NEW$ & VIEW$ (28 JANUARY 2014)

Calm Returns to Emerging Markets Efforts by emerging-market central banks to counter a vicious market selloff in recent days brought a measure of calm.

The Turkish lira held on to the large gains it made Monday, after the country’s central bank announced a previously unscheduled interest-rate decision for late Tuesday, with the dollar pinned just under 2.27 against the lira, well below the near-2.39 peak it hit Monday.

Bank Gov. Erdem Basci said Tuesday he will “not refrain from permanent policy tightening,” which appears to reaffirm the market’s clear expectation for aggressive rate rises to support the currency at the coming rates announcement, scheduled for midnight local time.

An unexpected 0.25-percentage-point rate rise by India’s central bank has also lent support to battered emerging-market currencies, which have been dented by drab economic news from China, concerns over the effects of the U.S. Federal Reserve’s pullback from monetary stimulus, and a long list of geopolitical stresses including those in Turkey, Argentina, South Africa and Ukraine.

Italy Grabs Record Low 2-Year Funding Costs

At Tuesday’s auction, the Italian treasury sold €2.5 billion euros ($3.42 billion) in December 2015-dated zero coupon notes, or CTZ, and a further €1.25 billion euros in September 2018-dated inflation-index bonds, or BTPei, the Bank of Italy said. The amounts sold were at the upper end of the treasury’s respective target ranges.

The yield on the CTZ was 1.031%. Italy’s previous lowest funding cost in this maturity segment was 1.113%, in May 2013.

Fears had surfaced that ongoing emerging-market turmoil could spill into to the euro zone’s relatively weak sovereign debt markets as the single currency area tentatively emerges from recession. But these auction results suggest the risks to the euro zone can remain contained.

 Italian Retail Sales Offer Very Slow Progress

Retail sales for Italy in November were flat, marking their best performance since August when sales also were flat. The last increase in Italian retail sales came in May 2013 with a 0.1% rise. Retail sales dropped by 1.2% over 12 months, they fell at a 1.5% annual rate over six months and they fell at an even faster, 1.7% rate, over three months. (…)

Real retail sales excluding autos are flat in November, but they had risen by 0.1% in October. Retail sales are down by 1.9% over 12 months and they are falling at a faster, 2.6% annual rate, over six months. However, over three months, real retail sales are declining at only a 0.9% annual rate. (…)

SOFT PATCH WATCH

 

(…) Last week, the flash January factory survey by data provider Markit said some respondents stated “extreme weather conditions in January had temporarily disrupted output levels.” So, too, the Kansas City Fed said its survey of area manufacturers showed production declined slightly this month because of weather.

Store chains are also feeling the freeze.

“It was a slow period for sales over the past week with some bouts of abnormal seasonal weather curbing the consumers’ appetite to shop,” the International Council of Shopping Centers said.

Consumer spending may also take a hit because households are paying more for natural gas to heat their homes.

“Weather was mentioned 21 times in the latest beige book, almost always in a negative context, the most in any winter month Beige Book since at least 2011,” wrote John Canally, investment strategist at LPL Financial, after looking at the book.

Besides store sales and manufacturing, other activity that could be hurt by weather include home building and car sales (who wants to drive a shiny new car off the lot during a snow storm).

As one positive for growth: higher demand for heat is probably lifting utility output this month.

The end result is that when January data roll out in February, the weak tone may cause some economists to trim their tracking of first-quarter GDP growth. (…)

  • FYI, updated to last Saturday:

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Economists polled by Bloomberg anticipate the economy grew 3.2 percent during the final three months of the year, a bit softer than the 4.1 percent gain in the third quarter, which was overwhelmingly the result of a $115.7 billion inventory build. While optimists may claim the fourth quarter was still strong, the data may not provide an accurate depiction of underlying conditions.

First, there’s little doubt the strong economic reports for November were
payback for the sharp, albeit temporary, weakness in October caused by
the shutdown of the U.S. government. Second, with December data coming in softer than Street expectations, recent issues such as the mass layoff announcements by Wal-Mart, Macy’s, JC Penney, Target and Intel, as well as deterioration in China’s industrial sector and currency
issues in the emerging markets, the accumulation of negatives could end up being too much weight for the sluggish recovery to bear.

The Chicago Fed’s National Activity Index decreased to 0.16 in December
from the 0.69 posting in November. Similarly, The Conference Board’s index of leading economic indicators (LEI) inched up 0.1 percent in December following a 0.8 percent spike in November. The LEI is known for predicting turning points in the economy. And the Conference Board’s coincident-to- lagging indicator ratio continues its downward descent.

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Meanwhile, meaningful housing data have been bleak – new home sales
tumbled 7 percent in November – essentially unchanged from mid-year 2013 levels. From an economist’s standpoint, new home sales matter more than their existing home counterpart since they require building materials, new durable goods (washers, dryers, refrigerators, etc.) and employ specialty trade contractors such as plumbers, landscapers,
electricians and other tradesmen.

Similarly, the MBA Purchases Index fell 3.6 percent during the week ended Jan. 17, and is off 15.2 percent from year ago levels. This gauge has been mired in weak territory for years now with no sign of improvement. (…)

 

Sales of newly built homes fell 7% to a seasonally adjusted annual rate of 414,000 in December from 445,000 in November, the Commerce Department said Monday. November’s figure was revised down by 19,000.

December sales came in below the 455,000 annual pace forecast by economists and were at their lowest level since the summer, when rising mortgage rates undermined demand.

It was not just weather related as Haver Analytics points out:

Poor weather crimped sales by more than one-third m/m in the Northeast to 21,000 (-27.6% y/y). Sales also fell 8.8% (+5.1% y/y) to 103,000 in the West while sales were off 7.3% (+4.1 y/y) in the South to 230,000, the second month of sharp decline.

Royal Philips NV and Siemens AG, two of Europe’s biggest industrial groups by revenue, reported Tuesday robust results for the three months to end-December but cautioned that business conditions remain tough, partly because of the euro’s strength against major currencies.

The cautious outlook from the Dutch and German companies follows similar downbeat forecasts from other blue-chip European companies to have reported in the past two weeks, some of them issuing profit warnings.

The year will start a bit slow,” Philips Chief Executive Frans van Houten said.

At Siemens, orders at its power-generation equipment division fell in Europe, the Americas, and Asia in the quarter. The Germany company’s main European competitors in the sector, Alstom SA of France and ABB Ltd. of Switzerland, warned on their earnings prospects last week. (,,,)

Fingers crossed States Weigh Plans for Revenue Windfalls Governors across the U.S. are proposing tax cuts, increases in school spending and college-tuition freezes as growing revenue and mounting surpluses have states putting the recession behind them.

(…) The strengthening in tax revenue started in late 2012 as higher-income residents in many states took increased capital gains among other steps to avoid rising federal tax rates on certain income. Those tax payments spilled over into 2013, and further fuel for collections came from a record stock market and improving economy. State tax revenue nationally climbed 6.7% in the fiscal year ended June 30, 2013, Moody’s Analytics says. (…)

Some states already have responded to rising tax collections by increasing spending on education and other programs, or cutting taxes. (…)

Economists warn the surge in tax revenue already is showing signs of slowing. Some of the strength has been fueled by people shifting income for tax purposes, making the gains more about timing than growth. New York, for example, forecasts income-tax receipts will grow 3% in the fiscal year starting this April after projecting a 6.5% rise in the current fiscal year. And rising collections spurred in part by profits from a record stock market leave some states such as New Jersey and California subject to sharp swings in revenue from income taxes. (…)

Can we now reasonably hope that state employment has bottomed out?

FRED Graph

 

FRED Graph

 

President to Hike Minimum Wage for Federal Contractors

President Barack Obama plans to act unilaterally to raise the minimum wage for employees of federal contractors, asserting his executive powers before the State of the Union address.

The executive order would raise the minimum wage for workers on new federal contracts to $10.10 an hour, according to a fact sheet from a White House official. It said Mr. Obama would announce the new policy in his speech Tuesday, which is scheduled to begin at 9 p.m. Eastern Time.

The current federal minimum wage is $7.25 per hour, and hasn’t been raised since July 2009. About 16,000 federal employees were paid at or below minimum wage in 2012, according to the Labor Department. The agency doesn’t specify how many employees were government contractors.

Mr. Obama’s executive policy change is the opening salvo in a broader, election-year push by Democrats to raise the federal minimum wage to $10.10 an hour for all eligible workers.

SENTIMENT WATCH

 

The “January indicator” says that if the stock market falls in January, it usually falls for the remainder of the year. So far, January has been a disaster for stocks. (…)

High five Wait, wait! Mike Lombardi, in the above post, reproduced in many other blogs today, writes that “it usually falls for the remainder of the year”. Ever thought what “usually” really means? Mark Hulbert shows you the stats since 1880:

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Voilà! Now you know that “usually” means anything above 50% of the time. Hulbert continues where Lombardi did not:

A follower of the January Indicator in 2009 and 2010 would have missed out on two years of double-digit gains if one were to have used the occasion of a “down” January to get out of the market.

Another example that it is usually best to check the facts out. Here “usually” means “generally”, at a minimum, “always” if you really care.

 

BANKING

 

Loan-Loss Reserves Shrink

At the end of September, about 6,500 U.S. banks had set aside loan-loss reserves of just 1.83% of their roughly $7.80 trillion in loans, according to data provider SNL Financial.

That cushion has been shrinking since 2010, and banks are on pace to have ended 2013 with reserves amounting to about 1.66% of total loans, based on fourth-quarter reports from eight of the country’s largest banks provided to The Wall Street Journal by SNL.

That would be the lowest proportion of such reserves since 1.74% in mid-2008, a few months before the collapse of Lehman Brothers.

By contrast, reserves hit a near-term peak of 3.24% at the end of 2010 as banks grappled with troubled loans in the aftermath of the Great Recession.

Total bank loans outstanding, however, still are below prerecession levels of $7.91 trillion at the end of 2007. (…)

U.S. Banks Prune Branches

Bank branch closures in the U.S. last year hit the highest level on record so far, a sign that sweeping technological advances in mobile and electronic banking are paying off for lenders but leaving some customers behind.

U.S. banks cut a net 1,487 branch locations last year, according to SNL Financial, the most since the research firm began collecting the data in 2002.

Branch numbers have been on a steady decline since 2009 and reached a total of 96,339 at the middle of last year, the lowest since 2006, according to data from the Federal Deposit Insurance Corp.

 

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. (…)

 

NEW$ & VIEW$ (20 JANUARY 2014)

China’s Economic Growth Slows to 7.7%

China’s economic growth slowed slightly in the fourth quarter, complicating the challenge for the country’s leaders as they seek to reshape the world’s No. 2 economy.

In the fourth quarter of 2013, China’s economy grew 7.7% from a year ago, slower than the 7.8% it posted in the third quarter, according to data released Monday by China’s National Bureau of Statistics. That translates into 7.4% growth on a quarter-to-quarter annualized basis, the way most major economies report growth. China doesn’t release a similar figure.

Investment, which accounts for about half of China’s economic output, was a major drag on growth in the fourth quarter, a result of monetary authorities making credit more expensive. Fixed-asset investment expanded 19.6% on-year in 2013, down from 19.9% from the first 11 months of the year, indicating slowing capital spending, according toANZ Bank. (…)

The economy was growing more slowly in December than at the beginning of the final quarter of the year.

Louis Kuijs, an economist at RBS in Hong Kong, points out that industrial production grew 9.7% on-year in December versus 10.3% in October. And export growth slowed in December after a strong showing in November. That could point to a slow start to 2014, unless other drivers like exports or local demand pick up above expectations.

One area of brightness in the fourth quarter was retail sales, which grew 13.6% on-year in December, almost the same pace of growth as November. (…)

Sarcastic smile  See anything strange in this CLSA chart? How about 7 straight quarters of stable growth.

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China’s Central Bank Providing Short-Term Cash to Lenders

In a rare accommodative measure, the state-run People’s Bank of China is providing short-term cash to the country’s biggest lenders, in a move seen as a bid to avoid a liquidity crisis near the Lunar New Year holiday.

The PBOC said it will inject further liquidity into the system via reverse purchase agreements, a form of short-term loans to banks, when it conducts its twice-a-week open market operation on Tuesday.

It said the moves are intended to maintain the stability of China’s money market ahead of the weeklong Spring Festival that kicks off on Jan. 31. (…)

The central bank’s apparent reassurance came after China’s financial system showed fresh signs of stress on Monday, with short-term borrowing costs for banks soaring on heavy holiday-induced demand for cash and rising worries over the vast shadow-banking sector.

The benchmark cost of short-term loans between banks, the weighted average of the seven-day repurchase agreement rate, rose to 6.59% on Monday, from 5.17% Friday and 4.35% Thursday. The current level marks the rate’s highest since Dec. 23, when it hit 8.94%.

The surging rates in the money markets also hammered stocks, with the benchmark Shanghai Composite falling below the key level of 2000 to 1991.25, its weakest in almost six months and down 5.9% this year, the worst performer in Asia. (…)

Housing Starts and Building Permits Decline

Housing Starts and Building Permits for the month of December both showed month/month declines but were still up compared to last year.  Relative to expectations, though, Housing Starts exceeded forecasts (999K vs. 985K), while Building Permits missed forecasts (986K vs. 1014K).

 

U.S. LABOR SUPPLY/DEMAND

The NFIB detailed report for December shows that employment was likely stronger than what the last NFP reported:

Overall, it appears that owners hired more workers on balance in December than their hiring plans indicated in November, a favorable development (apparently undetected by BLS).

Note the recent  spike in the marginal increase in employment per firm, bumping against its historical highs.image

Coming wage pressures?

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.

Margins pressures?

With a net 19 percent raising compensation but a net negative 1 percent raising selling prices, profits will continue to be under pressure. Higher compensation costs are not being passed on to customers, but there will be more pressure to do so as Obamacare begins to impact small businesses in 2014.

Pointing up Small firms capex is also brightening:

The frequency of reported capital outlays over the past 6 months surprisingly gained 9 percentage points in December, a remarkable increase. Sixty-four percent reported outlays, the highest level since early 2005.

Of those making expenditures, 43 percent reported spending on new equipment (up 5 points), 26 percent acquired vehicles (up 4 points), and 16 percent improved or expanded facilities (up 1 point). Eight percent acquired new buildings or land for expansion (up 1 point) and 16 percent spent money for new fixtures and furniture (up 6 points). The surge in spending, especially on equipment and fixtures and furniture, is certainly welcome and is hopefully not just an end-of-year event for tax or other purposes. This level of spending is more typical of a growing economy. 

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EARNINGS WATCH

We now have 52 S&P 500 companies’ Q4 results in, 19 of which are financials.

  • Of the 53 companies in the S&P 500 that have posted earnings for the latest quarter, 57% have topped analysts’ average earnings estimate, according to FactSet.
  • Out of the 52 companies in the gauge that have posted fourth-quarter results so far, 62 percent have exceeded analysts’ profit estimates, and 63 percent have topped revenue projections, according to data compiled by Bloomberg.

S&P’s own official tally shows a 52% beat rate and a 35% miss rate. Financials beat in 58% of cases while only 48% of non-financials beat (39% missed), so far.

Zacks has the best analysis:

The 2013 Q4 earnings season ramps up in the coming days, but we have results from 52 S&P 500 members already, as of Friday January 17th. And even though the early going has been Finance weighted, the overall picture emerging from the results thus far isn’t very inspiring.

The earnings reports thus far may not offer a representative sample for the S&P 500 as a whole. But we do have a good enough sample for the Finance sector as the 19 Finance sector companies that have reported already account for 47.5% of the sector’s total market capitalization and contribute more than 50% of the sector’s total Q4 earnings. (…)

Total earnings for the 19 Finance sector companies that have reported already are up +14.2% on -1% lower revenues. The earnings beat ratio is 63.2%, while only 36.8% of the companies have come out with positive top-line surprises.

Pointing up This looks good enough performance, but is actually weaker than what we had seen from these same banks in recent quarters. Not only are the earnings and revenue growth rates for the companies below what they achieved in Q3 and the 4-quarter average, but the beat ratios are weaker as well. The insurance industry, the sector’s largest industry behind the large banks, has still to report results and could potentially turnaround this growth and surprise picture for the sector.

We haven’t seen that many reports from companies outside of the Finance sector. But the few that we have seen don’t inspire much confidence. Hard to characterize any other way what we have seen from the likes of Intel (INTC), CSX Corp. (CSX), UPS (UPS) and even GE (GE). But it’s still relatively early and we will know more in the coming days.

The lack of positive surprises is ‘surprising’ following the sharp drop in Q4 estimates in the run up to the start of the reporting season.

The composite picture for Q4 – combining the results for the 52 companies that have reported already with the 448 still to come – is for earnings growth of +7.1% on +1.5% higher revenues and 50 basis points higher margins. The actual Q4 growth rally will most likely be higher than this, a function of management’s well refined expectations management skills.

Easy comparisons, particularly for the Finance sector, account for a big part of the Q4 growth. Total earnings for the Finance sector are expected to be up +25.0%. Outside of Finance, total earnings growth drops to +3.4%.

Profits Show Banks Back From the Brink

Large U.S. banks are finally emerging from the wreckage of the financial crisis, on the back of rising profits, a recovering economy and drastic cost cutting.

(…) As a group, the six earned $76 billion in 2013. That is $6 billion shy of the collective all-time high achieved in 2006, a year U.S. housing prices peaked amid a torrid economic expansion. (…)

One way for banks to improve their standing with investors is to cut compensation, jobs and business lines. This past week, Goldman Sachs announced its 2013 payroll was 3% lower than 2012’s, while Bank of America disclosed it eliminated 25,000 positions during the year. J.P. Morgan and Morgan Stanley both are in the process of exiting from the business of storing physical commodities.

Banks still face numerous headwinds, including high legal costs as regulators and investigators work through a backlog of industry activity and scrutinize everything from overseas hiring to potential manipulation of currency and interest-rate benchmarks. Higher borrowing costs are reducing homeowners’ demand for mortgages, a major profit center for some banks during the early half of 2013, and several firms reported fourth-quarter trading declines in fixed-income, currencies and commodities trading.

Despite the many challenges, big banks are beginning to find ways to boost revenue. The six largest banks posted a 4% revenue gain during 2013.

Smaller banks are recovering, as well. Earnings reports are still being released, but, together, all 6,900 commercial banks in the U.S. are on pace to match or exceed the industry’s all-time earnings peak of $145.2 billion in 2006, according to an analysis by The Wall Street Journal of Federal Deposit Insurance Corp. data. (…)

Another factor fueling earnings growth is a dramatic reduction in the reserves banks have set aside for future loan losses, as fewer U.S. borrowers default. J.P. Morgan, Bank of America, Citigroup and Wells Fargo freed up $15 billion in loan-loss reserves during 2013, including $3.7 billion in the fourth quarter. That money goes directly to the bottom line, boosting profits. The releases made up 16% of these banks’ pretax income for that final quarter. (…)

A closely watched investment-performance ratio called return on equity is well below levels achieved a decade ago. What pushed ratios lower were hundreds of billions of dollars of additional capital raised to protect the institutions from future problems and comply with new regulatory guidelines.

Goldman’s return on equity, which hit a peak of 33% in 2006, fell to 11% in 2013. The ratio was even lower for J.P. Morgan and Bank of America.

Banks are scrambling to make changes as a way of improving returns. The six biggest banks have reduced their workforces by more than 44,000 positions in the past year, while J.P. Morgan told investors it was done with an aggressive branch expansion and would no longer add to its network of 5,600 locations. Goldman Sachs’s 2013 pay reduction brings compensation expenses down to 36.9% of total revenue, the lowest percentage since 2009.

Banks will have to show they can earn money from lending and other businesses, as opposed to releasing reserves, said Fitch Ratings analyst Justin Fuller. Lending for the biggest banks was up 2% on the year, but there were limited signs that slim margins on those loans had begun to widen or at least stabilize.

Light bulb But if capex strengthen, loan demand will rise. Higher volume with the current steep yield curve = higher profits…

SENTIMENT WATCH

VOX POPULI (Gallup)

Half of Americans say investing $1,000 in the stock market right now would be a bad idea, even though the Dow Jones Industrial Average and Standard & Poor’s 500 index have recently hit record highs. Forty-six percent of Americans say investing $1,000 in the stock market would be a good idea. Trend: Americans' Views on Investing in the Stock Market

In January 2000, when the Dow was at a then-record high of 11,500, Americans were much more likely to say investing in the stock market was a good idea than they are today. A record-high 67% of Americans that month said investing was a good idea.

After the onset of the 2008-2009 Great Recession, the percentage of Americans who believed investing in the markets was a bad idea swelled to 62%. While that percentage has dropped, Americans’ confidence in buying stocks has clearly not returned to levels seen during the heady days of the early 2000s.

Stock Ownership Among Americans Still Near Record Low

Fifty-four percent of Americans now say they own stock, little changed from the 52% who said so last April — which was the lowest in Gallup’s 16-year trend of asking this question in its current format. Stock ownership is far lower than it was during the dot-com boom of 2000, when 67% said they owned stock — a record high. While staying above 60% for much of the 2000s, the ownership percentage fell into the 50% range as the Great Recession took hold and has not yet rebounded. Despite economic booms and busts, however, a majority of Americans have maintained an investment in the markets in the past 15 years. Trend: Americans' Ownership of Stocks

Although fewer Americans now own stocks, those who do, not surprisingly, are much more likely than non-owners to believe investing in the market is a good idea, 59% to 30%.

Bottom Line: The Dow is 5,000 points higher today than it was in 2000, but confidence in the markets is much lower, as is participation.

VOX DEI: Bearish Bond Belief At 20-Year Extremes

Jeff Gundlach recently warned that the trade that could inflict the most pain to the most people is a significant move down in yields (and potential bull flattening to the yield curve). (…) despite this, investors remain entirely enamored with stocks and, as the following chart shows, Treasury Bond sentiment now stands at 20-year extremes of bearishness.

Citi: “Time For Yields To Correct Lower”

The end of 2013 saw bond yields at their highs and the US equity markets making higher highs. This came as the Federal Reserve started to finally slow down its asset purchases and, as Citi’s Tom Fitzpatrick suggest, has now seemingly turned a corner in its so called “emergency” policy. That now leaves room for the market/economy to determine the proper rate of interest; and, he notes, given the patchy economic recovery, the fragile level of confidence and the low levels of inflation, Citi questions whether asset prices belong where they are today. As the Fed’s stimulus program appears to have “peaked” Citi warned investors yesterday to be cautious with the Equity markets; and recent price action across the Treasury curve suggests lower yields can be seen and US 10 year yields are in danger of retesting the 2.40% area.

US economic surprise index

General economic surprises look like they are now approaching a peak again. Only twice over the past 7 years have we been above current levels and they were short lived.

We should note that this index is naturally mean reverting as expectations rise with better than expected data and vice versa. A fall back below zero if seen may be quite important. (…)

High five  There is a lot more to Citi’s technical analysis, all mostly pointing to lower rates ahead. But before you get too technical, go back up and re-read the piece on the NFIB report.

Just kidding Up and Down Wall Street

Another sign of froth in European sovereign debt is described by Peter Tchir, a credit-market veteran who heads TF Market Advisors: Spain’s bonds due 2023 yield 3.68%, just a hair above the 3.60% from Apple‘s (AAPL) bond due 2023 issued in its then-record $17 billion offering to fund its share buyback. He admits the comparison is well, apples to oranges.

“One is denominated in euros, the other in dollars. One is a sovereign nation with devoted citizens, the other is Spain. One has so much cash on hand that trying to convince them to do something with that cash hoard has become the ultimate hedge-fund pastime. The other would have trouble rubbing two pesetas together, even if it hadn’t moved to the euro. Fifty percent of the world’s population under the age of 25 already owns or wants to own a device made by Apple. That is still a little behind the 57% in Spain who want a job (assuming some of the unemployed youth actually want jobs).”

GOLD

Physical Gold Shortage Goes Mainstream

As BNN reports, veteran trader Tres Knippa, pointing to recent futures data, says “there may not be enough gold to go around if everyone with a futures contract insists on taking delivery of physical bullion.” As he goes on to explain to a disquieted anchor, “the underlying story here is that the people acquiring physical gold continue to do that. And that’s what is important,” noting large investors like hedge fund manager Kyle Bass are taking delivery of the gold they’re buying. Knippa’s parting advice, buy physical gold; avoid paper.

One of the problems…

That won’t end well…

BUT, WILL THIS END WELL?

IMF warns on threat of income inequality

Lagarde raises stability concerns

(…) “Business and political leaders at the World Economic Forum should remember that in far too many countries the benefits of growth are being enjoyed by far too few people. This is not a recipe for stability and sustainability,” she told the Financial Times. (…)

The message is hitting home. Shinzo Abe, Japan’s prime minister, is coming to Switzerland with the message that Japanese companies must raise wages, while the government of David Cameron, his UK counterpart who is also attending the forum, called for a large inflation-busting rise in the British minimum wage last week.

In U.S., 67% Dissatisfied With Income, Wealth Distribution

Two out of three Americans are dissatisfied with the way income and wealth are currently distributed in the U.S. This includes three-fourths of Democrats and 54% of Republicans.

Satisfaction With Income and Wealth Distribution in the U.S., January 2014

The same poll updated a long-time Gallup trend, finding that 54% of Americans are satisfied, and 45% dissatisfied, with the opportunity for an American “to get ahead by working hard.” This measure has remained roughly constant over the past three years, but Americans are much less optimistic about economic opportunity now than before the recession and financial crisis of 2008 unfolded. Prior to that, at least two in three Americans were satisfied, including a high of 77% in 2002.

Satisfaction With Americans' Opportunities to Get Ahead by Working Hard, 2001-2014 Trend

 

NEW$ & VIEW$ (16 JANUARY 2014)

INFLATION WATCH

U.S. Consumer Prices Rise 0.3% in December

The consumer-price index rose a seasonally adjusted 0.3% in December from the prior month, the Labor Department said Thursday. Core prices, which strip out volatile food and energy costs, were up a mild 0.1%.

Compared with a year earlier, overall consumer prices increased 1.5% and core prices were up 1.7%. Energy prices led the monthly gain, with gasoline prices rising 3.1%. (…)

Pointing up A separate report Thursday showed inflation-adjusted average weekly earnings fell 0.5% in December from the prior month.

Real average weekly earnings are unchanged from a year earlier, giving many consumers little additional spending power.

U.S. Producer Prices Rise 0.4%

U.S. wholesale prices climbed in December after falling for most of the fall, but broader trends suggest inflation pressures remain subdued.

The producer-price index, reflecting how much firms pay for everything from paper to trucks, rose a seasonally adjusted 0.4% from November, led by a jump in energy costs, the Labor Department said Wednesday. That followed two consecutive months of declines and marked the biggest increase since June.

Core producer prices, which strip out volatile food and energy costs, increased 0.3%. But almost half of that rise was due to a surge in tobacco prices, which a Labor Department economist attributed to a routine price adjustment by manufacturers that occurs several times a year.

Fed’s Beige Book: Job Market Firming Up

Some regions of the U.S. are confronting labor shortages in construction and other high-skill fields, according to the Federal Reserve’s ‘beige book’ survey of economic conditions.

(…) The Dallas Fed district reported “acute labor shortages” for auditors, engineers, truck drivers and construction workers in late November and December.

The Cleveland Fed said hiring was “sluggish” for most industries, but construction firms were hiring. “Builders reported a scarcity of high-skilled trade workers,” according to the report. “As a result, there is upward pressure on wages, and subcontractors are demanding and getting higher rates.” (…)

“The labor markets showed signs of tightening,” the Minneapolis district reported, with 30% of businesses saying they expect to hire more full-time workers in 2014 versus 18% who expect to have fewer full-time employees.

In the Richmond district, there were “numerous reports of strong labor demand,” though the report also said few businesses offered permanent jobs to seasonal workers and there was high turnover among low-skill workers.

In all, two-thirds of districts reported “small to moderate” increases in hiring, according to the report, and many companies were optimistic as 2014 began. In the New York district, most companies said they kept staffing flat as 2013 came to a close, but “substantially more businesses plan to expand than reduce their workforces in 2014.” (…)

Most areas reported improving real-estate markets, with residential sales, prices and construction on the rise. Two-thirds of districts said commercial property sales and leasing were up, too.

Prices were described as “stable” in about half the districts and most of the rest reported “small increases,” with a couple exceptions. (…)

Eight of the 12 districts reported “small to moderate” increases in wages.

While spending on tourism and leisure was reportedly “mixed” across the country, the manufacturing sector saw “steady growth” and steady employment.

“A manufacturer in the Dallas district said that for the first time since before the recession, his firm had too many jobs to bid on,” according to the report.

No major changes in bank lending volume were reported, though six districts reported “slight to moderate growth,” three saw no change and one— New York—saw a “moderate decline in loan volume.” (…)

Robots vs humans (BAML)

Euro-Zone Inflation Weakens

Eurostat said consumer prices rose 0.3% from November, and were up 0.8% from December 2012. That marks a decline in the annual rate of inflation from 0.9% in November, and brings it further below the rate of close to 2.0% targeted by the ECB.

Eurostat also confirmed that the “core” rate of inflation—which strips out volatile items such as food and energy—fell to 0.7%, its lowest level since records began in 2001.

Lagarde warns of deflation danger IMF chief says ‘ogre’ of falling prices must be fought decisively

No reason for ‘irrational inflationary fears’ – ECB’s Weidmann

 

Europe Car Sales Fell in 2013

European car sales fell for the sixth straight year in 2013, despite a pickup in registrations in the final months of the year that sparked hope of a broader recovery in the region.

The European Automobile Manufacturers’ Association, known as ACEA, said Thursday that 11.9 million new cars were registered in the European Union last year, a decline of 1.7% compared with the previous year.

A moderate recovery of car sales in the second half of the year gathered pace in December, according to the ACEA data, but wasn’t strong enough to pull the industry into positive territory for the year. In December, new car registrations rose 13% to 906,294 vehicles—the strongest rate in the month of December since 2009 but still one of the lowest showings to date, ACEA said. Registrations also grew in the fourth quarter. (…)

Russia Faces Stagflation, Central Banker Warns

The emerging-market economy ‘can speak of stagflation,’ the Bank of Russia’s first deputy head tells an economic conference.

(…) Russia’s economic growth has been slowing amid dwindling investment, hefty capital outflows, and weak demand and low prices for its commodities exports. Officials repeatedly downgraded forecasts for economic growth last year to 1.4%, a far cry from the average annual pace of about 7% during the early 2000s and well below the medium-term target of 5% set by President Vladimir Putin. Consumer prices grew 6.5% last year, above the 5%-to-6% range the central bank was targeting.

The government acknowledged last year that the slowdown was a result of domestic economic vulnerabilities, such as low labor productivity, and not just a weak global economy, as it had earlier asserted. The economy ministry slashed its growth forecasts for the next two decades. It also warned that the oil-fueled growth that has been a foundation of Mr. Putin’s rule is over and that there is nothing ready to take its place, given the country’s poor investment climate and aging infrastructure.

In a sign of Russia’s waning appeal to foreign investors, the European Bank for Reconstruction and Development said Wednesday that its investments in Russia fell sharply last year to €1.8 billion ($2.5 billion) from €2.6 billion in 2012. (…)

Japan machinery orders hit five-year high
Data hint at greater corporate capital investment plans

(…) Orders of new machinery by businesses, considered a leading indicator of overall capital investment, surged to a five-year high in November, rising 9.3 per cent to Y882.6bn. The year-on-year increase, which handily beat analysts’ expectations, was the second in two months and the fifth biggest on record. (…)

Brazil raises benchmark rate to 10.5%
World’s most aggressive tightening cycle continues

The central bank raised the Selic rate by 50 basis points to 10.5 per cent on Wednesday, extending the world’s most aggressive tightening cycle. It has raised interest rates by 325 basis points over the past nine months. (…)

At Brazil’s previous interest rate meeting, the central bank changed its statement for the first time in months, signalling the tightening cycle would soon be over.

However, a surge in prices in December took the central bank by surprise, likely forcing a revision to the country’s monetary policy strategy, economists say.

Data from the national statistics agency last week showed consumer prices jumped 0.92 per cent in December, the most since April 2003.

The annual inflation rate for the month – 5.91 per cent – also came in above estimates from all analysts in a Bloomberg survey and far above the country’s official 4.5 per cent target. (…)

ITALY IN 3 CHARTS (From FT)

SENTIMENT WATCH 

Actually, the appropriate headline should be “The Bulls…ers Are Back” Crying face

Bulls Are Back

The stock market’s slow start to the year lasted all of two weeks, as back-to-back rallies pushed the S&P 500 back up to a record high.

(…) In a note to clients, Craig Johnson, Piper Jaffray’s technical strategist, said the market’s primary trend will remain higher in the coming months. He predicts the S&P 500 will jump another 8% and hit 2000 before suffering through a nasty correction around the middle of the year that could take the index back to the 1600-to-1650 range.

Such a drop from his projected peak would take the S&P 500 down as much as 20%, a drop that hasn’t occurred since the summer of 2011.

But have no fear, stock-market bulls. He then sees stocks staging a sharp rally through the end of the year, lifting the S&P 500 to 2100 and capping a 14% gain for the year. “A hop, a drop and a pop in 2014” is how Mr. Johnson predicts it will play out, as rising bond yields will prompt more cash to flow out of bonds and into stocks throughout the year.

“We believe that 2014 will be a good year, but not a great year like 2013,” he said. (…)

Choppy equities require investor focus
End of loose money spells change in market’s inner workings

(…) Whether 2014 is a profitable year will come down to investors relying less on endless liquidity from the Federal Reserve that, like a high tide, has floated all equity boats. Instead they must focus on specific sectors and opportunities such as likely merger and acquisition targets in the coming months. Sarcastic smile (…)

Yeah! Sure! Let’s all do that. Thank you FT.

 

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.” (…)

 

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:

cat

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.

image image

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

image

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

image 

  • 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!

 

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.

 

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.