NEW$ & VIEW$ (27 JANUARY 2014)

Emerging markets turmoil intensifies
Turkish central bank calls emergency meeting to tackle falling lira

The emerging markets sell-off intensified on Monday with stocks heading for their worst day in almost six months even before Latin American bourses opened, and currencies weakened further until the Turkish central bank prompted speculation it might raise rates by calling an emergency meeting. (…)

The FTSE Emerging Markets index was 1.4 per cent down in early afternoon London trading on Monday – and is more than 6.2 per cent weaker for the year. Hong Kong’s stock market fell 2.1 per cent, Taiwan’s tumbled 1.6 per cent and Indonesia’s dropped 2.6 per cent. (…)

U.S. Markets Tumble as Fear Spreads

U.S. stocks tumbled Friday to their biggest loss in more than seven months, extending a global selloff that investors fear signals turmoil to come as financial markets adjust to a pullback in central-bank stimulus.

The Dow Jones Industrial Average fell 318.24 points, or 2%, to 15879.11. The Stoxx Europe 600 lost 2.39%, and Germany’s DAX, down 2.48%, had its sharpest fall in months. The Nikkei also fell 1.94%.

While those drops were dramatic, much of the pain of investors’ readjustment is landing on developing economies, from Brazil and India to Thailand and South Africa. (…)

Friday’s swoon was notable for its breadth—nearly all major equity markets were in the red. In foreign-exchange markets, the selloff began with currencies such as the South African rand and Turkish lira that have been viewed as vulnerable because of sluggish domestic growth. But it soon spread to currencies of countries with relatively solid fundamentals, such as Mexico’s peso and South Korea’s won. Currencies also slid in Eastern Europe. (…)

WHAT NOW?

When equity markets foray into not-so-cheap territory, investors get nervous and edgy, ready to jump ship at the first alarm bell, justified or not. Even more so if the Fed is off the gas pedal. Argentina, South Africa and Turkey cannot wag the U.S. economic dog, but they can wag its financial dog for a while. Here’s Ben Hunt’s take on this latest EM rout:

For 20+ years there has been a coherent growth story around Emerging Markets, where the label “Emerging Market” had real meaning within a common knowledge perspective. Today .. not so much. Today the story is that it was easy money from the Fed that drove global growth, EM or otherwise. Today the story is that Emerging Markets are just the levered beneficiaries or victims of Fed monetary policy, no different than anyone else.

In my note, (It Was Barzini All Along), I’m not asking whether the growth rate in this EM country or that EM country will meet expectations, or whether the currency in this EM country or that EM country will come under more or less pressure. I’m asking if the WHY of EM growth and currency valuation has changed. The WHY is the dominant Narrative of a market, the set of tectonic plates on which investment terra firma rests. When any WHY is questioned and challenged – as it certainly is in the case of EM markets today – you get a tremor. But if the WHY changes you get an earthquake.

What are the investments that such an earthquake would challenge? You don’t want to be short the yen if this earthquake hits. You don’t want to be long growth or anything that’s geared to global growth, like energy or commodities. You don’t want to be overweight equities and underweight bonds. You don’t want to be overweight Europe. There .. did I cover one of your favorite investment themes? Bet I did. You can run from EM’s with US equities, but with S&P 500 earnings driven by non-US revenues you cannot hide. If you think that your dividend-paying large-cap US equities are immune to what happens in China and Brazil and Turkey .. well, good luck with that. My point is not to sell everything and run for the hills. My point is that your risk antennae should be quivering, too.

The U.S. “investment terra firma”, for now, is in Q4 earnings:

EARNINGS WATCH

Factset gives us a good rundown after the first quarter:

Overall, 123 companies have reported earnings to date for the third quarter. Of these 123 companies, 68% have reported actual EPS above the mean EPS estimate and 32% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is below the 1-year (71%) average and the 4-year (73%) average.

Note that S&P’s tally shows 66% beats and 24% misses.

In aggregate, companies are reporting earnings that are 2.7% above expectations. This surprise percentage is below the 1-year (3.3%) average and the 4-year (5.8%) average. Companies in the Information Technology (+6.6%) are reporting the largest upside aggregate differences between actual earnings and estimated earnings. On the other hand, companies in the Industrials (+0.7%) sector are reporting the smallest upside aggregate differences between actual earnings and estimated earnings.

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In terms of revenues, 67% of companies have reported actual sales above estimated sales and 33% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the average percentage recorded over the last four quarters (54%) and above the average percentage recorded over the previous four years (59%).

In aggregate, companies are reporting sales that are 0.7% above expectations. This percentage is above the 1-year (0.4%) average and above the 4-year (0.6%) average.

The blended earnings growth rate for Q4 2013 of 6.4% is slightly above the estimate of 6.3% at the end of the quarter (December 31). Four of the  sectors have recorded an increase in earnings growth during this time frame, led by the Information Technology (to 5.9% from 3.3%) sector. Five of the ten sectors have seen a decline in earnings growth since the end of the quarter, led by the Energy (to -10.9% from -8.0%) and Consumer Discretionary (to 3.7% from 6.2%) sectors.

The Financials sector has the highest earnings growth rate (23.5%) of all ten sectors. It is also the largest contributor to earnings growth for the entire index. If the Financials sector is excluded, the earnings growth rate for the S&P 500 falls to 3.1%.

Other than Energy and Consumer Discretionary, the earnings season is going pretty smooth so far.

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In fact, earnings estimates for Q4’13 have been rising in recent weeks from their low point of $28.14 on Jan. 9 to their current $28.77, a not insignificant 2.2% creep up. As a result, trailing 12 months EPS would reach $107.82 after Q4.

But there is this new variable:

Multinationals Start Warning on Q1 Currency Impacts

As currencies in emerging markets tumbled this week, Procter & Gamble Co. and Stanley Black & Decker Inc. warned investors Friday their earnings could take a hit. (…)

Procter & Gamble’s cautioned investors that foreign-exchange swings in the fourth quarter shaved 11 cents a share off earnings, which came in at $1.18 a share. And there’s not much, the company can do to offset the damage, said Jon Moeller, chief financial officer, according to a transcript of a conference call provided by FactSet.

(…) And though the company is still looking for ways to hedge financially, much of its currency woes stem from countries like Egypt, Venezuela, Argentina and Ukraine, “where there really isn’t a financial hedging option.” And even in countries where hedging is possible, “the cost of forward hedging gets pretty prohibitive.” (…)

Stanley Black & Decker CFO Donald Allan said currencies, including the Canadian dollar, Brazilian real and Argentine peso, dragged down earnings and would continue to do so this year. While the euro showed strength over the course of 2013, he said the Canadian dollar fell 11% against the dollar last year, the real lost 15% and the peso plunged 40%.

“We saw about $60 million of negative currency effects in 2013, primarily in the back half of the year,” Mr. Allen said on a conference call. “We would expect a very similar number to occur in the first half of the 2014, which would equate to about a 30-cent negative to in [earnings per share].”

The toolmaker reiterated its guidance for earnings of 2014 earnings of $5.18 to $5.38.

That said, Factset finds little panic among companies, so far:

Q1 Guidance: At this point in time, 25 companies in the index have issued EPS guidance for the first quarter. Of these 25 companies, 18 have issued negative EPS guidance and 7 have issued positive EPS guidance. Thus, the
percentage of companies issuing negative EPS guidance to date for the first quarter is 72% (18 out of 25). This percentage is above the 5-year average of 64%, but below the percentage at this same point in time for Q4 2013 (86%).

Nine of the 18 companies with negative guidance are in IT, 5 in Consumer Disc. and 3 in Health Care.

Analysts are paring down their expectations for Q1 however:

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Using S&P numbers, Q1’14 estimates are now $28.30, down 0.6% from their level of 2 weeks ago. Trailing 12-month EPS would thus reach $110.35, up 2.3% from their expected Q4’13 level. Full year 2014 estimates have been shaved 0.3% to $121.09, up 12.3% YoY.

For the third time since 2009, the S&P 500 Index failed to cross the “20” line on the Rule of 20 barometer. If it were to retreat to the 15-16 Rule of 20 P/E range like it did in 2010 and 2012, the S&P 500 Index would decline to between 1435 (another -20%) and 1540 (-14%), assuming inflation is 1.7%. Given the current state of the world economy (good in the U.S., better in Europe and OK in China), it seems doubtful that we would revisit such deep undervaluation territory. Central banks would no doubt intervene and keep the financial heroin plentiful.

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Given that trailing earnings remain in an uptrend and that inflation is stable, my sense is that the still rising 200-day (1700) moving average will hold the rout to another 5%. The Rule of 20 P/E would then be 17.5, right in the middle of the 15 (deep undervalue) and the 20 (fair value) range. In both the 2010 and 2012 corrections, the Rule of 20 Fair Index Value (yellow line on chart) was declining as inflation picked up temporarily, conditions not currently present.

Also consider that for most global investors, the U.S. must currently be seen as the only trustworthy terra firma from economic, financial and political points of view.

That said, volatility and caution will likely remain for a while. Furthermore, as Lance Roberts’ chart shows, investors are highly leveraged at this time, pretty dangerous if the rout continues.  image

I see no rush to step back in following my Jan. 13 post TAPERING…EQUITIES.

Moody’s Affirms France Rating

The ratings firm, which rates France Aa1, said it kept the negative outlook due to continuing reduced competitiveness in the nation’s economy, as well as the risk of further deterioration in the financial strength of the government.

“Although the French government has introduced or announced a number of measures intended to address these competitiveness and growth issues, the implementation and efficacy of these policy initiatives are complicated by the persistence of long-standing rigidities in labor, goods and services markets as well as the social and political tensions the government is facing,” Moody’s said. (…)

France’s fiscal policy flexibility is limited, which, together with the policy challenges noted above, imply a continued risk of missing fiscal targets,” the firm added. (…)

Markit adds that France official data overstate the reality:

image[A recent Markit] analysis suggests France official GDP data may have overstated growth in the French economy since 2012.

A divergence between the PMI and GDP has been evident since the third quarter of 2012. (…) Up to the third quarter of 2013 (the latest available data point), GDP has risen 0.3%. This growth has helped bring the French economy to within 0.2% of its precrisis peak reached in the first quarter of 2008.

However, the PMI has painted a far weaker picture of the French economy. The composite PMI, which is a GDP-weighted average of the PMI surveys’ manufacturing and services output measures, has been below 50 (thereby signalling falling output) in every month since March 2012 with the exceptions of September and October 2013. Furthermore, the rates of decline signalled by the PMI have been strong over much of this period – exceeding those seen in the prior survey history with the exception of the height of the financial crisis in 2008-9.

Importantly, much of this discrepancy can be accounted for by the fact that PMIs only cover private sector activity. The output of the government sector, which accounts for 25% of GDP, has grown 2.1%
since the second quarter of 2012. Excluding the government sector, GDP is in fact 0.2% lower than the second quarter of 2012 and still some 3.2% below its pre-crisis peak. Stripping out government spend brings the GDP data more into line with the PMI. (…)

The recent (weaker) trends signalled by the PMI survey are confirmed by INSEE’s own surveys of manufacturing and services. (…) Chart 4, which plots the INSEE survey results against growth of non-government GDP, adds confirmation to the PMI message that the official data may have overstated growth in recent quarters. (…)

The PMI exhibits a much higher correlation with official data than both INSEE and Banque de France surveys, whether we look at manufacturing, services or a weighted combination of the two sectors. The track record of the surveys therefore adds weight to the suggestion that the GDP data have been overstating the health of the economy since mid-2012.

imageThe possible overstatement of economic growth by the official data and Banque de France surveys is also something which is indicated by the employment data. Chart 7 shows that a clear divergence between the
official data on output and employment has become evident. Between mid-2012 and mid-2013, nongovernment GDP was flat but private sector
employment dropped by 153k (0.9%). To put this in context, the fall in employment was the steepest seen over such a period in recent history (since 1999) with the exception of the height of the 2008-9 financial crisis.

Rather than concluding that the French economy has undergone a period of rapid productivity growth, it is possible that the fall in employment over this period is another indication that GDP data have overstated output. To investigate this more closely, we look at the survey data on employment. Here we can see that the survey that has corresponded most closely with the upbeat GDP data over the past two years – namely the Banque de France survey – appears to have overstated employment growth.

Importantly, the PMI survey data on employment have not diverged from the official data. The PMI has in fact exhibited a correlation of some 89% with private sector employment excluding agriculture since the survey data were first available in 1998, outperforming the INSEE and Banque de France surveys. (…)

European banks have 84 billion euro capital shortfall, OECD estimates: report

European banks have a combined capital shortfall of about 84 billion euros ($115 billion), German weekly WirtschaftsWoche reported, citing a new study by the Organisation for Economic Cooperation and Development (OECD).

French bank Credit Agricole has the deepest capital shortfall at 31.5 billion euros, while Deutsche Bank and Commerzbank have gaps of 19 billion and 7.7 billion respectively, the magazine reported in a pre-release of its Monday publication. (…)

Confused smile STRANGE QUOTES

Marc Faber: What I recommend to clients and what I do with my own portfolio aren’t always the same. (…) About 20% of my net worth is in gold. I don’t even value it in my portfolio. What goes down, I don’t value. (…) I recommend the Market Vectors Junior Gold Miners ETF [GDXJ], although I don’t own it. I own physical gold because the old system will implode. Those who own paper assets are doomed. (Barron’s)

 
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NEW$ & VIEW$ (23 JANUARY 2014)

EMPLOYMENT SUPPLY/DEMAND (Cont’d)

Lance Roberts points out the jump in the Quits/Layoffs ratio which also suggests un tight supply/demand balance.

“Quits are generally voluntary separations initiated by employees. Quits are procyclical, rising with an improving economy and falling with a faltering economy. Layoffs and discharges are generally involuntary separations initiated by an employer and are countercyclical, moving in the opposite direction of quits. The ratio of the number of quits to the number of layoffs and discharges provides insight into churn in the labor market over the business cycle.

 
Boost for Spain as unemployment dips
Latest sign pointing to a nascent economic recovery

The number of unemployed people in Spain dropped slightly in the final quarter of last year, the first such fall in a decade and the latest in a series of broadly encouraging signs that point towards a nascent economic recovery in the country.

The data, contained in a labour market survey released on Thursday, are likely to bolster confidence in the Spanish economy at a time when investors are piling into the country’s sovereign debt and other assets on a scale not seen since the start of the crisis.

S Korea records fastest growth in 3 years
Robust domestic demand powers strong growth

Gross domestic product rose by 3.9 per cent in the last three months of 2013 from a year earlier, broadly in line with economists’ forecasts. In a break from the trend of recent years, the contribution to growth of domestic demand – or total purchases of goods and services – outstripped that of exports, the Bank of Korea said on Thursday.

However, confidence in South Korea is tightly linked to exports, which account for more than half of GDP, and economists said the improved domestic demand was based on growing faith in the strength of the global recovery, with South Korean exports growing 4.3 per cent last year. (…)

Companies’ investment in machinery and transport equipment fell heavily over most of the past two years, reflecting nervousness among manufacturers about overseas demand. But it rose by an annual 9.9 per cent in the fourth quarter, and this rebound was set to continue into the new year, said Kwon Young-sun, an economist at Nomura. (…)

Dollar sinks below 90¢ as Poloz ‘declares open season on loonie’

(…) Yesterday, it plunged below 91 cents U.S. after the Bank of Canada released its rate decision and monetary policy report that, over all, suggests interest rates aren’t going anywhere at any time soon because of its focus on stubbornly low inflation.

Pointing up Coupled with that was a line in the report that warned the currency “remains strong and will continue to pose competitiveness challenges for Canada’s non-commodity exports” even with its stunning loss over the past year.

“Until today, the Bank of Canada had been careful not to open talk down the loonie,” chief economist Douglas Porter of BMO Nesbitt Burns said late yesterday in a research note titled “BoC declares open season on loonie.”

“They effectively gave sellers the green light in today’s monetary policy report by stating that even with the big drop in recent weeks, it remained high and would still ‘pose a competitiveness challenge for Canada’s non-commodity exports,” he added. (…)

Some observers also believe that this is a deliberate move by Canadian policy makers to devalue the currency in a bid to boost the country’s exports, as a weaker loonie lowers the cost of Canadian goods in the United States.

The Bank of Canada denies any such thing, but everyone agrees that Mr. Poloz, while not driving down the dollar, is pleased with the outcome. (…)

THE BoC DOES NOT NEED TO CUT RATES
 

In Canada, low inflation and disappointing job creation have prompted many to ask whether the Bank of Canada (BoC) will need to ease in 2014. At this writing the OIS market is putting the odds of a rate cut by September at 33%. The question is legitimate, but we think the depreciation of the Canadian dollar is doing the job for the Bank.

An old rule of thumb was that a 10% depreciation of the Canadian dollar would add 1.5% to GDP over time. That was when the penetration of
Canadian exports in the U.S. market was stronger. Our share of U.S. imports has been declining since even before the last recession. Moreover, Canadian manufacturing capacity has shrunk as producers have restructured their operations in the wake of the Great Recession. So that rule of thumb is surely too optimistic by now.

Yet even if the impact of the exchange rate on the economy were only a third of what it used to be, the 9.5% drop in the effective exchange rate since January 2013, if sustained, would over time add 0.4% to GDP. As
today’s Hot Chart shows, that is probably as large a boost to the economy as would be expected from a BoC rate cut of 50 to 75 basis points. (NBF)

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Rouhani outlines growth plan for Iran
President calls for greater engagement with rest of the world

Hassan Rouhani, president of Iran, on Thursday predicted that his country had the potential to be one of the world’s top 10 economies in the next three decades if sanctions were lifted and economic ties normalised.

In an upbeat and conciliatory speech at the World Economic Forum in Davos, Mr Rouhani reiterated that developing nuclear weapons “has no place in Iran‘s security strategy” and forecast that ties with Europe would be “normalised” as the interim nuclear agreement is implemented.

Mr Rouhani said he intended to remove “all political and economic impediments to growth” in Iran and that one of his priorities was “constructive engagement with the world”. (…)

For its part, Iran intends to “reopen trade, industrial and economic relations with all of our neighbours”, he said, naming Turkey, Iraq, Russia, Pakistan, Afghanistan and Central Asia. (…)

Iran’s economy shrank more than 5 per cent in the last fiscal year as international sanctions imposed in response to the country’s nuclear programme took their toll. (…)

Benjamin Netanyahu, the Israeli prime minister, who is due to address the forum later on Thursday, described the speech as a continuation of “the Iranian campaign of deception”.

In a long post on his Facebook page he warned: “The international community mustn’t fall for this deception once again, and it must prevent Iran from being capable of manufacturing nuclear weapons.” (…)

SMALL IS BEAUTIFUL?

Chart from Citi Research (via ZeroHedge)

BUYBACKS BACK PRICE GAINS

Investing in the 100 stocks with the highest buyback ratios had a 49 percent total return for 2013. The S&P 500 Index gained 32 percent, and the CDX High Yield Index returned about 14 percent, including the 5 percent coupon. (BloombergBriefs)

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EARNINGS WATCH

Bespoke give us its tally of all NYSE companies:

Earnings and Revenue Beat Rates Decent So Far

Of the 121 companies that have released earnings since the Q4 2013 reporting period began, 68% have beaten bottom-line EPS estimates.  As you can see, 68% would be a strong reading if it holds. Keep in mind that it’s still very early, though.  More than 1,000 companies are set to report over the next few weeks, so the beat rate could fluctuate a lot.

Top-line sales numbers have been a little less rosy than the more-easily manipulated bottom-line numbers.  As shown in the second chart below, 57% of companies have beaten revenue estimates so far this season.  While this isn’t a stellar reading, it is better than all but one of the earnings seasons we’ve had since the start of 2012. 


CFOs Warn Investors on Impact of Expired R&D Tax Credit

Companies are flagging investors they may face higher tax rates this year because the U.S. tax credit they use to offset some research and development expenses expired at the end of last year.

As first quarter conference calls get going, companies ranging from Johnson & Johnson to Textron Inc. are providing detailed information about the missing credit. While chief financial officers widely expect Congress to reinstate the credit, companies cannot factor in the tax credit into their financial results unless it is current law.

Companies, including Johnson & Johnson, are warning the lapsed tax credit for research and development could boost their tax rate.

The impact for many companies could be significant. Because the credit was retroactively extended for 2012 at the beginning of 2013, many companies recognized five quarters of tax credits in the first quarter of last year, but will recognize zero in the first quarter of 2014. (…)

While the credit often expires and is retroactively enacted, Congress has only once allowed it to lapse completely in 33 years. Some companies are confident enough to continue giving financial guidance with the assumption it will be extended, while others are hedging their bets. (…)

 
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NEW$ & VIEW$ (15 JANUARY 2014)

Consumers Spent Solidly in December

Just kidding This is the WSJ’s headline today. Below is the reality:

U.S. Retail Sales Post Moderate Year-End Increase

Retail spending increased 0.2% (4.1% y/y) during December after a 0.4% November gain, revised down from 0.7%. For all of last year retail sales increased 4.3%, the weakest increase of the economic recovery.

A 1.8% reduction (+5.9% y/y) in sales of motor vehicles & parts held back the increase in overall December sales. Nonauto retail sales rose 0.7% (3.7% y/y) after a 0.1% November uptick. Nonauto sales rose 3.4% during all of 2013, also the weakest gain of the recovery.

Higher sales of food & beverages led last month’s sales with a 2.0% gain (4.2% y/y) following two months of slippage. Clothing & accessory sales increased 1.8% (5.2% y/y) after a 0.5% November dip and gasoline service station sales rose 1.6% (0.6% y/y), after two months of decline. Sales of nonstore retailers showed continued strength with a 1.4% jump (9.9% y/y) following a 1.6% November gain. Furniture store sales dropped 0.4% (+4.5% y/y) after a 0.2% decline and building materials & garden equipment store sales slipped 0.4% (+2.1% y/y), down for the third month in the last five.

Not easy to get a clear measure of retail sales given the calendar quirks and bad weather. It is best to look at average sales growth for November and December.

  • Total retail sales: +0.3% (Nov.-Dec. avg) vs +0.5% in October.
  • Autos and Parts:  +0.1% vs +1.0%.
  • Non Autos ex Gas and Building Supplies: +0.5% vs +0.6%

Surprised smile Total sales for the October through December 2013 period were up 1.0% YoY.

Note that these figures are subject to big revisions. November’s surprising 0.7% original gain was revised down to 0.4%.

Pointing up U.S. Business Inventories Increase Slows

Total business inventories increased 0.4% in November (4.0% y/y), the slowest increase in three months. This inventory rise accompanied a 0.8% jump (4.0% y/y) in business sales after October’s 0.5% increase. As a result, the inventory-to-sales ratio remained at 1.29, where it’s been since April.

Pointing up In the retail sector, inventories advanced 0.8% (7.3% y/y) in November, including a 1.3% jump (13.7% y/y) in motor vehicles. Inventories excluding autos rose 0.6% (4.4% y/y).

Sad smile Taking the 3 months to November, retail inventories rose 2.9% sequentially while sales advanced only 0.7%. Ex-Autos: +1.3% vs +0.5%.

As I have been warning, there is clearly an inventory problem entering Q114. If you don’t believe me, read this:

Auto AutoNation CEO Calls U.S. Vehicle Inventories Too High

AutoNation Chief Executive Mike Jackson says new-car supplies in the U.S. are rising rapidly, putting pressure on auto companies as they try to avoid a profit-sapping price war.

(…) U.S. dealers have about $100 billion worth of unsold cars and trucks sitting on their lots, Mr. Jackson said. That level is striking given that car makers have pledged not to overstock dealers the way they did in the run-up to the financial crisis and the auto-sales collapse of 2008-2009, Mr. Jackson said. Auto makers book revenue when a car is shipped, not when it is sold at the dealership.

At the end of 2013, auto dealers had 3.45 million cars and trucks in stock, enough to last 63 days at the current selling rate, according to research firm Autodata Corp. A 60-day supply of cars is typically considered as healthy by the industry.

High five But Mr. Jackson said the inventory levels are much higher than that—closer to 90 to 120 days of supply—if cars sold to fleets are excluded from the selling rate. (…)

AutoNation’s Mr. Jackson said discounts are starting to rise across the industry already, even if they aren’t as obvious to consumers.

Among them are “stair-step programs” where car companies give money directly to dealers in exchange for hitting monthly sales targets.

“What worries me is if the industry was as disciplined as it says it is we would have stopped before 3.5 million” vehicles at dealerships, Mr. Jackson said. He sees about a 50-50 chance the industry will resort to an all-out discount war.

“What I’m saying is you’re on the edge of a slippery slope and even sliding down it a bit,” he said. “It’s a risk.”

Auto Makers Dare to Boost Output

A string of new factories in the region will start cranking out a million or more cars over the next several years.

A large increase in production capacity poses a serious risk for auto makers. They reap strong profits if their factories are running near 100% of capacity, but their losses mount rapidly if the utilization rate falls below 80%. (…)

Some auto makers are already concerned about overcapacity.

“The last thing we need is to get bricks-and-mortar capacity increased,” Sergio Marchionne, chief executive of Chrysler Group LLC and Fiat SpA, said this week. Building new plants isn’t the only trend to watch, he added, because increasing the use of automated production lines can boost output at existing factories. (…)

Magna warns 2014 sales likely below analysts’ estimates

Canadian auto-parts giant Magna International Inc. is forecasting 2014 sales that are below analysts’ estimates.

Aurora, Ont.-based Magna said on Wednesday in its financial outlook that it anticipates total sales of between $33.8-billion (U.S.) and $35.5-billion in 2014, lower than the consensus analysts’ estimate of $35.8-billion.

Jobs Deal Collapses in Senate

(…) After more than a week of talks, lawmakers failed to reach agreement to revive benefits for the roughly 1.4 million people who have lost aid since last month. Senate Democrats rejected the latest proposal from a group of eight Republicans, while GOP lawmakers dismissed an overture from Senate Majority Leader Harry Reid (D., Nev.) to allow votes on a handful of Republican amendments.

The law that expired in December dates from the financial crisis and provided federal aid to supplement the 26 weeks of unemployment benefits provided by most states, giving up to 47 weeks of additional payments. The latest proposals from both Democrats and Republicans would scale that back to a maximum of 31 weeks. (…)

Several lawmakers said they hope to continue negotiations, but the Senate isn’t expected to return to the issue until late January after next week’s congressional recess. The Senate is shifting its focus on Wednesday to consider the short-term stopgap spending bill to prevent a partial government shutdown and the $1.012 trillion bill to fund the federal government through Sept. 30, the end of the current fiscal year. (…)

HOUSING WATCH

From Raymond James:

  • California’s November existing single-family home sales fell 3.4%, on a seasonally-adjusted basis relative to October as rising home prices and higher mortgage rates reduced affordability. Closed sales stood at the lowest level since July 2010, falling to an annual run rate of 387,520 units (down 12.0% y/y). We note on a sequential basis, sales fell for the fourth consecutive month in November and have now declined on a year-over-year basis in ten of the last eleven months. California’s non-seasonally-adjusted pending home sales index (PHSI) fell 9.4% y/y (versus -10.4% y/y in October), and declined 13.6% m/m as Golden State buyers’ sensitivity to interest rate swings becomes increasingly apparent.
  • Florida existing home sales fell 1.2% y/y in November, the first negative y/y comp since March 2012 and down from a +6.5% y/y comp in October. Sequentially, sales decreased 11.3% from October, fueled by the combined increase in prices and mortgage rates outpacing household income growth. According to November data from RealtyTrac, 62.7% of Florida homes sold were all-cash transactions, the highest level of any state and well ahead of the next closest state (Georgia, 51.3%).

German GDP Disappoints

German economic growth failed to gain momentum in the fourth quarter of 2013, but economists predict stronger growth this year

Germany’s gross domestic product expanded 0.4% in 2013, following growth of 0.7% in 2012, the Federal Statistics Office said on Wednesday. The economy grew 0.5% when taking account of the number of working days each year.

Based on the full-year figures, GDP increased around 0.25% in the three months through December—about the same rate as the third quarter—according to the statistics office, which is due to publish fourth-quarter national accounts in mid-February.

Productivity crisis haunts global economy
Report shows most countries failed to improve overall efficiency

A productivity crisis is stalking the global economy with most countries failing last year to improve their overall efficiency for the first time in decades.

In a sign that innovation might be stalling in the face of weak demand, the Conference Board, a think-tank, said a “dramatic” result of the 2013 figures was a decline in the world’s ability to turn labour and capital resources into goods and services.

Productivity growth is the most important ingredient for raising prosperity in rich and poor countries alike. If overall productivity growth disappears in the years ahead, it will dash hopes that rich countries can improve their population’s living standards and that emerging economies can catch up with the advanced world.

The Conference Board said: “This stalling appears to be the result of slowing demand in recent years, which caused a drop in productive use of resources that is possibly related to a combination of market rigidities and stagnating innovation.”

The failure of overall efficiency – known to economists as total factor productivity – to grow in 2013 results from slower economic growth in emerging economies alongside continued rapid increases in capital used and labour inputs. Labour productivity growth also slowed for the third consecutive year.

The decline in total factor productivity continues a trend of recent years in which the remarkable rise in the efficiency of emerging markets has slowed and in advanced economies it has declined. (…)

The Conference Board’s annual analysis of productivity uses the latest data to estimate economic growth in all countries, the increase in hours worked and the deployment of additional capital to estimate the efficiency of individual economies.

Globally, it found that labour productivity growth declined from 1.8 per cent in 2012 to 1.7 per cent in 2013, having been as high as 3.9 per cent in 2010. Total factor productivity dipped 0.1 per cent.

For the US it found that productivity gains of the early years of the crisis continued to be elusive in 2013, with labour productivity growth stable at 0.9 per cent in 2013.

The US trends were, however, better than those in Europe, which has seen extremely weak productivity growth alongside relatively muted unemployment in most large economies with the exception of Spain, where joblessness soared. Labour productivity grew 0.4 per cent in 2013, having fallen 0.1 per cent in 2012.

Mr van Ark said Europe’s problem in achieving more efficiency from its labour force stemmed from structural rigidities.(…)

Emerging economies saw rates of growth of productivity fall from extraordinarily rapid rates, even though the rate of growth at 3.3 per cent was still much higher than in advanced economies.

For China, the Conference Board said that, while “the statistical information for the latest years is sketchy, the indications are that sustained investment growth in China has not been accompanied by the efficiency gains (measured by total factor productivity growth) similar to those of the previous decade”. (…)

World Bank warns of emerging market risk
Capital flows could fall 80% if central banks move too abruptly

An abrupt unwinding of central bank support for advanced world economies could cause capital flows to emerging markets to contract by as much as 80 per cent, inflicting significant economic damage and throwing some countries into crises, the World Bank has warned.

Capital flows into emerging markets are influenced more by global than domestic forces, leaving them vulnerable to disorderly changes in policy by the US Federal Reserve, concludes a study by World Bank economists.

SENTIMENT WATCH

 

The Year-Two Curse

In a world full of January barometers, Super Bowl indicators and sell-in-May-and-go mantras, Jeffrey Kleintop, chief market strategist at LPL Financial, thinks he’s found an indicator that actually works: the “year-two curse.”

“Year two” refers to the second year of a presidential cycle, which is what we’re in right now. Per the chart below, courtesy of LPL, the middle of the year tends to be fairly volatile for investors.

“The start of the second quarter to the end of the third quarter of year two has consistently marked the biggest peak-to-trough decline of any year of the four-year presidential term,” Mr. Kleintop wrote in a note to clients.Since 1960, nine of the 13 presidential terms have suffered from the dreaded curse, as the S&P 500 fell in the second and third quarters of those years, he says. (…)

Still, Mr. Kleintop maintains a relatively bullish stance about the rest of the year. “We may again see some seasonal weakness, but there is no need to fear the curse,” he says. “In fact, the curse may be a blessing for some, allowing those who have been awaiting a long-overdue pullback a chance to buy. It is important to keep in mind that history shows that, on average, year two posts a solid gain for stocks, and the year-two curse is reversed by the end of the year.”

 
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NEW$ & VIEW$ (14 JANUARY 2014)

SMALL BIZ OPTIMISM BETTER

The December NFIB report just came out today. You will read about the overall results elsewhere. I am more interested in the details.

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NFIB’s December survey did provide some positive signals, with the best
job creation figure since 2007 and a large increase in the percent of owners reporting actual capital outlays in recent months. The jump of 9
percentage points in December over November suggests that most of the
increase in spending came very late in the year. Expectations for real sales growth and for business conditions over the next six months improved substantially over November readings as well.

NFIB owners increased employment by an average of 0.24 workers per
firm in December (seasonally adjusted), the best reading since February 2006. Forty-eight (48) percent of the owners hired or tried to hire in the last three months and 38 percent reported few or no qualified applicants for open positions. This is not just a “skills” issue, but one of poor attitudes, work habits, timeliness, appearance and expectations, especially among the applicants for lower skill jobs.

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Twenty-three (23) percent of all owners reported job openings they could not fill in the current period (unchanged), a positive signal for the unemployment rate and the highest reading since January 2008. Fourteen (14) percent reported using temporary workers, up 1 point from November. Job creation plans fell 1 point, falling to a net 8 percent, but maintaining the improved level of plans recorded last month. Overall, it appears that owners hired more workers on balance in December than their hiring plans indicated in November, a favorable development.

Last Friday’s NFP report showed no signs of that.

  • Wages are on the rise:

Two percent reported reduced worker compensation and 17 percent
reported raising compensation, yielding seasonally adjusted net 19 percent reporting higher worker compensation (up 5 points), the best reading since 2007. A net seasonally adjusted 13 percent plan to raise compensation in the coming months, down 1 point from November. Overall, the compensation picture remained at the better end of experience in this recovery, but historically weak for periods of economic growth and recovery.

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Boy “Daddy, is this a margin squeeze above?”

  • While inventories are too high:

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January retail sales are off to a slow start. Weekly chain store sales have dropped significantly in the past 2 weeks even though the 4-week m.a. remains at its recent peak levels. Weather or not, the goods are still on the shelves.

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  • SMALL BIZ CAPITAL SPENDING

The frequency of reported capital outlays over the past 6 months
surprisingly gained 9 percentage points in December, a remarkable increase. Sixty-four (64) percent reported outlays, the highest level since early 2005. The percent of owners planning capital outlays in the next 3 to 6 months rose 2 points to 26 percent. Ten (10) percent characterized the current period as a good time to expand facilities. Of those who said it was a bad time to expand (61 percent), 31 percent still blamed the political environment, suggesting that at least for these owners, Washington is preventing their spending on expansion. The net percent of owners expecting better business conditions in six months was a net negative 11 percent, 9 points better than November but still dismal.

Euro-Zone Factory Output Jumps Industrial production rose at the fastest pace in 3½ years, an indication that the euro-zone economy likely grew for the third straight quarter.

The European Union’s statistics agency said industrial output in November was 1.8% higher than in October, and 3% higher than the year-earlier month.

Figures for October were revised higher, and Eurostat now estimates that output fell 0.8% during the month, having previously calculated they fell 1.1%.

The rise in output compared with the month earlier was the largest since May 2010, when output jumped 2%. When compared with the year-earlier period, the increase was the largest since August 2011, when output surged 5.5%.

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The increase in industrial production was spread across much of the euro zone, with Germany recording a 2.4% rise, France a 1.4% increase, Spain a 1% rise and Italy a more modest 0.3% increase.

The rise was also spread across a number of different industries, led by manufacturers of capital goods, and including makers of intermediate and nondurable consumer goods. Manufacture of durable consumer goods fell 0.8%, however, an indication that households haven’t yet become confident enough about their prospects to make large purchases, such as of household appliances and cars.

For the 3 months ended in November, IP is up 0.8%, the same as for the three previous months. Capital Goods are notably strong: +1.2% last 3 months after +2.4% the previous 3 months.

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Spain GDP growth fastest in six years
Caution urged as economy starts to emerge from gloom

Luis de Guindos, the economy minister, told parliament on Monday that gross domestic product rose 0.3 per cent in the three months to December, a marked increase from the 0.1 per rise in output in the third quarter. (…)


There was more good news from Spain’s long-suffering services sector, which in December grew at its fastest pace in more than six years. Surveys of business and consumer confidence also showed striking leaps at the end of last year, suggesting that companies and households alike are starting to sense that a turnround is at hand.

Taken in conjunction, the data lend strength to the argument that Spain is experiencing the early stages of a classic recovery cycle, with falling wages leading to a rise in competitiveness, followed by a surge in exports that allows companies to invest in new plant and machinery, new hiring and – eventually – a rise in domestic demand and government tax revenue. Spanish exports have been on a tear for the past two years, and business investment started rising in early 2013. (…)

The consumer side of the Spanish ledger remains weak, however.

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Despite Slowdown, Employers in China Gave Bigger Raises Employers in China gave more-and bigger- raises last year on average than those elsewhere in Asia, a fresh sign that the country’s job market remains resilient despite slowing economic growth.

According to a survey by recruitment firm Hays, two-thirds of employers in China said they gave their workers raises during the last round of reviews of 6% or more—more than any other country surveyed. A majority, or 54%, of said they gave raises of between 6% and 10%, while 12% said they gave raises of more than 10%. Only 5% of employers in China said they gave no raises at all.

In contrast, in Asia as a whole, just 22% of employers said they gave raises between 6% and 10%, while only 7% said they doled out more than 10%. Across the region, paltry raises were common. In Hong Kong and Singapore, the survey notes, the majority of employers gave raises between 3% and 6%. And in Japan, despite the economic stimulus measures dubbed the Abenomics in 2013, 80% of employees received raises of 3% or less.

The survey featured 2,600 companies in China, Hong Kong, Japan, Singapore and Malaysia in professional sectors like  sales, marketing, engineering, human resources and accountancy & finance.

Chinese workers can also take heart in the fact that employers in China said they also plan to continue their generosity. For the next review, 58% of employers in China said they intend to give their staff a raise between 6%-10%, compared with less than a quarter of employers across Asia, the survey showed. (…) 

M&AAnimal spirits
Has the dealmaking cycle started to turn?

The burst of M&A activity announced on Monday – almost $100bn in total, including Suntory’s $16bn takeover of Beam Inc, Google’s $3.2bn purchase of Nest Labs and Charter’s $61bn move on Time Warner Cable – is enough for many bankers to declare that corporate animal spirits are back and the dealmaking cycle has finally started to turn, with activity taking place across all sectors and all regions.

“This is not just ‘animal spirits’, this is good, old-fashioned competition. If my competitor is growing, I need to grow. Yes, 2014 is different,” said Frank Aquila of law firm Sullivan & Cromwell. “Unlike the past three years when we have had a few big deals early in the year followed by disappointing levels of M&A activity, this year there is a high level of confidence that the global economy is growing and business confidence is the key ingredient to getting deals done.” (…)

 
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NEW$ & VIEW$ (13 JANUARY 2014)

DRIVING BLIND (Cont’d)

 

U.S. Hiring Slowdown Blurs Growth View

American employers added a disappointing 74,000 jobs in December, a tally at odds with recent signs that the economy is gaining traction and moving beyond the supports put in place after the recession.

The downbeat readings were partly attributed to distortions caused by bad weather, and many economists warned that the report may prove to be a fluke. Employers, too, are reporting a mixed take on the economy and their labor needs.

Government payrolls declined by 13,000 in December, and health care—usually a steady source of job growth—declined by 1,000. Construction jobs, which are often weather-dependent, declined by 16,000. Manufacturing payrolls expanded just 9,000.

Meanwhile, last month’s most significant job gains were in sectors that traditionally aren’t high-paying, such as retail, which added 55,000 positions. The temporary-help sector increased by 40,000.

One piece of good news in Friday’s report was a substantially revised increase in November’s tally, to 241,000 new jobs from 203,000.

Where Jobs Were Added

Weather or not? JP Morgan is rather cold about it (charts from WSJ):

The big question is how much of the disappointment was weather distortion. The 16,000 decline in construction payrolls is an obvious candidate as a casualty of cold weather in the survey week. Another clue comes from the 273,000 who reported themselves as employed but not at work due to bad weather, about 100,000 more than an average December. Caution should be taken in simply adding this 100,000 to the nonfarm payroll number, as the nonfarm number counts people as employed so long as they were paid, whether or not they were at work.

Our educated guess is weather may have taken 50,000 off payrolls. It’s hard to see how the weather — or anything else — was to blame for the 25,000 decrease in employment of accountants. Another outlier was health care employment, down 6,000 and the first monthly decline in over a decade, undoubtedly a data point that will enter the civic discussion on health care reform.

Weak personal income:

The weak payroll number was accompanied by a shorter work week and little change in hourly pay. The workweek fell by six minutes to 34.4 hours in December. Hourly pay for all employees increased only 2 cents, or 0.1%, to $24.17, less than the 0.2% gain forecasted.

The combination of weak net new jobs, fewer hours and very small pay raises suggests wages and salaries hardly grew last month. Since “wages and salaries” is the largest component of personal income, the household sector probably didn’t see much income growth in December. And the gain was even less when inflation is taken into account.

BloombergBriefs explains further:

A negative in the report was the underlying trend in average hourly wages, which slowed to a 0.1 percent month-over-month gain and 1.8 percent on a year-ago basis. Using data on hours worked and earnings, one can craft a labor income proxy that is up 1.8 percent, well below its
20-year average of 3 percent.

This is critical with respect to the growth outlook in the current quarter. During the past two quarters the growth picture has improved, due in part due to an increase in inventory accumulation. Given the increase in hourly wages and the labor income proxy, households may need to pull
back on spending in the first three months of the year, which increases the risk of a noticeable negative inventory adjustment in the first quarter.

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Fed Unlikely To Alter Course

Friday’s disappointing jobs report is likely to curb the Fed’s recent enthusiasm about the U.S. economic recovery, but it seems unlikely to convince officials they should alter the policy course Bernanke laid out.

That is even though the economy averaged monthly job gains of 182,000 positions last year. That is roughly the same as the 183,000-a-month pace of 2012 and 2011 average of 175,000. Is employment actually accelerating other than through the unemployment rate lens? The WSJ gets to the point:

(…) The report exacerbated another conundrum for officials.

The jobless rate, at 6.7% at year-end, is falling largely because people are leaving the labor force, reducing the numbers of people counted as unemployed.

Because the decline is being driven by unusual labor-force flows—aging workers retiring, the lure of government disability payments, discouraged workers and other factors—the jobless rate is a perplexing indicator of job-market slack and vigor.

Yet Fed officials have tied their fortunes to this mast, linking interest-rate decisions to unemployment-rate movements. Since late 2012, the Fed has said it wouldn’t raise short-term interest rates until after the jobless rate gets to 6.5% or lower. In December, officials softened the link, saying they would keep rates near zero “well past” the point when the jobless rate falls to 6.5%.

Most officials didn’t expect that threshold to be crossed until the second half of this year. At the current rate, it could be reached by February.

The jobless-rate movement and the Fed’s rhetoric create uncertainty about when rate increases will start. Short-term interest rates have been pinned near zero since December 2008, and officials have tried to assure the public they will stay low to encourage borrowing, investment, spending and growth.

Now, the public has more questions to consider: What does the Fed mean by “well past” the 6.5% threshold? Is that a year? A few months? How does it relate to the wind-down of the bond-buying program? What does it depend upon?

It will be Ms. Yellen’s job to answer the questions. Mr. Bernanke’s last day in office is Jan. 31.

To Tell the Truth 2000-2002.jpgRemember the To Tell The Truth game show?

  • Supply/demand #1: Oversupply

The total number of jobs in the U.S. hit a peak of about 138 million in January 2008, one month after the start of the most recent recession.

In the ensuing downturn, nearly nine million jobs disappeared through early 2010, when the labor market started turning around.

Job gains accelerated in 2011 and have remained fairly steady since, edging up a bit each year.

To date, almost 8 million jobs have returned, leaving a gap just shy of 1 million, which is likely to be closed this year. But that doesn’t account for changes in the population.

If the population keeps growing at that same rate, and the U.S. continues to add jobs near 2013’s pace, then the total number of nonfarm jobs in the U.S. won’t get back to where they should be until 2019. If the pace picks up in 2014 and beyond — say to 250,000 a month — the gap will narrow sooner, in 2017.

That said, the U.S. economy hasn’t added an average 250,000 jobs or more a month since 1999.

  • Supply/demand #2: Shortage

BlackRock: Jobs Report Shows Unemployment Is Structural

BlackRock fixed-income chief Rick Rieder says this morning’s disappointing December jobs report underscores the structural nature of an unemployment situation that’s beyond the control of the Federal Reserve.

“My view on unemployment is structural – you can’t fix it with quantitative easing,” Rieder tells Barron’s today. He said the disappointing number of jobs added can’t all be blamed on bad December weather, and that the labor force participation rate keeps dropping. “It means you have an economy that’s growing faster, and you don’t need people because of technology…. You’ve got all this economic data that’s strong but you don’t need people to do it.” (…)

  • Supply/demand #3: Dunno!

(…) imageAt least some of the decline in participation reflects demographic factors, including the Baby Boom generation moving into retirement age and younger people staying in school longer. But the participation rate for people age 25 to 54, which shouldn’t be affected much by such factors, has fallen to 80.7%, from 83.1% at the end of 2007.

Here’s the optimistic view…

This suggests the pool of people available for employment is substantially higher than the unemployment rate implies. So even if job growth does, as most economists expect, rev back up, it will be a while before companies need to pay up to attract workers. Indeed, average hourly earnings were up just 1.77% in December versus a year earlier, the slowest gain in more than a year. The net result is inflation may be even more subdued in the years to come than the Fed has forecast.

…but that optimism assumes that the drop-outs are simply waiting to drop back in, a view not shared by the Liscio Report (via Barron’s):

(…) But our friends at the Liscio Report, Doug Henwood and Philippa Dunne, find a rather different story, especially among younger groups: The vast majority of folks not in the labor force don’t want a job, even if one is available. That’s what they tell BLS survey takers anyway.

Data going back to 1994 show a steady uptrend in the percentage of young (16 to 24-year-old) and prime-age (25 to 54) Americans not in the labor force, with parallel rises in the number not wanting to work. Among younger ones, the percentage staying in school has remained around 1%, with no discernible trend, notwithstanding anecdotes of kids going to grad school while employment opportunities are scarce. Meanwhile, the overall share out of the labor force because they’re discouraged, have family responsibilities, transportation problems, illness, or a disability has stayed flat at around 1% since the BLS started asking this question in the current form in 1994, they add.

And, notwithstanding anecdotes of retiring boomers, the 55- to 64-year-olds were the only group in which the percentage not in the labor force and not wanting a job fell from 1994 to 2013. Perhaps they’ve got to keep working to support their kids, who aren’t? Annoyed

While there was some improvement in December, the number of those not in the labor force is surprising, to put it mildly — up some 2.9 million in the past year and up 10.4 million, or 13%, since July 2009, when the recovery officially began. The number of these folks who want jobs is down 600,000 in the past year, despite a 332,000 rise last month.

Pointing up “What is interesting,” Philippa observes, is that the number who wanted jobs “was climbing from late 2007 until the summer of 2012, when it hit 6.9 million. Since then, it’s been falling, and is down to 6.1 million, or minus 12%.”

Maybe there are a few millions there:

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I don't know smile For Yellen’s sake! Would the true supply/demand equation please stand up.

This is not trivial. We are all part of this extraordinary experiment by central bankers. History suggests that such massive liquefaction tends to fuel inflation but there are no sign of that in OECD countries. In fact, the JCB is fighting deflation while the ECB is pretty worried about it. In the U.S., the Fed has pegged its monetary policy on the unemployment rate but it is realizing that its peg is anchored in moving sands.

Actual employment growth is stable at a sluggish level but the unemployment rate is dropping like a rock. Could labour supply be much lower than generally thought? What is the U.S. real NAIRU (non-accelerating inflation rate of unemployment)? Truth is, nobody really knows.

But here’s what we know, first from David Rosenberg:

While it is true that employment is still lower today than it was at the 2007 peak, in some sense this is an unfair comparison. Many of those jobs created in the last cycle were artificial in the sense that they were created by an obvious unsustainable credit bubble. The good news is that non-financial employment has now recouped 95% of the recession job loss and is now literally two months away (390k) from attaining a new all-time high.  (…) it is becoming increasingly apparent that this withdrawal from the jobs market is becoming increasingly structural. (…)

With the pool of available labour already shrinking to five-year lows and every measure of labour demand on the rise, one can reasonably expect wages to rise discernably in coming years, unless, that is, you believe that the laws of supply and demand apply to every market save for the labour market. Let’s get real. By hook or by crook, wages are going up in 2014 (minimum wages for sure and this trend is going global). (…)

With this in mind, the most fascinating statistic in the recent weeks was not ISM or nonfarm payrolls, but the number of times the Beige Book commented on wage pressures. Try 26. That’s not insignificant. (…)

As I sifted through the Beige Book to see which areas of the economy were posting upward wage pressures and growing skilled labour shortages I could see a large swath – Technology, Construction, Transportation Services, Restaurants, Durable Goods Manufacturing. (…)

Now this from yours truly:

Minimum wages are going up significantly in 2014 in states like California (+12.5%), Colorado (+12.5%), Connecticut  (+5.5%), New Jersey (+13.8%), New York (+10.3%). These five states account for 25% of the U.S. population and 28% of its GDP. Obama intends to push for a 39% hike in the federal minimum wage to $10.10. In effect, many wages for low-skill jobs are tied to minimum wages.

The irony is that minimum wages affect non-skilled jobs which are clearly in excess supply currently. As we move up the skill spectrum, evidence of labour shortages is mounting in many industries and wages are rising.

Small businesses create the most jobs in the U.S. The November 2013 NFIB report stated that

Fifty-one percent of the owners hired or tried to hire in the last three months and 44 percent (86 percent of those trying to hire or hiring) reported few or no qualified applicants for open positions. This is the highest level of hiring activity since October, 2007.

Twenty-three percent of all owners reported job openings they could not fill in the current period (up 2 points), a positive signal for the unemployment rate and the highest reading since January, 2008.

  • Unfilled job openings are almost back to historical peaks if we exclude the two recent bubbles.

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  • Employers have been more willing to hire full time employees:

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  • Quit rates have accelerated lately, indicating a greater willingness to change jobs. People generally decide to change employers because they are offered better salaries.

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  • Hence, average hourly wages have been accelerating during the last 12 months.

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Nothing terribly scary at this point but the present complacency about labour costs and inflation is dangerous. Wages were rising by 1.5% in 2012 and they finished 2013 at +2.2%. Meanwhile, inflation decelerated from 2.0% in 2012 to 1.2% at the end of 2013 as did real final sales from +2.8% at the end of 2012 to +1.8% in Q313. What’s going to happen if the U.S. economy accelerates like more and more economists are now predicting.

Certainly, the economy can accelerate without cost-push inflation if there is as much slack as most believe. But is there really as much slack? Recent evidence suggests that there is less than meets the eyes. If that is true, investors will soon start to worry about rising corporate costs and interest rates.

All this so late in the bull market!

Punch Time to join the Fed and start tapering…your equity exposure.

Meanwhile,

Subprime Auto Lenders to Ease Standards Further: Moody’s

(…) Originations of subprime loans have increased to their highest levels since the financial crisis, with quarterly volume reaching $40.3 billion in the second quarter of last year, up from a recent low of $14.9 billion in late 2009 and the most since the second quarter of 2007, according to Equifax. Subprime auto loan volume was $39.8 billion in the third quarter.

Cheaper financing for lenders increases the difference between their costs and the rates they charge to consumers. In the third quarter, those rates averaged 9.64% and 14.25% for new and used cars, respectively, Moody’s said. High rates give lenders “room” to make weaker loans because of the cushion that the thicker profits provide against losses, the firm said. (…)

Lenders may cut standards more to grab market share as the pace of auto sales slow and the number of subprime borrowers stops expanding, the rating firm said.

Examples of weaker lending include larger amounts and longer loan terms, Moody’s said. The average term for subprime loans rose to 60.9 months from 59.9 months in the third quarter from a year earlier, it said. (…)

Why This European Is Bullish on America The billionaire founder of Ineos says the shale revolution is making the U.S. a world-beater again. It would be ‘unbeatable’ with a lower corporate tax rate.

(…) Seven or eight years ago in his industry, “people were shutting things down” in America “because it wasn’t competitive. Now it’s become immensely competitive.” (…)

On the contrary, Europe has “the most expensive energy in the world.” The Continent has been very slow to move on shale gas, and the U.K. has only lately, and somewhat reluctantly, started to embrace fracking. (…)

“There’s lots of shale gas around” in the U.K. and elsewhere, Mr. Ratcliffe says. But “in Texas there are 280,000 active shale wells at the moment. . . . And I think a million wells in the United States” as a whole. By contrast, “I think we have one, at the most two, in the U.K., and I don’t think there are any in France.” The French made fracking illegal in 2011, and the country’s highest court upheld the ban in October. (…)

Social protections in Europe make it much more expensive to shut down underperforming plants. Many Europeans will say, “Yes, that’s the idea. To protect jobs.” (…)

But Mr. Ratcliffe argues that European-style social protections lead to under-investment that ultimately benefits no one. (…)

By contrast, he says, in America “you’d just shut it down.” Which is why, he adds, “in America all our assets are good assets, they all make money.” That may sound like a European social democrat’s nightmare, but Mr. Ratcliffe takes a longer view, explaining that if the lost money had instead been invested in new capacity, the company would be healthier, employees’ jobs more secure and better-paying because the plant would be profitable. This logic is unlikely to persuade Europe’s trade unions, but Mr. Ratcliffe says that the difficulty and expense of restructuring is one of the things holding back Europe—and its workers.

(…)  Mr. Ratcliffe’s “only gripe” about the U.S.—”you have to have a gripe,” he says—is that America “has the highest corporate tax rates in the world: “They’re too high in my view, nearly 40%. And that’s a pity because in most other parts of the world corporate tax rates are about 25%.”

(…) If you weren’t paying all that tax, what you’d do is, you’d invest more. And we’d probably spend the money better than the government would.”

His suggestion for Washington on corporate taxes: “I think they should bring that down to about 30% or so. Then they’d be unbeatable. For investment, they’d be unbeatable, the United States.”

Light bulb Total joins UK’s pursuit of shale boom 
Oil group will be first major to explore British deposits

(…) The deal, to be announced on Monday, will be seen as a big vote of confidence in the UK’s fledgling shale industry. The coalition has made the exploitation of Britain’s unconventional gas reserves a top priority, offering tax breaks to shale developers and promising big benefits to communities that host shale drillers. (…)

George Osborne, chancellor, has argued that shale has “huge potential” to broaden Britain’s energy mix, create thousands of jobs and keep energy bills low. (…)

A boom in North American production from shale means natural gas in the US is now three to four times cheaper than in Europe. Cheap gas has driven down household energy costs for US consumers and sparked a manufacturing renaissance.

The coalition says Britain could potentially enjoy a similar bounty. It points to recent estimates that there could be as much as 1,300tn cubic feet of shale gas lying under just 11 English counties in the north and Midlands. Even if just one-10th of that is ultimately extracted, it would be the equivalent of 51 years’ gas supply for the UK. (…)

Italy’s November Industrial Output Rises

Italian industrial production rose for the third consecutive month in November, increasing by 0.3% compared with October in seasonally-adjusted terms, national statistics institute Istat said Monday.

Italy’s industrial production rose 0.7% in October compared with September, suggesting industry is on course to lift the country’s gross domestic product into expansionary territory in the fourth quarter.

Output rose 1.4% compared with November 2012 in workday-adjusted terms, the first annualized rise in two years, Istat said.

EARNINGS WATCH

The Q4 earnings season gets serious this week with bank results starting on Tuesday. So far, 24 S&P 500 companies have reported Q4 earnings. The beat rate is 54% and the miss rate 37% (S&P).

Still early but not a great start. Early in Q3, the beat rate was closer to 60%. Thomson Reuters’ data shows that preseason beat rate is typically 67%.

Historically, when a higher-than-average percentage of companies beat their estimates in the preseason, more companies than average beat their estimates throughout the full earnings season 70% of the time, and vice versa.

Q4 estimates continue to trickle down. They are now seen by S&P at $28.14 ($107.19 for all of 2103), rising to $28.48 in Q1 which would bring the trailing 12m total to $109.90. Full year 2014 is now estimated at $121.45, +13.3%. This would beat the 2013 advance of 10.7%. Margins just keep on rising!

SENTIMENT WATCH

Goldman Downgrades US Equities To “Underweight”, Sees Risk Of 10% Drawdown (via ZeroHedge)

S&P 500 valuation is lofty by almost any measure, both for the aggregate market (15.9x) as well as the median stock (16.8x). We believe S&P 500 trades close to fair value and the forward path will depend on profit growth rather than P/E expansion. However, many clients argue that the P/E multiple will continue to rise in 2014 with 17x or 18x often cited, with some investors arguing for 20x. We explore valuation using various approaches. We conclude that further P/E expansion will be difficult to achieve. Of course, it is possible. It is just not probable based on history.

The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock: (1) The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4) EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of (6) inflation; (7) nominal 10-year Treasury yields; and (8) real interest rates. Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings.

We downgrade the US equity market to underweight relative to other equity markets over 3 months following strong performance. Our broader asset allocation is unchanged and so are almost all our forecasts. Since our last GOAL report, we have rolled our oil forecast forward in time to lower levels along our longstanding profile of declining prices. We have also lowered the near-term forecast for equities in Asia ex-Japan slightly. Near-term risks have declined as the US fiscal and monetary outlook has become clearer.

Our allocation is still unchanged. We remain overweight equities over both 3 and 12 months and balance this with an underweight in cash over 3 months and an underweight in commodities and government bonds over 12 months. The longer-term outlook for equities remains strong in our view. We expect good performance over the next few years as economic growth improves, driving strong earnings growth and a decline in risk premia. We expect earnings growth to take over from multiple expansion as a driver of returns, and the decline in risk premia to largely be offset by a rise in underlying government bond yields.

Over 3 months our conviction in equities is now much lower as the run-up in prices leaves less room for unexpected events.Still, we remain overweight, as near-term risks have also declined and as we are in the middle of the period in which we expect growth in the US and Europe to shift higher.

Regionally, we downgrade the US to underweight over 3 months bringing it in line with our 12-month underweight. After last year’s strong performance the US market’s high valuations and margins leaves it with less room for performance than other markets, in our view. Our US strategists have also noted the risk of a 10% drawdown in 2014 following a large and low volatility rally in 2013 that may create a more attractive entry point later this year.

And this:

Ghost “Equity sentiment is, unsurprisingly, very bullish and Barron’s annual mid-December poll of buy- and sell-side strategists revealed near unanimity in terms of economically bullish sector views,” notes BCA Research in a note titled, “U.S. Equity Froth Watch.” Similarly, Citi strategists’ sentiment measure finds that “euphoria” has topped the 2008 highs and is back to 2001 levels. At the same time, the negativity toward bonds is nearly universal. (Barron’s)

But: Stock Bargains Not Hard to Find, JPMorgan Says

(…) Lee notes that by simply dividing the S&P 500 into equal groups leaves 125 stocks that have an average P/E of 11.8 times forward earnings, with a range of 8x to 13x. Not only are these stocks cheaper than the market, they’re not lacking for growth either, Lee says. The average member of this group should grow by about 11%, far lower than the most expensive stocks’ 20% growth rate, but at less than half the valuation.

“In other words,” Lee writes, “there remains a substantial portion of the market offering double-digit growth for a mere 11.8x P/E.”

Lee screened for stocks with low P/Es, positive net income growth, that had Overweight ratings by JPMorgan analysts and upside to analyst target prices. He found 19 (…)

GOOD QUOTES

Barron’s Randall Forsyth:

But truth to tell, the governor’s staff might not actually have been to blame. They may only have been taking active steps to stem the exodus from the Garden State’s sky-high taxes and housing costs. According to surveys by both United Van Lines and Allied Van Lines, New Jersey was at or near the top of states of outbound movers in 2013. And U.S. census data for 2011 showed 216,000 leaving the Garden State and 146,000 moving in, with New York the No. 1 destination. So, blocking access to the GW Bridge may simply have been a misguided effort to stanch the outflow.

Or the whole episode could have been the result of a simple misunderstanding on the part of the staff. According to one market wag, the governor’s actual order was to “close the fridge.”

Open-mouthed smile LAST, BUT CERTAINLY NOT LEAST, our third granddaughter, Pascale, will see the world today!

 
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NEW$ & VIEW$ (10 JANUARY 2014)

China Data Suggest Tepid Pickup in West

Exports in December were up just 4.3% compared with the same month a year earlier, down from a much stronger 12.7% year-over-year rise in November, according to customs data released on Friday. (…)

The poor export growth may in part be due to more than trade flows. China’s State Administration of Foreign Exchange said in December it was tightening supervision of trade financing to stop speculative “hot money” flows from being disguised as trade. That likely dragged down an already weak growth number, Ms. Sun said Friday.

Official data showed a jump in December 2012 that many economists attributed to capital flows misreported as trade.

By contrast, the latest import figures were strong, beating forecasts with an 8.3% year-over-year rise in December, up from 5.3% in November. They were boosted by high raw-material shipments. China brought in 6.33 million barrels a day of crude oil in December, a record, and copper, iron ore and plastic imports were up strongly, too. That could indicate that companies are building up inventories again after running them down earlier in the year, said Shuang Ding, an economist at Citigroup,  but he cautioned that the trend may not last long.

However:

CALIFORNIA BOOMING State Controller John Chiang today released his monthly report covering California’s cash balance, receipts and disbursements in December 2013. Revenues for the month totaled $10.6 billion, surpassing estimates in the state budget by $2.3 billion, or 27.7 percent.

California ended the 2013 calendar year with a burst of tax receipts as the economic recovery continued to boost jobs, incomes, profits, and spending. Revenues flowing into the State’s General Fund coffers totaled $10.6 billion, beating estimates contained in the 2013-14 Budget Act by a hefty $2.3 billion, or 27.7%.

As we noted in our analysis of November’s revenues which, at first glance, appeared to fall short of projections, approximately $400 million of December’s $2.3 billion of unanticipated revenues were actually generated in the month of November but were not deposited into the General Fund and booked into the State’s official ledger until the first week of December.  We attribute this timing anomaly to “Black Friday” weekend falling at the end of November, which impacted the timing of retail sales collections and when they were recorded in the state ledger.

Even when this anomaly is factored-out, December’s revenue numbers alone are still impressive. Retail sales tax receipts surged past estimates by over $700 million, a jump assisted by an improvement in the job market, last year’s 30% swell in stock prices, and strong rebound in housing-related holiday shopping. The growing popularity of online shopping and the agreement of online retailers to now collect California sales taxes also helped boost results.

Personal income taxes exceeded expectations by a large margin of $987 million in December. Estimated taxes were very high, bolstered by capital gains and the desire by taxpayers to make payments by year-end to add to their 2013 federal income tax deduction. Rounding out California’s three major tax sources, corporate tax receipts were better than expected by $189 million during December.

Low-End Retailers Had a Rough Holiday

Retailers such as Family Dollar and Sears had a rough holiday period as their lower-income customers remain under pressure.

Family Dollar Stores Inc. on Thursday lowered its full-year profit forecast and reversed course on strategy. It pledged to cut prices more deeply to win back shoppers, saying its economically challenged customers are under more pressure than ever.

Meanwhile, Sears Holding Corp. said sales at its Sears and K-Mart chains fell deeply from a year earlier, reflecting weakness in its customer base as well as strategic missteps by executives trying to reshape its business. Sears shares plunged 14% in after hours trading.

The company said sales over roughly the past two months, excluding recently opened or closed stores, fell 7.4%. Sales were dragged down by a 9.2% drop in its domestic Sears stores and a 5.7% decline at Kmart with weakness in traditionally strong areas such as tools and home appliances. (…)

Even retailers that target consumers in the middle market have struggled this holiday. Gap Inc., which had been clocking strong sales gains for much of last year, said Thursday that comparable-store sales increased a scant 1% in November and December. L Brands Inc., owner of Victoria’s Secret and Bath & Body Works, said December same-store sales rose just 2% and lowered its earnings guidance for the fourth quarter. (…)

Thomson Reuters rounds it up:

Excluding the drug stores, the Thomson Reuters Same Store Sales Index registered a 2.4% comp for December, beating its 1.9% final estimate. The 2.4% result is an improvement over November’s 1.2% result. Including the Drug Store sector, SSS growth rises to 3.8%, above its final estimate of 2.7%. The late Thanksgiving this year pushed revenue from CyberMonday and other post-Thanksgiving sales into December, helping to offset some of the reduction in sales from the shortened holiday shopping season.

Every apparel retailer in the index missed its SSS estimate with the exception of Stein Mart, as consumers avoided malls during the holiday shopping season, increasingly preferring to shop online. Retailers responded with discounts and promotions to lure customers, while settling for lower margins in the process.

Pointing up Our Thomson Reuters Quarterly Same Store Sales Index, which consists of 75 retailers, is expected to post 1.7% growth for Q4 (vs. 1.6% in Q4 2012). This is below the 3.0% healthy mark.

Banks Cut as Mortgage Boom Ends

A sharp slowdown in mortgage refinancing is forcing banks to cut jobs, fight harder for a smaller pool of home-purchase loans and employ new tactics to drum up business.

A sharp slowdown in mortgage refinancing is forcing banks to cut jobs, fight harder for a smaller pool of home-purchase loans and employ new tactics to drum up business.

The end of a three-decade period of falling mortgage rates has slammed the brakes on a huge wave of refinancing by U.S. households. The drop-off has deprived lenders of a key source of income at a time when the growth in loans for home purchases remains weak.

The Mortgage Bankers Association next week plans to cut its 2014 forecast for loan originations, which include loans for home purchases and refinancing. The current forecast of $1.2 trillion would represent the lowest level in 14 years. The trade group Wednesday reported that mortgage applications in the two weeks ending Jan. 3 touched a 13-year low. (…)

In the third quarter, mortgage-banking income, which includes fees from making new loans and processing payments on existing loans, tumbled by 45% at 10 big banks tracked by industry publication Inside Mortgage Finance. (…)

Draghi Says ECB Ready to Act

European Central Bank chief Mario Draghi pledged “decisive action” if needed to safeguard the euro-zone recovery, as it kept its key lending rate at a record low 0.25%.

The European Central Bank surprised markets with an emphatic assurance that it would respond aggressively if inflation weakens to dangerously low levels, as officials sought to spur the fragile euro-zone recovery.

President Mario Draghi‘s pledge Thursday to deploy “further decisive action” if needed to counter threats stands in contrast to the Federal Reserve, which deployed its stimulus measures sooner and is now slowly winding them down amid signs of more robust U.S. growth.

France’s industrial output surged by 1.3% in November (-0.5% in October), against expectations for a 0.4% rise. EU’s IP could be turning positive YoY:image

OIL
 
Slower China oil demand to test exporters
Crude imports grew by the least in almost a decade in 2013

(…) Last year imports averaged 5.64m barrels a day, an increase of 216,880 b/d, or just under 4 per cent from 2012, according to customs data released on Friday. That was the lowest annual growth since 2005 and a fraction of the record increase in 2010, when import growth topped 700,000 b/d. (…)

But China’s economic growth is beginning to slow, while the focus on energy-intensive manufacturing is also fading.

China also has moved from being a net importer of diesel – a key industrial fuel – to a regular exporter. As a result the need to build new refineries, which encourage more imports, has also become less urgent. (…)Site Meter

Oil Breaking Down

Oil has now given up all of its December gains since the calendar moved into 2014.  As shown below, another dip today has caused the commodity to “break down” below its lows from last November, leaving it just above the $90 level.

Now, that’s WTI which suffers from the surge in U.S. domestic production. Brent, the key crude for U.S. prices is holding its own:

Ghost SENTIMENT WATCH

Prospect of US bond market showdown rises
Pace of recovery brings forward expectations of tightening

Bond traders are bringing forward their expectations of when the Federal Reserve will start to tighten policy, leading to a jump in short-term US borrowing costs.

Recent economic data have pointed to a gathering American recovery, and could result in a showdown between policy makers and the Treasury market.

Ian McAvity:

image

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Lance Roberts:

One argument that I hear made consistently is that retail investors are just now beginning to jump into the market. The chart below shows the percentage of stocks, bonds and cash owned by individual investors according to the American Association of Individual Investor’s survey. As you can see, equity ownership and near record low levels of cash suggest that the individual investor is “all in.”

Click to View

(…) professional investors are just plain “giddy” about the market.

Click to View

Of course, with investors fully committed to stocks it is not surprising to see margin debt as a percentage of the S&P 500 at record levels also. It is important to notice that sharp spikes in this ratio have always coincided with market corrections of which some have been much worse than others.

Click to View

We sure need everything (profits, jobs, interest rates, inflation) to be right…Fingers crossed

 
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NEW$ & VIEW$ (9 JANUARY 2014)

Yellen Eyes Turnover as U.S. Workers Leave Jobs

More Americans are voluntarily quitting their jobs as they become increasingly confident about business conditions — a trend that Janet Yellen, the next Federal Reserve chairman, is monitoring.

Almost 2.4 million U.S. workers resigned in October, a 15 percent increase from a year earlier, based on seasonally adjusted data from the Department of Labor. These employees represent 56 percent of total separations, the 13th consecutive month above 50 percent and highest since April 2008. November figures are scheduled to be released Jan. 17. (…)

The quits ratio is highly correlated with how Americans feel about the job market and is especially helpful because it separates behavior from intentions, showing “what people are doing, not what they say they’ll do,” Colas said. “Voluntarily leaving one’s position requires a fundamental level of confidence in the economy and in one’s own personal financial story.” The ratio in November 2006, about a year before the recession began, was 58 percent.

The share of Americans who say business conditions are “good” minus the share who say they are “bad” rose in December to the highest in almost six years: minus 3 percentage points, up from minus 4.2 points the prior month, based on data from the Conference Board, a New York research group.

Job seekers also are more optimistic about the hiring environment. Sixty-three percent of callers to a job-search-advice help line Dec. 26-27 said they believed they could find new employment in less than six months, up from 55 percent a year ago, according to Challenger, Gray & Christmas Inc., a human-resources consulting company. (…)

U.S. December planned layoffs plunge to lowest since 2000: Challenger

The number of planned layoffs at U.S. firms plunged by 32 percent in December to the lowest monthly total in more than 13 years, a report on Thursday showed.

Employers announced 30,623 layoffs last month, down from 45,314 in November, according to the report from consultants Challenger, Gray & Christmas, Inc.

The last time employers announced fewer job cuts was June of 2000, when 17,241 planned layoffs were recorded.

The figures come a day ahead of the closely-watched U.S. non-farm payrolls report, which is forecast to show the economy added 196,000 jobs in December. (…)

The December figure fell 6 percent from a year earlier, when planned layoffs totaled 32,556, and marked the third straight month that announced workforce reductions dropped year over year. (…)

U.S. Consumer Credit Growth Eases

The Federal Reserve Board reported that consumer credit outstanding increased by $12.3 billion (6.1% y/y) during November following an unrevised $18.2 billion October gain. The latest monthly gain was the weakest since April.

Usage of non-revolving credit increased $11.9 billion (8.2% y/y) in November. Revolving credit outstanding gained $4.3 billion (1.0% y/y) in November.

Auto Markit Eurozone Sector PMI: Automobiles & auto parts posts its best quarterly performance since Q1 2011

Despite recent growth being high in the context of historical survey data, automobiles & auto parts still maintains some forward momentum heading into the New Year. New orders increased sharply and to the greatest degree in three years in December, leading to a substantial build-up of outstanding business. Job creation, which has until now been muted relative to the trends in output and new business, therefore looks set to pick up.

image

 

German Industrial Output Rises First Time in Three Months

Output, adjusted for seasonal swings, increased 1.9 percent from October, when it fell 1.2 percent, the Economy Ministry in Berlin said today. Economists predicted a gain of 1.5 percent, according to the median of 32 estimates in a Bloomberg News survey. Production climbed 3.5 percent from a year earlier when adjusted for working days.

German Orders Surge Back But Domestic Orders Lag

German orders rose by 2.1% in November, rebounding from a 2.1% drop in October. The headline trend shows solid growth with three-month growth at a 12.7% annual rate, up from a 6.2% annual rate over six-months and a 6.8% annual rate over 12-months. The strength is led by foreign demand.

Foreign orders rose by 2.2% in November from a 2.2% drop in October but also logged a 6.3% increase in September. As a result, foreign orders are rising at a 27.1% annual rate over three-months, up from a 12.8% annual rate over six-months, and a 9% annual rate over 12-months.

In contrast, domestic orders rose by 1.9% in November, unwinding a 1.9% drop in October. However, domestic orders also fell by 0.9% in September. As a result, the trend for domestic orders is poor. It is not just weaker than foreign orders – it is poor. Domestic orders are falling at a 3.8% annual rate over three-months following a 1.9% annual rate drop over six-months and a 3.9% annual rate gain over 12-months. The domestic sector is in a clear deceleration and contraction.

China’s 2013 Vehicle Sales Rose 14%

The CAAM said sales of both passenger and commercial vehicles totaled a record 21.98 million units, up 14% from a year earlier, the fastest pace since 2010. Passenger vehicles led the way, with sales up 16% to 17.93 million units.

Sales gain in December quickened due in part to local consumers’ habit of spending ahead of the Lunar New Year, which falls in the end of January this year. Auto makers shipped 2.13 million vehicles to dealers, up 18% from a year earlier. Among the total, sales of passenger vehicles were 1.78 million units, up 22% on year.

Even as China’s economy displayed clear signs of a slowdown, consumers bought new vehicles, motivated by some cities’ pending restrictions on car purchases to alleviate traffic congestion and air pollution. Within hours after the northern city of Tianjin announced a cutback on new license plates last month, thousands of residents rushed to buy cars. Some used gold necklaces as collateral, said local media.

CAAM said it expects gains to continue this year, though at a slower pace. The association projected a rise of 8%-10% for the overall auto market, to about 24 million units, and as much as an 11% gain for passenger vehicles, to nearly 20 million units.

“China’s auto market is still at the period of rapid expansion and growth has gradually shifted to small-sized cities where demand is significant,” said Shi Jianhua, deputy secretary-general at the CAAM.

China Consumer Inflation Eases

The consumer-price index rose 2.5% in December from a year earlier, slower than the 3.0% year-over-year rise in November, the National Bureau of Statistics said Thursday.

In the December price data, food remained the key contributor to higher prices, rising 4.1% year on year in December. But that was down from the 5.9% rise the previous month. Nonfood prices were up 1.7% in December, compared with November’s 1.6% gain.

But in a continued sign of weak domestic demand, prices at the factory level fell once again, declining for the 22nd consecutive month. They were down 1.4% in December, falling at the same rate as in November.

Stripped of food prices, inflation edged up to 1.7% YoY from 1.6% in November.

OECD Inflation Rate Rises

The Organization for Economic Cooperation and Development said Thursday the annual rate of inflation in its 34 developed-country members rose to 1.5% from 1.3% in October, while in the Group of 20 leading industrial and developing nations it increased to 2.9% from 2.8%.

The November pickup followed three months of falling inflation rates, but there are indications that it will prove temporary. Figures already released for December showed a renewed drop in inflation in two of the world’s largest economies, with the euro zone recording a decline to 0.8% from 0.9%, and China recording a fall to 2.5% from 3.0%.

Key Passages in Fed Minutes: Consensus on QE, Focus on Bubbles

Federal Reserve officials were largely in agreement on the decision to begin winding down an $85 billion-per-month bond-buying program. As they looked to 2014, they began to focus more on the risk of bubbles and financial excess.

    • Some … expressed concern about the potential for an unintended tightening of financial conditions if a reduction in the pace of asset purchases was misinterpreted as signaling that the Committee was likely to withdraw policy accommodation more quickly than had been anticipated.
    • Several [Fed officials] commented on the rise in forward price-to-earnings ratios for some small cap stocks, the increased level of equity repurchases, or the rise in margin credit.

Pointing up Something the Fed might be facing sooner than later:

Bank dilemma Time for Carney to consider raising rates

When your predictions are confounded, do you carry on regardless? Or do you stop, think and consider changing course? Such is the remarkable recovery in the UK economy since the first quarter of last year that the Bank of England is now facing this acute dilemma.

Just five months ago, the bank’s new governor pledged that the BoE would not consider tightening monetary policy until unemployment fell to 7 per cent so long as inflationary pressures remained in check. (…)

The question is what the BoE should now do. Worst would be to show guidance was entirely a sham by redefining the unemployment threshold, reducing it to 6.5 per cent. Carrying on regardless of the data is no way to run monetary policy. Instead, the BoE should be true to its word and undertake a thorough consideration of a rate rise alongside its quarterly forecasts in its February inflation report. (…)

EARNINGS WATCH

I have been posting about swinging pension charges in recent months. Most companies determine their full year charge at year-end which impacts their Q4 results.

Pendulum Swings for Pension Charges

Rising interest rates and a banner year for stocks could lift reported earnings at some large companies that have made an arcane but significant change to the way their pension plans are valued.

Rising rates and a banner year for stocks could lift earnings at some large companies that have made an arcane but significant change to the way their pension plans are valued.

Companies including AT&T Inc. and Verizon Communications Inc. could show stronger results than some expect when they report fourth-quarter earnings in coming weeks. They and about 30 other companies in the past few years switched to “mark-to-market” pension accounting to make it easier for investors to gauge plan performance.

With the switch, pension gains and losses flow into earnings sooner than under the old rules, which are still in effect and allow companies to smooth out the impact over several years. Companies that switch to valuing assets at up-to-date market prices may incur more volatility in their earnings, but it offers a more current picture of a pension plan’s health and its contribution to the bottom line.

In 2011 and 2012, that change hurt the companies’ earnings, largely because interest rates were falling at the time. But for 2013, it may be a big help to them, accounting experts said, a factor of the year’s surge in interest rates and strong stock-market performance.

“It’s going to account for a huge rise in operating earnings” at the affected companies, said Dan Mahoney, director of research at accounting-research firm CFRA.

Wall Street analysts tend not to include pension results in their earnings estimates, focusing instead on a company’s underlying businesses. That makes it hard for investors to know what the impact of the change will be. Some companies may not see a big impact at all, because of variations from company to company in how they’ve applied mark-to-market changes. (…)

Some mark-to-market companies with fiscal years ended in September have reported pension gains. Chemical maker Ashland Inc. had a $498 million pretax mark-to-market pension gain in its September-end fourth quarter, versus a $493 million pension loss in its fiscal 2012 fourth quarter. That made up about 40% of the Covington, Ky., company’s $1.24 billion in operating income for fiscal 2013. (…)

Not all mark-to-market companies will see gains. Some such companies record adjustments only if their pension gains or losses exceed a minimum “corridor.” As a result, Honeywell International Inc. says it doesn’t foresee a significant mark-to-market adjustment for 2013, and United Parcel Service Inc. has made similar comments in the past.

Moody’s adds: US Corporate Pension Funded Ratios Post Massive Increase in 2013

At year-end 2013, we estimate pension funding levels for our 50 largest rated US corporate issuers increased by 19 percentage points to 94% of pension obligations, compared with a year earlier. In dollar terms, this equates to $250 billion of decreased underfundings for these same issuers. We expect this reduction to be replicated across our entire rated universe. These improved funding levels will result in lower calls on cash, a credit positive.

Big Six U.S. Banks’ 2013 Profit Thwarted by Legal Costs

Combined profit at the six largest U.S. banks jumped last year to the highest level since 2006, even as the firms allocated more than $18 billion to deal with claims they broke laws or cheated investors.

A stock-market rally, cost cuts and a decline in bad loans boosted the group’s net income 21 percent to $74.1 billion, according to analysts’ estimates compiled by Bloomberg. That’s second only to 2006, when the firms reaped $84.6 billion at the peak of the U.S. housing bubble. The record would have been topped were it not for litigation and other legal expenses. (…)

The six banks’ combined litigation and legal expenses in the nine months rose 76 percent from a year earlier to $18.7 billion, higher than any annual amount since at least 2008. The costs increased at all the firms except Wells Fargo, where they fell 1.2 percent to $413 million, and Morgan Stanley (MS), which reported a 14 percent decline to $211 million. (…)

Legal costs that averaged $500 million a quarter could be $1 billion to $2 billion for a few years, Dimon told analysts in an Oct. 11 conference call. The firm is spending also $2 billion to improve compliance by the end of 2014, he said last month. (…)

VALUATION EXPANSION?

This is one of the main narratives at present, now that earnings multiples have expanded so much. The other popular narrative is the acceleration of the U.S. economy which would result in accelerating earnings, etc., etc… Here’s Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

It’s also possible valuations could continue to expand even if earnings growth doesn’t meet expectations. There is a direct link between valuation and the yield curve. A steep curve (long rates much higher than short rates); which we have at present and are likely to maintain; suggests better growth and easy monetary policy. This environment typically co-exists with rising valuation.

Low inflation is also supportive of higher multiples. Why? Earnings are simply more valuable when inflation is low; just like our earnings as workers are worth more when inflation is taking less of a bite out of them.

Lastly, as noted in BCA’s 2014 outlook report: In a liquidity trap, where interest rates reach the zero boundary, the linkage between monetary policy and the real economy is asset markets: zero short rates act to subsidize corporate profits, drive up asset prices and encourage risk-taking. Over time, higher asset values begin to stimulate stronger consumption and investment demand—the so-called “wealth effect.” We could be at the very early stages of a broad transition from strengthening asset values to better spending power by businesses and consumers. Global capital spending has begun to show signs of a rebound; while US consumers are beginning to borrow and spend again.

A few remarks on the above arguments:

imageThe yield curve can steepen if short-term rates decline or if long-term rates rise. The impact on equities can be very different. My sense is that the curve, which by the way is presently very steep by historical norms (chart from RBC Capital), could steepen some more for a short while but only through rising long-term yields. This is not conducive to much positive valuation expansion, especially if accompanied by rising inflation expectations which, normally, follow economic acceleration.

The next chart plots 10Y Treasury yields against the S&P 500 Index earnings yield (1/P/E). The relationship between the two is pretty obvious unless you only look at the last Fed-manipulated 5 years. Rising rates are not positive for P/E ratios.

image

Low inflation is indeed supportive of higher multiples as the Rule of 20 clearly shows. What is important for market dynamics is not the actual static level of inflation but the trend. Nirvana is when the economy (i.e. profits) accelerate while inflation remains stable or even declines. Can we reasonable expect nirvana in 2014?

The wealth effect was in fact Bernanke’s gambit all along. And it worked. But only for the top 20% of the U.S. population. What is needed now is employment growth. Can we get that without triggering higher inflation?

Miss Sonders reminds us that

This bull market is now the sixth longest in S&P 500 history (of 26 total bull markets). As of year end 2013, it’s run for 1,758 days, with the longest ending in 2000 at 4,494 days. It is the fourth strongest in history; up over 173% cumulatively as of year-end 2013.

Emerging Market Currencies Suffer as Dollar Rises

The South African rand sank to a fresh five-year low Thursday, as a rise in the dollar, fueled by strong U.S. jobs data, kept emerging market currencies under pressure.

The Turkish lira also suffered, closing in on its all-time low against the dollar reached earlier in the week. The rand and the lira are widely considered to be among the most vulnerable emerging market currencies, as both South Africa and Turkey are reliant on foreign investment flows to fund their wide current account deficits.

 
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NEW$ & VIEW$ (8 JANUARY 2014)

Companies in U.S. Added 238,000 Jobs in December, ADP Says

The 238,000 increase in employment was the biggest since November 2012 and followed a revised 229,000 gain in November that was stronger than initially estimated, according to the ADP Research Institute in Roseland, New Jersey. The December tally exceeded the most optimistic forecast in a Bloomberg survey in which the median projection called for a 200,000 advance.

Discounts drive U.S. holiday retail growth: ShopperTrak

Promotions and discounts offered by U.S. retailers drove a 2.7 percent rise in holiday season sales despite six fewer days and a cold snap that kept shoppers from stores, retail industry tracker ShopperTrak said. (…)

U.S. online retail spending rose 10 percent to $46.5 billion in the November-December 2013 holiday season, according to comScore (SCOR.O). This was below the 14 percent growth that the data firm had forecast.

ShopperTrak said shoppers spent $265.9 billion during the latest holiday period. The increase was slightly ahead of the 2.4 percent jump it had forecast in September.

ShopperTrak had forecast a 1.4 percent decline in shopper traffic.

Both retail sales and foot traffic rose 2.5 percent in the 2012 holiday season. (…)

ShopperTrak estimated on Wednesday that U.S. retail sales would rise 2.8 percent in the first quarter of 2014, while shopper traffic would fall 9 percent.

Growth Picture Brightens as Exports Hit Record

A booming U.S. energy sector and rising overseas demand brightened the nation’s trade picture in November, sharply boosting estimates for economic growth in late 2013 and raising hopes for a stronger expansion this year.

U.S. exports rose to their highest level on record in November, a seasonally adjusted $194.86 billion, the Commerce Department said Tuesday. A drop in imports narrowed the trade gap to $34.25 billion, the smallest since late 2009.

Pointing up The trade figures led many economists to sharply raise their forecasts for economic growth in the final quarter. Morgan Stanley economists raised their estimate to an annualized 3.3% from an earlier forecast of a 2.4% pace. Macroeconomic Advisers boosted its fourth-quarter projection to a 3.5% rate from 2.6%.

Fourth-quarter growth at that pace, following a 4.1% annualized increase in the third quarter, would mark the fastest half-year growth stretch since the fourth quarter of 2011 and the first quarter of 2012.

The falling U.S. trade deficit in large part reflects rising domestic energy production. U.S. crude output has increased about 64% from five years ago, according to the U.S. Energy Information Administration.

At the same time, the U.S.’s thirst for petroleum fuels has stalled as vehicles become more efficient. As a result, refiners are shipping increasing quantities of diesel, gasoline and jet fuel to Europe and Latin America.

Petroleum exports, not adjusted for inflation, rose to the highest level on record in November while imports fell to the lowest level since November 2010.

If recent trade trends continue, Mr. Bryson said net exports could add one percentage point to the pace of GDP growth in the fourth quarter. That would be the biggest contribution since the final quarter of 2010.

Rising domestic energy production also helps in other ways, by creating jobs, keeping a lid on gasoline costs and lowering production costs for energy-intensive firms. As a result, consumers have more to spend elsewhere and businesses are more competitive internationally. (…)

U.S. exports are up 5.2% from a year earlier, led by rising sales to China, Mexico and Canada. U.S. exports to China from January through November rose 8.7% compared with the same period a year earlier. Exports to Canada, the nation’s largest trading partner, were up 2.5% in the same period. (…)

US inflation expectations hit 4-month high
Sales of Treasury inflation protected securities rise

Inflation expectations, as measured by the difference between yields on 10-year nominal Treasury notes and Treasury inflation protected securities (Tips), have risen to 2.25 per cent from a low of around 2.10 a month ago.

Aging Boomers to Boost Demand for Apartments, Condos and Townhouses

 

(…) As the boomers get older, many will move out of the houses where they raised families and move into cozier apartments, condominiums and townhouses (known as multifamily units in industry argot). A normal transition for individuals, but a huge shift in the country’s housing demand.

Based on demographic trends, the country should see a stronger rebound in multifamily construction than in single-family construction, Kansas City Fed senior economist Jordan Rappaport wrote in the most recent issue of the bank’s Economic Review. (Though he also notes slowing U.S. population growth “will put significant downward pressure on both single-family and multifamily construction.”)

Construction of multifamily buildings is expected to pick up strongly by early 2014, and single-family-home construction should regain strength by early 2015. “The longer term outlook is especially positive for multifamily construction, reflecting the aging of the baby boomers and an associated shift in demand from single-family to multifamily housing. By the end of the decade, multifamily construction is likely to peak at a level nearly two-thirds higher than its highest annual level during the 1990s and 2000s,” Mr. Rappaport wrote.

In contrast, when construction of single-family homes peaks at the end of the decade or beginning of the 2020s, he wrote, it’ll be “at a level comparable to what prevailed just prior to the housing boom.” (…)

“More generally,” Mr. Rappaport wrote, “the projected shift from single-family to multifamily living will likely have many large, long-lasting effects on the U.S. economy. It will put downward pressure on single-family relative to multifamily house prices. It will shift consumer demand away from goods and services that complement large indoor space and a backyard toward goods and services more oriented toward living in an apartment. Similarly, the possible shift toward city living may dampen demand for automobiles, highways, and gasoline but increase demand for restaurants, city parks, and high-quality public transit. Households, firms, and governments that correctly anticipate these changes are likely to especially benefit.”

Euro-Zone Retail Sales Surge

A surprise jump in retail sales across the euro zone boosts hopes that consumers may aid the hoped-for recovery.

The European Union’s statistics agency Wednesday said retail sales rose by 1.4% from October and were 1.6% higher than in November 2012. That was the largest rise in a single month since November 2001, and a major surprise. Nine economists surveyed by The Wall Street Journal last week had expected sales to rise by just 0.1%.

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The pickup was spread across the currency area, with sales up 1.5% in low-unemployment Germany, but up an even stronger 2.1% in France, where the unemployment rate is much higher and the economy weaker.

The rise in sales was also broadly based across different products, with sales of food and drink up 1.1% from October, while sales of other items were up 1.9%.

The surge in sales during November follows a long period of weakness, with sales having fallen in September and October. Consumer spending rose by just 0.1% on the quarter in the three months to September, having increased by a slightly less feeble 0.2% in the three months to June.

High five Let’s not get carried away. Sales often rebound after two weak months. Taking the last 3 months to November, totals sales rose only 0.4% or 1.6% annualized, only slightly better than the 0.8% annualized gain in the previous 3 months. Core sales did a little better with  annualized gains of 3.6% and 0.4% for the same respective periods. The most recent numbers can be revised, however.image

Markit’s Retail PMI for December was not conducive to much hoopla!

Markit’s final batch of eurozone retail PMI® data for 2013 signalled an overall decline in sales for the fourth month running. The rate of decline remained modest but accelerated slightly, reflecting a sharper contraction in France and slower growth in Germany.

Record-Low Core Inflation May Soon Push ECB to Ease Policy (Bloomberg Briefs)image

Meanwhile:

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Auto U.K. Car Sales Top Pre-Crisis Levels

U.K. registrations of new cars rose 11% in 2013 to their highest level since before the 2008 financial crisis, reflecting the country’s relatively strong economic recovery in contrast with the rest of Europe, where car demand has revived only recently from a prolonged slump.

The outlook is nonetheless for more sedate growth in the U.K. this year and next as the impact of pent-up demand for new cars fades, the U.K. Society of Motor Manufacturers and Traders, or SMMT, said on Tuesday.

Much of the increase in sales last year stemmed from the generous provision of cheap financing from the car manufacturers.

The SMMT said registrations, which mirror sales, rose to 2.26 million vehicles from 2.04 million in 2012, with registrations in December jumping 24% to 152,918, a 22nd consecutive monthly rise.

As a result, the U.K. has entrenched its position as Europe’s biggest car market after Germany and ahead of France. Germany registrations of new cars fell 4.2% to 2.95 million in 2013, despite a 5.4% gain in December. French registrations fell 5.7% last year to 1.79 million cars, although they rose 9.4% in December. The German and French data were released by the countries’ auto-making associations last week. (…)

Eurozone periphery borrowing costs fall
Yields in Spain, Portugal and Greece down after Irish bond sale

(…) The strength of demand for eurozone “periphery” debt reflected increased investor appetite for higher-yielding government bonds as well as rising confidence in the creditworthiness of eurozone economies. It improved significantly the chances of Portugal following Ireland’s example and exiting its bailout programme later this year – and of Greece also soon being able to tap international debt markets. (…)

EARNINGS WATCH

Currency Swings Hit Earnings Currency swings are still taking a toll on corporate earnings despite efforts to manage the risk. Large U.S. multinational companies reported about $4.2 billion in hits to earnings and revenue in Q3, driven mostly by swings in the Brazilian real, Japanese yen, Indian rupee and Australian dollar, CFOJ’s Emily Chasan reports. The real declined 10% against the U.S. dollar during the quarter, while the rupee hit a record low.

A total of 205 companies said currency moves had negatively affected their results in the third quarter of 2013, according to FiREapps, a foreign exchange risk-management company. “More companies are trying to manage risk…but companies are still seeing highly uncorrelated moves [against the dollar] based on swings in one currency,” said FiREapps CEO Wolfgang Koester. Companies have spent much of the year insulating themselves against big moves in the euro or the yen, but swings in the Australian dollar, rupee and real dominated discussions because they were often surprises, Mr. Koester said.

Only 78 companies quantified the impact of currencies, which translated to about 3 cents a share on average. The total was up slightly from the second quarter when 95 companies reported a total impact of $4.1 billion.

On an industry basis, car makers suddenly started disclosing more currency moves during the quarter, with 16 companies mentioning their results had been affected. Ford, for example, warned last month of the potential impact from an expected Venezuelan currency devaluation in 2014.

Thumbs down A Flurry of Downgrades Kick Off the New Year

 

Wall Street analysts have gotten back to work in the new year with a flurry of ratings changes, and they have been more bearish than bullish.  As shown in the first chart below, there have been 226 total ratings changes over the first four trading days of 2014, which is the highest reading seen since the bull market began in 2009.  We have seen 134 analyst downgrades since the start of the year, which is also the highest level seen over the first four trading days since 2009.  

In percentage terms, 2014 is starting with fewer downgrades than in 2011 or 2012 (62.7% and 60.0% respectively vs. 59.2% in 2014), but these years both had very quiet starts in terms of the total number of ratings changes.  

Record-Setting Cold Hits Eastern U.S.

A record-setting cold snap in the Midwest enveloped the eastern half of the country Tuesday, with brutally cold temperatures recorded from the deep South up to New England.

Pointing up Is China About to Let the Yuan Rise? Don’t Bank on It  China’s central bankers are beginning to think the country’s huge pile of reserves – which is still growing as authorities intervene to keep the yuan from rising too fast — is excessive. Curbing its growth could even help the economy’s transition from an export-led model to one based on domestic consumption. But the top leadership’s fear of social unrest means things are unlikely to change soon.

(…) In an effort to hold down the value of its currency and keep Chinese exports competitive, the PBOC wades into markets, buying up foreign exchange and pumping out yuan on a massive scale. The PBOC probably bought $73 billion dollars of foreign exchange in October, the most in three years, and a similar amount in November, according to Capital Economics.

Even before that, official figures showed China’s reserves had hit a record $3.66 trillion by the end of the third quarter, the bulk of it invested in U.S. dollar securities like Treasury bonds. Policymakers are beginning to wonder if that hoard is too big.

Sitting on $4 trillion might not seem like a bad position to be in, but it can make a mess of domestic monetary policy if those reserves result from the central bank’s attempts to deal with capital inflows.

To prevent the yuan from appreciating, the PBOC buys up foreign exchange using newly created domestic currency. But that can fuel domestic inflation, so the central bank “sterilizes” the new money by selling central bank bills to domestic financial institutions. That leaves these institutions with less cash for lending, pushing up domestic interest rates (and ultimately leaving the central bank with a loss on its balance sheet).

Interest rates in China already are significantly higher than in many other countries, making it a tempting target for speculative “hot money” flows, which tend to find a way in despite the country’s capital controls.

“Monetary policy gets into a conundrum,” said Louis Kuijs, an economist at RBS. “If the central bank is intervening because there are huge capital inflows, the domestic interest rate in the market will go up. The more that interest rate goes up, the more capital will be attracted. It becomes difficult for the central bank to manage.”

Yi Gang, head of the State Administration of Foreign Exchange and guardian of the treasure trove, thinks the reserves are so large they’re becoming more of a burden than an asset. In an interview last month, he told financial magazine Caixin that a further build-up would bring “fewer and fewer benefits coupled with higher and higher costs.”

Those costs include not just losses on sterilization operations but also the impact of a huge export sector on the environment, he said.

But Mr. Yi does not make the decisions, any more than his boss, PBOC Gov. Zhou Xiaochuan, has the final say on interest rates. Monetary policy in China is too big a deal to be left to the central bank; the State Council, headed by Premier Li Keqiang, has to sign off on its decisions.

The technocrats at the PBOC, financial professionals who have as much faith in markets as anyone in China’s government, might want to dial back foreign-exchange intervention. But the top leaders are leery of any move that could pose a risk to employment. If factories go out of business and jobless migrants flood the streets of Guangdong, a market-determined exchange rate will be little comfort.

To be sure, China is allowing the yuan to appreciate — just not by much. The yuan has risen nearly 13% against the U.S. dollar since authorities relaxed the currency peg in June 2010, including 3% appreciation last year. But that’s far less than it would likely rise if the market were allowed to operate freely.

Never mind that a cheap currency makes it more expensive for Chinese households and businesses to buy things from the outside world, depressing standards of living and hampering the transition to a consumer society that China’s leaders ostensibly want. The policy amounts to forced saving on a huge scale — even as the officials who manage those savings say they already have more than enough for any contingency.

Some experts think the pace of China’s FX accumulation will even increase. Capital Economics says the PBOC could amass another $500 billion over the next year. That’s what they think it will take to keep the yuan from rising to more than 5.90 to the dollar, compared with 6.10 now.

“The PBOC will have to choose between allowing significant currency appreciation and continuing to accumulate foreign assets,” Mark Williams, the firm’s chief Asia economist, wrote in a research note Monday. “We expect policymakers to opt primarily for the latter.”

Emerging Markets See Selloff

The declines come amid concerns about faltering economies and political unrest.

Investors are bailing out of emerging markets from Turkey and Brazil to Thailand and Indonesia, extending a selloff that began last year, amid concerns about faltering economies and political unrest.

The MSCI Emerging Markets Index, a gauge of stocks in 21 developing markets, slipped 3.1% in the first four trading days of 2014, building on a 5% loss in 2013. This compares with double-digit-percentage rallies in stock markets in the U.S., Japan and Europe last year.

Indonesia’s currency on Tuesday hit its lowest level against the dollar since the financial crisis in Asia trading. Meanwhile, the Turkish lira plumbed record lows against the greenback this week. (…)

In the first three trading days of the year, investors yanked $1.2 billion from the Vanguard FTSE Emerging Markets ETF, VFEM.LN +0.07% the biggest emerging-markets exchange-traded fund listed in the U.S., according to data provider IndexUniverse. That is among the biggest year-to-date outflows among all ETFs. Shares of the ETF itself are down 4.2% in 2014.

Last year, money managers pulled $6 billion from emerging-market stocks, the most since 2011, according to data tracker EPFR Global. Outflows from bond markets totaled $13.1 billion, the biggest since the financial crisis of 2008. (…)

The stocks in the MSCI Emerging Markets Index on average are trading at 10.2 times next year’s earnings, compared with a P/E of 15.2 for the S&P 500, FactSet noted. (…)

In the Philippines, an inflation reading on Tuesday reached a two-year high and provided another sell signal to currency traders given officials and economists had expected the impact from the typhoon in November to be mild on inflation. The Philippine peso has weakened 1% against the dollar since the start of the year. (…)

Mohamed El-Erian
Do not bet on a broad emerging market recovery

(…) To shed more light on what happened in 2013 and what is likely to occur in 2014, we need to look at three factors that many had assumed were relics of the “old EM”.

First, and after several years of large inflows, emerging markets suffered a dramatic dislocation in technical conditions in the second quarter of 2013.

The trigger was Fed talk of “tapering” the unconventional support the US central bank provides to markets. The resulting price and liquidity disruptions were amplified by structural weaknesses associated with a narrow EM dedicated investor base and skittish cross-over investors. Simply put, “tourist dollars” fleeing emerging markets could not be compensated for quickly enough by “locals”.

Second, 2013 saw stumbles on the part of EM corporate leaders and policy makers. Perhaps overconfident due to all the talk of an emerging market age – itself encouraged by the extent to which the emerging world had economically and financially outperformed advanced countries after the 2008 global financial crisis – they underestimated exogenous technical shocks, overestimated their resilience, and under-delivered on the needed responses at both corporate and sovereign levels. Pending elections also damped enthusiasm for policy changes.

Finally, the extent of internal policy incoherence was accentuated by the currency depreciations caused by the sudden midyear reversal in cross-border capital flows. Companies scrambled to deal with their foreign exchange mismatches while central bank interest rate policies were torn between battling currency-induced inflation and countering declining economic growth.

Absent a major hiccup in the global economy – due, for example, to a policy mistake on the part of G3 central banks and/or a market accident as some asset prices are quite disconnected from fundamentals – the influence of these three factors is likely to diminish in 2014. This would alleviate pressure on emerging market assets at a time when their valuations have become more attractive on both a relative and absolute basis.

Yet the answer is not for investors to rush and position their portfolios for an emerging market recovery that is broad in scope and large in scale. Instead, they should differentiate by favouring companies commanding premium profitability and benefiting from healthy long-run consumer growth dynamics, residing in countries with strong balance sheets and a high degree of policy flexibility, and benefiting from a rising dedicated investor base.

 
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