NEW$ & VIEW$ (4 NOVEMBER 2013)

DRIVING BLIND

We had two important U.S. stats last week: the manufacturing PMIs and car sales. Draw  your own conclusions:

The PMIs:

The Institute for Supply Management’s index of industrial activity edged up from 56.2 in September to 56.4 in October, reaching its highest level since April 2011.

The components of the ISM index were somewhat mixed. New orders and new export orders grew faster, while production and employment grew at slower paces compared with the previous month. Prices also increased at a slower pace. But economists still cheered.

(Bespoke Investment)

High five  Wait, wait: Markit’s U.S. PMI report

indicated “only modest improvement in business conditions”, “output growth weakest for over four years“, and “new orders increasing at the slowest pace since April.”

image

image

Car sales:

The seasonally adjusted annual sales pace for October was 15.2 million vehicles, up from 14.4 million a year ago but down from August and September’s pace, said researcher Autodata Corp.

High five  In reality, car sales are not showing any momentum (next 2 charts from CalculatedRisk):

image

High five  A longer term chart suggests that car sales are at a cyclical peak if we consider the early 2000s sales levels abnormally high (internet and housing bubbles, mortgage refis):

image

This RBC Capital chart shows that even boosted incentives fail to propel sales lately. Can incentives get much higher?

image
 

So, taper or no taper?

HELP COMING?

Oil-Market Bears Are Out in Force The oil market bears are out in force today.

(…) According to Morgan Stanley’s analysis, the structure of the Brent market “is at its weakest point for this time of year since 2010,” and they point out that of the things currently keeping oil prices high—a weaker dollar, the aforementioned Middle Eastern instability and the wide difference between the U.S. and North Sea benchmark prices—all appear more likely to improve than get worse.

image
 

image

Fingers crossed  Gas prices have dropped 12% since July. They are 7% lower than at this time last year and in line with prices last Christmas. Welcome additional pocket money at this crucial time…image

…because income growth is very very slow.

image
 
THAT’S NOT HELPING
 
US public investment at lowest since 1947
Republicans stymie Obama push for more spending

(…) Gross capital investment by the public sector has dropped to just 3.6 per cent of US output compared with a postwar average of 5 per cent, according to figures compiled by the Financial Times, as austerity bites in the world’s largest economy.

US public investment is at its lowest percentage share of GDP since post-WW2 demobilisation

Construction projects have taken the early hit as budgets come under pressure, with state and local government building fewer schools and highways

Emerging economies show diverging fortunes Brazil’s industrial production misses forecasts, fiscal deficit widens

Industrial production rose 0.7 per cent seasonally adjusted in September, government statistics agency IBGE said. The figure missed expectations for a 1.2 per cent rise, underscoring one of the myriad economic issues the country is facing.

World-Wide Factory Activity, by Country

image

China manufacturers squeezed as costs rise
Wage rises and renminbi strength weigh on companies

(…) On top of the stronger Chinese currency, wages in the Pearl River Delta are climbing at double-digit rates each year as factories compete for workers in a tight labour market.

Sean Mahon, managing director of an Irish company called Brandwell that owns several accessory brands and has been coming to the Canton Fair for 20 years, says his suppliers charge 20 per cent more each year for the 3,000 products – everything from umbrellas to underwear – that he sources. (…)

China Industrial Activity Weakening

CEBM’s October survey results indicate that aggregate demand has stabilized, but remains weak. The CEBM Industrial Sales vs. Expectations Index decreased from -4.9% in September to -8.1% in October, suggesting that the industrial activity has again weakened.

Investment was sluggish, while real estate and automobile sectors outperformed. Steel sales dropped substantially relative to the past two months’ sales volume, implying that the investment rebound observed over the past several months is losing steam. Automobile and residential home sales growth exceeded expectations.

In general, external demand was stable in October, but consumption remained weak. Freight forwarding agents reported positive shipment growth due to fee adjustments and shipments being delayed from September. However, absolute shipment volume M/M in October, as well as Y/Y growth, was flat. In consumer sectors, home appliance sales outperformed other products, but, overall, consumer demand remained weak.

Looking forward into November, the forward-looking CEBM Industrial Expectations Index (SA) decreased to -7.7% in November from -7.4% in October, suggesting enterprises have weaker expectations toward next month’s sales demand.

EARNINGS WATCH

S&P updated its data as of Oct. 31 with 356 company results in. The beat rate rose to 69% from 67% the previous week. Beat rates are highest in IT (85%) and Consumer Discretionary (73%) and weakest in Consumer Staples (54%) and Utilities (59%). Factset calculates that

In aggregate, companies are reporting earnings that are 1.4% above expectations. Over the last four quarters on average, actual earnings have surpassed estimates by 3.7%. Over the past four years on average, actual earnings have surpassed estimates by 6.5%. If 1.4% is the final surprise percentage for the quarter, it will mark the lowest surprise percentage since Q4 2008 (-62%).

Q3 earnings are now expected at $26.77, down from $26.94 the previous week and from $26.81 on Sept. 30. It is curious to see good beat rates but flat earnings vs expectations. That could mean that misses are more significant than beats.

At this stage of Q3 2013 earnings season, 79 companies in the index have issued EPS guidance for the fourth quarter. Of these 79 companies, 66 have issued negative EPS guidance and 13 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the fourth quarter is 84% (66 out of 79). This percentage is well above the 5-year average of 63%.

But the average of the last 3 quarters is 79.5% at the same stage, not terribly different considering the small sample.

Q4 estimates keep being tweaked downward. They are now $28.38 compared with $28.52 on Oct. 24 and $28.89 on Sept. 30. Nothing major, so far. In fact, according to Factset

the decline in the bottom-up EPS estimate recorded during the course of the first month (October) of the fourth quarter was lower than the trailing 1-year, 5-year, and 10-year averages.

Money  US bank securities portfolios back in black  Reversal of fortunes as Treasuries rally

Big US banks have seen billions of dollars of losses on their vast portfolios of securities reversed following the recent rally in the price of Treasuries and other assets.

Data released by the Federal Reserve on Friday showed unrealised gains in these portfolios had recovered to $8bn after plummeting into negative territory from June to September, when worries that the central bank might taper its bond-buying programme caused investors to sell securities including US government debt.

Profits on big banks’ securities portfolios plummeted from almost $40bn at the beginning of the year as the yield on the benchmark 10-year Treasury spiked to 3 per cent. The yield on the Treasury note has fallen back to 2.6 per cent in recent weeks, helping to push banks’ securities portfolios back into black.

The recovery will come as a relief to bank executives who had worried that the paper losses, which reached more than $10bn in early September, would translate into lower regulatory capital ratios under new Basel III proposals. (…)

The central bank revealed last week that it would include a sharp rise in interest rates when it next “stress tests” the largest US banks, suggesting it is concerned about rate risk in the financial system.

SENTIMENT WATCH

Europe Stocks Hit Five-Year High

Investors Return to IPOs in Force

Investors are stampeding into initial public offerings at the fastest clip since the financial crisis, fueling a frenzy in the shares of newly listed companies that echoes the technology-stock craze of the late 1990s.

October was the busiest month for U.S.-listed IPOs since 2007, with 33 companies raising more than $12 billion. The coming week is slated to bring a dozen more initial offerings, including Thursday’s expected $1.6 billion stock sale by Twitter Inc., the biggest Internet IPO since Facebook Inc. FB -0.91% ‘s $16 billion sale in May 2012.

The 190 U.S.-listed IPOs this year have raised $49.2 billion, more than the $45 billion raised by the 132 deals during the same period in 2012. (…)

Many of these companies aren’t profitable. But investors increasingly are willing to roll the dice, particularly on technology firms that they say have the potential to “disrupt” the industry. (…)

So far this year, 61% of companies selling U.S.-listed IPOs have lost money in the 12 months preceding their debuts, according to Jay Ritter, professor of finance at the University of Florida. That is the highest percentage since 2000, the year the Nasdaq Composite Index roared to its all-time high of 5048.62. The index closed Friday at 3922.04.

Investors this year are putting a higher value on debut companies’ revenue than at any time since the crisis. The median IPO this year has been priced at five times the past 12 months’ sales, according to Mr. Ritter. That is the highest mark since 2007, when the median ratio was more than six times.

Companies holding their IPOs in the U.S. this year have posted an average 30% gain in share price, according to Dealogic. That compares with a 23.5% advance in the S&P 500 index.

Many IPOs this year have raised funds to pay back debt to private-equity owners rather than to invest in corporate expansion, a use of funds that many observers say is more likely to lead to stronger performance. Thinking smile So far this year, 41% of U.S.-listed IPOs have been of private equity-backed firms, according to Dealogic. (…)

In 1999 and 2000, the median IPO company was valued at more than 25 times past-year sales, according to Mr. Ritter. Many had revenue of less than $50 million. This year, fewer than 40% of IPOs fall into that category.

And so far this year, 3% of the 190 U.S.-listed IPOs have doubled in their first trading day. That compares with 22% of the 536 U.S. debuts in 1999. (…)

Three charts from The Short Side of Long

  • Most bullish newsletter sentiment since 2011 market top

  • Managers are holding extreme net long exposure towards stocks

  • Retail investor cash levels are now at extreme lows

Italy’s economic woes pose existential threat to euro zone

(…) I have lived in Italy for six years and have never seen its citizens worry so much about their children, whether those children are kids, university students or young adults starting families. There is no work, or work so beneath their skill levels they can barely muster the enthusiasm to get out of bed in the morning.

Every young Italian I know is leaving the country, or wants to. The U.S., Canadian and British consulates in Rome are seeing a surge in work-visa applications from desperate Italians.

Statistics released on Thursday confirm that Italy suffers a hellish employment problem. The overall jobless rate ticked up in September to 12.5 per cent, the highest since the records began in 1977. The youth jobless rate also rose, to 40.4 per cent, approaching Greek levels.

Even as the rest of the euro zone emerges from the economic crypt, Italy alone continues to dig its grave, tragically unaware of Warren Buffett’s maxim: “The most important thing to do if you find yourself in a hole is to stop digging.”

Besides being a textbook case for relentless wealth destruction, Italy poses an existential threat to the euro zone. Forget Greece; its economy is the size of a corner store compared with Italy. Italy is a Group of Eight country. Its economy is bigger than Canada’s. It is the euro zone’s third-largest player and second-biggest manufacturer, after Germany. If Italy goes down, the euro zone is finished.

This may sound like newspaper columnist hyperbole. It is not. Only a few days ago, the eminently sober-minded Joerg Asmussen, the German economist who sits on the executive committee of the European Central Bank, said this in a speech in Milan: “The future of the euro area will not be decided in Paris or Berlin, or in Frankfurt or Brussels. It will be decided in Rome.” (…)

A recent article on the London School of Economics website by Roberto Orsi, a professor at the University of Tokyo, was refreshingly brutal in its analysis of Italy. He called it “the perfect showcase of a country which has managed to sink from a condition of prosperous industrial country just two decades ago to a condition of unchallenged economic desertification, total demographic mismanagement, rampant ‘thirdworldization,’ plummeting cultural production and complete political-constitutional chaos.”

Evidence that he is not exaggerating comes from the youth diaspora. Writing this week in The New York Times, Corriere della Sera newspaper columnist Beppe Severgnini noted that 400,000 university graduates have left Italy in the last decade.About 60,000 Italians flee Italy every year, most of them with university degrees. You can’t blame them.

Italy needs an economic revolution, pronto. What’s happening now – a slow-motion suicide – is still a suicide. (…)

 

NEW$ & VIEW$ (31 OCTOBER 2013)

Fed Opts to Stay Course For Now

Fed officials emerged from a policy meeting with their easy-money program intact and no clear signal about whether they would begin pulling it back at their December meeting or continue it into 2014.

(…) “The housing sector has slowed somewhat in recent months,” the Fed said in its statement. All in all, however, officials stuck to their view that the economy is expanding “at a moderate pace” and exhibits growing underlying strength.

Inflation Stays Tame, Supporting Fed on Easy-Money Strategy

U.S. consumer prices climbed modestly in September, underscoring weak inflation and supporting the Federal Reserve in keeping its bond-buying program intact.

The consumer-price index, which measures what Americans pay for everything from bread to dental care, rose 0.2% from August, the Labor Department said Wednesday. Core prices, which exclude volatile food and energy costs, increased 0.1%.

From a year ago, overall prices were up 1.2% while core prices were up 1.7%.

Wednesday’s report is particularly noteworthy because it’s used to calculate annual cost-of-living increase in Social Security payments for almost 58 million Americans. The Social Security Administration said Wednesday that benefits would increase 1.5% in January.

Pointing up But underlying inflation trends remain above 2.0%:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.1% annualized rate) in September. The 16% trimmed-mean Consumer Price Index also increased 0.2% (2.2% annualized rate) during the month. The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.

image

 

Another Downbeat Payrolls Report

ADP private-sector payrolls rose a lackluster 130,000 in October following a downwardly-revised 146,000 increase in September. While firms are still hiring, there’s no denying the slowing trend. Pronounced weakness among small service-providing businesses suggest the 16-day government shutdown was a special factor this month, and that payrolls will rebound in November…unless business owners fear another shutdown in the New Year. (BMO Capital)

image

 

Money  Rich People’s Views of the Economy Near Pre-Recession Levels

Affluent U.S. households, buoyed by a surging stock market, feel better about the economy this fall than at any time since before the recession began.

A gauge of sentiment about current economic conditions among the wealthiest 10% of Americans jumped 22 points from the spring to a fall reading of 93, a survey by the American Affluence Research Center showed.

It’s the first “neutral” reading after five years mired in “negative” territory. The last time the index found positive sentiment — above 100 — was the fall of 2007, just before the recession began.

(…) “The stock market has made a big recovery…and these people control over 80% of all stocks and securities owned by the general public.”

Despite the optimism, many wealthier Americans said they’re reluctant to open their wallets further.

Of 17 categories tracked by the biannual survey, respondents only expect spending on domestic vacations to increase during the next 12 months.

The affluent said they plan to decrease spending on designer apparel, fine jewelry and camera equipment. They expect to hold steady in most other categories, including entertainment, dining out and home furnishings.

Ghost The rich even said they’ll cut back on holiday shopping.

The survey found affluent households plan to spend an average of $2,175 on holiday gifts, a 2.8% decline from 2012. (…) Last year, the rich spent 7% more than they said they would in the fall 2012 survey, Mr. Kurtz said.

Goldman Shrinking Pay Shows Wall Street Poised for Bonus Gloom

The firm’s average compensation cost per employee fell 5 percent to $319,755 in the first nine months of 2013. At JPMorgan Chase & Co.’s investment bank, it fell 4.8 percent to $165,774. The figure plummeted 16 percent at Zurich-based Credit Suisse Group AG to $204,000.

At the other extreme:

Retailers Brace for Cut in Food Stamps

Retailers and grocers are bracing for another drain on consumer spending when a temporary boost in food-stamp benefits expires Friday.

The change will leave 48 million Americans with an estimated $16 billion less to spend over the next three years and comes just months after the expiration of a payroll tax cut knocked 2% off consumers’ monthly paychecks.

On the business side of the equation, the cuts will fall particularly hard on the grocers, discounters, dollar stores and gas stations that depend heavily on low-income shoppers. Weak spending in that stressed consumer segment has already led retailers including Wal-Mart Stores Inc. and Target Corp. to lower their sales forecasts for the rest of the year ahead of holidays. (…)

Enrollment in food-stamp benefits surged during the recession and in its wake, increasing by 70% from 2007 to 2011 before leveling off. The government’s stimulus program increased Supplemental Nutrition Assistance Program, or SNAP, benefits across the board by 13.6% in 2009.

As that temporary increase expires on Friday, benefits for a family of four receiving a maximum allotment will drop by 5.4%, the equivalent of about $36 a month, or $420 a year, according to the U.S. Department of Agriculture.

The $16 billion, three-year toll of the cuts estimated by the Center on Budget and Policy Priorities pales in comparison with the estimated $120 billion, one-year hit caused by the earlier expiration of the payroll tax cut. But for many retailers the two have a cumulative effect.

Wal-Mart estimates it rakes in about 18% of total U.S. outlays on food stamps. That would mean it pulled in $14 billion of the $80 billion the USDA says was appropriated for food stamps in the year ended in September 2012.

THE EUROZONE IS NOT OUT OF THE WOODS JUST YET

Storm cloud  Eurozone retail sales fall at faster rate in October

Eurozone retail PMI® data from Markit showed a steeper drop in sales at the start of the final quarter of 2013. The Markit Eurozone Retail PMI remained below neutrality and declined to 47.7, from 48.6, indicating the fastest monthly rate of decline since May. In contrast, the average reading over the third quarter was the highest since Q2 2011 (49.5).

The faster decline in eurozone retail sales mainly reflected a steeper contraction in Italy, which had seen the slowest fall in sales in two years one month previously. Sales fell further in France, albeit at a slower rate, while the rate of growth in Germany was the weakest since May.

image

image

France September consumer spending was down 0.1% on the month, having dropped 0.4% in August and was down 0.1% YoY.

image

 

Euro Inflation Slows, as Rate-Cut Pressure Grows

Annual inflation in Germany fell in October to 1.3% from 1.6% the previous month based on common European Union definitions, Germany’s statistics office said. In monthly terms, consumer prices fell 0.2% from September.

Separately, Spain’s statistics institute said annual price growth in the euro zone’s fourth-largest economy fell to 0.1% in October from 0.5% in September.

Belgium also reported low inflation rates this month, with annual consumer price growth of 0.6%, the lowest since January 2010.

Taken together, Wednesday’s reports suggest annual euro-zone inflation, due for release Thursday, will come in as low as 0.9%, economists said. That compares with 1.1% in September and is far below the ECB’s target of just under 2% over the medium term.

The October CPI Flash Estimate rose 0.7% YoY up 1.1% in September.

SENTIMENT WATCH

From Bank of America Merrill Lynch:

image

US stock market cap to GDP (Exhibit 2), one of Warren Buffet’s favored valuation metrics, is currently 1.12x, clearly high by the standards of the last 60 years. The measure is at the very least a reminder that growth in 2014, rather than liquidity, is essential to prevent an overshoot of the equity market.

image

 

U.S. Blasts German Policy

The Treasury’s semiannual report says Germany’s export-led growth is creating problems for the euro zone and the global economy.

Employing unusually sharp language, the U.S. on Wednesday openly criticized Germany’s economic policies and blamed the euro-zone powerhouse for dragging down its neighbors and the rest of the global economy.

In its semiannual currency report, the Treasury Department identified Germany’s export-led growth model as a major factor responsible for the 17-nation currency bloc’s weak recovery. The U.S. identified Germany ahead of its traditional target, China, and the most-recent perceived problem country, Japan, in the “key findings” section of the report. (…)

The focus on Germany represents a stark shift in the Obama administration’s economic engagement with one of its most important allies. (…)

Punch  Jacob Kirkegaard, an expert on the euro zone at the Peterson Institute for International Economics, said the timing of the criticism is likely an attempt to influence economic policy in Germany while a new coalition government is being formed and is debating its agenda for the next several years. (…)

Ninja  The currency report comes at a time when officials in Berlin and Washington are already clashing over other issues including allegations about U.S. spying. (…)

THE STATE OF THE UNION

 

NEW$ & VIEW$ (9 OCTOBER 2013)

Yellen to Be Named Fed Chairman, First Female Chief

image

 

Shutdown Now 6th Longest In History (Longer Than Average Of All Others)

 

U.S. mortgage applications edge up on more refinancing: MBA

 

IMF’s Pessimism on Global Growth Widens

The IMF cut its world growth forecast amid deteriorating emerging-market prospects, urging authorities to shore up their economies as the U.S. prepares to exit its easy-money policies and wrestles with a budget impasse.

In its sixth consecutive downward revision, the IMF cut its growth forecast for this year by 0.3 percentage point to 2.9% and next year by 0.2 percentage point to 3.6%, compared with the fund’s last assessment in July.

image

Just kidding (…) “contrary to popular impression,” the cooling down of emerging markets wasn’t solely driven by the Fed’s action. Rather, the potential reversal of years of cheap cash exposed areas of financial and economic weakness around the globe, the fund said. And many emerging markets that have hit a peak in expansion are likely to grow at much lower rates on average than the previous decade as competitiveness constraints, infrastructure bottlenecks and slowing investments curb potential economic expansion. (…)

The Fed will eventually start withdrawing its stimulus, and “in this setting, emerging-market economies may face exchange rate and financial market overshooting as they also cope with weaker economic outlooks and rising domestic vulnerabilities,” the fund said.

“Some could even face severe balance of payment disruptions,” it said.

Emerging markets should use the small window of time available to get their economic houses in order, said Olivier Blanchard, the IMF’s chief economist.

Reforms, such as boosting domestic consumption in China and removing barriers to investment in India and Brazil, “can help ease the adjustment and are becoming more urgent,” Mr. Blanchard said. Countries with large budget deficits need to tighten their fiscal belts, and those with high inflation, such as Turkey, must raise interest rates and put in place a more credible monetary policy framework, he said.

To ride out turbulence, emerging markets should allow their currencies to depreciate and be prepared to flood dysfunctional markets with cash reserves. (…)

U.S. Refiners Exporting More Fuel

U.S. refiners are selling more fuel abroad than ever before, effectively exporting the American energy boom around the world.

While federal law bars overseas shipments of most U.S.-produced oil, refiners can export petroleum products created from that crude, including gasoline, diesel and jet fuel.

In July, U.S. refiners shipped a record 3.8 million barrels of products a day to places as far flung as Africa and the Middle East, according to the latest monthly data from the Energy Information Administration. That volume is nearly 65% above the 2010 export level, when the U.S. oil boom was still in its infancy. (…)

Exports to Asia have grown by a third this year, with greater demand coming not just from Japan—a traditional buyer of U.S. fuel—but also from China and India, which have been building up their own refining industries.

Latin America’s voracious appetite for U.S. fuel comes from countries like Brazil and Venezuela, which have aging energy infrastructures that can’t keep up with demand. Fuel flows to that region rose 5% this year between January and July to more than 1.6 million barrels a day. (…)

New markets have cropped up for U.S. fuel, including West Africa—primarily Nigeria—where fuel imports from the U.S. surged 60% in the first half. North African countries along the Mediterranean have imported 52% more U.S. fuel this year.

These areas have traditionally been served by European refiners, but they have been struggling with high crude costs, outdated equipment and economic malaise at home. U.S. fuel exports to Europe doubled between 2007 and 2012 as at least 15 inefficient refineries on the continent closed. But demand in Europe is so lackluster that U.S. fuel moving across the Atlantic in 2013 has slumped nearly 19%, to just over 500,000 barrels a day.

Despite the recent drop, American refiners continue to steal their European counterparts’ market shares, not just in the Mediterranean and Africa but also in the big cities on the U.S. East Coast. European refiners, which have been sending gasoline there since the 1980s, have suffered a 22.5% drop this year. (…)

THE “P”, THE “E” AND THE “P/E”

The U.S. Q3 reporting season is about to get officially underway. Throughout 2013, analyst estimates projected slow growth of U.S. earnings in the first half balanced by strong growth in the second half. As the third-quarter announcement season approaches, our calculations show that the consensus earnings growth estimate for the quarter stands at a modest 2.2% for the S&P 500 constituents with no compression in profit margins.

As for the fourth quarter, current estimates continue to call for a strong rebound. It seems to us that the bottom-up consensus is failing to price in a potential disappointment from the ongoing debt ceiling stalemate. The S&P 500 is now trading at 14.4 times forward earnings that are expected by analysts to expand no less than 11.3% in calendar 2014.

As today’s Hot Chart shows, the S&P 500 has already enjoyed the largest year-to-date multiple expansion of the major equity-market regions. That expansion accounts for a whopping three-quarters of its 20% year-to-date return. That leaves U.S. equities vulnerable to a profit miss. (NBF)

image

The P/E expansion in U.S. equities is reflected in the rise of the Rule of 20 P/E (black line below) from 15 in May 2012 to the 18.8 peak last July (current is 18.1). This has almost completely closed the gap between actual equity prices (blue) and The Rule of 20 fair value (yellow line) which has been going sideways since May 2012 as both earnings and inflation have stabilized while the S&P 500 Index rose nearly 20%.

image

Flattish Q3 earnings would extend the sideways trend in the Rule of 20 fair value unless inflation declines from its current 1.5% YoY reading. However, a marked slowdown in inflation from its current low level may not be welcome news for corporations as it would signify weak demand, poor pricing power and threats to profit margins.

 

The Equity Drumbeaters Are Out

(Note: my good friend I. Bernobul just published this post on his blog)

Now that equity prices have more than doubled and that it has become fashionable to be bullish, the gurus are out with their often convoluted theories and the media are all too happy to act as megaphones. However, one would expect the more serious media to be a little critical and choosy.

James W. Paulsen, chief investment strategist at Wells Capital Management, was given front page exposure in Monday’s Financial Times to trumpet the arrival of ‘the second
confidence-driven bull market of the postwar era”. Unfortunately, his facts and figures are not what one would expect from the FT. Some excerpts with my comments (my emphasis):

(…) But while many investors have turned cautious, the bull market has probably not ended. This is because the primary force driving the stock market is not earnings performance, low yields or quantitative easing; rather, it is a slow but steady revival in confidence, a trend that is just beginning.

In this scenario, investors need not be overly concerned about slower earnings growth. While earnings are obviously important, stock prices have frequently diverged from earnings trends. In fact, for the third time in the postwar era, stock prices and earnings are repeating a remarkably similar three-stage cycle.

Here’s Paulsen’s recipe:

First, earnings surge while the stock market remains essentially flat (the earnings production cycle). Second, earnings performance flattens while the stock market surges (the valuation cycle). Finally, both stock prices and earnings move in tandem (the traditional cycle). It appears the contemporary bull market has just entered the second phase, making earnings growth less important. (…)

So, for the third time in the postwar era, we would be in a “remarkably similar” three-stage cycle which apparently begins with an earnings surge accompanied by a flat market. Mr. Paulsen does not divulge when exactly his first stage began, but the fact is that the stock market has doubled along with surging earnings between March 2009 and May 2012.

Nonetheless, “it appears the contemporary bull market has just entered the second phase”, when “earnings performance flattens while the stock market surges”. If there is such a “second phase”, it began in the spring of 2012 when equity prices rose 30% on flat earnings.

So much for the “remarkably similar” three-stage cycle. But there’s more:

In both the 1950s and the 1980s, the earnings cycle was followed by an explosive stock market run despite almost flat earnings performance. Between 1952 and 1962 the market rose about 3.5 times, while from 1982 to about 1994 it surged almost fourfold.

Here’s the chart for the 1952-62 period during which we can see five periods when earnings and equity prices moved pretty much in tandem. Based on monthly closes, the S&P 500 Index actually tripled between January 1952 and the December 1961 peak.

image

There were actually two broad stages between 1952 and 1962:

  • between 1952 and September 1958, earnings grew only 18% while the S&P 500 Index doubled from extremely undervalued levels after going through highly volatile times following the end of WWII. Inflation went from 2% in 1945 to 20% in 1947 to -3% in 1949, to 9% in mid-1951, to -0.7% in mid-1955 and to 3% at the end of 1957. Understandably, investors were totally uncomfortable with this extreme volatility. As a result, P/Es on trailing earnings plummeted from 22 times in June 1946 to a deeply undervalued 6 times in June 1949. By January 1952, P/Es had recovered to 10x but were still very undervalued based on the Rule of 20 formula which then called for P/Es around 17-18x.
  • Multiples reached 19 in December 1958 as inflation decelerated from 3.6% in the spring of 1958 to less than 1% 12 months later. Between September 1958 and the end of 1962, equities rose 26% while earnings rose 20%, not a meaningful discrepancy.

The same can be said of the 1982-1994 period which is Paulsen’s second “remarkably similar period”.

Inflation reached 14.8% in March 1980 when the U.S. economy was in recession. Inflation receded to 8% in early 1982 but a second recession had begun in July 1981. Equity prices troughed in July 1982 at 7.7x earnings as 10Y Treasury yields reached 14%. Earnings bottomed in December 1982 and doubled by June 1989. Meanwhile, the S&P 500 Index more than tripled as P/E ratios reached 14.5 in June 1989 right where the Rule of 20 stated since inflation was then 5%.

The U.S. entered a mild recession in July 1990 but the sudden 170% jump in oil prices between July and October 1990 created a severe margins squeeze which brought earnings down 25% by the end of 1991. The successful Operation Desert Storm and the subsequent rapid decline in oil prices led investors to expect a rapid restoration of profit margins which brought P/E ratios to 21x by the spring of 1992.

image

In brief, Paulsen’s characterisations of the 1952-1962 and the 1982-1994 periods to fit his theory are far fetched and certainly not even close to the present circumstances.

But on with more recent data:

In the contemporary era, since autumn 2012, despite earnings growth slowing to low single-digit rates, the price-earnings multiple has risen from about 13 times to about 16 times. If this means the stock market just entered its third “valuation cycle” of the postwar era, is slower earnings growth really that worrying?

We are obviously nowhere near the extreme undervaluation levels of the so-called “remarkably similar periods”. Actually, using trailing earnings rather than Paulsen’s forecast, the S&P 500 Index is currently selling at 17x earnings. With inflation at 1.8%, the Rule of 20 P/E is 18.8x, a mere 6% below the “20” fair value level. If there was a “third valuation cycle”, we’ve just had it.

As to the question whether “slower earnings growth is really that worrying?”, the chart below, covering 1946 to the present, is a clear reminder of the importance of profits in equity valuation.

image

Yes, equity markets can, and sometimes do, for brief periods, rise in spite of slow or even negative earnings growth. When it is not to correct extremely low valuation levels, such advances inevitably bring markets to overvalued levels which significantly raises investors risk.

Mr. Paulsen does address some of the risks:

One concern is that the recent rise in US bond yields will abort the stock market bull run. But rising bond yields reflect improving economic confidence, rather than increasing inflation expectations or concerns about the creditworthiness of the US government. A rise in bond yields predicated on a growing belief the “world will not soon end” hardly seems bad for the stock market. Indeed, since 1967, when bond yields have risen in tandem with consumer confidence, the stock market has advanced at almost 12 per cent a year. (…)

Hmmm! Never heard that one. It would have been nice to get the details, especially given that, during the 45 years since 1967, only the first 14 years have seen a marked rise in long term interest rates.

image

Just for fun, however, I checked Paulsen’s assertion since 1977, the last year I have data on the Conference Board Consumer Sentiment Index. I only found 3 periods when interest rates rose in tandem with consumer confidence:

  • April 1983 to July 1984. S&P 500 down 7.9%.
  • January 1987 to October 1987: down 8%.
  • September 1998 to February 2000: +34%. The dot.com bubble years!

You might want to scratch that last one. But there is more:

Since 1900, there have been three major bull markets, in the 1920s, 1950s-60s and the 1980s-90s. Both the first and the third of these were driven by a persistent decline in interest rates, an option not feasible today. However, the 1950s-60s bull market was characterised by a simultaneous rise in both stock prices and bond yields, driven by rising confidence. (…)

May I just mention that earnings have grown at a 5.0% compound annual rate of growth between 1950 and 1969. As to rising confidence, read the above comments on the 1952-62 period once again.

Mr. Paulsen’s conclusion:

Certainly earnings, bond yields and Fed actions will create some turbulence along the way. But beware of becoming too myopically focused on these mainstream issues lest you miss what could be the second confidence-driven bull market of the postwar era.

Now, how confident are you?

image

(Thanks to news-to-use.com for the charts)

 

NEW$ & VIEW$ (2 AUGUST 2013)

Auto  U.S. Vehicle Sales Remain Firm

Unit sales of light motor vehicles slipped 1.8% during July versus June to 15.67 million (SAAR) according to the Autodata Corporation. Despite the dip, sales remained up 11.2% from July of last year and were nearly their strongest since December 2007.

Auto sales dipped 1.0% m/m (+10.4% y/y) to 7.88 million last month.  Light truck sales declined 2.7% (+12.1% y/y) in July to 7.79 million.

Imports’ share of the U.S. car market recovered m/m to 29.0% but remained down from its 37.8% monthly peak in 2010.

 

Pointing up  Japan carmakers accelerate as yen falls

(…) The fall in the yen, which has been driven in large part by a monetary expansion by the Bank of Japan aimed at ending prolonged consumer-price deflation, has allowed carmakers to book more profit while, in some cases at least, reaching for greater market share by cutting the prices they charge foreign customers.

Nissan’s US sales expanded 20 per cent last quarter after it cut prices on seven models including its top-selling Altima saloon.

The beneficial effects of the yen have been magnified by cost cuts implemented by Japanese carmakers during the currency’s relentless climb between 2007 and last year.

Taken together, the competitive shift has put carmakers in other countries on the defensive. Last month Ford’s top executive in Washington attacked the Japanese economic policies that have weakened the yen and said Japan was unfit to join the Trans-Pacific Partnership, a proposed regional trade pact that it began talks to enter last month. (…)

Karl Brauer, senior analyst at Kelley Blue Book, the car information service, said Toyota could struggle to protect its share of the market as Americans rediscover their preference for larger vehicles – Detroit’s traditional strength.

“It’s confirmation Toyota has revitalised its production efficiency. That’s impressive, but it can’t stop a US market shift toward large trucks and SUVs,” he said. (…)

U.S. Construction Spending Backpedals

The value of construction put-in-place declined 0.6% (+3.3% y/y) during June after a revised 1.3% May jump, initially reported as 0.5%. April’s increase also was revised up to 1.1% from 0.1%. Declines in building activity were logged across sectors. The value of public sector building experienced the largest decline and was off 1.1% (-9.3% y/y).

Private sector building activity also showed weakness, posting a 0.4% decline (+9.7% y/y) in June. That reflected a roughly unchanged (18.1% y/y) level of residential building. It  owed to a 3.3% collapse (+40.6% y/y) in multi-family construction and a 0.8% drop (+28.2% y/y) in single-family building. Spending on improvements rose 1.7% (4.4% y/y). Nonresidential building activity declined 0.9% (+1.4% y/y), pulled lower by a 6.6% slump (-0.8% y/y) in education and a 5.6% drop (0.0% y/y) in commercial building.

 large image

ISM Manufacturing Spikes to Highest Level Since June 2011

Following on the heels of stronger than expected Manufacturing PMIs across the world, the ISM Manufacturing jumped from 50.9 to 55.4 in July for its largest one month increase since June 1996.  That’s right.  The ISM Manufacturing report has not had a one month increase like this in 17 years!

Looking at the internals of this morning’s report shows that six components rose this month, while just three declined.  Relative to last year, this month’s report was even stronger as the only two components that declined were Business and Customer Inventories.  Besides the big jump in the headline reading, the most notable aspect of the ISM Manufacturing report for July was the Production component, which increased from 53.4 to 65.0.  That is the highest level since May 2004 and represents the 7th largest monthly increase going all the way back to 1948.

Global manufacturing growth remains lacklustre in July

The global manufacturing sector made a subdued start to the third quarter. At 50.8 in July, the JPMorgan Global Manufacturing PMI™  remained only slightly above the no-change mark of 50.0.

image

Rates of expansion in production and new orders were broadly unchanged from the modest levels signalled during the second quarter of the year. July nonetheless saw output and new orders rise for the ninth and seventh successive months respectively.

National PMI suggested that the Asia region was the main drag on global manufacturing growth during July. Production volumes declined in China, India, Taiwan, South Korea and Vietnam, stagnated in Indonesia, while growth slowed to a five-month low in Japan. Elsewhere, Spain, Brazil, Russia, Mexico, Australia and Greece also reported contractions.

In contrast, output growth hit a four-month high in the US, near two-and-a-half year high in the UK and returned to expansion for the first time since February 2012 in the eurozone. Eastern Europe also faired better, with production rising in both Poland and the Czech Republic. The upturn in Canada extended into its third successive month.

The level of new export orders – an indicator of international trade flows – rose for the fourth time in the past five months, although only slightly. Growth of new export business was registered in the US, the eurozone, Japan, Canada, India, Poland, Czech Republic, Singapore and Russia.

image
Pointing up  Here’s a good, realistic, economic snapshot from Moody’s, unlike most brokerage reports:

The Limpest Recovery Since WWII Weighs on Revenues and Profits

Though 2012’s real GDP growth was revised up from 2.2% to 2.8%, the 2.2% average annualized rise by real GDP for the current recovery to date was slower than the 2.8% of 2002-2007’s upturn, which was the erstwhile “worst recovery since the Second World War.”

The Fed is more likely to begin tapering if fourth quarter 2013’s real GDP grows by at least 2.3% to 2.6% year-over-year. However, as inferred from Q2-2013’s 1.4% yearly rise by real GDP, real GDP is unlikely to achieve the Fed’s threshold by the final quarter.

After edging higher by merely 1.4% annualized during 2013’s first half, the consensus expects that real GDP will grow by between 2.5% and 3% annualized through the middle of 2014. This forecast assumes an end to the sequester and a rise by the annualized growth of real consumer spending from first half 2014’s 2.0% to 2.6%.

However, the current political dynamic favors a continuation of sequestration. Moreover, consumer spending may have difficulty reaching its projected growth if home sales subside and incomes do not accelerate.

Jobs growth may slow according to the sluggishness of revenues, profits, and labor productivity. Ordinarily the recent 1.6% yearly increase by payrolls would be joined by 3% growth for real GDP, which is well above the actual 1.4% growth rate. The latest deficiency of GDP growth relative to what otherwise is suggested by payrolls reflects a notable deceleration of labor productivity. The slowdown by productivity suggests a drop in the quality of new jobs. And lower quality jobs tend to be associated with below-trend income growth.

And, let me add, lower productivity likely means lower profit margins (see below on that). And if margins don’t rise, it might be difficult to report strong profit gains, especially if revenues grow only 2.0% YoY like we are seeing in Q2.

EARNINGS WATCH

S&P’s tally of Q2 earnings is now 72% complete. The beat rate is 66%, unchanged from last week, and the miss rate is 24.8%, also in line with last week’s. The overall beat is slim, however, being only 0.4% above estimates. It looks like operating margins will shrink a little.

Note however that the bulk of the remaining companies to report are in Energy, Consumer, Telecom and Utilities where the miss rates have been well above average.

Q2 earnings are now seen at $26.41, down $0.27 or 1.0% from last week’s estimate. Analysts have shaved their forward estimates just a little: Q3 is now estimates at $27.33 (vs $27.42 last week), up 13.9% YoY, and Q4 is $29.18 (vs $29.25), up a truly spectacular 26% YoY. If you are using forward earnings, 2013 EPS are estimated at $108.70 and 2014 at $122.42. Beware, however, since Q1 EPS were up 6.3% and Q2 are on track to rise 3.9%. Also. consider that other than during 2010 when profits bounced from the appalling low base of 2008-09, growth rates in the high 20’s are truly exceptional, the last sighting being in early 2004. For reference, I include Ed Yardini’s chart below:

Here’s another proxy for sales: total business sales (YoY):

image

Same series but monthly rates of growth. see any growth pattern there?

FRED Graph

I keep using trailing EPS and these are now seen at $99.33 after Q2, barely breaking the $97-98 range of the last 6 quarters. Meanwhile, the S&P 500 Index soared 21% while inflation remained stable at 1.7-1.8%.

As a result, the Rule of 20 fair value remains stuck at around 1800 where it has been since April 2012 (yellow line on chart), leaving only 6% upside to fair value (blue line meeting yellow, or black line hitting the red “20” line). Equities were 29% undervalued in early June 2012 (1278 on the S&P 500 Index). The whole rally has been from the result of higher valuations, courtesy of central bankers and gradually more upbeat media coverage.

image

Since trailing earnings will remain unchanged for another 3 months, market sentiment will be the only support for equities which currently trade 5% and 10% above their 100-day and 200-day moving average respectively.

This is the 3rd time since March 2009 that the S&P 500 Index has been at or close to fair value (black line on chart). Equities dropped 16% in early 2010 and 18% in mid-2011, even though earnings were still rising nicely (rising yellow line), providing a value backstop that is not apparent at this critical juncture.

SENTIMENT WATCH

 

Fingers crossed Europe Sees Bottom of Downturn as Daimler Leads Rebound From German luxury carmaker Daimler AG and French builder Vinci SA to International Business Machines Corp. and 3M Co., global companies say the worst is over for Europe.

 

Money Europe Banks Pare Cash Stockpiles

Some European banks are planning to deploy a counterintuitive tactic to improve the appearance of their financial health: whittling down their huge cash stockpiles.

The maneuver will boost the banks’ so-called leverage ratios, which a growing number of regulators and investors are using as a key gauge of banks’ financial safety.

But by reducing their cash hoards by billions of dollars, the banks would be moving away from the ultimate low-risk asset. Some analysts said the move is a gamble that is unlikely to please regulators or risk-averse investors.

[image]

With a financial crisis raging and regulators pushing banks to be ultraconservative, many European banks in recent years amassed ever-greater sums of cash on deposit at central banks. The total cash holdings of a dozen of Europe’s largest banks soared to about $1.3 trillion at the end of last year, up 55% from 18 months earlier, according to a Wall Street Journal tally.

That trend started ebbing earlier this year. But in the past week, at least three big European banks—Barclays PLC, Deutsche Bank AG and Société Générale SA signaled that they plan to accelerate their shifts away from cash.

The moves coincide with U.S. and European regulators’ recent embrace of the leverage ratio as an important measure of banks’ safety. The leverage ratio consists of banks’ equity as a percentage of their total assets. Shedding assets therefore represents an easy way for banks to strengthen their ratios. (…)

To the frustration of many bank executives, the leverage ratio doesn’t take into account different levels of risk among assets. So for two banks with similar amounts of equity, their leverage ratios would be the same even if one bank was brimming with toxic assets and the other was holding nothing but cash. (…)

Some analysts, though, suspect banks are threatening to drain their liquidity pools in an attempt to cajole regulators to back away from the leverage ratio. (…)

Indeed, some banks are pushing regulators to let them exclude assets in their liquidity pools from the denominator of their leverage ratios, industry officials say. Such a change would boost most banks’ leverage ratios and make it easier for them to avoid issuing new equity or dramatically cutting costs.

 

NEW$ & VIEW$ (17 JULY 2013)

Consumer Inflation Climbs 0.5%

Consumer prices are up 1.8% from a year earlier. Excluding the volatile food and energy categories, prices rose a milder 1.6% over the past year.

Much of June’s gain in overall prices came from a 6.3% increase in seasonally adjusted gasoline costs. Actual prices at the pump rose only slightly, but they failed to follow the expected pattern of declining in the weeks after Memorial Day, causing the adjusted number to rise.

From the Cleveland Fed:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.1% annualized rate) in June. The 16% trimmed-mean Consumer Price Index rose 0.2% (2.2% annualized rate) during the month.

The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.

Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers rose 0.5% (5.9% annualized rate) in June. The CPI less food and energy increased 0.2% (2.0% annualized rate) on a seasonally adjusted basis.

Over the last 12 months, the median CPI rose 2.1%, the trimmed-mean CPI rose 1.7%, the CPI rose 1.8%, and the CPI less food and energy rose 1.6%

image

Haver Analytics offers the salient details:

Prices for goods less food and energy gained 0.2% (-0.2% y/y) following several months of having been unchanged. Apparel prices led the way higher with a 0.9% jump (0.7% y/y) while medical care goods prices rebounded 0.5% (-0.1% y/y). New car and truck prices gained 0.3% (1.2% y/y). Furniture and bedding costs rose 0.2% (-0.5% y/y) and home appliance prices also increased 0.2% (-1.9% y/y). Recreation goods prices were off 0.6% (-1.8% y/y).

Core services prices increased 0.2% (2.3% y/y). Medical care service prices rose 0.4% (2.8% y/y). Shelter costs (32% of the CPI) gained 0.2% (2.3% y/y) while owners equivalent rent of primary residences increased 0.2% (2.2% y/y). Public transportation prices fell 0.9% (+3.6% y/y) and transportation services costs slipped 0.1% (+2.5% y/y).

But Doug Short has the best tables:

image

image

Note the sharp acceleration in Housing costs which accounts for 41% of CPI. It has been rising at a 4.5% annualized rate in Q2, +5.5% in the last 2 months.

So, the inflation jury is still out. Core inflation, however you measure it, continues to rise around a 2% annualized rate, in spite of tepid demand and a rising dollar.

For the Rule of 20, June’s 1.8% inflation rate reduces the Fair P/E to 18.2, from 18.6 in May and 18.9 in April. Based on trailing EPS of $98.35 after Q1’13 results, fair value for the S&P 500 Index is 1790, +6.8% from current levels. This is the lowest level of undervaluation since April 2010. Note how the big rise in equity prices since May 2012 (blue line on chart) has occurred against stalled fair value readings (yellow line) due to flat earnings, resulting in the big decline in equity undervaluation (black line rising towards “20”).

image

 

Either earnings, or investors sentiment (QE?) rise smartly, for inflation does not seem about to break down given recent trends in energy prices and shelter costs.

Downside? Fundamentally, renewed fears could take the rule of 20 P/E to 16 which, assuming inflation at +1.8%, would mean a trailing P/E of 14.2. Times $98.35 (?), equals 1400 or –16.5%. technically, the 100 day m.a is at 1598 (-4.6%) and the 200 day m.a. is at 1522 (-9.2%).

U.S. equity markets have not traded at the Rule of 20 fair value since September 2008 (on the down trip) or July 2007 on the uptrend. Are current conditions such that investors have  become fearless?

If Q2 earnings fail to grow…

Real Wages Still Below June 2009 Level

Average hourly wages were unchanged from May to June after adjusting for inflation, the latest sign of households struggling to gain purchasing power in the aftermath of the Great Recession.

Average hourly wages were unchanged from May to June after adjusting for inflation, the latest sign of households struggling to gain purchasing power in the aftermath of the Great Recession.

The flat result stemmed from a 0.4% increase in average hourly earnings being offset by a rise in the consumer price index. Over the last 12 months, inflation-adjusted hourly wages have risen by just 0.4%.

Speaking of shelter costs:

 

Bay Area Rally Sends Rents Soaring

Rents in the Bay area are getting juiced by a healthy tech sector, exciting investors but riling some tenants.

San Francisco led the top-50 U.S. metropolitan areas in average rent growth during the second quarter, jumping 7.8% to $2,498, while Oakland was No. 2 at a 6.9% increase, and San Jose was in fifth place at 5%. The 6.8% increase for the combined San Francisco Bay area was more than double the nation’s 3.1% increase, according to preliminary estimates by MPF Research, a market-research firm in Carrollton, Texas.

Coke’s Growth Stalled Globally

North American volume slipped for the first time in 13 quarters amid a steep drop in soda consumption (…).

Coke also estimated a stronger dollar will shave 4% off of operating profit this year, up from an earlier 2% forecast.

Coke’s sales volume grew only 1%, slowing from 4% in the first quarter and below Wall Street forecasts of 3% to 4% growth. Revenue dropped 3% to $12.75 billion from $13.09 billion, hurt by the dollar and the sale of its bottling operations in the Philippines.

North American volume slid 1% as a 4% fall in soda sales offset a 5% rise in still beverages. Coke blamed unusually wet and chilly weather in the U.S., including the wettest June in more than 50 years, for the steeper-than-usual drop in soda consumption.

Soda consumption has fallen in North America for eight straight years amid growing obesity and health concerns.

It said tough weather conditions in Europe, including floods and Germany’s coldest spring in four decades, pushed volumes down 4% on that continent, where demand also was hurt by the poor economy and high unemployment.

Elsewhere, in India volumes rose a mere 1% as monsoon rains arrived early, washing out roads and reversing 20% growth in the year-earlier quarter, when the monsoon arrived late.

Weather wasn’t always a factor in certain emerging markets. In Brazil, a source of strong growth in recent years, consumption was flat amid slackening consumer spending and social unrest. Volumes were up just 1% in Mexico, which consumes more Coke products per capita than any other country.

For China, Coke reported flat volume.

U.S. HOUSING

 

NAHB Sentiment Index Hits 7.5 Year High

For the month of July, the NAHB Sentiment survey rose from 51 up to 57.  Even more impressive is the fact that the homebuilder sentiment index has now risen by 13 points in the last two months.  The last time the index saw that big a jump in a two month period was back in February 1992!

The Traffic diffusion Index, though rising, remains below 50.

image

 

 

 

This morning:

Pointing up  U.S. Housing Starts Fall by 9.9%

Home construction fell sharply in June, highlighting turbulence in the sector as mortgage rates threaten to restrain new activity.

Housing starts declined 9.9% in June from a month earlier to a seasonally adjusted annual rate of 836,000 units, led by a 26% fall in the volatile multi-unit category.

In a report released Wednesday, the Commerce Department said building permits, a measure of future construction activity, fell by 7.5%. That was the sharpest drop in more than two years and was led by a 21% decline in permits for multi-unit buildings.

U.S. Factories Show Pickup in Output U.S. industrial production rose in June as factories built more autos and electronics, a sign that businesses and consumers may be ready to start pulling the economy out of a second-quarter soft patch.

Industrial output increased a seasonally adjusted 0.3% last month and the use of available production capacity inched up 0.1 percentage point to 77.8%, the Federal Reserve said Tuesday.

Manufacturing, the biggest component of industrial production, rose 0.3% in June. Output of automotive products, machinery and home electronics all saw big gains.

The fact is that total output was flat in Q2. (table from Haver Analytics)

image

SLOW AND SLOWER

China Won’t Have Large Stimulus This Year, Finance Minister Says

Chinese Finance Minister Lou Jiwei said the nation won’t use “large-scale fiscal stimulus” measures this year, adding to signals that the government will tolerate a slowdown in the economy.

China will promote growth and boost employment while fine-tuning policies and keeping the fiscal deficit unchanged, and will also avoid big adjustments to short-term macroeconomic policies, Lou said in July 11 comments in meetings with U.S. officials in Washington. The remarks were posted yesterday on the Finance Ministry’s website.

Lou said in a press briefing at the Washington meetings last week that growth as low as 6.5 percent may be tolerable in the future. While the government in March set a 2013 growth goal of 7.5 percent, Lou said he’s confident 7 percent can be achieved this year.

The official Xinhua News Agency later amended its English-language report on Lou to say there’s no doubt that China can achieve this year’s growth target of 7.5 percent.

Wait, wait:

China’s premier holds the line on reforming economy

China’s Premier Li Keqiang urged caution about rushing to change economic policy to try to revive the country’s sputtering growth, but he also signaled Beijing was prepared to take action if the economy slips too far.

Li was quoted by state television saying late on Tuesday that the government is able to achieve key economic tasks for this year, reinforcing the official view that a 7.5 percent annual economic growth target remains achievable.

“Neither should we change policy orientation due to temporary economic fluctuations, which may affect the hard-won restructuring opportunity, nor should we lack vigilance and preparations when the economy might slide below the reasonable range,” Li was quoted as saying.

Pointing up  FT Alphaville has a great post today:When does a Chinese growth deceleration become a crisis? 

(…) Does that mean an imminent crisis? Does it mean, for example, a financial crisis, outright GDP contraction, or an overthrow of the regime?

We’re not sure.

What is very difficult about China right now is to see past the signs of slowdown and change (liquidity, property markets, precarious WMPs, etc) and connect them to the underlying shifts: the decline of growth led by exports, demographics and most recently, credit-fuelled investment.

If you like, it’s a question of differentiating between symptoms and the cause.

It’s even harder to predict how this will all play out and in what kind of time frame. What we’ve seen recently appears to be the beginnings of the undoings of the most important current tool for both driving growth and creating imbalance — liquidity and credit. (…)

The Q2 GDP number and the associated data suggest the worst of both worlds. Growth is slowing — the number itself looks particularly questionable this quarter — but the rebalancing is not taking place. (…)

The liquidity problems, WMP managers scrambling to cover redemptions, Ordoshaving to borrow money to pay wages — these are symptoms.

They’re serious symptoms. Reuters has a great exploration of how much more volatile and unsettling things could get if/as the authorities pursue the kinds of financial reforms that they’ve already outlined. Jim Chanos argues property price falls could spark middle class unrest and allowing banks more freedom to set lending and deposit rates could mean a scramble to gain deposits. Quartz’s Matt Phillips also looks at the scary implications of China’s capital inflows reversing. Likewise, WMP failures could spark bank runs. (…)

There are of course real constraints on how much longer China’s central government can perpetuate the unbalanced, fast-growth model. Employment is an obvious mechanism for economic slowdown to result in unrest. Yet the ageing population demographic seems to be taking care of that a little earlier than anyone expected. Again, it could change. The ‘employment’ segment of the manufacturing PMIs have been weak for some time. Consumer prices are another — although price controls,strategic pork reserves and the like can probably be deployed to some extent.

Essentially, the point is not so much that ‘China is different’. China can handle many things differently, as its unique approach to growth has already demonstrated. But ultimately, it all ends up being another form of can-kicking. Which, in itself, is not so ‘different’.

 

NEW$ & VIEW$ (21 MAY 2013)

Chicago Fed: Economic Activity Was Slower in April

According to the Chicago Fed’s National Activity Index, April economic activity slowed from March, now at -0.53, down from March’s -0.23. This index has been negative (meaning below-trend growth) for eleven of the past fourteen months. (Doug Short)

Click to View

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

Fingers crossed  Developed Economies See Slight Growth

Developed economies returned to growth in the first three months of the year, although the euro zone continued to lag behind the U.S. and Japan, according to figures released by the Organization for Economic Cooperation and Development.

In the United States, the CLI continues to point to economic growth firming. In Japan, it indicates that growth should remain above trend.
In the Euro Area as a whole, the CLIs continue to indicate a gain in momentum. In Germany, the CLI shows that growth is returning to trend. In France, the CLI points to growth close to trend rate. As in April, the CLI points to a positive change in momentum in Italy.

The CLIs for the United Kingdom, Canada, Brazil and Russia point to growth close to trend rates. In China, the CLI indicates that growth is returning to trend while for India, it continues to indicate growth below trend.

image

image

Thumbs up  German Central Bank Sounds Upbeat Note

The German economy is due to recover at a stronger clip in the current quarter than in the first three months of the year, but the euro-zone debt crisis remains a significant risk, Germany’s central bank wrote Tuesday.

Both an expected recovery in construction after weather delays in the winter and encouraging signs from the industrial sector support the outlook, the Bundesbank said. (…)

The bank said that not only would a “catch-up effect” in the construction sector following a rough winter contribute to growth, but the “noticeable increase in industrial new orders after the weak beginning of the year generates hope that exports and equipment investment,” two traditional growth drivers of the German economy, will increase. (…)

High five  Markit’s latest PMIs were not that upbeat: 

Germany’s manufacturing sector started the second  quarter of 2013 with declines in output, new orders  and employment. As a result, the final seasonally  adjusted Markit/BME Germany Purchasing  Managers’ Index® posted below the  neutral 50.0 mark in April. At 48.1, down from 49.0  in March, the latest reading indicated a moderate  worsening of overall business conditions, and the  rate of deterioration was the most marked since  December 2012.

The final seasonally adjusted Markit Germany Composite Output Index – which measures the  combined output of the manufacturing and service
sectors – dropped to 49.2 in April, from 50.6 in  March. This was below the 50.0 no-change value for  the first time in five months and signalled a marginal  reduction of overall private sector output in  Germany.

Storm cloud  Chile’s Economy Slows Sharply, As Hit From Copper Price Fall Dazes  The decline of copper prices this year has started to undermine the economy of Chile, the world’s leading source of the red metal.

The Andean nation Monday reported annual gross domestic product growth of 4.1% in the first quarter, less than the 4.5% expected.  Even adjusted for the Easter holiday, which fell in March this year and April last year, growth was still 4.7%, pretty good relative to most other parts of the world. But it was a full percentage point below Chile’s 5.7% expansion in the last quarter of 2012.

Moreover, its seasonally adjusted quarterly growth was just 0.5%, making for an annualized rise of about 2%.

No one expects Chile’s economy to downshift to that extent this year after growing 5.6% in 2012. But it’s now highly likely to grow closer to the bottom end of the central bank’s 4.5% to 5.5% forecast range.

LONG TIME CLOSE FRIENDS PARTING WAYS

Highly unusual divergence.

image

U.K. Inflation Rate Falls More Than Forecast to 2.4%  U.K. inflation slowed more than economists forecast in April to a seven-month low and producer prices rose the least since 2009 as fuel costs fell.

EARNINGS WATCH

S&P’s just updated earnings tally to May 17:

  • Of the 465 (93%) companies having reported, 66% beat and 26% missed. The miss rate rose to 58% last week, up from 48%, 28% and 21% in each of the previous weeks respectively.
  • Q1 EPS are now estimated at $25.74, down 0.8% from last week but up 1% from the estimate on March 28. Q2’13 estimate is $26.69, up $0.06 from last week but down 3% from March 28. The full 2013 estimate, at $109.69 is down $0.20 from last week and 1.3% from March 28.
  • Trailing 12-month EPS should total $98.32, down $0.22 from last week and up only 1.5% QoQ and +0.2% YoY.

Earnings preannouncements for Q2 as of May 16 (from Factset):

image

Nerd smile  MARKET HISTORY

Here is an interesting statistic to think about for a moment.

The current rise in the stock market has gone uninterrupted for 181
days which is the longest period in the history of the stock market.
Think about that for a moment.

Over the last 113 years of stock market history we are now witnessing the longest rise – ever. Every single time in history, when the markets have gone on extended runs, they have NEVER, not once, lasted as long as the current artificially fueled advance. What do you think is likely to happen next? (Lance Roberts)

 

FEELING GROOVY!

Note Slow down, you move too fast.
You got to make the morning last. Note

The media and most talking heads have abandoned their negative bias, struggling to explain any which way they can the mysteries of rising equity markets reaching new milestones just about every day.

Even though most recent economic stats are worse than expected and point to further economic weakness, there seems to be a constant positive spin to make them acceptable to the investing crowd. If markets keep rising on so-so news, it probably means that the news is not that so-so after all.

The latest case is U.S. consumer sentiment, one of the most useless data.

US consumer sentiment nears six-year high

US consumer sentiment rebounded at the start of May to the highest level in almost six years as more Americans, led by those on the highest incomes, felt better about their economic situation.

The Thomson Reuters/University of Michigan’s preliminary reading on the overall index on consumer sentiment rose to 83.7 from 76.4 in April – the highest level since July 2007. Economists surveyed by Bloomberg had expected a level of 78.

Why the economists surveyed missed so badly on that particular data is itself a surprise since they obviously belong to the “highest incomes” segment. Introspection is likely not their forte.

“ Consumer confidence rose to a fresh post-crisis high in May, with sharply higher home, auto, and durable goods purchase expectations likely to have positive implications for the expected economic growth rebound later this year,” said Gennadiy Goldberg, US strategist at TD Securities.

Never mind that consumer sentiment indices have demonstrated little, if any, predictive qualities (see Doug Short’s chart).

Click to View

Never mind also that these surveys have no bearing on the actual, objective reality of the average American as these charts reveal:

Median-Income-051713

Social-Benefits-DPI-051713

Food-Stamps-Yearly

Obviously, the average Joe and Jane were too busy to answer the U. of M. survey. They seem to have taken the Conference Board call however as this one shows confidence still way below average historical grooviness levels.

Click to View

Small biz people, the main job creators in the U.S. also missed the U. of M. call:

Click to View

So, before you jump to place a buy order on the basis of better consumer sentiment, think of this following ISI chart:

image

Nothing makes SUV owners happier than low gas prices.

Happiness is in the little things!

Note Hello lamp-post, what’s cha knowing, I’ve come to watch your flowers growin’
Ain’t cha got no rhymes for me, do-it-do-do, feelin’ groovy
Feeling groovy Note

There are better explanations for the momentum in equity markets. Two sharp minds interviewed by Barron’s:

Steve Einhorn: The Fed’s policy has protected the equity market from bad economic and earnings news. Bad economic news encourages investors to think that QE will last longer; good economic news is good because it underpins better earnings growth but also because near-term economic strength is not deemed sufficient to deter the Fed. So, bad news is good news for stocks, and good news is good news for stocks. This, along with the lack of return in fixed income, is a reason to think the bull market can persist after a period of consolidation. So the market’s downside risk is limited.

Leon Cooperman: Everyone is in the process of moving up the risk curve. We have an investor who put all of his money in T-bills when he retired, because he didn’t want duration risk or credit risk. So for the guy who bought T-bills, he can’t get any return anymore, so he migrated to T-bonds. The guy who bought T-bonds has migrated into industrial credits. The buyers of industrial credits have migrated into high yield. The high-yield buyers have migrated into structured credit, where we are now in our credit exposure at Omega, and the structured-credit people are increasingly looking at equities. So everybody is moving up the risk curve.

That helps equities, no doubt?

Einhorn: There is no effective alternative to common stocks and people are getting fatigued sitting on cash earning zero and bonds, which have such unattractive returns.

Buying the least unattractive asset. Hmmm…

Einhorn: So, for a whole host of reasons, I would expect the market to enter a prolonged consolidation, at around current levels. The basis for that consolidation is, first, the market is up 12% in the first four months of this year. That’s 3% a month. The average monthly gain for the S&P is about seven-tenths of 1%. So, just on the surface, the year-to-date advance has been rather extreme.

Second, if you look at the sectors that have led the market for most of this year, they are defensive: health care, utilities, telecom, and consumer staples. Rarely, if ever, does the U.S. equity market march to new highs on the back of defensive, noncyclical industries. Third, earnings are challenged. Excluding financials, for the S&P 500 in the first quarter, year-over-year earnings growth was about 1% to 2%. Revenue growth was essentially flat. So there is not much earnings growth, and what earnings growth there is isn’t sourced in revenue. It is sourced in cost-cutting, with margins at a record that can only go so far.

Cooperman: He is not saying the bull market is over; he’s saying it’s ahead of schedule.

What schedule? There is no schedule. Just the reality that Bernanke and the world central banks have succeeded: the liquidity flood with interest rates through the floor without any apparent inflationary effect are pushing investors into risk assets, bringing stock valuations near fair value even though earnings have flattened out due to pretty sluggish top line growth. Slow and slower is bullish, for now.