NEW$ & VIEW$ (23 DECEMBER 2013)

Surprised smile Economy Gaining Momentum The U.S. economy grew at a healthy 4.1% annual rate in the third quarter, revised figures showed, boosting hopes that the recovery is shifting into higher gear after years of sluggishness.

Friday’s report showed consumer spending—a key driver of the economy—grew at a 2% annual rate in the summer, instead of the previously estimated 1.4%.

U.S. Economy Starts to Gain Momentum

ZeroHedge drills down:

(…) many are wondering just where this “revised” consumption came from: of the $15 billion revised increase in annualized spending, 60% was for healthcare, and another 27% was due to purchases of gasoline. The third largest upward revision: recreation services. On the flip side, the biggest revision detractors: transportation services and housing and utilities.

No boost to retailing from these revisions.

Meanwhile, profit margins keep defying the naysayers, this time because of lower taxes:

(…) after-tax corporate profits in the third quarter topped 11% of gross domestic product for the first time since the records started in 1947. At the same time, taxes paid by corporations has declined nearly 5% in the third quarter compared with a year earlier.

Another positive sign?

The U.S. economy seems to be getting “a little bit better,” said General Electric Co. Chief Executive Jeff Immelt, speaking after an investor meeting this past week. “We’ve seen some improvements in commercial demand for credit,” he said, a positive sign that companies are investing.

Wells Fargo CEO said same 10 days ago.

Is it because companies are finally investing…or because companies must now finance  out of line inventories due to the lack of growth in final demand?

real final sales

 

On the one hand, the official GDP is accelerating beyond any forecasts. On the other hand, final demand is slowing to levels which most of the time just preceded a recession. Go figure! Confused smile

But don’t despair, on the next hand, here’s David Rosenberg painting a “Rosie” scenario for us all (my emphasis):

(…) But things actually are getting better. The Institute for Supply Management figures rarely lie and they are consistent with 3.5% real growth. Federal fiscal policy is set to shift to neutral from radical
restraint and the broad state/local government sector is no longer shedding jobs and is, in fact, spending on infrastructure programs again.

On top of that, manufacturing is on a visible upswing. Net exports will be supported by a firmer tone to the overseas economy. The deceleration to zero productivity growth, which has a direct link to profit margins, will finally incentivize the business sector to invest organically in their own operations with belated positive implications for capex growth.

But the centrepiece of next year’s expected acceleration really boils down to the consumer. It is the most essential sector at more than 70% of GDP. And what drives spending is less the Fed’s quest for a ‘wealth effect,’ which only makes rich people richer, but more organic income, 80% of which comes from working. And, in this sense, the news is improving, and will continue to improve. I’ll say it until I’m blue in the face. Freezing

Indeed, all fiscal policy has to do is shift to neutral, and a 1.5-percentage-point drag on growth — the major theme for 2013 — will be alleviated. With that in mind, the two-year budget deal that was just cobbled together by Paul Ryan and Patty Murray at the least takes much of the fiscal stranglehold off the economy’s neck, while at the same time removing pervasive sources of uncertainty over the policy outlook.

Since the pool of available labour is already shrinking to five-year lows and every measure of labour demand on the rise, one can reasonably expect wages to rise discernibly in coming years, unless, that is, you believe the laws of supply and demand apply to every market save for the labour market.

Pointing up Let’s get real: By hook or by crook, wages are going up next year (minimum wages for sure and this trend is going global). With this in mind, the most fascinating statistic this past week was not ISM or nonfarm payrolls, but the number of times the Beige Book commented on wage pressures: 26. That’s not insignificant. Again, when I talked about this at the Thursday night dinner, eyeballs rolled.

There was much discussion about the lacklustre holiday shopping season thus far, with November sales below plan. There was little talk, however, about auto sales hitting a seven-year high in November even with lower incentives. And what’s a greater commitment to the economy — a car or a cardigan?

As I sifted through the Beige Book to see which areas of the economy were posting upward wage pressure and growing skilled labour shortages, I could see it cut a large swath: technology, construction, transportation services, restaurants, durable goods manufacturing.

Of the 115 million people currently working in the private sector, roughly 40 million of them are going to be reaping some benefits in the form of a higher stipend and that is 35% of the jobs pie right there. That isn’t everyone, but it is certainly enough of a critical mass to spin the dial for higher income growth (and spending) in the coming year. Macro surprises are destined to be on the high side — take it from a former bear who knows how to identify stormy clouds. (…)

On the consumer side, the aggregate debt/disposable income ratio has dropped from 125% at the 2007 peak to 100%, where it was a decade ago (down to 95% excluding student loans, an 11-year low). In other words, the entire massive 2002-07 credit expansion has been reversed, and, as such, the household sector is in far better financial position to contribute to economic activity.

On the government side, the U.S. federal deficit, 10% of GDP just four years ago, is below 4% today and on its way to below 3% a year from now, largely on the back of tough spending cuts and a big tax bite.

Then throw in the vast improvement in the balance-of-payments situation, courtesy of the energy revolution. With oil import volumes trimmed 5% over the past year and oil export volumes up a resounding 30%, the petroleum deficit in real terms has been shaved by one-quarter in just the last 12 months. This, in turn, has cut the current account deficit in half to 3% of GDP from the nearby high of 6%. (…)

In a nutshell, I feel like 2014 is going to feel a lot like 2004 and 1994 when the economy surprised to the high side after a prolonged period of unsatisfactory post-recession growth. Reparation of highly leveraged balance sheets delayed, but, in the end, did not derail a vigorous expansion.

High five That by no means guarantees a stellar year for the markets, because, as we saw in 2013 with a softer year for the economy, multiple expansion premised on Fed-induced liquidity can act as a very powerful antidote. Plus, a rising bond-yield environment will at some point provide some competition for the yield delivered by the stock market.

While 1994 and 2004 were hardly disasters, the market generated returns both years that were 10 percentage points lower than they were the prior year even with a more solid footing to the economy — what we gained in terms of growth, we gave up in terms of a less supportive liquidity/monetary policy backdrop.

But make no mistake, the upside for next year from a business or economic perspective as opposed to from a market standpoint is considerable.

Just kidding It is open for debate as to how the stock market will respond, but it is not too difficult to predict where bond yields will be heading (up) since they are, after all, cyclical by nature. Within equities, this means caution on the rate-sensitives and the macro backdrop will augur for growth over value.

Thanks David, but…

First, let’s set the record straight:

  • According to Edmunds.com’s Total Cost of Incentives (TCI) calculations, car incentives on average were flat from a year ago, though some automakers increased their incentives and even others lowered them. One car dealer said that manufacturers are pushing retailers to buy more vehicles, “slipping back into old habits”.
  • The S&P 500 Index peaked at 482 in January 1994, dropped 8% to 444 at the end of June and closed the year at 459. EPS jumped 18% that year while inflation held steady around 2.5%.
  • In 2004, equity markets were essentially flat all year long before spiking 7% during the last 2 months of the year. Profits jumped 24% that year while inflation rose from 1.9% to 3.3%.
  • In both years, equity valuations were in a correction mode coming from Rule of 20 overvalued levels in the previous years.

Second, we should remember that car sales have been propelled by the huge pent up demand that built during the financial crisis. Like everything else, this will taper eventually. The fact remains that car sales have reached the levels of the previous 4 cyclical peaks. Consider that there are fewer people actually working these days, even fewer working full time, that the younger generation is not as keen as we were to own a car and that credit conditions remain very tight for a large “swath” of the population. And just to add a fact often overlooked by economists, car prices are up 8% from 2008 while median household income is unchanged. (Chart from CalculatedRisk)

Third, it may be true that the ISM figures rarely lie but we will shortly find out if recent production strength only served to grow inventories. To be sure, car inventories are currently very high, prompting some manufacturers to cut production plans early in 2014.

Fourth, building an economic scenario based on accelerating wages invites a discussion on inflation and interest rates, both key items for equity valuation and demand. There is no money to be made from economic scenarios, only from financial instruments. Rosie’s scenario may not be as rosy for financial markets if investors become concerned about labour demand exceeding supply. (See Lennar’s comments below).

Ghost  Gasoline Heats Up in U.S.

Futures prices rose 5.9% last week in response to signs of unusually srong demand for the fuel.

Gasoline for January delivery rose 4.3 cents, or 1.6%, to $2.7831 a gallon Friday on the New York Mercantile Exchange.

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Pressure builds as retailers near the holiday finish line

(…) Thom Blischok, chief retail strategist and a senior executive adviser with Booz & Company’s retail practice in San Francisco, said many U.S. shoppers are holding back this season because they have fewer discretionary dollars.

“Sixty-five percent of (Americans) are survivalists. They are living from paycheck to paycheck,” he said. “Those folks simply don’t have any money to celebrate Christmas.”

People with annual income of $70,000 and up account for 33 percent of U.S. households, but 45 percent of spending, according to U.S. Census data crunched by AlixPartners. That group has seen the most benefit from the improving economy as rising home and stock prices bolster their net worth.

But even those with higher incomes are holding back.

“The era of ‘living large’ is now officially in the rear-view mirror,” said Ryan McConnell, who heads the Futures Company’s US Yankelovich Monitor survey of consumer attitudes and values.

Responses to the 2013 survey suggested that the “hangover effect” of the so-called Great Recession remained prevalent with 61 percent of respondents agreeing with the statement: “I’ll never spend my money as freely as I did before the recession.” (…)

Competing for shoppers led major retailers to significantly ramp up the frequency of their promotions in the first part of December, according to data prepared for Reuters by Market Track, a firm that provides market research for top retailers and manufacturers.

A group of eight major retail chains, including J.C. Penney Co Inc, Wal-Mart Stores Inc  and Best Buy Co Inc, increased the number of circulars they published between December 3 and December 18 nearly 16 percent over the comparable period a year earlier.

Those retailers, which also include Sears and Kmart, Macy’s Inc, Kohl’s Corp and Target Corp, ramped up the online deals even more, increasing the number of promotional emails by 54.5 percent, according to the Market Track data.

The battle for shoppers has also led to the most discount-driven season since the recession, according to analysts and executives.

“There is a quicker turnover of promotions this year, and now several times, within a day,” eBay Enterprise CEO Chris Saridakis said. “It’s an all-out war.”

Clock  Shoppers Grab Sweeter Deals in Last-Minute Holiday Dash

U.S. shoppers flocked to stores during the last weekend before Christmas as retailers piled on steeper, profit-eating discounts to maximize sales in their most important season of the year.

Retailers were offering as much as 75 percent off and keeping stores open around the clock starting Friday. “Super Saturday” was expected to be one of the busiest shopping days of the year, according to Chicago-based researcher ShopperTrak. (…)

Holiday purchases will rise 2.4 percent, the weakest gain since 2009, ShopperTrak has predicted. Sales were up 2 percent to $176.7 billion from the start of the season on Nov. 1 through Dec. 15, said the firm, which will update its figures later today. The National Retail Federation reiterated on Dec. 12 its prediction that total sales will rise 3.9 percent in November and December, more than the 3.5 percent gain a year ago.

Factset concludes with the important stuff for investors: Most S&P 500 Retail Sub-Industries Are Projected to Report a Decline in Earnings in Q4

In terms of year-over-year earnings growth, only five of the thirteen retail sub-industries in the S&P 500 are predicted to report growth in earnings for the fourth quarter. Of these five sub-industries, the
Internet Retail (66.7%) and Automotive Retail (10.3%) sub-industries are expected to see the highest earnings growth. On the other hand, the Food Retail (-20.2%), General Merchandise Stores (-10.6%), and Apparel Retail (-8.8%) sub-industries are expected to see the lowest earnings growth for the quarter.

Overall, there has been little change in the expected earnings growth rates of these thirteen retail subindustries since Black Friday. Only four sub-industries have recorded decreases in expected earnings growth of more than half a percentage point since Black Friday: Drug Retail, Food Retail, General Merchandise, and Hypermarkets & Supercenters. On the hand, no sub-industry has recorded an increase in expected earnings growth of more than half a percentage point since November 29.

These folks are unlikely to be jolly unless Congress acts, again at the last hour:

Tom Porcelli, chief U.S. economist at RBC Capital Markets, estimates that 1.3 million folks will lose their unemployment checks after this week, forcing some to take jobs they previously passed up or join the legions of workforce dropouts. If even half do the latter, the jobless rate could slip to 6.6% in fairly short order. (Barron’s)

This could have interesting consequences as JP Morgan explains:

(…) the potential expiration of federal extended unemployment benefits (formally called Emergency Unemployment Compensation) at the end of this month could push the measured unemployment rate lower.

The state of North Carolina offers a potential testing ground for this thesis. In July, the North Carolina government decided to no longer offer extended benefits, even though the state still met the economic conditions to qualify for this federal program. Since July, the North Carolina unemployment rate has fallen 1.5%-points; in the same period the national unemployment rate has fallen 0.4%-point. (…)

The information from one data point is a long way from statistical certainty, but the limited evidence from North Carolina suggests that the potential expiration of extended benefits will place further downward pressure on the measured unemployment rate. In which case the Fed could soon have some ‘splainin’ to do about what “well past” 6.5% means with respect to their unemployment rate threshold.

GPSWebNote ImageGPSWebNote Image

Rampant Returns Plague E-Retailers Behind the uptick in e-commerce is a secret: As much as a third of all Internet sales gets returned, in part because of easy policies on free shipping. Retailers are trying some new tactics to address the problem.

(…) Retailers are zeroing in on high-frequency returners like Paula Cuneo, a 54-year-old teacher in Ashland, Mass., who recently ordered 10 pairs of corduroy pants in varying sizes and colors on Gap Inc. GPS +0.73% ‘s website, only to return seven of them. Ms. Cuneo is shopping online for Christmas gifts this year, ordering coats and shoes in a range of sizes and colors. She will let her four children choose the items they want—and return the rest.

Ms. Cuneo acknowledged the high costs retailers absorb to take back the clothes she returns, but said retailers’ lenient shipping policies drove her to shop more.

“I feel justified,” she said. “After all, I am the customer.” (…)

HOUSING WATCH

FHFA to Delay Increase in Mortgage Fees by Fannie, Freddie

The incoming director of the regulatory agency that oversees Fannie Mae and Freddie Mac said he would delay an increase in mortgage fees charged by the housing-finance giants.

(…) Upon being sworn in, “I intend to announce that the FHFA will delay implementation” of the loan-fee increases “until such time as I have had the opportunity to evaluate fully the rationale for the plan,” he said in a statement.

The FHFA signaled that it would increase certain fees charged by Fannie and Freddie that are typically passed on to mortgage borrowers on Dec. 9, on the eve of Mr. Watt’s Senate confirmation. (…)

In updates posted to their websites on Monday, Fannie and Freddie showed that fees will rise sharply for many borrowers who don’t have down payments of at least 20% and who have credit scores of 680 to 760. (Under a system devised by Fair Isaac Corp., credit scores range from 300 to a top of 850.) (…)

Surely, the housing market does not need more headwinds. ISI’s homebuilders survey is continuing to plunge, existing house sales have declined sharply, and existing house prices are down -1.6% from their peak.  In addition, ISI’s house price survey has been flat for five months. On the other hand, NAHB’s survey is at a new high, and housing starts surged in November. Inventory accumulation?

Pointing up Meanwhile, costs are skyrocketing:

Lennar noted that while its “aggressive” pricing strategies led to significant margin improvements, labor and construction material costs last quarter were up about 12% from a year ago, and that labor costs were up by “more” than material costs. (CalculatedRisk)

I remain concerned that higher inflation is slowly sneaking in, hidden behind weighted indices while un-weighted measures suggest that prices are being regularly ratcheted up. The median CPI, measured by the Cleveland Fed, is still up 2.0% YoY even though the weighted CPI is down to +1.0% YoY.

Differences between changes in the CPI and the median consumer price
change underscore the impact of the distribution of price movements on our monthly interpretation of inflation. The median price change is a potentially useful indicator of current monetary inflation because it minimizes, in a nonsubjective way, the influence of these transitory relative price movements.

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Assume there is no abnormal inventory accumulation and that David Rosenberg’s scenario pans out, we might get both demand pull and cost push inflation simultaneously. Far from a rosy scenario. Mrs. Yellen would have her hands full.

Thumbs up Economic Conditions Snapshot, December 2013: McKinsey Global Survey results

As 2013 draws to a close, executives are more optimistic about economic improvements than they have been all year, both at home and in the global economy. They also anticipate that conditions will continue to improve, thanks to the steady (though modest) improvements in the developed world that many expect to see.

imageIn McKinsey’s newest survey on economic conditions, the responses affirm that economic momentum has shifted—and will continue to move—from the developed to the developing world, as we first observed in September. Indeed, executives say the slowdown in emerging markets was one of the biggest business challenges this year, and respondents working in those markets are less sanguine than others about the current state of their home economies.

Respondents from all regions agree, though, on the world economy: for the first time since we began asking in early 2012, a majority of executives say global conditions have improved in the past six months.
Looking ahead to 2014, many executives expect economic progress despite growing concern over asset bubbles and political conflicts—particularly in the United States. Respondents there say that ongoing political disputes and the government shutdown in October have had a
notable impact on business sentiment, despite the less noticeable effect on the country’s recent economic data. Still, at the company level, executives maintain the consistently positive views on workforce size, demand, and profits that they have shared all year. (…)

Amid the shifting expectations for growth that we saw in 2013, executives’ company-level views have held steady and been relatively positive throughout the year. Since March, respondents most often reported that their workforce sizes would stay the same, that demand
for their companies’ products would grow, and that their companies’ profits would increase over the next six months; the latest results are no different.

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Pointing up Executives are still very focused on increasing margins!

Across regions, executives working in developed Asia are the most optimistic—and those in the eurozone are the most pessimistic—about their companies’ prospects. Forty-four percent of those in developed Asia say their workforces will grow in the next six months, while just 7 percent say they will shrink; in contrast, 31 percent of executives in the eurozone expect a decrease in workforce size. Two-thirds of respondents in developed Asia expect demand for their companies’ products and services to increase in the coming months, and they are least likely among their peers in other regions to expect a decrease in company profits.

In their investment decisions, though, executives note a new concern: rising asset prices, which could affect company-level (as well as macroeconomic) growth in the coming year. Of the executives who say their companies are postponing capital investments or M&A decisions they would typically consider good for growth, the largest shares of the year now cite high asset valuations as a reason their companies are waiting.

Strains Grip China Money Markets

Borrowing costs in China’s money market soared again, as the central bank’s recent fund injection failed to appease jittery investors amid a seasonal surge in demand for cash by banks.

Borrowing costs in China’s money market soared again after a brief fall earlier Monday, as the central bank’s recent fund injection failed to appease jittery investors amid a seasonal surge in demand for cash by banks.

The seven-day repurchase-agreement rate, a benchmark measure of the cost that banks charge each other for short-term loans, rose to 9.8%, up from 8.2% Friday and its highest level since it hit 11.62% on June 20, at the peak of China’s summer cash crunch. (…)

The stress in the banking system has spread elsewhere, with stocks in Shanghai falling for a ninth straight day Friday to the weakest level in four months while government bonds dropped, pushing the 10-yield up to near the highest in eight years.

Vietnam’s Growth Picks Up

The country’s gross domestic product grew 5.42% this year, compared with 5.25% in 2012, the government’s General Statistics Office said Monday. Last year’s GDP, the slowest since 1999, was revised up from 5.03%. Inflation was down as well.

The government said on-year growth in the fourth quarter was 6.04%, compared with 5.54% in the third quarter.

Japan forecasts GDP growth of 1.4% for 2014
Planned sales tax increase forecast to hit consumption

The Japanese government forecast on Saturday that real gross domestic product will grow by 1.4 per cent for the fiscal year starting March 2014, slowing from an expected 2.6 per cent growth for the current year as a planned sales tax increase is seen dampening consumption. (…)

The government also forecast that consumer prices will rise by about 1.2 per cent in the 2014 fiscal year, without considering an impact from the sales tax hike. Consumer prices are expected to show a rise of 0.7 per cent in the current fiscal year. The Bank of Japan launched a massive monetary stimulus programme aimed at pushing the inflation rate up to 2.0 per cent in two years, in a bid to wrench the country out of a long phase of deflation.

SENTIMENT WATCH

 

U.S. Economy Begins to Hit Growth Stride

 

Even Skeptics Stick With Stocks

Money managers and analysts say they are beginning to think the Federal Reserve is succeeding in restoring economic growth.

(…) Ned Davis, founder of Ned Davis Research in Venice, Fla., and a skeptic by nature, told clients last week that the economic picture is brightening. “There are still mixed indicators regarding economic growth, but most of our forward-looking indicators are suggesting the economy is accelerating to at least ‘glass-half-full’ growth rates,” he wrote. (…)

Because they now think the economy is on the mend, many money managers share the view that, while 2014 probably won’t match 2013, indexes probably will finish the year with gains. (…)

Ageing stocks bull can still pack some power

(…) While the S&P 500 is unlikely to match the 27 per cent jump it achieved in 2013, the odds favour another strong year for equities. Investors with a long time horizon have little to fear from wading into the market, even after a 168 per cent run-up from the index’s post-financial crisis nadir. (…)

It is no secret that companies have cut their way to profitability growth. They have put off investment, including in wages and hiring; they have slashed their financing costs by issuing record amounts of debt at this year’s rock-bottom interest rates; and they have juiced earnings per share further by buying back and cancelling shares at a pace not seen for five years.

These are trends that will all be slow to reverse. Slack in the economy will keep the lid on what companies have to spend on employees, and the benefits of those low financing costs are locked in for years to come. To the extent that wages and interest rates rise, it will be because the economic outlook is brightening, which will fill in the missing piece of the puzzle: top line revenue growth. (…)

In the historical context, current return on equity for the S&P 500 is not high; at 14.1 per cent during the last quarterly reporting season, it was only 5 basis points above the average since 1990. Profit growth, in other words, is as likely to carry on rising as it is to U-turn. Confused smile

The path of least resistance for equities is still up. There is a whole swath of bond investors who are yet to reassess their overweights in that asset class, who may do so when January’s miserable annual statements land. The diversifying “alternative” investments – hedge fund-like mutual funds and their mutant brethren – remain too expensive to become significant parts of a portfolio for most investors.

The S&P 500’s down years have all, with the exception of 1994, been recession years. Of course, the spectre of 1994 is haunting, since that was precisely when the Federal Reserve last attempted a big reversal of policy and began to raise interest rates to choke off inflation.

There is an asterisk to even the most bullish equity forecast, which is that all bets will be off if the Fed loses control of rates, dragging bond yields higher not just in the US where they might be justified, but also across the world, where they could snuff out a nascent recovery in Europe and cause untold harm in emerging markets.

After the smooth market reaction to the announcement of a slowdown in quantitative easing last week, a disaster scenario looks even more unlikely. And lest we forget, tapering is not tightening, so 2014 is not 1994.

If the S&P 500 closes out the year where it began this week, 2013 will go down as the fifth best year for share price gains since the index was created in 1957. Each of the four occasions when it did better – 1958, 1975, 1995 and 1997 – were followed by an additional year of strong returns, ranging from 8.5 per cent to 26.7 per cent.

Equity markets should maintain their positive momentum as long as the global economy maintains its, and the odds look good. Even in middle age, a bull can pack some power.

Bull Calls United in Europe as Strategists See 12% Gain

Equities will rise 12 percent in 2014, according to the average projection of 18 forecasters tracked by Bloomberg News.Ian Scott of Barclays Plc says the StoxxEurope 600 Index can rally 25 percent because shares are cheap even after a 49 percent gain since 2011. (…)

The average estimate is the most bullish since at least 2010, with no strategist predicting a gain of less than 3.3 percent, and comes even as company analysts reduced income forecasts for an 85th straight week. While more than 2.7 trillion euros ($3.7 trillion) has been restored to European equity values since September 2011, shares would have to gain another 65 percent to match the advance in the Standard & Poor’s 500 Index during the last five years.

“You would have lacked credibility being bullish on Europe 18 months ago, although stocks were very cheap and the economy was bottoming,” said Paul Jackson, a strategist at Societe Generale SA inLondon, who predicts a 15 percent jump for the Stoxx 600 next year. “As soon as the market started to do well, suddenly everybody wants to listen. And now not only is everybody listening, but everyone is saying the same thing. The time to worry about the Armageddon scenario is gone.” (…)

Analysts have downgraded earnings estimates on European companies excluding the U.K. for 85 weeks, a record streak, according to Citigroup Inc. data on Bloomberg. Mark Burgess, chief investment officer at Threadneedle Asset Management Ltd., says European earnings will probably disappoint again. (…)

“The region remains beset by relatively poor growth dynamics compared with the rest of the developed world,” Burgess, who helps oversee $140 billion from London, said in e-mailed comments on Dec. 11. “This year’s stock market recovery could easily herald a false dawn. While for the first time in three years we believe Europe is likely to return to positive GDP growth in 2014, earnings growth is likely to be steady rather than dramatic.” (…)

Evans at Deutsche Bank says his team at Europe’s largest bank has become “increasingly convinced” that lending in the region will rebound and will help companies beat estimates in what he calls investors’ “complete loss of confidence in the earnings cycle.”

The ECB said in a quarterly survey released Oct. 30 that banks expect to relax standards on corporate lending this quarter. That’s the first such response since the fourth quarter of 2009 and, if it occurs, would mark the first easing of conditions since the second quarter of 2007. Lenders also plan to simplify access to consumer loans and mortgages, and predicted a rise in loan demand.

Everybody is jumping on the bandwagon on the basis of an accelerating economy and equity momentum.

Time to stay rationale and disciplined. Good luck, and happy holidays! Gift with a bow

 

NEW$ & VIEW$ (11 DECEMBER 2013)

Pointing up Pointing up Pointing up The Fed Plan to Revive High-Powered Money

By Alan Blinder
Don’t only drop the interest paid rate paid on banks’ excess reserves, charge them.

Unless you are part of the tiny portion of humanity that dotes on every utterance of the Federal Open Market Committee, you probably missed an important statement regarding the arcane world of “excess reserves” buried deep in the minutes of its Oct. 29-30 policy meeting. It reads: “[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage.”

As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative, I can assure you that those buried words were momentous. The Fed is famously given to understatement. So when it says that “most” members of its policy committee think a change “could be worth considering,” that’s almost like saying they love the idea. That’s news because they haven’t loved it before. (…)

Not long ago—say, until Lehman Brothers failed in September 2008—banks held virtually no excess reserves because idle cash earned them nothing. But today they hold a whopping $2.5 trillion in excess reserves, on which the Fed pays them an interest rate of 25 basis points—for an annual total of about $6.25 billion. That 25 basis points, what the Fed calls the IOER (interest on excess reserves), is the issue. (…)

At this point, you’re probably thinking: “Wait. If the Fed charged banks rather than paid them, wouldn’t bankers shun excess reserves?” Yes, and that’s precisely the point. Excess reserves sitting idle in banks’ accounts at the Fed do nothing to boost the economy. We want banks to use the money.

If the Fed turned the IOER negative, banks would hold fewer excess reserves, maybe a lot fewer. They’d find other uses for the money. One such use would be buying short-term securities. Another would probably be lending more, which is what we want. (…)

Deal Brings Stability to U.S. Budget

House and Senate negotiators, in a rare bipartisan act, announced a budget agreement Tuesday designed to avert another economy-rattling government shutdown and to bring a dose of stability to Congress’s fiscal policy-making over the next two years.

Sen. Patty Murray (D., Wash.) and Rep. Paul Ryan (R., Wis.), who struck the deal after weeks of private talks, said it would allow more spending for domestic and defense programs in the near term, while adopting deficit-reduction measures over a decade to offset the costs.

Revenues to fund the higher spending would come from changes to federal employee and military pension programs, and higher fees for airline passengers, among other sources. An extension of long-term jobless benefits, sought by Democrats, wasn’t included.

The plan is modest in scope, compared with past budget deals and to once-grand ambitions in Congress to craft a “grand bargain” to restructure the tax code and federal entitlement programs. But in a year and an institution characterized by gridlock and partisanship, lawmakers were relieved they could reach even a minimal agreement. (…)

The Murray-Ryan deal will likely need considerable Democratic support to pass the GOP-controlled House. Many Republicans, as well as a large number of conservative activists off Capitol Hill, argue that the sequester cuts have brought fiscal austerity to the federal budget and that they should not be eased. (…)

The depth of conservative opposition will become apparent as lawmakers absorb the details, which were released to the public Tuesday night. To draw support from the GOP’s fiscal conservatives, the deal includes additional deficit-reduction measures: While the agreement calls for a $63 billion increase in spending in 2014 and 2015, it is coupled with $85 billion in deficit reductions over the next 10 years, for a net deficit reduction of $22.5 billion.

The deal achieves some of those savings by extending an element of the 2011 budget law that was due to expire in 2021. The sequester currently cuts 2% from Medicare payments to health-care providers from 2013 through 2021. The new deal extends those cuts to 2022 and 2023. (…)

A Least Bad Budget Deal

The best that can be said about the House-Senate budget deal announced late Tuesday is that it includes no tax increases, no new incentives for not working, and some modest entitlement reforms. Oh, and it will avoid another shutdown fiasco, assuming enough Republicans refuse to attempt suicide a second time.

The worst part of the two-year deal is that it breaks the 2011 Budget Control Act’s discretionary spending caps for fiscal years 2014 and 2015. The deal breaks the caps by some $63 billion over the two years and then re-establishes the caps starting in 2016 where they are in current law at $1.016 trillion. Half of the increase will go to defense and half to the domestic accounts prized by Democrats. (…)

The deal means overall federal spending will not decline in 2014 as it has the last two years. (…)

All of this doesn’t begin to match the magnitude of America’s fiscal challenges, but it is probably the best that the GOP could get considering Washington’s current array of political forces. (…)

Four Signs the Job Market Is Getting Better 

Layoffs keep on falling: 1.5 million Americans were laid off or fired in October, the fewest since the government began keeping track in 2001. The October drop was unusually large and may be a fluke, but the trend is clear: Layoffs are back at or below prerecession levels.

Quits are rising: (…)  2.4 million Americans left their jobs voluntarily in October, the most since the recession ended and 15% more than a year earlier. Quits are still below normal levels, but they’re finally showing a clear upward trend.

And openings too: Employers posted 3.9 million job openings in October, also a postrecession high. (…) There were 2.9 unemployed workers for every job opening in October, the third straight month under 3 and down from a more than 6:1 ratio during the recession.

Hiring is finally rebounding: (…) Hiring has topped 4.5 million for three straight months for the first time in the recovery, and has been up year-over-year for four consecutive months.(…)

But don’t get too excited: (…)The three-to-one ratio of jobseekers to openings is nearly double its prerecession level, and would be higher if so many unemployed workers hadn’t abandoned their job searches. Companies remain reluctant to hire, and many of the jobs that are getting created are in low-wage sectors — nearly a third of October’s hiring came in the low-paying hospitality and retail sectors. The epidemic of long-term unemployment has shown little sign of easing. Despite signs of healing, in other words, a healthy job market remains a long way off.

Wells Fargo Chief Sees Healing Economy

Wells Fargo& Co. Chief Executive John Stumpf said Tuesday the economy is healing, five years after the bank purchased Wachovia Corp. in the midst of a global financial meltdown.

He said government progress on a budget deal, lower unemployment and signs businesses are looking to expand give him reason to be optimistic. “As I’m talking with our customers, especially our small business and middle-market customers, I’m starting to hear a little more about expanding businesses,” he said.

Now, go back to Alan Blinder’s op-ed above.

European carmakers: speeding up

(…) Consultants at LMC Automotive reckon that November saw a 0.7 per cent rise year on year. That follows increases of over 4 per cent and almost 5.5 per cent in October and September respectively – so, at long last, a sustained upward trend for Europe’s crisis-hit sector. 

High five In three of the big markets – Germany, France and Italy – the November sales pace was lacklustre at best and down by over 4 per cent at worst. Spain, which saw a strong advance, benefited from a very easy year-on-year comparison and scrappage incentives. Pricing, too, remains weak across the sector. Last week, Fiat detailed transaction (as opposed to listed) price trends, in segments ranging from economy to basic luxury models for both the German and Italian markets. As of September, these were barely above 2007 levels and, after allowing for inflation in the intervening period, well down in real terms.

Above all, given the small number of plant closures since 2008, Europe still has massive overcapacity on the production side. If 2013 ends with under 12m cars sold in western Europe and 4.5m in eastern Europe, the total will be down by a fifth on 2007 levels. Europe’s light vehicle production, meanwhile, will probably top 19m units – just two-thirds of estimated plant capacity. Sales rises of 2-3 per cent, say, in 2014 will make only modest inroads on that gap so pricing pressures may persist.

China New Yuan Loans Higher Than Expected

Chinese financial institutions issued 624.6 billion yuan ($103 billion) worth of new yuan loans in November, up from 506.1 billion yuan in October and above economists’ expectations.

Total social financing, a broader measurement of credit in the economy, came to 1.23 trillion yuan in November, up from 856.4 billion yuan in October.

China’s broadest measure of money supply, M2, was up 14.2% at the end of November compared with a year earlier, slightly lower than the 14.3% rise at the end of October, data from the People’s Bank of China showed Wednesday.

IEA Boosts 2014 Global Oil Demand Forecast on U.S. Recovery

The IEA estimated today in its monthly oil market report that demand will increase by 1.2 million barrels a day, or 1.3 percent, to 92.4 million a day next year, raising its projection from last month by 240,000 a day. U.S. fuel use rose above 20 million barrels a day in November for the first time since 2008, according to preliminary data. While the agency boosted its forecast for the crude volume OPEC will need to supply, “making room” for the potential return of Iranian exports “could be a challenge for other producers” in the group, it said.

“The geopoliticals are now bearish, while the fundamentals are bullish,” Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts, said before the IEA published its report. “This is quite a change from just recently. People are anticipating tighter supplies as we go into next year. Demand will be higher.”

The agency raised estimates for supplies required next year from the Organization of Petroleum Exporting Countries by about 200,000 barrels a day, to 29.3 million a day. That’s still about 400,000 a day less than the group’s 12 members pumped in November, according to the report.

OPEC’s output fell for a fourth month, by 160,000 barrels a day, to 29.7 million a day in November, as a result of disruptions in Libya and smaller declines in Nigeria, Kuwait, the United Arab Emirates and Venezuela. The group decided to maintain its production target of 30 million barrels a day when it met on Dec. 4 in Vienna.

Saudi Arabia, the organization’s biggest member and de facto leader, kept production unchanged last month at 9.75 million barrels a day, the report showed.

This chart via FT Alphaville reveals how OPEC is effectively managing supply.

SENTIMENT WATCH

Can We Finally All Agree That This Is Not a Bubble?  All the bubble chatter over the past few months is increasingly looking like just a bunch of hot air.

A look at the IPO and M&A markets also point to caution rather than exuberance. “A hot market for mergers and acquisitions has often been a sign of an overheated stock market as confident corporate executives seek to aggressively expand their businesses,” said Jeffrey Kleintop, chief market strategist at Boston-based brokerage firm LPL Financial. While M&A activity is trending higher, it remains far below the peak 2007 levels, and 2000 for that matter, he pointed out.

RBC Capital has the chart:

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Media bubble?

It seems to me that most media have been giving a positive spin to the not so great economic news of the past few months. This RBC Capital chart carries no emotion:

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High Yield Spreads Hit a Six Year Low

(…) At a current reading of 411 basis points (bps) over treasuries, spreads are at their lowest level in more than six years (October 2007)!

With high yield spreads at their lowest levels since October 2007, skeptics will argue that the last time spreads were at these levels marked the peak of the bull market.  There’s no denying that, but we would note that in October 2007, spreads had already been at comparably low levels for more than three and a half years before the bear market started.  Additionally, back in the late 1990s we also saw a prolonged period where spreads were at comparably low levels before the market began to falter.

Another reason why the low level of spreads is of little concern is because default rates are also at historically low levels.  According to Moody’s, the default rate for junk rated American companies dropped to 2.4% in November, which according to Barron’s, “is barely more than half its long-term historic average and down from 3.1% a year ago.”

Not really bubbly, but getting closer…

Here’s an interesting chart:

Performance of Stocks vs Bonds

(…)  With the S&P 500 up 23.4% and long-term US Treasuries down 10.2% over the last 200-trading days, the current performance spread between the two asset classes is above 30 percentage points.  (…)

While it is common for equities to outperform treasuries, the current level of outperformance is relatively uncommon.  In the chart below, anything above the green line indicates a performance spread of more than 30 percentage points.  As you can see, the only other periods where we saw the spread exceed 30 were in 1999, 2003, 2009, and 2011.

What makes the current period somewhat different, though, is the period of time that the spread has been at elevated levels.  With the spread first exceeding 30 percentage points back in March, we are now going on nine months that the spread has been at elevated levels.  At some point you would expect the two to revert back to their long-term historical average.

Hedge funds attract billions in new money
Investor inflows jump sharply even as performance lags stocks

Funds brought in $360bn this year in investment returns and inflows from investors, an increase of 15.7 per cent on their assets under management at the end of 2012, according to figures from the data provider Preqin.(…)

“We are seeing a shift in how investors view hedge funds,” said Amy Bensted, head of hedge funds at Preqin. “Pre-2008, investors thought of them – and hedge funds marketed themselves – as a source of additional returns.

“Now, they are not seen just being for humungous, 20 per cent-plus returns, but for smaller, stable returns over many years.”

With the same humongous fees…

Yesterday, I posted on this:

 

Fatter Wallets May Rev Up Recovery

The net worth of U.S. households and nonprofit organizations—the values of homes, stocks and other assets minus debts and other liabilities—rose 2.6%, or about $1.9 trillion, in the third quarter of 2013 to $77.3 trillion, according to the Fed.

Which deserves two more dots to explain the feeble transmission pattern of the past several years:

The Federal Reserve gives us the nominal value of total net worth, which is significantly skewed by money illusion. Here is my own log scale chart adjusted for inflation using the Consumer Price Index.

Click to View

  • And these charts from RBC Capital:

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NEW$ & VIEW$ (9 DECEMBER 2013)

GREEN FRIDAY

After pretty tame Black Friday and Thanksgiving sales, investors got their Green Friday with an ‘Unambiguously Positive’ Jobs Report accompanied by a relieving 1.1% jump in the S&P 500 Index, the best of all worlds for taper advocates. Good news is good news again!

The media narratives just flowed from that.

Employers Gain Confidence to Hire

U.S. employers are gaining confidence heading into year’s end, hiring at the quickest clip since before Washington’s political dysfunction rattled consumers and businesses this fall.

Payrolls rose by a seasonally adjusted 203,000 in November in sectors ranging from construction to health care, a striking pickup at an uncertain moment for the economy. Moreover, the jobless rate fell to 7% from 7.3%, though its declines in recent months have been driven in part by people leaving the labor force. (…)

U.S. job growth over the past three months now averages 193,000. In September, the average was thought to be 143,000; it has since been revised higher. (…)November’s job gains were more broad-based than in some previous months, suggesting fundamental economic improvements are reaching more parts of the economy.

Economists have worried that the biggest drivers of the nation’s job growth are lower-paying industries like retailers and restaurants. While those industries still represent a big chunk of the job gains, higher-paying sectors like manufacturing also grew in November, adding 27,000 jobs. (…)

It remains that

Nearly one-third of the private-sector job gains in November came from retailers, hotels, restaurants and temporary help agencies.

Retailers added 22,000 workers last month, while restaurants and hotels added 17,000 positions. Temporary help services hired another 16,000.

Lower-paying industries have dominated U.S. job growth for much of the recovery. Over the past year, retailers and temporary-help services have added 323,000 and 219,000 jobs, respectively.

By comparison, manufacturers added only 76,000 jobs.

As we all know, stats can be used to fit any viewpoint: the low month for job growth in 2013 was July at 89k.

  • First 6 months average employment change: +195k.
  • Last 5 months average employment change: +181k. Not enough to call it an ‘Unambiguously Positive’ jobs report. Tapering delayed.

But move July into the first part of the year:

  • First 7 months average employment change: +180k.
  • Last 4 months average employment change: +204k. Here comes the taper!

Never mind that the economy has added 2.3 million jobs over the past year, a pace that has changed little for the past two years in spite of QE1, 2,and 3.

Never mind that

Compared with September, the last reading before the shutdown, the new figures showed 265,000 fewer people working or looking for work, taking the labour market participation rate down from 63.2 per cent to 63 per cent of the adult population.

Declining participation was the main cause of the large fall in the unemployment rate, creating a puzzle and a worry for the Fed. If people are permanently dropping out of the labour force then it suggests there is less spare capacity in the economy.(FT)

Never mind that

Markit’s recent PMI surveys showed that the rate of growth was below that seen in September. Hiring slipped to the lowest for eight months as a result of firms reporting growing unease about the outlook. (Markit)

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And never mind the important inventory build up revealed by the Q3 GDP, recent car data and clear evidence of enormous surplus retail inventory post Thanksgiving, all suggesting that the recent manufacturing uptrend may be short lived. The U.S. economy, and for that matter Europe’s as well, have been propped up by a production push rather than by a more solid and durable consumer pull.

Real consumer expenditures rose 0.3% MoM in October after edging up 0.1% in September, in spite of a 0.2% advance in real disposable income during the last 2 months. Taking the 4-month period from July, real expenditures are growing at a 1.8% annualized rate, unchanged from the preceding 4-month period. During both periods, real disposable income has grown 2.7% annualized but real labour income growth halved from 1.8% annualized in March-June to 0.9% annualized in July-October.

Consumer demand sustained by government transfer income and a low savings rate is not solid foundation for economic growth, needless to say. It gets even more dangerous when corporate inventories accumulate rapidly, especially during the all important fourth quarter.

Taper or not? Taking liquidity out when things are so fragile would be a big mistake in my view. The Fed won its bet with QE-induced wealth boost for the top 10% but it would be ill-advised to take the punch bowl away before the ordinary people’s party begins.

Fed credibility has already been hurt by all the goofy rhetoric since last May. The only transparency they have achieved is to expose their flaws wide open. When you decide to be more transparent, you better make sure that what you have to show is attractive…otherwise, be a Greenspan and let markets guess for haven’s sake.

To be sure, as BCA Research is quoted in Barron’s (my emphasis),

(…) policy makers are hoping for a cyclical rebound in the participation rate as discouraged workers are drawn back into the labor market. There is no evidence that this is occurring so far.


As a result, BCA thinks the Fed will lower the threshold for forward guidance about increases in the federal-funds target (which has been pinned near 0% to 0.25% since late 2008) until the jobless rate falls to 5% or even 5.5%, instead of the current 6.5%, which could be reached by next October if current trends continue. The Fed’s notion is that the better job market will lure folks on the sideline to start looking for work again, slowing the decline in unemployment, even as more people find positions. But BCA says its clients are increasingly worried that there is less slack in the labor market than presumed and that the Fed is making an inflationary policy mistake.

Much like a rising equity market eventually lures investors into action.

In all what was said and written last Friday, this is what must be most reassuring to Ben Bernanke:

Jonas Prising, president of staffing company Manpower Group, said the official numbers fit with what is happening on the ground. “What we see is a continued improvement in employers’ outlook. Despite what you see and hear about uncertainty, employers are clearly seeing a gradually improving economy,” said Mr Prising, noting that the pick-up in hiring was slow but steady. (WSJ)

TAPER WATCH

This is from Fed’s mouthpiece John Hilsenrath:

Fed Closes In on Bond Exit

Fed officials are closer to winding down their $85 billion-a-month bond-purchase program, possibly as early as December, in the wake of Friday’s encouraging jobs report.

The Fed’s next policy meeting is Dec. 17-18 and a pullback, or tapering, is on the table, though some might want to wait until January or even later to see signs the recent strength in economic growth and hiring will be sustained. On Tuesday, officials go into a “blackout” period in which they stop speaking publicly and begin behind-the-scenes negotiations about what to do at the policy gathering. (…)

The sharp rise in stocks Friday shows that the Fed is having some success reassuring investors that it will maintain easy-money policies for years to come.

(…) the November employment report was the latest in a batch of recent indicators that have boosted their confidence that the economy and markets are in better position to stand with less support from large monthly central bank intervention in credit markets.

Pointing up The economic backdrop looks better now than it did in September. Fingers crossed

Payroll employment growth during the past three months has averaged 193,000 jobs per month, compared with 143,000 during the three months before the September meeting.

Moreover, in September, the White House and Congress were heading into a government shutdown and potential a debt ceiling crisis. Now they appear to be crafting a small government spending agreement for the coming year. The headwinds from federal tax increases and spending cuts this year could wane, possibly setting the stage for stronger economic growth next year.

Still, the jobs report wasn’t greeted as unambiguously good news inside the Fed. One problem was an undertone of distress among households even as the jobless rate falls.

The government’s survey of households showed that a meager 83,000 people became employed between September and November, while the number not in the labor force during that stretch rose by 664,000. The jobless rate fell from 7.2% to 7% during the period effectively because people stopped looking for jobs and removed themselves from the ranks of people counted as unemployed.

“The unemployment rate [drop] probably overstates the improvement in the economy,” Chicago Fed President Charles Evans told reporters Friday.

Another worry among officials, and another reason some officials might wait a bit before moving: Inflation, as measured by the Commerce Department’s personal consumption expenditure price index, was up just 0.7% from a year earlier, well below the Fed’s 2% target. Mr. Evans said he was troubled and puzzled by the very low inflation trend. (…)

Fed December Taper Odds Double in Survey as Jobs Beat Estimate

 

The share of economists predicting the Federal Reserve will reduce bond buying in December doubled after a government report showed back-to-back monthly payroll gains of 200,000 or more for the first time in almost a year. (…)

The payroll report puts the four-month average for gains at 204,000, and the six-month average at 180,000. Chicago Fed President Charles Evans, a supporter of record stimulus who votes on policy this year, said in April he wants gains of 200,000 a month for about six months before tapering. Atlanta’s Dennis Lockhart, who doesn’t vote, said several months of gains exceeding 180,000 would make slowing appropriate.

“The 200,000 number hits you right between the eyes,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “That’s a number that everyone agrees the labor market is showing good-size gains, and the progress they’re making seems to be sustainable if that marker is met, which it was.”

See! It all boils down to where July stands in the economic calendar.

Credit-Card Debt Hits Three-Year High

U.S. consumers pushed their credit-card debt to a three-year high in October, a possible sign of their willingness to boost spending into the holiday season.

Revolving credit, which largely reflects money owed on credit cards, advanced by a seasonally adjusted $4.33 billion in October, the Federal Reserve said Friday. The expansion pushed total revolving debt to $856.82 billion, the highest level since September 2010.

The expansion marked a reversal from the prior four months when revolving balances either declined or held nearly flat. Consumers’ reluctance to add to credit-card balances was viewed by some economists as a sign of caution.

“Increasingly households are becoming more comfortable with using their plastic, and carrying a balance on it,” said Patrick J. O’Keefe, director of economic research at consulting firm CohnReznick. “The scars of 2007 and 2008 are starting to heal.”

When consumers are willing to carry a credit-card balance, it suggests they are confident they’ll have the future income needed to pay down the debt, he said.

The turnaround came in a month that brought a 16-day government shutdown, which weighed on consumer confidence and left hundreds of thousands of government workers without paychecks for weeks. (That may have been one factor in the increased use of credit cards. The federal workers received back pay after the shutdown.)

Total consumer credit, excluding home loans, rose by $18.19 billion in October, the largest gain since May. Economists surveyed by Dow Jones Newswires had forecast a $14.8 billion advance. (…)

The Fed report showed non-revolving debt, mostly auto and education loans, increased by $13.85 billion, or a 7.5% annualized jump. Such debt has been trending steadily higher since 2010, reflecting a surge in government-backed student loans and purchases of new autos. (…)

(ZeroHedge)

Fingers crossed  Congress Readies a Year-End Budget Dash

A Congress stymied by partisan divides, blown deadlines and intraparty squabbling gets a late chance to end the year with an elusive budget deal.

In the final week of 2013 that the Senate and House are scheduled to be in Washington at the same time, lawmakers and aides are optimistic that negotiators can reach a budget accord and continue to make progress on a farm bill and other measures.

China Exports Rise More Than Estimated

Overseas shipments rose 12.7 percent from a year earlier, the General Administration of Customs said today in Beijing. That exceeded estimates from 41 of 42 analysts surveyed by Bloomberg News. The trade surplus of $33.8 billion was the biggest since January 2009, while imports gained 5.3 percent, compared with a median projection of 7 percent.

The export figures reflect pickups in shipments to the U.S., Europe and South Korea, according to customs data.

China Inflation Stays Benign

 

The November consumer-price index was up 3% from a year ago, slowing down slight from October’s 3.2% pace, the statistics bureau said Monday. That was just below market expectations of a 3.1% rise and well within the government’s target of 3.5% inflation for the year.

Consumer inflation was even less of a worry when looked at on a month-over-month basis: It showed a decline of 0.1% in November, its first such drop since May.

At the factory level, producer prices continued to slide year-over-year, falling 1.4% for the 21st monthly decline in a row, showing continued weakness in domestic demand for raw materials. The decline in November was slightly less than the October’s 1.5%.

Japanese growth revised down
Third-quarter growth hit by weaker business activity

The updated calculation of gross domestic product in the three months to September showed that economic output increased at an annualised rate of 1.1 per cent, compared with an initial estimate of 1.9 per cent announced in November. (…)

The downward revision for the third quarter owed to lower estimates of investment and inventory-building by companies. Consumer spending was revised upward, but not enough to offset the less favourable view of business activity.

Corporate capital investment did not grow at all during the period, the data showed; the initial estimate had suggested a 0.7 per cent expansion. Inventory growth was cut to 0.7 per cent from double that figure in the initial data, while the estimate of private consumption growth was doubled to a still modest 0.8 per cent.

Bundesbank lifts German growth outlook
Central bank forecasts economic expansion of 1.7% in 2014

Germany’s Bundesbank has upgraded its economic projections, saying on Friday that strong demand from consumers would leave the euro area’s largest economy operating at full capacity over the next two years.

The Bundesbank has forecast growth of 1.7 per cent in 2014 and 1.8 per cent the following year. The unemployment rate, which at 5.2 per cent in October is already among the lowest in the currency bloc, is expected to fall further. (…)

The Bundesbank also expected inflation to fall back in 2014 – to 1.3 per cent from 1.6 per cent this year – before climbing to 1.5 per cent. If falls in energy prices were excluded, inflation would register 1.9 per cent next year.

EARNINGS, SENTIMENT WATCH

Notice the positive spin and the bee-sss just about everywhere now.

U.S. stocks could weather grim profit outlooks

The ratio of profit warnings to positive outlooks for the current quarter is shaping up to be the worst since at least 1996, based on Thomson Reuters data.

More warnings may jolt the market next week, but market watchers say this trend could be no more than analysts being too optimistic at the beginning and needing to adjust downward.

“There’s a natural tendency on the part of Wall Street in any given year to be overly optimistic as it relates to the back half of the year … It isn’t so much the companies’ failing, it’s where Wall Street has decided to place the bar,” said Matthew Kaufler, portfolio manager for Clover Value Fund at Federated Investors in Rochester, New York.

So any negative news about earnings may “already be in the stock prices,” he said. Sarcastic smile (…)

Still, estimates for fourth-quarter S&P 500 earnings have fallen sharply since the start of the year when analysts were building in much stronger profit gains for the second half of the year.

Earnings for the quarter are now expected to have increased 7.8 percent from a year ago compared with estimates of 17.6 percent at the start of the year and 10.9 percent at the start of the fourth quarter. (…)

The 11.4 to 1 negative-to-positive ratio of earnings forecasts sets the fourth quarter up as the most negative on record, based on Reuters data.

So far 120 companies have issued outlooks. In a typical quarter, between 130 and 150 S&P 500 companies issue guidance.

In small and mid-cap stocks, the trend appears much less gloomy.

Thomson Reuters data for S&P 400 companies shows 2.2 negative outlooks for every one positive forecast, while data for S&P 600 companies shows a similar ratio.

The S&P 500 technology sector so far leads in negative outlooks with 28, followed by consumer discretionary companies, with 22 warnings for the fourth quarter. (…)

“It appears while the percentage (of warnings) is high, it’s still not really infiltrating to all sectors,” said Peter Cardillo, chief market economist at Rockwell Global Capital in New York. “Obviously it impacts the individual (stocks), but maybe not the market trend.” (…)

So, this is a stock market, not a market of stocks!

Punch  That said, here’s a surprise for you: analysts estimates have actually gone up in the past 10 days:

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CAPITULATION
 
Hugh HendryA bear capitulates
Hugh Hendry on why equities will rise further

Hugh Hendry is CIO of Eclectica Asset Management

(…) In this environment the actual price of an asset no longer has anything to do with our qualitative perception of reality: valuations are out, liquidity in. In the wacky world created by such monetary fidgeting there is one reason for being long markets and one alone: sovereign nations are printing money and prices are trending. That is it. (…)

So here is how I understand things. You should buy equities if you believe many European banks and their sovereign paymasters are insolvent. You should be long risk assets if you believe China will have lowered its growth rate from 7 per cent to nearer 5 per cent over the course of the next two years. You should be long US equities if you are worried about the failure of Washington to address its fiscal deficits. And you should buy Japanese assets if you fear that Abenomics will fail to restore the fortunes of Japan.

It will all end badly; the mouse will die of course but in the meantime the stock markets look to us much as they did in 1928 or in 1998. In economic terms, America and Europe will remain resilient without booming. But with monetary policy set much too loose it is inevitable we will continue to witness mini-economic cycles that convince investors that economies are escaping stall speed and that policy rates are likely to rise. This happened in May.

The Fed, convinced its QE programme had succeeded in re-distributing global GDP away from China, began signalling its intent to taper. However, the anticipated vigorous American growth never materialised. The Fed had to shock market expectations by removing the immediacy of its tighter policy and stock markets rebounded higher.

So the spectre of tapering will probably continue to haunt markets but stronger growth in one part of the world on the back of easier policy will be countered by even looser policy elsewhere. Market expectations of tighter policy will keep being rescinded and markets, for now, will probably just keep trending.

Lance Roberts today (with a lot more from Hugh Hendry if you care):

(…) The PRIMARY ISSUE here is that there is NO valuation argument
that currently supports asset prices at current levels.

It is simply the function of momentum within the prevailing trend that makes the case for higher prices from here.

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Hmmm…The trend is your friend, hey? With friends like that…

THE U.S. ENERGY GAME CHANGER

I wrote about that in 2012 (Facts & Trends: The U.S. Energy Game Changer). It is now happening big time.

Shale gas boom helps US chemicals exports
America now second cheapest location for chemicals plants

The US chemicals industry is planning a sharp increase in its exports as a result of the cost advantage created by the shale gas boom, putting pressure on higher-cost competitors in Europe and Asia.

The American Chemistry Council, the industry association, predicts in forecasts published this week that US chemicals exports will rise 45 per cent over the next five years, as a result of a wave of investment in new capacity that will be aiming at overseas markets. (…)

The shale revolution has caused a boom in US production of natural gas liquids used as chemical feedstocks such as ethane, and sent their prices tumbling.

US producers also face electricity costs about half their levels in Europe, and natural gas just one-third as high.

The result has been a dramatic reversal from the mid-2000s, when the US was one of the world’s most expensive locations for manufacturing chemicals, to today when it is the second cheapest, bettered only by projects in the Middle East that have tied up feedstock on favourable terms.

International chemicals companies have announced 136 planned or possible investments in the US worth about $91bn, according to the ACC, with half of those projects proposed by non-US companies. (…)

“The US has become the most attractive place in the world to invest in chemical manufacturing.”

DEMOGRAPHICS

We can discuss political and financial philosophies, fiscal policies and monetary policies till the cows come home. But there is one thing that is mighty difficult to argue about: demographics. As Harry Dent says in this interview with John Mauldin, you have to go back 250 years to find a generation with as much impact as the current supersized baby boomer generation. The impact of retiring baby boomers is so powerful that it can totally offset fiscal and monetary policies without anyone noticing. The 20 minutes interview is not as good as I was hoping it might be but still deserves your time.

A team of Kansas City Fed economists just wrote about The Impact of an Aging U.S. Population on State Tax Revenues (http://goo.gl/u5g3j5) with this chart that summarizes the stealth trends underway:

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Here’s another way to deal with an adverse job market:

Saudi deportations gain momentum
Riyadh to expel up to 2m workers

Riyadh has said it wants to forcibly expel as many as 2m of the foreign workers, including hundreds of thousands of Ethiopians, Somalis, Indians, Pakistanis and Bangladeshis, who make up around a third of the country’s 30m population.

At home, the exodus of illegal workers is being seen as the kingdom’s most radical labour market experiment yet. With one in four young Saudi males out of work, analysts applaud Riyadh’s determination to tackle the problem, but doubt the crackdown will achieve its objective, as Saudi nationals are unlikely to apply for menial jobs. (…)

Ethiopia, Yemen, Somalia and several other countries are struggling to absorb the thousands of unemployed young men now returning, with development officials worrying about the impact on remittances.

Saudi Arabia is the world’s second biggest source of remittances, only behind the US, with outflows of nearly $28bn last year, according to estimates by the World Bank. (…)  Saudi analysts expect the crackdown on illegal workers to reduce remittance flows by nearly a quarter next year, or about $7bn. (…)

The crackdown on African and Asian illegal migrants is meant to complement a government labour market reform known as nitaqat, Arabic for “ranges”. Replacing the failing fixed-quota “Saudisation” system of 1994, nitaqat places a sliding scale of financial penalties and incentives on employers who fail to hire enough Saudi nationals. By draining the pool of cheap expatriate labour, the Saudi government hopes to encourage private sector employers to hire more nationals.

“The nationalisation agenda has been around for 20 years, but what’s changed is that the Arab spring has made private sector jobs for nationals a political priority,” says Steffen Hertog of the London School of Economics. “Saudi Arabia has become a laboratory for labour market reform,” he says. (…)

BUY LOW, SELL HIGH

A 700- year chart to prove a point:

Global Financial Data has put together an index of Government Bond yields that uses bonds from each of these centers of economic power over time to trace the course of interest rates over the past seven centuries.  From 1285 to 1600, Italian bonds are used.   Data are available for the Prestiti of Venice from 1285 to 1303 and from 1408 to 1500 while data from 1304 to 1407 use the Consolidated Bonds of Genoa and the Juros of Italy from 1520 to 1598.

General Government Bonds from the Netherlands are used from 1606 to 1699.   Yields from Britain are used from 1700 to 1914, using yields on Million Bank stock (which invested in government securities) from 1700 to 1728 and British Consols from 1729 to 1918.  From 1919 to date, the yield on US 10-year bond is used.

Ralph Dillon of Global Financial Data

 

NEW$ & VIEW$ (26 NOVEMBER 2013)

U.S. Pending Home Sales Continue to Erode

Pending home sales continue to show weakness. The number of homes on the market for sales has dropped for five straight months. The number of homes for sale has contracted by 1.2% over the past year. There are still year-over-year increases in homes for sale in the Northeast and the Midwest. But in the South and the West, the numbers have shrunk.

In all regions, sales are lower over six months. Sales are lower over three months in the Midwest, the South and the West with only the tiny Northeast showing a gain.

Pointing up Pending home sales are usually stronger than actual existing home sales. When the gap between the growth rates of the two series is squeezed, as it is now, that is usually a sign of more weakness to come. (Haver Analytics)

Auto Vehicle Sales Forecasts: Stronger Sales Expected in November
From CalculatedRisk:

The automakers will report November vehicle sales on December 3rd.
Here are a few forecasts:
From WardsAuto: Forecast Calls for Post-Shutdown Bounce

U.S. automakers should sell 1.21 million light vehicles in November, according to a new WardsAuto forecast.

The forecast sales volume (over 26 days) would represent … equate to a 15.9 million-unit SAAR.

From JD Power: Consumer Demand for New Vehicles Picks Up in November

In November, U.S. new-vehicle sales are likely to reach 1.2 million units … based on an auto sales forecast update from J.D. Power and strategic partner LMC Automotive.
The average sales pace in November is expected to translate to a 16.1 million-unit seasonally adjusted annual rate, or SAAR, which would … outpace the 15.2 million-unit SAAR in October, 2013.

From Edmunds.com: November Auto Sales Set the Tone for Final Stretch of 2013, Forecasts Edmunds.com

Edmunds.com … forecasts that 1,196,663 new cars and trucks will be sold in the U.S. in November for an estimated Seasonally Adjusted Annual Rate (SAAR) of 15.7 million.

It appears sales in November will be significantly above the government slowdown pace of 15.154 million in October 2013.

High five  …but within the monthly range of 2013 and at previous cyclical peaks if we consider the early 2000s sales levels abnormally high (internet and housing bubbles, mortgage refis):
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Thinking smile  While inventories are pretty high…

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New PMI-based indicators for non-farm payroll

Markit Flash US PMI™ surveys are signalling non-farm payroll growth of 163k in November, down slightly on the 219k rise signalled in October (which compared with a 204k rise in the official data for October). The latest increase in employment is being led by the service sector, while
manufacturing payrolls remained broadly stagnant.

Markit has extended its US PMI survey coverage to encompass private services as well as manufacturing. The data for services, as well as combined indices covering both manufacturing and services, are published for the first time for November, including the back histories extending to late-2009.

imageThe Flash Composite PMI Employment Index fell from 54.6 in October to 53.3 in November, signalling a modest easing in the pace of job creation. However, comparisons of the survey indicator against actual non-farm payrolls shows that the survey remains consistent with buoyant payroll growth of 163k in November, fuelled by a 176k rise in private sector payrolls (implying a small fall in government payroll numbers).

Over the latest three months, the PMI has averaged 54.2, signalling an average 202k monthly increase, identical to the change signalled by the official data.

The PMI showed services driving the increase, with private sector services employment up by 163k in November (as signalled by a Flash Services PMI Employment Index reading of 53.6). However, the manufacturing PMI data were consistent of a mere 1k rise in November (as signalled by a Flash Manufacturing PMI Employment Index reading of 52.2).

The PMI survey comparisons against the official data reveal that, while small variations in the monthly numbers are to be expected (a standard error of 49k for total non-farm payrolls), the PMI acts as a valuable advance guide to the trend in the data, helping not only in the prediction of official data but also providing additional information on the degree of confidence with which official data should be considered.

Fears Rise as China’s Yields Soar

Yields on Chinese government debt have soared to their highest levels in nearly nine years amid Beijing’s relentless drive to tighten the monetary spigots in the world’s second-largest economy.

The higher yields on government debt have pushed up borrowing costs broadly, creating obstacles for companies and government agencies looking to tap bond markets. Several Chinese development banks, which have mandates to encourage growth through targeted investments, have had to either scale back borrowing plans or postpone bond sales.

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The slowing pace of bond sales from earlier in the year is reviving worries of reduced credit and soaring funding costs that were sparked in June, when China’s debt markets were rattled by a cash crunch. (…)

Last week, China Development Bank, one of the nation’s largest issuers and regarded as one of the most creditworthy, delayed a planned bond sale by two days and cut the size of the offering from 24 billion yuan ($3.9 billion) to 8 billion yuan. China Development Bank supports funding for China’s major infrastructure projects.

Also cutting the size of a debt offering last week was another regular issuer, Export-Import Bank of China, according to people familiar with the deal. The Agricultural Development Bank of China, which helps fund the development of China’s vast rural areas, has postponed its borrowing plans indefinitely, according to bankers familiar with that deal. Export-Import Bank and Agricultural Development Bank weren’t available to comment on their plans to issue bonds.

According to the latest data from Financial China Information & Technology Co., bond issuance in China totaled 687.36 billion yuan last month, down from 785.88 billion yuan in September and 822.14 billion yuan in August. It also represents a 24% drop from April’s 908.13 billion yuan, which was the most of any month this year. (…)

Even the Chinese government is having a tough time selling debt. In October, China’s Ministry of Finance sold 28.25 billion yuan of one-year debt offering an interest payment of 4.01%. (…)  Offers to buy the bonds roughly matched the number of bonds available, according to the Finance Ministry. Analysts said that typically demand for such bonds has been about double the supply.

 

NEW$ & VIEW$ (25 NOVEMBER 2013)

Iran nuclear deal pushes oil prices lower Geopolitical tensions expected to ease and supply rise

Brent crude fell $2.29 to $108.76 a barrel and US-traded WTI was down $1.44 to $93.40 in response to the agreement between Iran and six world powers reached at the weekend to curb Tehran’s nuclear programme in return for the easing of sanctions.

However, some analysts warned that Iranian exports are unlikely to jump in the short term because key limitations on sales – including a ban on exports to the EU – will remain in place until a comprehensive deal is reached.

US-led sanctions have reduced Iranian exports from almost 2.5m barrels a day to just 1mb/d over recent years, squeezing crude supplies, while the prospect of an Israeli or US strike on Iran’s nuclear facilities has added a further risk premium to the market. (…)

Within the oil market the focus is growing on a sentence in a copy of the interim agreement posted on an Iranian news website, which says western powers will suspend sanctions on insurance and transportation services.

Fereidun Fesharaki, head of the FACTS Global Energy consultancy, said a relaxation of shipping and insurance sanctions could lead to an increase of between 200,000 and 400,000 b/d in Iranian export immediately. (…)

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Continued Signs of Healing in Labor Market

The job market isn’t healing quickly. But it is healing.

(…) Employers are still hiring close to a million fewer people every month than before the recession, and the pace of hiring has edged up only slowly in recent years. Millions of Americans are still looking for jobs, and millions more have given up looking. (…)

But there are signs that both workers and companies are becoming more confident about the state of the economy. The 3.9 million jobs posted in September is the most since the recession ended nearly four and a half years ago. Perhaps even more significantly, 2.3 million people quit their jobs voluntarily in September, 18.5% more than a year ago. Janet Yellen, President Barack Obama’s nominee to lead the Federal Reserve, has highlighted the rate of voluntary exits as a key measure of confidence — one that until recently had been lagging other measures of economic health.

Things are also looking up for the nation’s 11.3 million job seekers. There were 2.9 unemployed workers for every job opening in September, the best mark of the recovery and the second month in a row where the ratio fell under three to one; in the worst of the jobs crisis, there were nearly seven job seekers for every opening.

HOUSING WATCH

 

Weak October Sales Have Home Builders Fretting About Spring

A monthly survey of builders across the U.S. by John Burns Real Estate Consulting, a housing research and advisory firm, has found that respondents’ sales of new homes declined by 8% in October from the September level and by 6% from a year earlier.

Last month’s result marked the second consecutive month in which the survey yielded a year-over-year decline in sales volumes, the first dips since early 2011.

In addition, the percentage of builders disclosing that they raised prices continued to decline, registering 28% in October in comparison to 32% in September and 64% in July. Of respondents, 12% lowered prices in October, in comparison to 12% in September and none in July. (…)

The Burns survey found that sales volumes increased by 31% in the Northwestern U.S. in October from September. Other regions that notched gains included the Southeast, up 13%; Northern California, up 11%; and the Midwest, up 1%. Decliners included Texas, down 21%; the Southwest, down 16%; Florida, down 15%; the Northeast, down 12%; and Southern California, down 8%.

Hottest Housing Markets Hit Headwinds

Some of the nation’s hottest housing markets over the past year are cooling off as buyers balk at paying higher prices while faced with rising mortgage rates, according to a Wall Street Journal survey of market conditions.

In a number of cities across California, Arizona and Nevada—where price gains have been especially strong in the past year—sales are slowing and supply is rising.

Real-estate agents and economists attribute the current slowdown to rising prices and a jump in mortgage rates, which have made homes less affordable for prospective buyers and a less compelling deal for the investors that have played significant roles buying up cheap foreclosures and other distressed homes over the past two years.

For the 12-month period ending in September, values have climbed by more than 33% in Las Vegas and Sacramento, Calif., and by more than 20% in San Francisco, Phoenix, San Diego, and Orange County, Calif., according to Zillow Inc., the real-estate website.

But lately, those gains have moderated. For the July-to-September quarter, home values in Orange County rose just 1%; in San Diego, 2%; and in San Francisco, 3%. Those were the smallest increases in those markets since prices began to rise in early 2012.

(…) In Southern California, Mr. Wheaton said, “we’re seeing more price reductions than we are price increases.” (…)

Inventories are falling in Texas, the Midwest and the Northeast. Compared with a year ago, listings were down in around half of all markets, with big declines in Denver, where inventories were 26% below year-earlier levels, and Manhattan, where inventories fell by 22%.

Listings were down by 19% in Houston; 18% in Dallas; 14% in New York’s Long Island; and 13% in the northern New Jersey suburbs.

Broadly speaking, however, of the 28 major metro areas tracked in the latest Journal survey, nearly half saw inventories rise on an annual basis in September. That represents the highest share of markets showing a rise in supply in nearly three years, with notable increases in San Francisco, Phoenix, Las Vegas, Atlanta and Sacramento. (…)

As demonstrated in my June 2013 post U.S. Housing A House Of Cards?, real estate is a local business. National stats have little meaning for the actual supply demand equation in Houston, in Sacramento or Boca Raton.

France: The people see red

The scarlet hat has become the symbol of protest against François Hollande’s tax rises

In 1675 a popular revolt exploded in Brittany, the rugged north western region of France that juts into the Atlantic Ocean. It was against taxes imposed by Louis XIV, the Sun King, to finance war against the Dutch. The red-capped protesters were known as Les Bonnets Rouges. Nearly 440 years after the uprising was bloodily suppressed, people in Brittany have donned theirbonnets rouges once more. This time they are fighting a wave of taxes imposed not by a king, but by President François Hollande and his socialist government.

“It is another guerre de Hollande,” exclaims Thierry Merret, a bluff Breton vegetable grower, farming union chief and a leader of the new bonnets rouges.

Their challenge has added to a tide of discontent engulfing Mr Hollande. An Ifop poll this month showed his approval rating slumping to 20 per cent, a low no previous president has plumbed in the poll’s 55-year history.

The bonnet rouge has become a symbol of protest not just against taxes, but also the perceived inability of Mr Hollande to deal with a stuttering economy that has seen unemployment climb to nearly 11 per cent of the workforce. (…)

“The situation is unprecedented,” says Laurent Bouvet, professor of politics at Versailles-Saint-Quentin university. “A year and a half after the election, the left is in a potentially catastrophic situation. There is no capacity for movement on the economy or other questions.”

It is not just the business community that is expressing frustration. The bonnets rouges have brought together farmers, fishermen, traders, shopkeepers and workers.

Note Red: the blood of angry men!
     Black: the dark of ages past!
    Red: a world about to dawn!
                Black: the night that ends at last! Note
 
THERE’S ALSO ITALY:

In September, the seasonally adjusted retail trade index decreased by 0.3 per cent compared with August, with food goods falling 0.2 per cent and non-food goods 0.3 per cent. Year on year, retail sales were down an unadjusted 2.8 per cent. The monthly decline was the steepest for eight months, and on an annual basis it was also the biggest in three months.

In the third quarter, retail sales fell 1.2 per cent compared with the same period last year. The data are not adjusted for consumer price inflation, which stood at 0.9 per cent in September, based on the main index, suggesting that retail sales posted a much worse annual contraction in inflation-adjusted terms.

SENTIMENT WATCH

 

S&P Climbs Past 1800

The run to records continued Friday for stocks, with the S&P 500 closing above 1800 for the first time.

S&P Closes Above 1800, Posts 7th Consecutive Weekly Increase: Longest Streak Since 2007

The S&P 500 has now managed the longest weekly winning streak (7 weeks) since May 2007 (when it managed a 9% gain). Off the recent lows, the current run is an impressive 9.6% (for the S&P) (…).

Embarrassed smile Hugh Hendry Capitulates: “Can’t Look At Himself In The Mirror” As He Throws In The Towel, Turns Bullish

First David Rosenberg, then Jeremy Grantham, and now Hugh Hendry: one after another the bears are throwing in the towel. (…)

“I can no longer say I am bearish. When markets become parabolic, the people who exist within them are trend followers, because the guys who are qualitative have got taken out,” Hendry said.

“I have been prepared to underperform for the fun of being proved right when markets crash. But that could be in three-and-a-half-years’ time.”

“I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends.”

(…) Finally, Hendry’s “come to Bernanke” moment does not come easily:

The manager acknowledged his changing stance may be viewed by some investors as a ‘top of the market’ signal, but said he is not concerned by the prospect of a crash.

“I may be providing a public utility here, as the last bear to capitulate. You are well within your rights to say ‘sell’. The S&P 500 is up 30% over the past year: I wish I had thought this last year.”

Crashing is the least of my concerns. I can deal with that, but I cannot risk my reputation because we are in this virtuous loop where the market is trending.”

BUBBLE WATCH

The Four Horsemen of the Apocalypse are Pulling in the Same Direction. They are a Harbinger for More Stock Market Returns (Hubert Marleau, Palos Management)

Barring financial crises, stock market bull runs need the continuous blessing of four macro drivers. These are: Positive Economic Growth, Sustainable Price Stability, Reasonable Valuation and Accommodative Monetary Policy.

While I recognize that the US stock market is up 150% since the lows of March 2009 without any serious corrections, stock prices could go up more for investors are still selectively and mildly exuberant. A rotation towards equity has just started and it could last for several years.

Since the first quarter of 2009, investors have de-risked their portfolios by adding $1.3 trillion in bonds and selling $255 billion worth of equities. Lately, investors are now allocating somewhere around 20% of their new monies to the stock market. Before the financial crisis as much as 30% to 40% of investors’ capital found its way into stocks. Household balance sheets are much healthier, banks are profitable and settling their wrongdoings, and corporations are loaded with cash. In this context, even if the economy may not be doing as well as one would like a financial crisis is not looming.

Moreover, the four horsemen that choose the direction of the stock market are still bullish.

1) Positive Economic Growth: The level of economic output in the US has been steadily growing without any interruptions for 51 months since it bottomed during the second quarter of 2009. During the period under review, the US economy grew at the annual rate of change of 2.0%. In the past six months, the pace of the economy has accelerated to 2.7%.

2) Price Stability: A steady annual rate of increase in the general price levels between 1% and 3% is considered by the Fed and most seasoned market observers as price stability. Since the third quarter of 2009, the GDP Chain Price Index increased at the annual rate of 1.4%. For the period under review, the lowest quarterly annual rate was 0.6% in the second quarter of 2013 and the highest was 2.6% in the second quarter of 2011. During the third quarter of 2013, GDP Deflator printed a year over year increase of 1.3%. Based on recent developments in commodity prices, wages and output per hour, there is reason to believe that price inflation is going to remain stable for a prolonged period of time. Moreover, the gap between actual and potential output is sufficiently wide to prevent any upward cost pressure.

3) Accommodative Monetary Policy: The rate on Federal Funds has been near zero throughout the period under review. The Zero Rate Policy had three beneficial effects. It kept the level of real interest rate negative, the yield curve positive and the cost of capital below the return on capital. The latter is often called the “Wicksellian Differential”.

While we expect the Fed to start paring down the $85 billion-a-month bond purchase program in the coming months, the monetary authorities will continue to hold short term rates near zero until a higher participation rate and/or a lower unemployment rate firmly takes hold. The Palos Monetary policy index currently stands at 60 indicating that the interest rate stance of the Fed is not about to change. In this connection, the beneficial effect of ZIRP (zero interest rate policy) on real rates, yield curve and the Wicksellian spread is maintainable.

4) Reasonable Equity Valuation: The stock market is not necessarily cheap, but it’s not stretched by historical standards. Currently, the median 12-month forward price-to-earnings ratio of 16.0 times is consistent with other periods of earnings growth. Moreover, the spread between corporate bond yields and stock dividend yields at 250 bps are as narrow as they were in the 1950’s. One should also bear in mind that the EPS of the S&P-500 increased 125% from the first quarter of 2009 to the third quarter of 2013 closely matching stock market returns. Year over year, the same EPS is up 9.3% and forecast to increase another 5.1% in 2014.

In conclusion, what is not to like? In tandem, the major drivers are pulling the stock market up. It is not that stock prices will surge ahead over the next few years in a perpetual upward motion. However, stock market returns should continue to beat bond market returns.

Hubert is a good friend of mine, an excellent economist and a good strategist. I am not sure how investors can be “selectively and mildly exuberant” but I know Hubert can’t be only mildly exuberant.

The first chart below plots the S&P 500 Index PE on forward EPS, currently at 15.4x, 28% above its 60-year median of 12x and at the mid-point of the 1 standard deviation channel (10-20x).

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One can make a case for decent valuations here, even more so if the 60-year average of 15x is used instead of the median. Do it at your own risk, however, if you chose to ignore the statistical impact of recent bubble years. As to Hubert’s assertion that “the median 12-month forward price-to-earnings ratio of 16.0 times is consistent with other periods of earnings growth”, it does not verify in the 1991-92 period (profits troughed in mid-1992).

During the 1955-1972 period of prolonged high P/E multiples, earnings remained flat until 1962 before rising steadily through 1966. Inflation was quite volatile between 1955 and 1960, fluctuated narrowly within 1-2% up to 1966, then skyrocketed from 2% to 6.5% by 1970 before coming back to the 3% range by 1972.

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The 1961 to 1966 period most closely resembles the current environment of expected sustained low inflation. Earnings rose strongly and steadily until inflation peaked in late 1966. Equities dropped sharply in 1962 (Bay of Pigs crisis) but skyrocketed during the next 4 years. Throughout that period, forward P/Es fluctuated between 15x and 17x, partly validating Hubert’s comments.

Nevertheless, with forward P/Es, one must deal with the pitfalls associated with earnings forecasts. But even with trailing earnings, absolute valuations never looked really compelling during the 1960s except in late 1966 and in mid-1970 when trailing P/Es reverted back to their 60-year median value of 13.7. Waiting for even median valuation would have meant missing the near doubling in equities between October 1960 and December 1965.

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So Hubert has a point. But I have a better and stronger one. The Rule of 20 worked really well during the 1960’s while using actual trailing earnings and constantly taking account of inflation fluctuations.

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Using the Rule of 20, investors would have sold before the 1962 decline of 24%, bought back aggressively late in 1962, remained reasonably invested as the market rose 67% to December 1965 while flirting with “fair value” (20), suffered the 16% setback of 1966 if they were not mindful of rising inflation, bought aggressively again in the fall of 1966 to enjoy a 30% gain until getting entirely out of equities in mid-1968 just before the ending of the Nifty-fifty stocks era.

Freezing  Some Stock Bulls Tread Lightly

Stock-market strategists, typically a bullish bunch, are taking a cautious approach to the S&P 500.

(…) Forecasts center on gains in the mid-to-high single-digit percentages for the S&P 500 in 2014.

In large part this caution reflects expectations that investor enthusiasm for stocks will be restrained in an environment in which structural challenges continue to hold back the U.S. economy. The result, many strategists said, is that stocks are unlikely to see a continued rise in valuations against earnings growth as they did in 2013.

In addition, bullishness is being muted by a belief that the Fed will in coming months start to pare back the easy-money policies that many said have played a key role in driving stock prices higher this year.

But some strategists said it also reflects a conscious effort to present a tempered outlook.

 

NEW$ & VIEW$ (12 NOVEMBER 2013)

THE AMERICAN PROBLEM

Job Gap Widens in Uneven Recovery

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

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

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

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

Wage growth has moved on two tracks

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

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

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

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

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

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

In summary (chart from Doug Short):

Click to View
 

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

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

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

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

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

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

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

Sad smile  Small Businesses Optimism Takes a Tumble

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

Small business optimism report data through October 2013

 

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Fingers crossed OECD: Global Growth to Pick Up

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

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Punch  LE PROBLÈME FRANÇAIS (from Reuters’ AlphaNow):

COTW_1111

Rating the Euro Zone’s Progress

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

SENTIMENT WATCH

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

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

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

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

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

 

NEW$ & VIEW$ (11 NOVEMBER 2013)

DRIVING BLIND

 

Jobs Strength Puts Fed on Hot Seat

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

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

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

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

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

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

image  image

However,

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

And these peculiar stats:

Retail boom coming to a store near you?

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

Amazon to Hire 70,000 Workers For Holiday Selling Season

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

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

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

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

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

image

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

Confused smile More quirks:

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

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

From the GDP report:

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

 

image

 

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

Fingers crossed POTENTIAL SAVIOR:image

But there is also this:

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

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

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

Other notable findings:

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

Nonetheless:

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

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

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

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

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

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

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

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

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

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

Elsewhere:

S&P Cuts France’s Credit Rating

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

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

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

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

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

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

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

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

Surprise Jump in China Exports

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

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

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

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

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

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

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

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

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

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

China inflation hits eight-month high amid tightening fear

China’s Inflation Picks Up

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

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

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

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

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

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

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

INFLATION/DEFLATION

Central Banks Renew Reflation Push as Prices Weaken

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

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

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

image

The Economist agrees (tks Jean):

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

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

Race to Bottom Resumes as Central Bankers Ease Anew

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

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

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

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

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

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

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

EARNINGS WATCH

From various aggregators:

  • Bloomberg:

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

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

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

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

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


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

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

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

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

SENTIMENT WATCH

 

Stocks Regain Broad Appeal

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

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

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

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

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

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

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

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

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

 

NEW$ & VIEW$ (7 NOVEMBER 2013)

U.S. LEADING ECONOMIC INDEX KEEPS RISING

The Conference Board LEI for the U.S. increased for the third consecutive month in September. Improvement in the LEI was driven by positive contributions from the financial indicators, initial claims for unemployment and new orders. In the six-month period ending September 2013, the leading economic index increased 3.0 percent (about a 6.0 percent annual rate), much faster than the growth of 1.2 percent (about a 2.4 percent annual rate) during the previous six months. In addition, the strengths among the leading indicators have become more widespread than the weaknesses.

These charts from Doug Short suggest that the probability of a recession remains very low:

Click to View

Click to View

Click to View

ISM Services Surprises to the Upside

Following up on the heels of Friday’s stronger than expected ISM Manufacturing report, Tuesday’s release of the non-manufacturing ISM index also came in ahead of expectations.  While economists were expecting the October headline reading to come in at a level of 54.0, the actual reading came in at 55.4.  This represents a one point increase from September’s level of 54.4.  With both the manufacturing and non-manufacturing indices having been released, we can see that the combined composite PMI (bottom chart) for October also increased from 54.6 to 55.5.

Of the ten components shown, only four increased this month, while six declined.  Compared to one year ago, ‘breadth’ in the components was more positive as seven increased and just three declined. 

Credit Jobs at 10-Month Low as Borrowing Slows

The credit-intermediation industry shed 7,700 workers — including commercial bankers, credit-card issuers and mortgage and loan brokers — in September, the biggest drop since June 2011, Labor Department figures show. The total fell to about 2.6 million, the lowest since November 2012. (…)

Mortgage refinancing is the more labor-intensive segment, so a recent rise in interest rates has resulted in sluggish credit growth and fewer people needed to make such loans (…)

German Industrial Production Falls as Recovery Slows

Output (GRIPIMOM), adjusted for seasonal swings, fell 0.9 percent from August, when it rose a revised 1.6 percent, the Economy Ministry in Berlin said today. Economists forecast no change, according to the median of 36 estimates in a Bloomberg News survey. Production advanced 1 percent from a year earlier when adjusted for working days.

Another highly volatile series.. Output is up 0.6% in the last 5 months but down 0.4% in the last 4 months.

CHINA ECONOMY NOT REACCELERATING

The CEBM November Survey indicates that aggregate demand has stabilized, but remains weak. From the perspective of domestic demand, overall consumer sector demand remained sluggish. From the perspective of external demand (…) overall Y/Y growth was flat. Commercial bank feedback communicated a cautious outlook for November.

SENTIMENT WATCH

Investors Rush Back Into Europe

Equities investors are returning in droves, but the region’s recovery remains fragile and deep structural problems remain.


Maligned Markets Return to Vogue

Cash is returning to emerging markets, sparking stock rallies and a surge in fundraising. Calm in the U.S., combined with low rates, has spurred global investors to try to juice returns before year’s end.

cat

The availability of foreign cash is also sparking a flurry of sales of corporate debt. Emerging-market companies have sold $71 billion of bonds since June, taking this year’s total to $236 billion, almost a third more than was sold at this stage in 2012, according to Dealogic, a data provider.

Yields on emerging-market sovereign debt, which rose until September, have also fallen sharply, signaling the return of foreign investors to the market. Average yields on five-year emerging-market government debt have dropped by 0.57 percentage point. In Indonesia, where the decline has been among the most dramatic, yields fell to 7.2% from 8.1%.

TAPER WATCH

Gavyn Davies
What Fed economists are telling the FOMC

(…) The implication of these papers is that these Fed economists have largely accepted in their own minds that tapering will take place sometime fairly soon, but that they simultaneously believe that rates should be held at zero until (say) 2017. They will clearly have a problem in convincing markets of this. After the events of the summer, bond traders have drawn the conclusion that tapering is a robust signal that higher interest rates are on the way.

The FOMC will need to work very hard indeed to convince the markets, through its new thresholds and public pronouncements, that tapering and forward short rates really do need to be divorced this time. It could be a long struggle.

Russia slashes long-term growth forecast
GDP growth will fall behind global average in the next 12 years

(…) The economy ministry said it now expected the economy to grow at an annual rate of just 2.5 per cent through to 2030, down from its previous forecast of 4.3 per cent made in April. Data for gross domestic product growth in the third quarter are due next week, and are also expected to show a continued slowdown.

The sharp cut follows a drop in fixed investment which independent analysts have warned can only be reversed by decisive structural reforms of which the government has so far given little indication.

At the end of September, fixed investment showed a 1.5 per cent drop year on year, and consumer spending slowed to 3 per cent from 7 per cent in the same period in 2012. (…)

The economy ministry said it expected corporate earnings and salaries growth to slow and the wealth gap to widen further, with the share of the middle class falling from half to just one-third of society. (…) …

EARNINGS WATCH

Q3 earnings season is almost over with more than 90% of S&P 500 companies having reported.

RBC Capital calculates that the earnings surprise was 64% with a 5.7% YoY EPS growth rate (3.6% ex-Financials) on a 3.1% revenue growth rate (3.3% ex-Financials). Bespoke Investment below writes about all NYSE companies:

Earnings Season Ending with a Whimper

As shown below, the percentage of companies that have beaten earnings estimates this season has dropped below the 60% mark (59.8%).  

Early on this season, the earnings beat rate looked pretty good, but things have turned around over the past few weeks.  The blue bars in the chart below show the overall earnings beat rate as earnings season has progressed.  The green area chart represents the total number of companies that have reported this season.  As of today, nearly 1,800 companies have reported.  

On October 23rd, 63.9% of the companies that had reported had beaten earnings estimates, which was the highest reading seen this season.  Since then the beat rate has trickled lower.  On November 1st, the beat rate was down to 61.1%, but as of today, it has crossed below the 60% mark (59.8%).