three to six months increased 0.6 percent after no change in June.

Eight of the 10 indicators in the leading index strengthened in July, led by a widening gap between long- and short-term interest rates, higher stocks and more building permits. Fewer jobless claims and gains in factory orders also propelled the leading index last month.

Click to View

Here is a look at the rate of change, which gives a closer look at behavior of the index in relation to recessions.

Click to View(charts from Doug Short)

On the other hand:

This rise, however, was spearheaded by the three financial components (equities, credit spreads and yield curve). The steepening of the yield curve alone was responsible for half of the monthly increase in the LEI in July.

Excluding financial components, the gauge of future economic activity was only up 0.1% on the month. As today’s Hot Chart shows, the
behaviour of the LEI in this economic recovery has been very peculiar with little to no contribution from its non-financial components (there are seven of them). Four years into a recovery, it remains difficult to have strong convictions about the underlying strength of the U.S. economy. Under these circumstances, we believe that QE tapering by the Federal Reserve will proceed in slow increments. (NBF)



Hot smile  Central-Bank Moves Blur The View

The escalating role policy makers are playing in the foreign-exchange market is injecting new uncertainty into financial markets.

Central banks from Indonesia to Turkey to Brazil are stepping up efforts to fight steep declines in their currencies and protect vulnerable economies as investors pull cash from emerging markets.

These measures to support local markets are a sharp reversal from much of the past two years, when some of these same emerging-market central banks were trying to tame excessive currency appreciation.

On Thursday, Turkey’s central bank auctioned $350 million out of its reserves, making good on its promise to hold daily sales to support the lira.

Brazil’s central bank on Thursday said it would provide at least $60 billion more in dollar liquidity through the end of the year. Under the plan, the bank will offer $3 billion of dollar loans and swaps per week in regular auctions starting Friday.

Indonesian President Susilo Bambang Yudhoyono is expected on Friday to announce a “policy package” to stabilize the economy. (…)

The Fed released minutes Wednesday from its last policy meeting that did little to change investors’ expectations. The Philippines PSE Composite share index dropped 6% after markets reopened for the first time since Friday, while Indonesian stocks have shed 9% this week and Turkey’s are down 8%.

As money flows back to rich economies, developing countries face questions about how they will continue to fund economic growth and pay off their debts. A weaker currency can help on that front, spurring growth by boosting exports. But it also can trigger inflation, already viewed as too high in countries such as Brazil and India.

Some countries already have burned through foreign-exchange reserves with little to show for it. Turkey has spent about 15% of its reserves since May, while Nomura estimates Indonesia’s reserves are down 26% from their 2013 peak. Reserves in 21 emerging economies tracked by Nomura are down $153 billion from their peak this spring, a level of spending that hasn’t been seen since 2008, the bank said. (…)

Fed Burned Once Over Taper Now Twice Shy on QE3

U.S. central bankers have $3 trillion of losses reminding them they had better get their communications right should they decide to taper their bond purchases.

That’s how much global equity markets declined in the five days after Federal Reserve Chairman Ben S. Bernanke’s June 19 remarks that he may reduce his $85 billion in monthly securities buying this year and halt it altogether by mid-2014. His comments pushed the yield on the benchmark 10-year Treasury to a 22-month high.

Gillian Tett
Central bank chiefs must master art of storytelling

(…) Rather than operating the controls, moreover, central bankers also try to control economic outcomes by using words, not merely to influence price and interest rate expectations but to shape the mood. Thus the seemingly dry ritualistic texts that are issued each month – and supplemented by sober speeches – no longer merely describe policy; they are creating it too. Words are the weapon. (…)

At the European Central Bank, Mario Draghi has been masterful at delivering economic outcomes through words, as much as deeds. Indeed, what is most striking is that Mr Draghi has managed to reframe public discourse about the euro not so much by what he has said but what he implicitly persuaded us to assume. (…)

“[This] is about the creation of a monetary regime – a regime impelled by a series of communicative experiments … in which we are all participants, knowingly or not,” Prof Holmes argues. It is, he says, now defined “by the concept of a ‘public currency’, a term used in passing by Mervyn King, [former] governor of the Bank of England.” Central bankers now operate in an area where linguists, psychologists – and even anthropologists – know as much as economists. (…)

Narratives, narratives…(see EPSILON THEORY)

Clock  Coming soon at a theater near you: Lew warns Congress to strike debt deal US Treasury secretary fears risk of damage to economy

On a visit to Mountain View, California, in the heart of Silicon Valley, Mr Lew did not offer an exact deadline by when US lawmakers will need to strike a deal to raise America’s borrowing limit or face default. But analysts at the Bipartisan Policy Center, a think-tank, believe it will be somewhere between mid-October and mid-November, depending on the government’s cash flow.


Much has been written about current high profit margins and the risk of mean-reversion. BMO Capital takes another approach that I find interesting:

(…) regarding profit margins – it is extremely difficult for corporations to improve margins for long periods of time. Sooner or later organic growth is required to deliver results. Based on historical data the market
appears to be at an inflection point. For instance, using corporate profits as a percentage of nominal GDP as a broad proxy for US profit margins there have been only four other periods since 1950 where profit margins expanded for four or more consecutive years (Exhibit 1, left).

Interestingly, only two periods reached five years of profit margin expansion (market is currently in its fifth consecutive year of profit margin expansion). Following each of those periods, profit margins deteriorated quite significantly. In addition, current profit margins are at
all-time highs and well above one standard deviation from its average since 1950. As Exhibit 1 (right) shows, similar profit margin levels have proved to be short lived.


Given recent productivity and labor cost trends, we believe history is likely to repeat itself with profit margins having already peaked. This is important because following similar peak levels, market performance, EPS growth, and P/E levels tend to suffer in the period that follows. As
imageExhibit 2 illustrates, in the calendar year following an extreme peak in profit margins, market performance is slightly negative, price multiples contract while profits are roughly flat.

We believe this is explained by subdued productivity growth and increased labor costs during these periods (trends that are occurring now). What compounds matters is the fact that the current economic backdrop has been much weaker compared with those other periods where margins expanded significantly, yet market performance and valuation trends have been stronger. Whether or not the market is correctly anticipating stronger economic growth remains to be seen. Nonetheless, stronger economic growth is exactly what we believe will be required to keep EPS and market momentum intact.

Chart of the day: from Morgan Stanley’s Viktor Hjort via ZeroHedge


My good friend I. Bernobul wrote last week about a FT front page piece by James W. Paulsen, chief investment strategist at Wells Capital Management who was arguing that rising consumer confidence would more than offset slower earnings growth and rising bond yields as it apparently did in previous “remarkably similar cycles”.

Unfortunately, Paulsen provided no evidence of his assertions. However, it just happens that BMO Capital’s strategist published a chart correlating the equity risk premium with consumer confidence over the years. Nice of him to include the regression line to the scattergram; if this is what Paulsen means…how confident can you be?



The media are clearly in a positive mood these days.

U.S. Small-Business Owners Most Optimistic Since 2008

U.S. small-business owners are more optimistic now than at any time since late 2008. The Wells Fargo/Gallup Small Business Index improved to +25 in July, from +16 in the second quarter. The latest result, while not as high as pre-recession levels, is the highest index score since the third quarter of 2008.


Pointing up  Prior to the recession and financial crisis of 2008-2009, Small Business Index scores were generally in the triple digits. The Wells Fargo/Gallup Small Business Index was initiated in August 2003, reached its peak at 114 in December 2006, and hit its low point of -28 in July 2010.

The latest results are based on a national random sample of 603 small-business owners having $20 million or less of sales or revenues, conducted July 22-26.

Small-business owners’ ratings of their current operating environment are mostly flat compared with April. The Present Situation Dimension of the index was +4 in July, essentially the same as the +2 in the previous quarter. But, this is only the second time the Present Situation Dimension has been in positive — if still broadly neutral — territory since December 2008.


I’d say they’re just barely out of misery. But they are good spirited…

Fingers crossed  The increase in the overall index score comes more from owners’ improving future outlook than from their views of present conditions.

The Future Expectations Dimension of the index, which measures owners’ expectations for their business’ operating environment over the next 12 months, increased to +21 in July, up from +14 in April. Small-business owners are modestly more optimistic about their future operating environment compared with one year ago, when this dimension stood at +18.


…although really not that much more.

But here’s the real thing:

Small-business owners’ increased overall optimism correlates with their more positive views toward the ease of obtaining credit. Fewer business owners say they have experienced difficulty in the last 12 months obtaining credit, at 25%, than did so last quarter, at 30%.


My reading of the above chart is that “% easy” is flat but “% difficult” is down a little. Simple math suggests that “% unchanged” must be up, and this is unchanged from poor. Nothing “more positive” here.

FYI: Disruptive technologies: Advances that will transform life, business, and the global economy

The McKinsey Global Institute set out to identify which of these technologies could have massive, economically disruptive impact between now and 2025.



NEW$ & VIEW$ (21 AUGUST 2013)


Asian Shares Mixed After Sell-Off Asian stocks traded mixed following a dramatic two-day selloff across the region that sent governments in some markets rushing to stem further declines.

Emerging-Market Currencies Fall

Emerging-market currencies seen as most vulnerable to shifts in U.S. monetary policy slumped once again Wednesday, hours before the U.S. Federal Reserve is set to release minutes from its most recent policy meeting.

With traders and investors bracing for the possibility that the Fed will signal greater confidence that it will start peeling back, or tapering, stimulus measures from as soon as next month, some of the currencies that have been the biggest beneficiaries of the easy-money era fell hard. (…)

Malaysia Cuts 2013 Growth Forecast as Expansion Misses Estimates

The economy may expand 4.5 percent to 5 percent in 2013, from a previous prediction of as much as 6 percent, the central bank said in Kuala Lumpur today. Gross domestic product rose 4.3 percent last quarter from a year earlier, after gaining 4.1 percent in the previous period, it said.

Net exports of goods and services slumped 41.6 percent in the second quarter from a year earlier, after falling 36.4 percent in the first quarter of 2013, today’s report showed.

Total consumption rose 8 percent in the April-to-June period from a year ago after climbing 6.1 percent in the earlier quarter. Gross fixed capital formation gained 6 percent, after an increase of 13.1 percent in the previous period.

For Asia, Shades of 1997

The same toxic combination of U.S. and Japanese tightening that sparked the Asian financial crisis in 1997 is looming now. Time to freak out? Watch the dollar and yen, writes Vince Cignarella.

(…) Rewind to March 1997. Then, the Fed’s communications policy bore little resemblance to the current era of transparency, so inevitably some investors were taken aback when the central bank raised the discount rate, the rate at which the Fed lends money to commercial banks, to 5.5% from 5.25% after two years of trimming rates. (Remember, this was before fed funds targeting was in vogue.)

One month later, in April 1997, the Japanese government raised a nationwide consumption tax to 5% from 3%. This was seen at the time as a major contributing factor to Japan’s economy falling into a recession in Q41997.

Fast forward to today. The Fed is expected to usher in the beginning of the end of its bond-buying program, put in place after the financial crisis to stimulate growth. Whether the Fed makes a move in September or December will ultimately become a footnote in history. What’s important is that this tapering right now looks inevitable.

Meanwhile, Prime Minister Shinzo Abe is weighing an increase in the same exact consumption tax, to 8% starting April 2014 from the current 5%.

No wonder emerging markets in Asia are freaking out. By any measure, that’s a lot of money that’s going to stop making its way into the financial system. Say bye-bye to the search for yield and those “hot money” flows that propelled those markets higher. (…)

The question remains: Is this 1997 all over again?

So far, the market moves have been milder. A big reason: Many currencies back then were set at a fixed exchange rate against the dollar. Unmoored, the baht plunged 40% in four months after the central bank was forced to let it float in July 1997. A similar fate met the Indonesian rupiah when the crisis made the managed float rate impossible.

There are other differences this time around, as well. Before the Asian financial crisis, Japan helped drive the growth of the developing countries that neighbored it. This time around, China plays that role. And for all the hand-wringing about China’s growth outlook, no one is making any comparisons between China today and Japan in 1997.

So what’s an investor to do?

My approach: Keep close tabs on the dollar, especially how it trades against the yen. During the Asian financial crisis, investors looking for a safe place to camp out piled into the dollar. In April 1997, one dollar bought about 106 yen. By August 1998–at which point the crisis had spread to Russia and was causing U.S. stocks to reel–one dollar was fetching about 147 yen.

If the dollar begins to gain rapid ground against the yen, the Asian cold may turn into the Asian flu–a bug we’re all likely to catch.

Fingers crossed  Bloomberg offers hope thanks to Japan

The Fed’s surprise signal in May of the approaching tapering of asset purchases has unsettled emerging markets. Economies such as India and Indonesia, which are more reliant on foreign investment for growth and the funding of current account deficits, have been hit the hardest. The anxiety may not be justified, using past phases of Fed tightening as a guideline.

During 1999 and 2004-06, Asian GDP growth averaged 5.9 percent and currencies, after an initial bout of selling pressure, gained an average 5 percent against the U.S. dollar. The key this time will be the Fed’s ability to preserve risk appetite amid a leadership transition.





Chicago Fed Index Remains in Negative Territory

The Federal Reserve Bank of Chicago said Tuesday that its National Activity Index rose to -0.15 in July from -0.23 in June, while the less-volatile three-month moving average improved to -0.15 from -0.24.

It was the fifth straight month the two measures have remained in negative territory, indicating below-trend growth.

Doug Short adds this:

The next chart highlights the -0.70 level and the value of the CFNAI-MA3 at the start of the seven recession that during the timeframe of this indicator. The 1973-75 event was an outlier because of the rapid rise of inflation following the 1973 Oil Embargo. As for the other six, we see that all but one started when the CFNAI-MA3 was above the -0.70 level.

Click to View

The next chart includes an overlay of GDP, which reinforces the accuracy of the CFNAI as an indicator of coincident economic activity.

Click to View

Summer Jobs Elude Many Teenagers

The job-market recovery is leaving teenagers behind—especially those from low-income and minority backgrounds.

Less than a third of 16- to 19-year-olds had jobs this summer, essentially unchanged from a year ago, according to Labor Department data released Tuesday. Before the recession, more than 40% of teens had summer jobs. One in four teens who tried to find work failed to get a job, far above the 7.4% unemployment rate for the broader population.

Retailers, fast-food restaurants and other traditional employers of this cohort have stepped up hiring in recent months. But with the ranks of unemployed including many better-qualified candidates, companies have little incentive to hire inexperienced teenagers. With work still scarce, college students and even college graduates are settling for jobs once done mostly by teens, while at the same time more retirees are taking part-time jobs.



More on Job Growth Quality

(…) In short, yes, the U.S. economy is adding a large number of low-paying jobs, however we are also seeing relatively strong growth at the top end of the employment scale as well. We are missing the growth in jobs at the middle of the income distribution.



In short, the middle class is holed out.

Home Depot’s Earnings Rise 17%

For the first time since 1999, quarterly sales at Home Depot Inc.’s stores open at least a year rose at a double-digit rate, as the home-improvement retailer benefited from an improving housing market that has shoppers spending more freely on bigger ticket items like appliances and lawn mowers.

Amazing: Comps at Home Depot’s U.S. stores increased 11.4%. In F2Q, total transactions (traffic) increased 4.9% YoY to 393 million and average ticket increased 4.3% to $57.39.

Pointing up  Also note the following:

The Atlanta-based retailer has benefited from looser credit standards, as customers with lower credit scores were able to get approved for private-label credit cards, whose usage increased by 0.44%. The company’s professional customers, who represent 36% of its sales, also were able to attain increased lines of credit, which rose by an average $200 from a year earlier to $68,000. The company has been working with underwriters to help professional customers get extended credit lines.

Lowe’s Profit Up 26%, Boosts Outlook

Lowe’s Cos. fiscal second-quarter earnings jumped 26%, beating analyst expectations, and the home improvement retailer raised its outlook after logging double-digit percentage growth in revenue, buoyed by an improving housing market.

Net sales were up 10% to $15.71 billion, while same-store sales were up 9.6%. Gross margin widened to 34.4% from 33.9%.

The company also raised its financial outlook for the year, now expecting per-share earnings of $2.10 on sales growth of 5% and same-store sales growth of 4.5%. Its previous expectation was for share earnings of $2.05 on sales growth of 4% and same-store sales growth of 3.5%.

But the recent rise in mortgage rates seems to be biting as this chart from CalculatedRisk shows:



Iran Fills Rhetoric Void With Bullish Words on Oil Iran is willing to start an oil-price war to win back the market share lost through sanctions.

Iran is willing to start an oil-price war to win back the market share lost through sanctions, Bloomberg reports.

The country’s new, old oil minister Bijan Zanganeh says Iran wants to increase production by 70% in an effort to retake its place as OPEC’s second-largest producer.

“We only ask those who have replaced us in the world’s oil markets to know that when we are re-entering these markets they will have to accept that the oil prices decline or they should reduce their production to create enough space for Iran’s oil,” Mr. Zanganeh said.

It is the use of “only” in that sentence that stands out. There may or may not be a transliteration error, but the minister isn’t asking a small favor here. Internal OPEC politics mean the group’s other members won’t roll out the red carpet for the return of Iranian oil.

Iran already needs oil to trade way above where it now is in order to break even. A price war would be in nobody’s interests.

Can Iran even manage to increase its production? Bullish noises come from the state oil company, and Mr. Zanganeh, who was an oil minister from 1997 to 2005, has been welcomed as an authoritative, knowledgeable figure who will remove the politics from domestic oil production.

Raising production will likely require the return of those foreign, western oil majors — Norway’s Statoil ASA, France’s Total or Italy’s Eni – that quit Iran when sanctions hit. Getting them back will likely require the lifting of sanctions.


News of violent unrest in Libya has been flying under the radar somewhat in the face of the ructions in Egypt, but for the oil market the former situation is easily the one that is more interesting.

Libya last year was the fourth-largest oil supplier to Europe.

Clashes erupted Tuesday at oil terminals that had been closed in eastern Libya, The Wall Street Journal’s Benoit Faucon reports, with more peaceful protests at other terminals helping to cut the North African country’s oil production to levels not seen since the 2011 civil war that toppled strongman Moammar Gadhafi.

Remarks made to the Journal by Libya’s deputy oil minister this week suggest the government is running out of patience with the situation. This isn’t surprising — the disruption has cost the country over $1 billion in lost revenue to date.

Conflicting reports are only adding to an already-confusing situation. One day Libya invokesa legal clause known as force majeure, which excuses a seller from making deliveries because of events beyond its control; the next, ports are being prepared for reopening.

There is no certainty about anything in the world of Libyan oil.



Leveraged ETFs, the Flash Crash, and 1987

(…) You could be forgiven if you’ve never heard of leveraged ETFs. But this smallish corner of the investing universe could, under the right circumstances, do to the market what portfolio insurance did to the market in 1987: that is, force a liquidation that sparks a big selloff.

At least, that’s the suggestion of a new paper from the Federal Reserve Board, written by staffer Tugkan Tuzun. He likens leveraged ETFs to the portfolio insurance schemes of the 1980s, which are believed to have either contributed to or even caused the great crash of October 1987, when the Dow Jones Industrial Average dropped 22% in one day.

Portfolio insurance was a popular hedging strategy in the ’80s that used options, and “synthetic options,” to protect against losses. But it involved a daily rebalancing that, in October 1987, led to a “cascade” of sell orders that exacerbated what happened on Oct. 19, 1987.

That kind of one-day drop would be much harder to produce today, given the circuit breakers that were installed specifically in response to the ’87 crash. But the point of the Fed paper is that leveraged ETFs could, under the right conditions, produce a similar cascade of sell orders, amplifying the severity of any market drop.

Leveraged ETFs date back only to 2006, and have only about $20 billion in total assets. The key here, though, is what’s called rebalancing, which these funds typically do on a daily basis. Because these funds promise a certain multiple over the underlying exchange it’s tracking, the funds use derivatives and borrowed money to amplify their returns. Also, to maintain those returns, the fund managers must buy when the market is going up, and sell when it’s going down.

That’s where the 1987 connection comes in. What is generally believed to have happened in 1987 – it is still a debated subject – was that once the selling started, the portfolio insurance strategies demanded investors sell, resulting in a massive wave of sell orders.

Leveraged ETFs could bring about the same dynamic, Tuzun writes. Imagine a situation where the market is selling off. “LETF rebalancing in response to a large market move could amplify the move and force them to further rebalance, which may trigger a ‘cascade’ reaction.” If the fund is using swaps, counterparties are likely hedging their positions in equities or futures markets. Thus, a forced selloff of leveraged ETFs could, through derivatives and counterparties, wind up moving the cash stock markets.

Moreover, because most of this daily rebalancing occurs in the last hour or so of trading, a cascade of selling could amplify late volatility and drive indexes down near the close, leading to “disproportionate” price changes. (…)

I was managing equities in 1987 and Black Monday is still very much present in my mind. That was a scary day!

It was not caused by portfolio insurance, rather by a total loss of confidence in the willingness of world central bankers to cooperate and coordinate their actions in order to correct the imbalances in world currency markets.

This happened as U.S. equities were selling at very risky levels as per the Rule of 20. As portfolio insurance kicked in after the first down draft (whew!), markets sank further. The overvaluation quickly changed into a deep undervaluation creating a terrific buying opportunity for those who understood that this was not the end of the world.



Just kidding Mohamed El-Erian
Don’t wait for autumn to reposition portfolios


The next few months promise to be particularly tricky and volatile for markets, with uncertainty coming from the US, Europe, Japan and the Middle East. (…)

In the US, the Federal Reserve is expected to signal at its September policy meeting its appetite for tapering its exceptional support for markets and the economy. (…)

September may also bring news of the next chairman of the Federal Reserve. (…)

Then there is America’s highly polarised Congress. When they return from their summer recess, lawmakers will be unable to avoid for long two important pieces of legislation: the immediate one required for the continued functioning of the government; and that needed to avoid a technical sovereign default a few months down the road. (…)

The situation across the Atlantic is also quite uncertain. With German elections in September, and with few wishing to undermine Chancellor Angela Merkel’s likely victory, several national and regional initiatives have been placed on hold. This summer pause has reduced policy disagreements; but at the cost of heavily burdening the autumn policy agenda facing officials who have repeatedly proven reluctant to take prompt decisions absent crisis-like conditions. (…)

In Japan, delays in unveiling the “third policy arrow” are undermining the policy pivot implemented by the Bank of Japan at the behest of Prime Minister Shinzo Abe. Judging from the recent sell-off in Japanese equities and the behaviour of the currency, markets are already signalling that Japan’s policy experiment will falter if exceptional monetary and fiscal stimulus is not accompanied quickly by structural reforms. (…)

Then there is the Middle East. (…)

Rising Stocks Hit Short Sellers  Short sellers are facing their worst losses in at least a decade, a Wall Street Journal analysis has found, as many of the rising stocks they bet against have only continued to soar.

(…) [image]In the Russell 3000 index, the 100 most heavily shorted stocks are sharply outperforming the average returns of stocks in the index, according to a Journal analysis of data provided by S&P Capital IQ. The shorted stocks are up by an average of 33.8% through Aug. 16, versus 18.3% for all stocks in the index.

The gap between the performance of the most-shorted shares—as measured by percent of total shares outstanding at the beginning of the years—and the market as a whole is wider than it has been in at least a decade. (…)

Stock hedge funds are expected to outperform when markets fall but underperform during bull runs, since they generally hedge their bets by betting against stocks. But the gap is wider than usual. Through July, stock hedge funds returned 7.7% on average, compared with 19.6% by the Standard & Poor’s 500-stock index, including dividends. (…)