NEW$ & VIEW$ (30 JANUARY 2014)

BLAME THE FED GAME

Investors Seek Safer Options as Ground Shifts

Just one month into 2014, investors from Illinois to Istanbul are finding the tide going out fast for stocks and other riskier investments.


(…) After years of unprecedented monetary stimulus propping up the world’s financial markets, investors are now confronting the reality of an end to the Federal Reserve’s bond-buying program, which, as expected, the central bank reduced by another $10 billion on Wednesday. (…)

Less Room to Maneuver

Some even argue that the long-simmering troubles in emerging markets will draw global investors to U.S. stocks.

But the landscape seems to have shifted from one where unprecedented central-bank stimulus enabled markets to steamroll past issues that might have otherwise spooked investors. (…)

No Respite for Emerging Markets

The pullback from emerging-market currencies showed no signs of a pause, with the Hungarian forint and Russian ruble bearing the brunt of selling pressure.

Meanwhile: Fed Sticks to Script

The Federal Reserve—unfazed by recent selloffs in emerging markets or disappointing U.S. job gains in December—said it would scale back its bond-buying program for the second time in six weeks, pressing ahead with a strategy to wind down the purchases in small and steady steps.

The Fed said it would cut its purchases of Treasury bonds and mortgage-backed securities to $65 billion a month, from $75 billion, and officials suggested they would continue reducing the purchases in $10 billion increments in the months ahead. The first cut, from $85 billion, was announced in December and made in January. (…)

Though they have been watching developments in emerging markets closely, Fed officials made no mention of these trends in the statement released Wednesday after their two-day policy meeting.

U.S. economic growth “picked up” in recent months and was expected to continue at a “moderate pace,” the Fed said. Though job-market indicators were mixed, “on balance” the labor market “showed further improvement,” the Fed said. (…)

“MIND YOUR OWN BIZ”: Citigroup summarizing the Fed statement:

From the viewpoint of domestic US economic conditions the Statement is completely anodyne. From the point of view of EM, the Fed has just said “hasta la vista, baby

FED UP?

Confused smile Confused? Here’s a great read that puts things into their proper perspective: Emerging Markets – Emerging Crisis or Media Hysteria?

Here’s the conclusion but the whole post is well worth reading:

Currently the financial press is working investors into a hysteria surrounding building stress in emerging markets. Stress in emerging markets is nothing new and pops up in specific countries on a yearly basis; however, there is always a risk that country-specific stress can spill over into a global contagion similar to what occurred in 1997-1998. The best way to determine when the risk spills over into something more dangerous is to monitor CDS readings globally as well as the price action in gold. If CDS readings remain muted then we are dealing with country-specific flare ups, but if they spike to levels higher than what has occurred over the last few years and gold surges we need to become more defensive.

With all that said, there is a bright side to the weakness in emerging markets and commodities for developed markets: a disinflationary stimulus similar to what occurred in the late 1990s and, more recently, since 2011…with the caveat that contagion does not result.

Dr. Ed explains the disinflationary stimulus:

The Fed, the Dollar, and Deflation

The woes of emerging economies could temper the Fed’s tapering in coming months by strengthening the dollar, which could push US inflation closer to zero. The JP Morgan Trade-Weighted Dollar Index has been trending higher since mid-2011. A strong dollar tends to depress inflation.

Indeed, the US import price index excluding petroleum has been falling over the past 10 months on a y/y basis through December, when it was down 1.3%. A stronger dollar would be bad news for commodity producers, especially in the emerging economies. When the dollar is rising, commodity prices tend to fall. Weak commodity prices have depressed the currencies of commodity-producers Canada and Australia over the past year.

The latest FOMC statement noted that near-zero inflation could be a problem for the US economy: “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.”

The emerging markets crisis, strength in the dollar, and weakness in commodity prices could frustrate the Fed’s expectations that inflation will rise back closer to 2%.

WHAT NOW?

The S&P 500 hast retreated 4% and is now right on its 100 day m.a. from which it has bounced back three times since June 2013 and which is still rising. If that fails to hold, the next major support is the 200 day m.a. at 1705, another 4% decline.

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The Rule of 20 P/E is back into undervalue territory but, at 18.2, is not screaming “buy”. At the 200 day m.a., it would be 17.6, right in the middle of the range between “deep undervalue (15) and fair value (20). This is all about shifting sentiment. Let’s wait for the earnings season to end in a couple of weeks. We also might have a better view of a possible soft patch.

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HOUSING WATCH: BEAZER HOMES FEELS THE HOUSING SLOWDOWN IN ITS LAST QUARTER

Total home closings were flat at 1,038 closings, with the average sales price from closings up 19%. New orders dropped 4%.

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The 4-week average of the purchase index is now down about 12% from a year ago. (CalculatedRisk)

Spain’s Economy Picks Up Pace

In its preliminary GDP estimate for the quarter, statistics institute INE said Thursday that Spain’s GDP rose 0.3% in the fourth quarter from the third. This is in line with a previous estimate by the country’s central bank, and statements made by Finance Minister Luis de Guindos.

GDP was down 0.1% in the fourth quarter from the same period of 2012, INE said, with a better contribution from internal demand offset by a smaller contribution from the export sector.

For the whole of 2013, the Spanish economy—the euro zone’s fourth-largest—contracted 1.2%, INE added.

The fourth-quarter reading compares with 0.1% growth in the third quarter from the second, and a 1.1% contraction in the third quarter from the same quarter of 2012.

THE (MIDDLE) CLASS OF 2001 VS THE (NOT SO MIDDLE) CLASS OF 2011

From BloombergBriefs: The latest tax data from the IRS (2011) illustrates the fairly grim reality the American middle class faces.image

And this telling, and warning, chart:

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TRY NOT TO LAUGH!

 

Winking smile  President Obama: If You Like Your Retirement Plan, You Can Keep It Fingers crossed

 

NEW$ & VIEW$ (27 JANUARY 2014)

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

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

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

U.S. Markets Tumble as Fear Spreads

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

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

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

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

WHAT NOW?

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

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

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

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

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

EARNINGS WATCH

Factset gives us a good rundown after the first quarter:

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

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

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

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

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

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

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

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

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

But there is this new variable:

Multinationals Start Warning on Q1 Currency Impacts

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

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

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

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

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

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

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

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

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

Analysts are paring down their expectations for Q1 however:

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

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

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

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

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

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

Moody’s Affirms France Rating

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

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

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

Markit adds that France official data overstate the reality:

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

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

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

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

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

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

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

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

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

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

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

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

Confused smile STRANGE QUOTES

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

 

NEW$ & VIEW$ (24 JANUARY 2014)

No Recession In Sight:Conference Board Leading Economic Index Edged Up in December

The index rose to 0.1 percent to 99.4 percent from the previous month’s 99.3 (2004 = 100). This month’s gain was mostly driven by positive contributions from financial components. In the six-month period ending December 2013, the leading economic index increased 3.4 percent (about a 7.0 percent annual rate), much faster than the growth of 1.9 percent (about a 3.9 percent annual rate) during the previous six months. In addition, the strengths among the leading indicators have been more widespread than the weaknesses.

Click to View

Chicago Fed: Economic Growth Moderated in December

Led by declines in employment- and production-related indicators, the Chicago Fed National Activity Index (CFNAI) decreased to +0.16 in December from +0.69 in November. Three of the four broad categories of indicators that make up the index decreased from November, although three of the four categories also made positive contributions to the index in December.

The index’s three-month moving average, CFNAI-MA3, edged down to +0.33 in December from +0.36 in November, marking its fourth consecutive reading above zero. December’s CFNAI-MA3 suggests that growth in national economic activity was above its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests limited inflationary pressure from economic activity over the coming year.

The CFNAI Diffusion Index ticked down to +0.38 in December from +0.40 in November. Forty-seven of the 85 individual indicators made positive contributions to the CFNAI in December, while 38 made negative contributions. Twenty-seven indicators improved from November to December, while 56 indicators deteriorated and two were unchanged. Of the indicators that improved, seven made negative contributions.

Click to View

HOUSING WATCH

Existing Home Sales Approach a New Normal

Sales increased 1.0% in December, to an annual rate of 4.87 million, below economists’ expectations, and the November sales pace was revised down to 4.82 million.

But the year-end weakness wasn’t enough to stop the year from being the best for resales in years. Sales totaled just over 5 million last year, “the strongest performance since 2006 when sales reached an unsustainably high 6.48 million at the close of the housing boom,” said the National Association of Realtors that compiles the existing home data.

A sales pace of five million homes looks more sustainable. “We lost some momentum toward the end of 2013 from disappointing job growth and limited inventory, but we ended with a year that was close to normal given the size of our population,” said Lawrence Yun, NAR chief economist.

CalculatedRisk adds:

The key story in the NAR release this morning was that inventory was only up 1.6% year-over-year in December. The year-over-year inventory increase for November was revised down to 3.0% (from 5.0%).

 

Pointing up All-cash sales jump as “normal” buyers go on strike. RealtyTrac reports:

All-cash purchases accounted for 42.1 percent of all U.S. residential sales in December, up from a revised 38.1 percent in November, and up from 18.0 percent in December 2012.

States where all-cash sales accounted for more than 50 percent of all residential sales in December included Florida (62.5 percent), Wisconsin (59.8 percent), Alabama (55.7 percent), South Carolina (51.3 percent), and Georgia (51.3 percent).

Institutional investor purchases (comprised of entities that purchased at least 10 properties in a year) accounted for 7.9 percent of all U.S. residential sales in December, up from 7.2 percent the previous month and up from 7.8 percent in December 2012.

Metro areas with the highest percentages of institutional investor purchases in December included Jacksonville, Fla., (38.7 percent), Knoxville, Tenn., (31.9 percent), Atlanta (25.2 percent), Cape Coral-Fort Myers, Fla. (24.9 percent), Cincinnati (19.3 percent), and Las Vegas (18.2 percent).

For all of 2013, institutional investor purchases accounted for 7.3 percent of all U.S. residential property purchases, up from 5.8 percent in 2012 and 5.1 percent in 2011.

 

Not a sign of a healthy market, is it? Meanwhile,

Framing Lumber Prices: Moving on Up

 

 

The faith may well be strong, the means are simply not there:image image

Also: Gundlach Counting Rotting Homes Makes Subprime Bear

 

GE’s Rice Sees Global Growth

General Electric vice chairman John G. Rice said that the global economy “was getting better, not worse,” and that beneath lower growth expectations for emerging markets “there was tremendous underlying demand for infrastructure.”

Investors Flee Developing Countries

Investors dumped currencies in emerging markets, underscoring growing anxiety about the ability of developing nations to prop up their economies as they face uneven growth.

The Argentinian peso tumbled more than 15% against the dollar in early trading as the South American nation’s central bank stepped back from its efforts to protect the currency, forcing the bank to reverse course to stem the slide. The Turkish lira sank to a record low against the dollar for a ninth straight day. The Russian ruble and South African rand hit multiyear lows. (…)

Countries with similar current-account deficits considered especially fragile by investors include Brazil, South Africa, India and Indonesia. But the emerging-markets tumult hasn’t hit the “contagion” stage of across-the-board, fear-driven selling of all emerging economies. Indonesia’s rupiah and India’s rupee, for example, advanced against the dollar Thursday, benefiting from those countries’ efforts to adjust their policies to support their currencies.

And this little nugget:

Art Cashin, who runs UBS’s operations on the floor of the New York Stock Exchange, picked up on this in a mid-afternoon note to clients. “China Beige Book has a sentence that translates into English as ‘credit transmission is broken,’ ” he wrote. “That suggests the current credit squeeze may be far more complicated than Lunar New Year drawdowns.” (WSJ)

BOE’s Carney Suggests Falling Unemployment Doesn’t Mean Rates Will Rise Bank of England Gov. Carney said the U.K. central bank will look at a broad range of economic factors when assessing the need for higher interest rates, a sign that officials may be preparing to play down the link between BOE policy and falling unemployment.

imageBoE signals scrapping of forward guidance Carney flags dropping of 7% jobless threshold

(…) Mr Carney made it clear in the interview that there was “no immediate need to increase interest rates” but said the economy was now “in a different place” to the time he introduced guidance. Then, he said, the concern was that the UK economy was stagnating and might contract again: now the concern is that rapid growth might need action by the BoE to make it more sustainable. (…)

Punch If this is not clear guidance, what is? FYI, here’s the situation in the U.S.:

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Google chief warns of IT threat
Range of jobs in danger of being wiped out, says Schmidt

 

(…) Mr Schmidt’s comments follow warnings from some economists that the spread of information technology is starting to have a deeper impact than previous periods of technological change and may have a permanent impact on employment levels.

Google itself, which has 46,000 employees, has placed big bets on automation over some existing forms of human labour, with a series of acquisitions of robot start-ups late last year. Its high-profile work on driverless cars has also led to a race in the automobile industry to create vehicles that can operate without humans, adding to concerns that some classes of manual labour once thought to be beyond the reach of machines might eventually be automated.

Recent advances in artificial intelligence and mobile communications have also fuelled fears that whole classes of clerical and research jobs may also be replaced by machines. While such upheaval has been made up for in the past by new types of work created by advancing technology, some economists have warned that the current pace of change is too fast for employment levels to adapt. (…)

“There is quite a bit of research that middle class jobs that are relatively highly skilled are being automated out,” he said. The auto industry was an example of robots being able to produce higher quality products, he added.

New technologies were creating “lots of part-time work and growth in caring and creative industries . . . [but] the problem is that the middle class jobs are being replaced by service jobs,” the Google chairman said. (…)

Shale Boom Forces Pemex’s Hand

For decades, Mexico’s state oil company, Petróleos Mexicanos, had the best customer an oil company could want: the U.S. But now the U.S. energy boom is curtailing the country’s demand for imported oil, and Pemex is being forced to look farther afield.

For the first time, the company is negotiating to sell its extra-light Olmeca crude oil in Europe, according to Pemex officials. The first shipment will go out in the second half of February to the Cressier refinery in Switzerland, the company said.

The change is one of many in the North American energy landscape affecting Pemex, which also faces competition in exploration and production as Mexico prepares to allow foreign oil companies back into the country for the first time in 75 years. (…)

 

NEW$ & VIEW$ (8 JANUARY 2014)

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

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

Discounts drive U.S. holiday retail growth: ShopperTrak

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

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

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

ShopperTrak had forecast a 1.4 percent decline in shopper traffic.

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

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

Growth Picture Brightens as Exports Hit Record

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

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

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

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

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

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

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

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

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

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

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

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

Aging Boomers to Boost Demand for Apartments, Condos and Townhouses

 

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

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

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

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

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

Euro-Zone Retail Sales Surge

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

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

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

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

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

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

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

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

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

Meanwhile:

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

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

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

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

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

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

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

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

EARNINGS WATCH

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

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

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

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

Thumbs down A Flurry of Downgrades Kick Off the New Year

 

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

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

Record-Setting Cold Hits Eastern U.S.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Emerging Markets See Selloff

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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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.

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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%). 

 

NEW$ & VIEW$ (30 AUGUST 2013)

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

 

Second-Quarter GDP Revised Upward

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

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

BMO Capital offers a good summary:

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

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

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

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

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

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

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

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

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

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

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

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

U.S. Prepares for Solo Strike Against Syria

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

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

Hmmm…

This morning:

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

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

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

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

U.S. HOUSING COOLING?

Bidding Wars Continue to Tumble as Housing Market Rebalances

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

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

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

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

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

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

EUROTURN?

 

Euro-Zone Adds 15,000 Jobs

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

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

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

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

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

These are big drops!

Fingers crossed Eurozone sales rise marginally in August

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

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

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

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

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

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

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

DOUCE FRANCE from BloomberBriefs:

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

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

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

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

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

Red heart EPSILON THEORY: CENTRAL BANK COMPETENCE OR LACK THEREOF

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

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

Ben Hunt’s latest note is highly relevant here:

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

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

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

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

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

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

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

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

Right on cue:

India’s Central Bank Governor Concedes to Missteps

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

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

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

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

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

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

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

Edwards then links with the EM debacle:

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

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

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

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

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

Emerging Markets Raise Rates

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

image

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

They’re important for a few reasons.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Have a good one!

 

NEW$ & VIEW$ (26 AUGUST 2013)

U.S. HOUSING: A HOUSE OF CARDS?

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

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

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

The actual number was 394,000.

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

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

New-Home Sales Tumble

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

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

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

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

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

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

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

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

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

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

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

image(Doug Short)

…with a 97% correlation:

image(CalculatedRisk)

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

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

image

  • Less than 59% of Americans have a job.

image

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

    image

  • Social security payments have ballooned exponentially.

image

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

image

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

Click to View

From Family Dollar Stores’ Q2 conference call:

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

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

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

Nerd smile  Barron’s Randall Forsyth:

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

It wouldn’t be the first policy blunder.

But, bad news can be good news for some:

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

More Homes for Sale, At Last

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Pointing up  Fed Officials Rebuff Coordination Calls as QE Taper Looms

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

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

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

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

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

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

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

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

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

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

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

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

EARNINGS WATCH

Bad Week for Earnings

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

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

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

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

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

Meanwhile, Factset reports that

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

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

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

 High Profit Margins Point to Stock Pain

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

Wilted rose  China Rethinks Deals for Resources

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

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

Mining projects are high on the list.

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

 

NEW$ & VIEW$ (21 AUGUST 2013)

ASIAN FLU

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

Emerging-Market Currencies Fall

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

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

Malaysia Cuts 2013 Growth Forecast as Expansion Misses Estimates

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

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

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

For Asia, Shades of 1997

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

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

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

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

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

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

The question remains: Is this 1997 all over again?

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

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

So what’s an investor to do?

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

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

Fingers crossed  Bloomberg offers hope thanks to Japan

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

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

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Chicago Fed Index Remains in Negative Territory

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

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

Doug Short adds this:

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

Click to View

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

Click to View

Summer Jobs Elude Many Teenagers

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

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

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

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More on Job Growth Quality

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

USOccGroups

 

In short, the middle class is holed out.

Home Depot’s Earnings Rise 17%

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

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

Pointing up  Also note the following:

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

Lowe’s Profit Up 26%, Boosts Outlook

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

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

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

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

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OIL

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

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

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

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

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

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

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

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

LIBYA, NOT EGYPT, INTERESTS OIL MARKET

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

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

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

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

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

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

Meanwhile:

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Leveraged ETFs, the Flash Crash, and 1987

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

Then there is the Middle East. (…)

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

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

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

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