NEW$ & VIEW$ (19 NOVEMBER 2013)

EU Car Sales Maintain Growth

New car registrations in the European Union rose in October from a year earlier, the latest in a series of indications that Europe’s long auto-sales slump may be moderating.

The data, released Tuesday, marked the first time year-to-year demand for new cars has risen for two consecutive months since September 2011.

High five  But underscoring the still-daunting challenges faced by European auto makers, the October figures were lower than registrations a month earlier, and represented the second-lowest number of vehicles registered during October since 2003. During the first 10 months of the year, EU new car registrations fell 3.1% from the year-earlier period.

October new car registrations, a proxy for sales, rose 4.7% from a year earlier to 1.00 million vehicles, compared with 5.4% growth to 1.16 million in September.

Demand was supported by all major European markets, with registrations up 2.3% in Germany, 2.6% in France, 4.0% in the U.K. and 34% in Spain. The exception was Italy, where registrations fell 5.6% from a year earlier. (…)

Punch  The WSJ article failed to mention that Spain had its fourth cash-for-clunkers program last month.

Home Builders’ Confidence Eases a Bit

The National Association of Home Builders, an industry trade group, said Monday its monthly housing-market index stood at 54 in November, matching a downwardly revised figure for October. The figure measures builder confidence in the market for newly built, single-family homes.

Readings above 50 indicate that more builders view conditions as good than poor, and the index crossed that threshold in June for the first time since April 2006. At the height of the building bubble, readings were in the high 60s and low 70s. (…)

The figure hit 58 in August and has been falling since. (…) In recent weeks, mortgage rates have started to rise, with the average rate for a 30-year fixed-rate mortgage at 4.35% as of Nov. 14, according to Freddie Mac. That is the highest rate in eight weeks, though rates remain near historic lows. (…) (Charts from CalculatedRisk and Bespoke Investment)




(…) With shoppers expected to visit fewer stores this holiday, sales are projected to advance 2.4 percent, the smallest increase since the year the recession ended, according to ShopperTrak, a Chicago-based researcher. Sales from Black Friday through Cyber Monday are projected to rise 2.2 percent year-over-year, researcher IBISWorld said yesterday. (…)

“The consumer is more deal-driven than ever,” Ken Perkins, president of researcher Retail Metrics LLC, wrote in a Nov. 14 note. “Discretionary dollars for holiday spending are limited for the large pool of lower- and moderate-income consumers due to lack of wage gains this year coupled with the increased payroll tax.” (…)

The six-fewer shopping days this year also could make the chains “push the promotional ‘panic button’ earlier than needed, putting their margins at risk,” they said. (…)

The National Retail Federation, a Washington-based trade group, is more upbeat than ShopperTrak. It has forecast that U.S. retail sales may increase 3.9 percent during the holiday season. That increase would be slightly higher than last year’s 3.5 percent gain. (…)

  • Best Buy warns promotions could hurt holiday quarter margins
  • Amazon’s Toys Cheaper Than Wal-Mart Online
  • Inc. (AMZN)’s toy prices were lower than those available online from Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT) last week as retailers seek to attract shoppers heading into the crucial holiday selling season.

    Amazon’s prices, excluding those from its third-party sellers, were 3 percent lower on average than Wal-Mart’s on a basket of 87 toys, according to a study conducted by Bloomberg Industries on Nov. 14. Including the Marketplace vendors, which use Amazon’s platform to sell their own products, the pool of comparable goods expanded to 115, and Wal-Mart was cheaper by 1.2 percent, on average.

    The pricing battle may help determine which retailers win consumers’ toy purchases during the holiday season. Sales in November and December account for 20 percent to 40 percent of U.S. retailers’ annual revenue, according to the National Retail Federation. (…)

    Wal-Mart’s prices were 2.4 percent lower than at Target, 5 percent less than Sears Holdings Corp. (SHLD)’s Kmart and 7.2 percent lower than Toys “R” Us Inc., according to the study.

  • Chain store sales rose 0.1% last week and the 4-week m.a. is up 2.3% YoY.


Worldwide business confidence lifts from post-crisis low

The 13th Markit global survey of business expectations for the year ahead, covering 11,000 companies, indicated that firms have become more upbeat about their business prospects since the post-crisis low seen mid-year, resulting in higher expectations about employment and investment. However, optimism remains well below the highs seen earlier in the recovery, indicating that global economic growth is likely to remain subdued in the coming year.

The number of companies expecting their business activity levels to rise in the next 12 months outnumbered those anticipating a decline by +33%, up from +30% in June but below the +39% reading seen in February.


Improving prospects for the developed world contrasted with still-low levels of confidence about the year ahead in the emerging markets.
Among the developed world, the upturn in confidence was led by the UK, where the outlook is the brightest seen since the survey began in early-2009. Optimism also improved in the eurozone, hitting its highest since mid-2011, notably improving in the ‘periphery’, with Spain and Italy reporting a higher degree of optimism than Germany and France, the latter seeing the weakest positive sentiment.

In the United States, business confidence about the year ahead was the second–lowest seen since the financial crisis, up only slightly on the low seen in June but above the global average. Optimism edged up slightly in both manufacturing and services but remained subdued. Companies again fretted about the impact of the ongoing uncertainty surrounding the government budget.

Worries about the outlook meant employment intentions were only marginally higher than the survey low seen in June, though capex plans recovered to a slightly greater extent.

In Japan, optimism remained weak, and slipped compared to mid-year, suggesting companies are unconvinced that the recent growth spurt is turning into a sustainable and robust upturn, in many cases harbouring concerns about growth prospects in other Asian countries, especially China. However, price pressures are set to improve, with input costs and output charges both rising at slightly faster rates.

Prospects among the four largest emerging markets remained unchanged on the post-crisis low seen in the mid-year survey. Both India and Russia saw optimism slide, while China’s outlook failed to improve on the low seen in the summer. Only Brazil saw business sentiment improve, reaching a new post-crisis high, buoyed by optimism about the positive impact of the soccer World Cup and Olympics.


High five  Corporate Results Expose Lack of Confidence

Investors sifting through third-quarter financial results should be a bit nervous about the future growth of the U.S. economy.

Though corporate profits were higher overall, companies slashed their spending on factories, equipment and other performance-enhancing investments by 16% from year-earlier levels, according to an analysis by REL Consultancy for The Wall Street Journal.

Instead of putting money to work in their operations, companies gave more of it back to shareholders in the form of buybacks and dividends.

Weakness in emerging markets and strong currency headwinds also were common themes in the quarterly results. (…)

Almost 90% of the companies that have given financial forecasts for the final quarter of the year have prompted Wall Street analysts to lower their numbers. Only a dozen companies have painted rosier pictures, according to data tracker FactSet.

“Companies are reluctant to raise the bar,” said John Butters, senior earnings analyst at FactSet. “We’re not really seeing a huge increase in companies turning negative, but the number of companies giving positive guidance is almost half of what we’ve seen lately.”

A broad range of companies scaled back capital spending plans during the quarter, including Honeywell Inc., Corning Inc., Yahoo Inc., Cliffs Natural Resources Inc. and McDonald’s Corp. (…)

To be sure, earnings continued to be strong in the third quarter. With more than 90% of companies in the S&P 500 index having posted results for the quarter, blended earnings were up 3.5% from a year earlier, and profit remained in record territory, according to FactSet. (…)

Profit margins, at 9.6%, were near records, thanks to cost cutting, automation and lower commodity prices. But revenue growth was a tepid 2.9% from a year earlier. (…)

The lack of confidence is part of the reason why U.S. companies were on pace to have more than $1.144 trillion in cash at the end of the quarter, making it the fourth quarterly record in a row, according to S&P Dow Jones Indices. (…)

Corporate buybacks totaled $103 billion in the quarter, an increase of 12% from the second quarter, excluding Apple’s record $16 billion buyback in the spring, according to FactSet. (…)

Companies also announced a combined 2.5% increase in dividend payments, which now total almost $75.5 billion for the quarter, according to FactSet. (…)

Another prominent trend in third-quarter results was the harm caused by the dollar’s strength against the currencies of several major U.S. trading partners, including Japan, Brazil and India.

The dollar has climbed between 11% and 20% against the currencies of those three countries, making U.S.-made goods more expensive there. (…)

OECD Warns of U.S. Threat to Global Recovery

The uncertain future of U.S. fiscal and central bank policies poses a growing risk to a global economic recovery that has already been weakened by a slowdown in growth in many developing economies, the Organization for Economic Co-operation and Development said Tuesday.

In its twice-yearly Economic Outlook report, the Paris-based research body said the U.S. debt ceiling should be abolished, and replaced by “a credible long-term budgetary consolidation plan with solid political support.”

The report marks a significant shift in the OECD’s focus of concern, which in recent years has been centered on the euro zone’s attempts to tackle its fiscal and banking crises. While the OECD remains worried about the euro zone’s frailties, the most immediate threats to the global recovery now appear to come from the U.S.

The OECD said a series of events has undermined confidence and stability in recent months, including the “surprisingly strong” reaction by investors to the possibility that the Federal Reserve will soon start to reduce its asset-purchase program. That led to related concerns about developing economies, and was followed by a “potentially catastrophic” crisis precipitated by negotiations over the U.S. debt ceiling.

“These events underline the prominence of negative scenarios and risks that the recovery could again be derailed,” OECD chief economist Pier Carlo Padoan said.

The heightened risks from the U.S. are in addition to continued ones from a fragile euro-zone banking sector and Japan’s fiscal situation, the OECD said.

The warnings came as the OECD forecast only a modest economic recovery through 2015. The combined economies of the 34 members of the OECD will grow 1.2% this year, before accelerating to 2.3% in 2014 and 2.7% in 2015, according to its forecasts.

Growth rates between developed economies will continue to differ markedly with the euro zone contracting 0.4% this year before growing 1% next year, while the U.S. will grow 1.7% and 2.9% over the same periods.

The twice-yearly economic outlook is slightly weaker than in May, mainly because of an expected slowdown in some large developing economies that partly reflects their vulnerability to capital outflows when the Federal Reserve does eventually start to reduce its stimulus program.

“The turmoil following the tapering discussions in mid-year has revealed how sensitive some emerging market economies are to U.S. monetary policy,” the OECD said.

The OECD cut its 2014 growth forecast for Brazil to 2.2% from 3.5% in May, its forecast for India to 4.7% from 6.7%, and its forecast for Indonesia to 5.6% from 6.2%. It cut its growth forecast for China more modestly to 8.2% from 8.4%, still leaving it above that of many other economies.

The research body said the weaker growth outlook for some developing economies was more deeply rooted in “long-standing structural impediments that had been hidden by abundant capital inflows.” Solutions to those problems vary from country to country, but generally developing economies need more formal and efficient labor markets and stronger, market-based financial systems, Mr. Padoan said.

Largely as a result of its more downbeat assessment of the outlook for large developing economies, the OECD cut its forecast for global gross domestic product growth by around 0.5 percentage points this year and next to 2.7% and 3.6%, respectively. (…)

But not to worry:

Mohamed El-Erian
Yellen shows Fed remains risk markets’ best friend

(…) and not by choice but by necessity.

This is music to the ears of investors conditioned to position their portfolios to gain from steadfast central bank liquidity support, especially in the US. But with Wall Street having already reflected this in asset prices, and with the benefits for Main Street continuing to disappoint, investors may well need an increasingly differentiated approach if they are to continue to benefit from the “central bank put”. (…)

Ms Yellen left no doubt that she is committed to maintaining the Fed’s current approach – one that places asset markets front and centre in the transmission mechanism linking Fed actions to policy objectives.

Positioning for the impact of Fed policy rather than fundamentals has been a winning strategy for investors – not only in the immediate aftermath of the 2008 global financial crisis, but also in the past three years during which the Fed has pivoted from normalising markets to pursuing much more ambitious macroeconomic objectives. But they now need to be increasingly mindful of the level of prices and the associated (and growing) number of disconnects that the Fed is underwriting.

This year’s impressive performance of risk assets (including the 21 per cent year-to-date increase in the MSCI world equity index as of Friday, powered in particular by US stocks) contrasts with a global economy still stuck in third gear. (…)

Fed policy fuels wealth-led growth
Still no sign of a real economic recovery

(…) Ms Yellen’s remarks, prepared for her confirmation hearings last week, contained no hint of tapering. That underscores the Fed’s obsessive fear of the negative wealth effect of any slowdown in asset purchases and a move towards higher interest rates. Five years after the meltdown, it is clear the Fed’s quantitative easing is not about a real economic recovery, it is only about generating the liquidity that gives rise to asset inflation and wealth-led growth. Or super wealthy people-led growth since wages and incomes for the rest of us are not rising at all. (…)


Stocks Are Way, Way Overvalued: GMO

As U.S. stocks sit in record territory, money managers at GMO – never a bunch to shy away from bold calls – are warning that the market is significantly overvalued.

As U.S. stocks sit in record territory, money managers at GMO – never a bunch to shy away from bold calls – are warning that the market is significantly overvalued.

In a report titled ”Breaking News! U.S. Equity Market Overvalued!“, Ben Inker, head of the asset allocation group at GMO, comes out with some eye-popping numbers. He argues that the S&P 500′s fair value is 1100, about 40% below Monday’s closing level, and the expected return is -1.3% a year, after inflation, for the next seven years.

Small-cap valuations, he writes, are even more elevated. (…)

Mr. Inker’s call came after comments by billionaire investor Carl Icahn, who told a conference sponsored by Reuters that he was “very cautious” on the stock market and could see a “big drop” because earnings at many companies have been goosed by low borrowing costs rather than strong management. (…)

GMO’s calls are widely watched in part because the firm’s money managers don’t have a reputation for being perma-bulls or perma-bears. Mr. Grantham was early in predicting the financial crisis and then reversed course before markets started rebounding in 2009. He has also advocated investing in timber and high-quality dividend-paying stocks. (…)

Here’s the conclusion to Mr. Inker’s rather downbeat analysis:

“We don’t consider non-U.S. equity markets a screaming buy. But as value managers listening for any assets, anywhere, that are screaming to be bought, the world currently sounds a deathly quiet place. The hoarse whisper of “buy me” coming from European and emerging equities (as well as the polite cough for attention coming from U.S. high quality stocks) comes through loud and clear. “

Hmmm… U.S. equities 40% overvalued and still willing to buy equities. I wouldn’t.

But others are also trumpeting Euro equities:

Europe Stocks Seem Cheap

As U.S. stocks push to record highs, more U.S. money managers are looking for better opportunities across the pond.

The big rally in U.S. stocks has pushed valuations higher than those of European shares. Meanwhile, sentiment is rising that Europe has gotten past the worst of its debt crisis, and some say the European Central Bank appears to be on a path for more easing of monetary policy, both of which augur for more room to run in European stocks.

Unlike the S&P 500, which is well into record territory, the Stoxx Europe 600 stock index hasn’t recovered to its precrisis peak. The S&P 500 has risen 26% this year while the Stoxx Europe 600 is up 16%.

Aren’t you convinced by this great analysis?

What about these mundane facts?

  • U.S. P/Es have exceeded Euro P/Es by an average of 10% over the last 25 years. In fact, the U.S. premium is at its low point of the past 14 years.
  • US trailing EPS are some 20% above their 2007 peak, whilst in Europe they are some 25% below.
  • U.S. profit margins are higher than Euro margins.
  • The U.S. economy keeps growing faster than that of the Eurozone.
  • U.S. inflation is higher than that of the Eurozone.
  • The U.S. government is more efficient than that of the Eurozone, which speaks volume about the latter.
  • The Fed is also more efficient than the ECB.


These reasons amply justify higher multiples for American companies.

This is not to deny the possibility that Eurozone profits could rise faster than U.S. profits in the next few years. In fact, this is a key argument for many strategists. The hurdles are significant, however. Slow domestic growth, a strong euro, low inflation and very liberal labour laws are big impediments to profit margins. Don’t simply extrapolate America’s margin expansion. Expectations for rising margins in Europe have remained elusive so far.

image image

A case in point: the following is especially true in Europe:

Just kidding  Business taxes fall more heavily on labor.

Companies around the world are paying more in employment taxes than in profit taxes, the FT reports. Labor taxes accounted for 32% of the average total tax rate paid by midsize businesses in 2004, but now account for almost 38% of the rate, compared with slightly more than 37% for profit taxes. Mary Monfries, tax partner of PwC, said the shift is a world-wide trend, “with governments lowering profit taxes to encourage investment and entrepreneurship. Getting the right tax mix is a hard call. Lower profit taxes can drive growth which brings employment, whilst lower employment taxes can ease the cost of hiring.”

Fed Official Says Big Banks Need Higher Capital Levels Very large banks that rely on broker-dealer operations need to hold higher levels of capital to reduce the risk to the broader financial system, Federal Reserve Bank of Boston President Eric Rosengren said.

European banks are also in a worse situation.

Now you know the essentials. All the best.  Winking smile


NEW$ & VIEW$ (18 NOVEMBER 2013)

OECD Economic Growth Stalls

(…) The Organization for Economic Cooperation and Development Monday said the combined gross domestic product of its 34 developing-country members rose by 0.5% from the second quarter, the same rate of expansion recorded in the three months through June. (…)

The OECD will release new forecasts for economic growth in its 34 members and a number of large developing economies Tuesday. The International Monetary Fund last month cut its growth forecast for the world economy in 2013 to 2.9% from 3.2%, but expects output to rise 3.6% in 2014. (…)

OECD leading indicators released last week suggested growth is set to pick up in the euro zone, China and the U.K. in coming months, while remaining sluggish in India, Brazil and Russia.

Among the Group of Seven largest developed economies, the U.K. recorded the strongest growth in the third quarter, with an expansion of 0.8%, while France and Italy saw their economies contract by 0.1% each.

Euro zone rebound weaker than hoped: ECB’s Nowotny

The economic situation in the euro zone has started to improve but is still weaker than the European Central Bank had hoped, ECB Governing Council member Ewald Nowotny said on Monday. (…)

But “one has to say that this improvement is not as strong as we would have expected it perhaps some time ago, and at the same time inflation rates are clearly below the price stability level that we set at the ECB.” (…)

Spain’s bad loans ratio rises to 12.7 percent in Sept

Spanish banks’ bad loans as a percentage of total lending rose to 12.7 percent in September from 12.1 percent in August, marking a new high, Bank of Spain data showed on Monday.

The ratio has been steadily climbing as households and small companies struggle with debts and as banks, fighting to improve their own capital quality ahead of new stress tests, rein in lending. (…)

Bad debts rose by 6.9 billion euros ($9.3 billion) to 187.8 billion euros in September, while total credit fell by 8.9 billion euros to 1.5 trillion euros, the data showed.

Italian Tax Model Thwarts Recovery

(…) Italy’s tax model stands out in Europe for relying heavily on payroll taxes, which are paid by companies and employees, to fund the country’s state pension system. Payouts for old-age pensions alone are nearly 13% of GDP—a rate that is a third higher than in Germany and twice the U.S. percentage, according to the OECD.

(…)  “The absurdity is that an Italian worker costs more than a Spanish worker, but has a lower income,” said Riccardo Illy, owner of the eponymous coffee brand.

Economists say that the high mandatory contributions—33% of Italian salaries, compared with 13% in the U.S.—are particularly painful for younger workers in lower-income, entry-level jobs. (…)

Other European countries with even bigger welfare states have started to tackle the problem, at least in part. Germany puts more of the onus for pension contributions on the workers’ tab, which crimps income but not jobs.

French President François Hollande last year pushed through measures to reduce the country’s notoriously high labor costs, which help fund a broader array of social services. But he opted for tax breaks instead of direct payroll-tax cuts.

(…) the task facing Italy is daunting. Paolo Manasse, an economist at the University of Bologna, estimates that Italy would need to cut a further €30 billion in employment taxes to bring it in line with average employment taxes among OECD members.

Once pensions and interest on government debt are stripped out, Italy spends only 32% of gross domestic product on core services compared with 43% for Germany, meaning there is less budgetary fat to trim in other areas.

Some countries, such as Denmark, which has one of Europe’s highest overall tax rates, fund a bigger welfare state than Rome provides with a broader array of taxes covering income, investments and wealth.

Thus, Danish companies pay only a 10th of what their Italian peers do for social-security programs. Denmark’s total employment rate—the percentage of the working-age population with jobs—is 75% compared with Italy’s 61%. (…)

However, given the fragile nature of his two-party coalition, the prime minister has so far avoided bigger tax overhauls. He has criticized generational inequities in Italy but has been reluctant to trim current pension benefits.

Since future pensions in Italy will eventually be tied to actual contributions over a lifetime of working, the dearth of new jobs due to hefty payroll levies will have repercussions well into the future.

Younger generations are “at risk of being excluded from both work and, as a result, a main form of welfare,” said Marco Maniscalco, a partner at the Bonelli Erede Pappalardo law firm in Milan. (…)

Riskier loans hit record levels
‘Cov-lite’ proportion within CLOs surges in US markets

The amount of riskier loans offering fewer protections to lenders contained in packages of debt sold to investors have hit record levels, amid resurgent lending markets and a continued thirst for higher returns.

Managers of collateralised loan obligations, which buy up corporate loans then package and slice them into different pieces, have increased the proportion of riskier loans that their investment vehicles are allowed to buy to the highest levels on record. (…)

Already, 55 per cent of new leveraged loans come in “cov-lite” form, eclipsing the 29 per cent reached at the height of the leveraged buyout boom just before the financial crisis.

“The increased prevalence of cov-lite in the primary market has quickly translated into a similar market-wide increase,” Brad Rogoff, head of US credit strategy at Barclays, said in a recent note. (…)

While the majority of CLOs sold last year had a 40 per cent limit on the amount of cov-lite loans that could be bought by the vehicles, a 50 per cent cap has become the industry standard in 2013, according to data from S&P Capital IQ.

At least three deals have come to market this year with a 70 per cent limit.

In 2011 – the earliest data available from S&P – about 67 per cent of new CLOs came with a 30-40 per cent limit on the amount of cov-lite loans that were allowed to be placed into the deals. Limits of 70 per cent were completely unheard of. (…)

In addition to officially increasing the percentage of cov-lite loans allowed into their deals, some CLO managers have also been easing their definition of cov-lite in deal documentation, thereby allowing more of the loans into their products. (…)

Thai growth slips in third quarter Growth falls to 2.7% as investment and consumption dip

Thailand Cuts Economic Growth Forecast as Exports Falter

Gross domestic product rose 1.3 percent in the three months through September from the previous quarter, the National Economic & Social Development Board said in Bangkok today. It revised a contraction in the second quarter to no growth from the previous three months.

The state agency cut its full-year expansion forecast to 3 percent from a range of 3.8 percent to 4.3 percent projected in August, and said the economy may grow 4 percent to 5 percent in 2014. It said it expected no export growth this year, from an earlier estimate of 5 percent.

Household consumption fell 1.2 percent last quarter from a year earlier, the NESDB said. Public investment slumped 16.2 percent from a year ago as both government construction and investment in machinery and equipment declined, it said.


Thomson Reuters:

Third quarter earnings are expected to grow 5.6% over Q3 2012. Excluding JPM, the earnings growth estimate is 8.3%.

Of the 463 companies in the S&P 500 that have reported earnings to date for Q3 2013, 68% have reported earnings above analyst expectations. This is higher than the long-term average of 63% and is above the average over the past four quarters of 66%.

54% of companies have reported Q3 2013 revenue above analyst expectations. This is lower than the long-term average of 61% and higher than the average over the past four quarters of 51%.

For Q4 2013, there have been 83 negative EPS preannouncements issued by S&P 500 corporations compared to 9 positive EPS preannouncements. By dividing 83 by 9, one arrives at an N/P ratio of 9.2 for the S&P 500 Index. If it persists, this will be the most negative guidance sentiment on record.


At this stage of Q3 2013 earnings season, 94 companies in the index have issued EPS guidance for the fourth quarter. Of these 94 companies, 82 have issued negative EPS guidance and 12 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the fourth quarter is 87%. This percentage is well above the 5-year average of 63%.

Since the start of the fourth quarter, analysts have reduced earnings growth expectations for Q4 2013 (to 6.9% from 9.6%). However, they still expect a significant improvement in earnings growth in the fourth quarter of 2013 relative to recent quarters.


Up and Down Wall Street  Flacks Are People, Too


Spare, if you will, a moment of pity for the PR people. That may sound surprising coming from these quarters, given journos’ near-universal disdain for public-relations folks, many of whom see their function as obstructing or obfuscating on behalf of their bosses. But after the terrible, horrible, no-good, very bad week the spinmeisters had, even we stone-hearted, ink-stained wretches must have some sympathy.

Consider the PR genius at JPMorgan Chase (ticker: JPM) who came up with the idea of a Twitter (TWTR) Q&A with the bank’s vice chairman, Jimmy Lee, a week after it helped underwrite Twitter’s much-ballyhooed initial public offering. The idea presumably was to connect with the younger, social media-hip crowd. But instead of seeking career advice from the legendary deal-maker, the exchanges at #AskJPM quickly became an outlet for the public’s ire about banks and JPM in particular.

Starting with mock questions about whales, an allusion to the infamous London Whale trading fiasco, the queries became more acerbic about the alleged misdeeds by the nation’s largest bank by assets. It descended into what one wag dubbed “snarkalypse,” but not before he tweeted: “I have Mortgage Fraud, Market Manipulation, Credit Card Abuse, Libor Rigging and Predatory Lending. AM I DIVERSIFIED?” Not surprisingly, JPM cut short the “conversation,” but nobody was sacked over what a spokesman e-mailed the New York Times’ Dealbook blog as “#Badidea!”

Peggy Noonan:

(…) More and more it seems obvious that the vast majority of the politicians who pushed the [ObamaCare] bill in the House and Senate never read it. They didn’t know what was in it. They had no idea. They don’t understand insurance—they’re in politics, a branch of showbiz. (…)


NEW$ & VIEW$ (19 JULY 2013)

Conference Board Leading Economic Index: Unchanged in June

The Conference Board LEI for the U.S. was unchanged in June. The improving indicators were yield spread, the Leading Credit Index™ (inverted), initial claims for unemployment insurance (inverted) and consumer expectations for business conditions. Negative contributions came from building permits, ISM® new orders and declining stock prices.

Click to View


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Philly Fed Survey: Manufacturing Conditions Improved


The latest gauge of General Activity rose to 19.8 from the previous month’s 12.5. The 3-month moving average came in at 5.0, up from 2.9 last month. Today’s headline number is the highest since March 2011, and the 3-month MA trend is well above its interim low set in July of last year.


The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, increased from 12.5 in June to 19.8, its highest reading since March 2011. The percentage firms reporting increased activity this month (37 percent) was greater than the percentage reporting decreased activity (17 percent).


Other current indicators suggest continued growth this month. The shipments index increased notably, from 4.1 in June to 14.3. The demand for manufactured goods as measured by the current new orders index
remained positive, although it fell back 6 points to 10.2. Firms reported a drawdown of inventories this month: The inventory index fell 15 points, from -6.6 to -21.6.image

Labor market conditions showed a notable improvement this month. The current employment index, at 7.7, registered its first positive reading in four months. The percentage of firms reporting increases in employment
(18 percent) exceeded the percentage reporting decreases (10 percent). Firms also indicated an increase in the average workweek compared with June.



Baring teeth smile  Bernanke: Recent Tightening Unwelcome

During his testimony Wednesday before a House panel, Mr. Bernanke stressed that the Fed would be watching for any adverse impact to the housing market from recent rate moves. He said the Fed would act if necessary to ensure the housing recovery doesn’t falter. (…)

Mr. Bernanke said Thursday that at least part of the interest-rate spike in recent weeks happened because investors misinterpreted what he was trying to say at that news conference.

“We’ve not changed policy. We are not talking about tightening monetary policy,” Mr. Bernanke said, repeating the message he delivered repeatedly throughout the two days of testimony before Congress as well as at an economics conference last week.

(…)  “I want to emphasize that none of that implies that monetary policy will be tighter at any time in the foreseeable future,” he said.

Mr. Bernanke also cautioned that “it’s way too early to make any judgment” about exactly when the first reduction to the bond program will happen. He demurred when asked about market speculation that the first reduction will happen at the Fed’s Sept. 17-18 policy meeting, saying it will depend on economic data.

Pointing up There hasn’t been enough data since the June policy meeting to make such a determination, and the data that has come in has been “mixed,” he said. (…)

He’s getting clearer: they just don’t know what’s going to happen. Another truth: Bernanke: Nobody Really Understands Gold Prices

Fed Surveys Highlight Job Risk in Healthcare Reform  Surveys released this week by two regional Federal Reserve banks highlight how the Affordable Care Act may have the unintended consequence of keeping the labor market’s share of part-time workers historically high.

In New York state, 7.6% plan to fire or refrain from hiring in order to stay under the mandate, and 6.5% plan to shift from full time to part-time workers.

In Philly the answers are 5.6% and 8.3%, respectively. Many also planned to outsource work. (…)

During the 2000s expansion, the percentage of workers who had part-time jobs because of economic reasons hovered around 3%. Then in the last recession, the share jumped to 6.6%. It has come down, but stood at a historically high 5.7% in June. If the two Fed surveys prove correct, the percentage will remain elevated.

These surveys were done with manufacturers. Retailers, restaurants and other service providers are the most likely to change their hiring practices.

Electrolux Sees Higher U.S. Demand

Electrolux said the worst of Europe’s recent economic doldrums may finally be in the rearview mirror, potentially allowing the Swedish company to lessen its reliance on American appliance buyers.

Electrolux, the world’s No. 2 maker of home appliances after Whirlpool Corp. of the U.S., said its operations in Europe continued to suffer in the second quarter with demand remaining weak, albeit slightly higher than a year earlier. But while the company expects overall market demand in Europe to decline by 1% to 2% for the full year, it says it sees some signs of a turnaround.

“There are some signs that we are at or near the bottom,” Chief Executive Keith McLoughlin said, adding that market conditions are improving in most of Northern Europe, but that the market remains weak in Spain, France and Italy.

In North America, where the company makes nearly a third of its sales, Electrolux maintained strong sales and earnings growth, supported by a recovering housing market, which it expects to continue throughout the year. It raised its guidance for North American demand for appliances in 2013 to 5%-7% from 3%-5% previously. The company’s North American operating margin reached a record level of 7.8%.


US crude oil rallies to 16-month high
WTI discount to Brent narrows to near three-year low




First Reading on EPS and Revenue Beat Rates

Roughly 150 companies have reported earnings since the second quarter reporting period began on July 8th.  While this is less than a tenth of the total amount of companies set to report throughout earnings season, it’s enough to get an initial reading on the percentage of companies beating earnings and revenue estimates.

As shown in the first chart below, 69% of companies have beaten earnings estimates so far this season. It’s still very early, but compared to the final quarterly readings over the past few years, the earnings beat rate has gotten off to a great start.  The revenue beat rate, on the other hand, has been below average at just 50%.  Top line numbers have struggled in three of the last four quarters, and it’s looking like the same could be in store this quarter as well.

Morning MoneyBeat: What’s That You Said About a Strong Earnings Season? Almost a fifth of companies in the Standard & Poor’s 500-stock index have reported earnings for the second quarter, and things are already looking grim.

Earnings for S&P 500 companies are on track to grow 1.5% from the previous year. That isn’t exactly screaming growth—and is solidly below the 4.1% of growth analysts expected at the beginning of the quarter—but it’s not a decline, either. Of the 82 companies that have reported so far, 74% have beaten analyst estimates for their earnings. Sales are on track to grow a relatively meager 0.9% this quarter, but that marks a sequential improvement from their 0.1% first-quarter decline.

High five  But the results look different when you leave out bank stocks. You know, the group with the exceptionally easy comparisons from last year? When financial shares are excluded, S&P 500 companies would actually see earnings shrink 2.7% from last year, according to FactSet. That’s worse than Wall Street expected at the beginning of the quarter, when analysts were aiming for a decline of 2.3% in earnings without financial stocks.

Sales are on track to grow just 0.1% if banks are excluded, according to FactSet. Any growth still seems like a good thing, right? But there’s one big asterisk on that growth. Kinder Morgan Inc. alone has contributed that much to sales expectations in the S&P 500, after a quarter in which its revenue grew 56% from the previous year.

Even when banks and Kinder Morgan are included, the top line still looks shaky. Companies are missing analyst estimates for their sales figures, with just 48% of firms beating expectations for the second quarter.

Pointing up  The pain probably isn’t over yet, either. A flurry of companies have announced that their second-quarter profit would be lower than expected. United Parcel Service said last week that its earnings would be worse than expected. Other companies that have recently warned about lower-than-expected profits include E.I. DuPont de Nemours & Co., Ingredion Inc., Valero Energy Corp., and Nabors Industries Ltd.

As of last Friday, 97 companies in the S&P 500 had projected that their second-quarter earnings will be lower than Wall Street’s forecasts, compared to 16 that had said their results would be better than expected, according to Thomson Reuters.

That is the highest rate of lower-than-expected guidance since the first quarter of 2001–making it pretty tough to be optimistic on earnings.

Meanwhile, the crowd is moving back in…

Wall of money shifts into US equity funds
Weekly inflows at highest since June 2008

Some $19.7bn was invested in global equity funds in the past week, the most for six months, while $700m was pulled from bond funds, according to Bank of America Merrill Lynch citing EPFR figures. The amount put in US equity funds was the most since June 2008, the bank said.

China, U.S. companies’ great hope, now a drag

It’s official. China’s slowdown is starting to hurt corporate America.

The slowing has occurred as major U.S. names garner more revenue from Asia. Among 18 S&P companies with large exposure to China, 12 of them were underperforming the broader S&P 500 .INX index year-to-date, including Yum Brands Inc and Intel, which noted the slower growth in China as a headwind.

“The China impact is becoming more and more significant because the (U.S.) companies’ exposure has grown so much over the years,” said Robbert van Batenburg, director of market strategy at Newedge in New York.

G-20 Poised to Back Global Tax Overhaul

The G-20 is set to back a major reform of international taxation designed to eliminate loopholes that enable many companies to keep their tax bills low.

The 15-point action plan has been developed by the Organization for Economic Cooperation and Development, and is being discussed by finance ministers from the G-20. They are likely to endorse the plan in a communiqué to be issued at the end of their two-day meeting Saturday.

The action plan aims to plug the gaps created by a complex web of bilateral tax treaties that has expanded since the 1920s, and which now allow for “aggressive” tax planning, where companies adopt legal structures designed to shift their profits to the lowest tax jurisdictions, regardless of where those profits are earned.

More fundamentally, it seeks to modernize the international tax system to match the increasingly globalized operations of companies, and move away from a system in which tax administrations are largely focused on what happens within their national borders.

The plan aims to do that by updating rules on how services and goods transferred between units of a company located in different countries are priced to reflect the fact that many are now “intangible,” and take the form of licenses and the use of branding.

The action plan also includes steps to widen legislation that allows governments to tax profits that have been shifted to low-tax jurisdictions, eliminate opportunities for avoiding tax through the use of complex financing structures, and the use of contracts to avoid having a taxable presence in a country in which a company operates. (…)

Clock  Tax experts warned that the OECD’s action plan will be difficult to implement, and may not have the full support of all G-20 members.

“Notwithstanding the fact that the G-20 leaders are far from united on how to proceed, any global reforms will have to be brought in through changes between countries on a bilateral basis…and also amend existing domestic laws,” said Sandy Bhogal, head of tax at international law firm Mayer Brown “This process will take a considerable amount of time, even with the cooperation of all the relevant parties.”

The drive is on and we should all keep in mind that corporate profits, at least as measured by the S&P 500, are currently taxed at low rates which may not prevail a few years hence.


NEW$ & VIEW$ (19 JUNE 2013)

Inflation Continues to Undershoot Fed Target  Federal Reserve officials both expect and want inflation to be higher than it is. So far, that isn’t happening.

Consumer price data released Tuesday showed inflation rose a mere 1.4% in May from a year earlier.

But the inflation jury remains out. The seasonally adjusted CPI for all urban consumers rose 0.1% (1.8% annualized rate) in May but the core CPI less food and energy increased 0.2% (2.0% annualized rate) on a seasonally adjusted basis.

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.2% (2.0% annualized rate) in May. The 16% trimmed-mean Consumer Price Index increased 0.1% (1.6% annualized rate) during the month.

Over the last 12 months, the median CPI rose 2.1%, the trimmed-mean CPI rose 1.7%, the CPI rose 1.4%, and the CPI less food and energy rose 1.7%.

Sequentially, core CPI and the median CPI continue to grow at a 2.0% annualized rate. Only the 16% trimmed-mean CPI measure has slowed noticeably during the last 3 months.


Housing Starts Rise 6.8%

Overall housing starts rose 6.8% in May from a month earlier to a seasonally adjusted annual rate of 914,000 units, the Commerce Department said Tuesday. That level was nearly 29% higher from a year ago.

The increase was driven almost entirely by a 24.9% surge in construction of multifamily units, such as apartments, which are benefiting from high demand from many consumers—such as those with weaker credit—opting to rent instead of buy. New starts on single-family homes, meanwhile, rose a slight 0.3%.

Building permits for single-family homes, a measure of future demand, rose by 1.3% last month to the highest level since May 2008.


(Haver Analytics)

I inserted the red circle in Haver’s chart juts to point out that while the media are highlighting the high YoY growth rates, starts are no longer rising sequentially. Permits were pretty good in April and May, however.


Will Home Prices Be Constrained by Stagnant Incomes?

(…) Consider the trends in home prices and incomes since housing’s bottom in 2011. The average new-home price is up about 17%, while per capita income has increased just 2.8% (or about the same pace as inflation). (…)

The constraint will fall harder on adults aged 35 or younger who make up the usual cohort of first-time buyers. They have higher unemployment rates than other adult workers. And many also carry large amounts of student-loan debt.

Bond Investors Head for the Hills

Signs of a stronger U.S. economy are rippling through the bond markets, sending investors and corporate leaders racing to prepare for higher interest rates.

The recent moves show how comments by Federal Reserve Chairman Ben Bernanke and other Fed officials about tapering the central bank’s bond-buying programs already have had a huge impact on the markets. Investors are on tenterhooks hoping for clarity from Mr. Bernanke when he speaks Wednesday at a news conference concluding the two-day meeting of the Federal Open Market Committee. Many investors are looking to his words to determine the scale of further retreats or a rush back into bonds. (…)

If the Fed is clear about its intentions, “we’ll go about the business of this slow but steady recovery,” Mr. Kotok said. “If the Fed fails on Wednesday, you’re in for a shock and more volatility.”

But, will the Fed be right on its economic assessment?


China cash crunch deepens as PBOC stalls
Central bank witholds funding for interbank market

(…) Signalling that the cash crunch could persist for a while, the China Securities Journal, a major state-run newspaper, ran a front-page commentary saying China was at a turning point in monetary policy.

“We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth,” the newspaper said. “This means that authorities must control the pace of money supply growth.”

Stan Druckenmiller On China

Part of a Goldman Sachs interview:

Hugo Scott-Gall: What are the risks of investing in China that are not well understood in your view?

Stan Druckenmiller: The growth in credit at a time when GDP growth is slowing is a problem for China. And I think this is the 2009-11 stimulus coming back to bite. I understand that it had to be done to fund entrepreneurs and the private sector, but it’s easier said than done if you’re channelling funds through local government investment vehicles. I’m a believer in markets. A few men sitting around a table and deciding how to allocate capital goes against everything I’ve ever believed. Not only are they not great at capital allocation, such an exercise also needs to deal with a lack of property rights and corruption.

In essence, the frantic stimulus China put together at the end of 2008 sowed the seeds of slower growth in the future by crowding out more productive investments.

And now, the system’s building enough leverage and misallocation of resources to warrant risks of a financial crisis, but the timing of that is still uncertain in my mind. What we’ve seen in China since 2009 is similar to what happened in the US in 2005, in terms of credit growth outpacing economic growth.

I think ageing demographics is a bigger issue in China than people think. And the problems it creates should be become evident as early as 2016.

Pointing up You also need to keep in mind that for China to grow and evolve further, it will need to compete with a more innovative Korea and now a more competitive Japan. I don’t think China can do that with where its exchange rate is today. I think productivity is a key concern too. And I think that could be one of the reasons why the US has been so supportive of Abenomics.

People mention lack of infrastructure as a constraint. But when I go over there, it looks like they have a lot of infrastructure. It seems ahead of the population, not behind. I see expensive apartments in empty cities that 300 mn rural Chinese are expected to migrate to.  That looks very unbalanced to me. Nobody’s ever had investment to GDP at 47%. Japan and Korea peaked at 36%-38%, so as a result I think capacity is way ahead of demand in some areas in China. (…)

And these via John Mauldin’s Outside the Box. Some excerpts but the whole article is fascinating.

    • The demographic challenge is the greatest of all. Here is a bracing forecast: China’s population in 2100 will shrink to 941 million, but the U.S. population will grow to 478 million. Instead of four Chinese to every American, there will be two. As Beardson notes:
    • Societies with steadily falling populations do not normally have a sustained high rate of economic expansion. As China’s population is estimated to peak around 2026 and then to fall, there is a narrowing window for China to continue its high economic growth rates.

    • (…) the solar industry is only the most pronounced example of broader overcapacity in China. Its rise and fall has followed a pattern that is becoming familiar across the world’s second-biggest economy.

    The problems stem from China’s industrial policies and a vast array of subsidies that allow whole sectors to spring up overnight. Ambitious local officials are keen to lavish government money on what they hope will be success stories that can further their careers.

    “When you have administrative measures you get huge overcapacity and this country has created overcapacity in a whole lot of areas,” says Hank Paulson, former US Treasury secretary, who often visits China. “It’s not just clean technologies; steel, shipbuilding we can name all the areas.”

    From chemicals and cement to earthmovers and flatscreen televisions, Chinese industry is awash with excess capacity that is driving down profits inside and outside the country and threatens to further destabilise China’s already shaky growth.

    • In a recent study, Usha and George Haley, US-based academics, studied how Chinese steel, glass, paper and auto parts producers turned from bit players and net importers to the world’s largest manufacturers and exporters in just a couple of years.

    In each of these highly fragmented, capital-intensive industries, labour accounted for between 2 and 7 per cent of costs and the vast majority of companies enjoyed no economies of scope or scale.

    “Our findings contradict the widespread belief that China’s enormous success as an exporting nation derives primarily from low labour costs and deliberate currency undervaluation,” says Usha Haley. “There is enormous overcapacity and no gauging of supply and demand and we found that subsidies account for about 30 per cent of industrial output. Most of the companies we looked at would probably be bankrupt without subsidies.”

    • Another big problem for almost every industry is that companies’ investment and growth plans have been predicated on the belief that the government would never allow growth to drop below 8 or 9 per cent.
    • Today, as growth slips towards 7.5 per cent and lower, China’s new leaders do appear more determined than their predecessors to tackle overcapacity.
    • “We intend to accelerate the transformation of the economic development model and vigorously adjust and optimise the economic structure,” said Zhang Gaoli, the executive vice-premier in charge of the economy and a member of the all-powerful Standing Committee of the politburo, in a speech this month. “We will strictly ban approvals for new projects in industries experiencing overcapacity and resolutely halt construction of projects that violate regulations.”

      However, Beijing has tried for years to tackle this problem but meets fierce resistance from local governments trying to protect their local “seeds”.

Vietnam to Reduce Corporate Income Tax Rate to Help Businesses

The tax rate will be cut to 22 percent from 25 percent starting Jan. 1, 2014, and to 20 percent from Jan. 1, 2016, said National Assembly Vice Chairwoman Nguyen Thi Kim Ngan. The rate for companies with fewer than 200 employees and total revenue of less than 20 billion dong ($950,887) will be lowered to 20 percent from July 1, 2013 and to 17 percent from Jan. 1, 2016.


Pointing up  Ed Yardini warns:

We are a bit surprised by the strength in forward earnings given the recent weakness in S&P 500 forward revenues. We monitor lots of domestic and global economic indicators that are highly correlated with S&P 500 revenues. The y/y growth rates of almost all of them are in the low single digits and seem to be heading toward zero. For example, US manufacturing and trade sales rose just 1.5% y/y during April.



Margins Calls Can Be Ruinous In Many Ways

Bearish calls based on mean-reverting profit margins may be missing important points.

I generally avoid using forward earnings in valuing equities. I have therefore not spent much time writing about profit margins and whether or not they are about to mean-revert, one of the main points of the equity bear population.

Also, I tend to avoid forecasting future equity levels, preferring to concentrate on evaluating fair market values and monitoring the risk/reward equation along with economic momentum in order to assess whether equities should be favoured or not.

This blog began in early 2009 and rapidly advocated buying equities on the basis of very attractive valuations based on a detailed analysis of P/E ratios over the previous 80 years (S&P 500 P/E Ratio at Troughs: A Detailed Analysis of the Past 80 Years). During the following 4 years, using unbiased economic analysis and the objective Rule of 20 valuation tool, I modulated my general bullishness along with the fluctuations in the risk/reward ratio provided by the Rule of 20’s factual analysis (black line in chart below). Managing risk is what this blog is all about.


In DRIVING BLIND, I recently highlighted the facts that S&P 500 trailing earnings peaked one year ago and that revenue growth has decelerated to +1.3% in Q1’13 with most indicators pointing to more weakness in coming quarters. This suggests that maintaining profit margins will be a real challenge for corporate managers, unlike the past several years when rising revenues combined with sharply decelerating costs boosted margins to all-time highs even though world economies remained pretty sluggish.

(Gavyn Davies in FT)

Wondering what is the downside risk in profits, I recently started to look into profit margins and the reasons for their admittedly elevated level. Among the many straight line forecasters and the several astute and patient mean-reverters, few seem to have done a thorough analysis to support their thesis, other than posting charts like the one above and ridiculing people who say “this time may be different”. I wonder what such people were saying back in 1995. While margins have been pretty volatile lately, the two recent lows never went back near previous lows while new highs were recorded in each of the last 3 cycles. Patience is an essential investment virtue, but there is a limit. As Keynes said, in the long run, we’re all dead.

The relationship with wages is most interesting and obviously revealing of some secular trends. The slow declining long term trend in the share of wages observed since the 1960s clearly accelerated during the last 10 years. The easy explanation is that high unemployment allowed corporate America to squeeze labor as the caption on the chart above suggests.

This may be true of the last 4 years but productivity gains have been accelerating for much longer. The huge advances in technology since 1995 coupled with accelerating globalization have strongly contributed to the more recent productivity gains. Previously, these gains eventually transpired into lower prices, keeping margins pretty constant over time. The fact that profit margins have kept rising since 1995 may have more to do with the changing complexion of the economy than with the evil side of capitalistic corporate America. In fact, Gavyn Davies’ next chart shows that the same phenomenon is observed in all advanced economies.

Raj Yerasi, a money manager, wrote a guest post for Greenbackd to show how rising foreign earnings have helped boost American corporate profit margins. Importantly, he explained how the quirks of the national accounts can distort the reality:

To understand this, it is important to note that current analyses do not directly measure profit margins per se (meaning, profits divided by revenues). Rather, they measure corporate profits as a percentage of GDP, which captures not total revenues but the total value addition of corporations (along with other components). While there are multiple potential data issues in comparing profits to GDP, it nonetheless stands to reason that profits as a percentage of GDP should generally correlate with profit margins.

However, one big source of error is that the most widely known NIPA corporate profits data series, which the analyses referenced above appear to be using, represents profits generated by corporations that are considered US residents. As such, this data series includes profits generated by US companies’ international operations (e.g. Coca-Cola India, Coca-Cola China) and excludes profits generated by foreign companies’ US operations (e.g. Toyota USA). GDP, meanwhile, captures all economic activity within US borders, whether undertaken by US companies or foreign companies, and it excludes any economic activity abroad. It should be clear that one cannot compare these two metrics, since the corporate profits data series introduces profits generated by other economies and excludes profits generated by the US economy.

US companies’ profits from abroad have grown tremendously over the last 10 years, much more so than foreign companies’ profits from US operations:

This skews the calculated profits level upwards and by an increasing amount over time, making profit levels today look exceedingly elevated.

To do the analysis correctly, we need to use data that are more apples-to-apples. Fortunately, the NIPAs do include a data series of corporate profits that simultaneously excludes US companies’ profits from abroad and includes foreign companies´ profits from US operations, called “domestic industries” profits. Comparing these profits to GDP, profit levels still appear elevated but now not as much as when using the prior “national” profits data series:

He then tackles another important factor:

It is also worth noting that effective corporate tax rates are lower today than in the past. Per the NIPA data, tax rates have decreased from about 45 percent in the 80s to 40 percent in the 90s to 30 percent in recent years. Using pre-tax “domestic industries” profits as a percentage of GDP, profit levels today may be closer to 20 percent elevated relative to historical norms. (…)

National accounts are one thing but, in reality, we invest in equity markets. The composition of the S&P 500 Index is different than that of the corporate component of the national accounts. Importantly, the industrial complexion of the Index fluctuates over time. To the extent that certain industries have very different structural operating margins and effective tax rates than other sectors, changes in industry weightings within the index will impact the total.

This chart from the American Petroleum Institute (note the typo, they meant 2012) shows how net margins vary by industry. Pharmaceuticals, tobacco and technology enjoy much fatter margins than most other sectors.


Part of the reason is found in the respective effective tax rates, likely the effect of R&D expensing and foreign earnings:

Bespoke Investment plots historical sector weightings of the S&P 500 Index. The 15% increase in Technology stocks’ share of the Index over the last 20 years, reflective of the huge advances in technology referred to above, no doubt has had an impact on total Index margins. The strong rise in importance enjoyed by Tech and Heath Care companies, combined with the decline in Industrials’ weight, phenomena observed in all advanced economies and supported by normal evolutionary and demographic trends, surely explain much of the secular growth in Index margins.

Another factor for currently elevated margins is historically low interest rates which have substantially reduced financing costs in recent years, boosting margins more so than in previous cycles. Obviously, this will succumb to higher rates later in the cycle.

In brief, arguing that margins are historically high and assuming they will necessarily mean revert appear to be too simplistic analysis, at least until we begin to see a real trend toward tax rates normalization across the world.

I don’t have the resources nor the time to try to thoroughly explain why margins have increased over time. It would be useful if large organisations like GMO and Hussman Funds did and shared thorough research on this non-trivial matter. 

The following charts from CPMS Morningstar plot a proxy for net margins for various market sectors since 1993. Current margins are in effect high and have been rolling over. Note how margins and trends can vary significantly over time. Also, cyclicality varies meaningfully between sectors. Importantly, note the volatility at a high level for the CPMS average during the 1990s.

Forecasting aggregate margins is a perilous activity, especially if done without a good understanding of the root causes for trend changes. Making investment decisions on the basis of such forecasts can be very frustrating.













NEW$ & VIEW$ (1 APRIL 2013)

The U.S.economy: good but not so good. Weakness persists in Eurozone, spreads elsewhere. Earnings watch. Sentiment watch. Investor indebtedness.

Jobless Claims Higher Than Expected

Like most of this (last) week’s economic indicators, initial jobless claims came in higher than expected today.  While economists were looking for claims to come in at 340K, the actual level of claims came in 17K higher at 357K.  This is the highest level since February 15th, and the largest weekly increase since late January.  With this week’s increase, the four-week moving average of claims rose from a post-recession low of 340.8K up to 343K, so there was not a large impact here.


Consumers Step Up Their Spending

Americans saw bigger paychecks and stepped up their spending last month, despite higher taxes and gas prices, boosting the economy’s growth outlook for the first quarter.

Consumer spending rose 0.7% last month, the Commerce Department said Friday. The gain was the largest since September and prompted several economists to revise upward their growth estimates for the first part of 2013.

Macroeconomic Advisers said it now expects 3.5% growth in the first quarter, up three-tenths of a percentage point from earlier estimates.(…)

Personal income also went up last month, by 1.1%. A driver of that was an 11.9% jump in dividend income, which had dropped even more sharply the month before. Dividend payments were roiled when many companies pulled payments forward into 2012 to avoid higher tax rates.

The fact is that the last several months have be pretty messy as personal income data have been whipsawed by Hurricane Sandy, personal tax rate changes and special dividends. The reality is that with all the turbulence and a big dip in the savings rate, real spending has remained stuck at +2.0% Y/Y while real income has meaningfully slowed from +1.5% between July and October 2012 to +0.6% in January and +0.9% in February.

Consumers will not sustain expenditures much above their disposable income growth rate for very long. In fact, the odds are that they will seek to restore their savings rate back to the 3.5-4.0% range.


Let’s not forget that special dividends were one-offs and benefitted the wealthier segments. On the other hand, the tax rate changes are permanent and hit just about everybody. the next 2 months will be crucial if the U.S. is to avoid another spring soft patch.Selected Dividend Trends – 20 Years(Factset)

US growth revised higher
Fourth-quarter figures point to commercial real estate revival

ChartBut the quarter was still dragged down by big falls in defence spending and business inventories, both of which analysts regard as temporary, suggesting that underlying growth continued at a slow but steady 2 per cent.

The big change in the latest revision was a much higher estimate of business investment in buildings. The Bureau of Economic Analysis now estimates that it added 0.46 percentage points to the growth rate instead of a previous estimate of 0.16 percentage points before.


Economic Indicators Ending March on a Down Note

During the first half of March, we saw a remarkable amount of economic indicators beating estimates.  As March comes to an end, however, it looks as if economists have begun to get ahead of themselves. (…)   As shown, there were 15 indicators released this week, and 11 of them came in weaker than expected.  For comparison’s sake, during the weeks of 3/4 to 3/8 and 3/11-3/15, there were 30 indicators released and 24 of them came in better than expected.




The important stuff is that new orders dropped from an average of 59.2 in Jan-Feb to 53.0 in March and that order backlogs fell back to 45.0.

The Richmond and Philly Fed surveys were also uninspiring in March. This week, we get the final PMIs for the U.S. The flash PMI was pretty strong so if the final reading comes in weaker, it would mean that the economy is getting softer as we speak. The sequester’s gotta hit at some point.


Lightning  Record fall in French sales weighs on Eurozone retail sector in March

The downturn in the Eurozone retail sector gathered momentum at the end of the first quarter, Markit’s retail PMI® data for March showed. The rate of decline in sales in the latest period was the fastest since May 2012, and the trend over the first quarter as a whole was the second-weakest since Q1 2009.

Retail PMI data by country signalled steep falls in sales in both France and Italy, and a broadly stable trend in Germany.

In particular, the month-on-month rate of decline in French retail sales accelerated further to a new survey record (data were first collected in January 2004). Italian sales continued to fall sharply, but at a weaker rate than the trend shown over 2012.

image image

Blow for ECB as wider loan rates hit south
Bank measures fail to ease credit conditions in periphery

(…) Since mid-2012, the spread between yields on Spanish and Italian sovereign 10-year debt and the German equivalent has narrowed significantly. Goldman Sachs’ interest rate divergence indicator – measuring cross-border variations in interest rates charged by eurozone banks on a variety of business loans – also dipped initially.

But the indicator has since risen again and reached a record of 3.7 percentage points in January, indicating companies in southern Europe were paying significantly higher interest rates than northern rivals. (…)

France misses 2012 deficit target
Deficit reached 4.8 per cent of GDP

Official figures showed the nominal deficit last year was 4.8 per cent of gross domestic product, overshooting the government’s target of 4.5 per cent. The 2011 deficit was also revised slightly upwards to 5.3 per cent.

The government has already acknowledged it will overshoot this year’s target deficit of 3 per cent previously agreed with the European Commission. With the figure now forecast to hit 3.7 per cent, France is seeking a year’s delay from the commission for reaching the target, the level at which growth in the public debt should stabilise.

Hollande says employers to pay 75% tax rate  Switch is attempt to preserve key election pledge

French President François Hollande has moved to preserve his controversial promise to impose a 75 per cent marginal income tax rate by making companies pay the levy.

The president’s original proposal to impose the tax on individuals earning above €1m was in effect blocked by France’s constitutional council and, last week, by the state council, the government’s legal watchdog. (…)

Speaking in a television interview on Thursday, the president said shareholders would have to be consulted on pay and, where a company paid more than €1m, it would have to pay a levy to meet the 75 per cent rate. The measure would last for two years.


Storm cloud  S. Korean Output Unexpectedly Falls as Growth Forecast Cut

Output fell 0.8 percent last month from January when it fell 1.2 percent, Statistics Korea said today. (…)

The government cut the 2013 growth outlook from 3 percent to 2.3 percent as South Korean exporters including Samsung Electronics Co. and Hyundai Motor Co. grapple with a won that’s risen 17 percent against the yen in the last year.

South Korea Offers Tax Breaks to Revive Flagging Home Sales

South Korea will give tax breaks to home buyers and cut borrowing costs as the government seeks to revive home sales that tumbled to the lowest level since 2006, threatening a rebound in Asia’s fourth-largest economy.

First-time home-buyers with annual income less than 60 million won ($53,900) will be exempted this year from taxes on property purchases worth no more than 10 times their salary, according to a government statement. Multiple-home owners will see rules relaxed on capital-gains taxes. (…)

Transactions fell 14 percent to 47,288 in February, the least for that month in seven years, according to the land ministry. Prices are also sliding, with values in Seoul lower than any time since March 2008. January’s total of 27,070 home transactions was the second-lowest for any month dating back to 2006, when the data was first released, land ministry data show.



Stocks, Commodities Part Ways

imageCommodities have posted their worst first quarter since 2010. The Dow Jones Commodity Index, which tracks commodities ranging from oil to corn, is down 1.1% in the period. The S&P GSCI commodities index, which also follows a variety of commodities but has more exposure to energy prices, has performed slightly better, rising 1.5%.

CHINA BACK IN GEARS? CEBM’s survey suggests that the economy has picked up moderately in late March.

Respondents from the cement and construction machinery sectors reported above-expectations sales data. Some respondents reported that most construction projects had resumed during the last two weeks of March, which has led to improving demand. Most respondents from the cement sector indicated that the current demand recovery is stronger than last year. In addition, sales of construction machinery also exceeded expectations, and utilization hours also improved. Most respondents from the machinery sector believe that the demand recovery was later than previous years due to leadership transitions at central and local governments.

However, demand recovery for steelmakers and machinery tool manufacturers remained relatively weak, as 45% of surveyed steelmakers reported increasing inventory levels of finished goods. Auto sales were also below expectations, and automakers became more cautious as a result.

Storm cloud  Japan’s Business Pessimism Shows Challenges for Kuroda: Economy

The quarterly Tankan for large manufacturers was at minus 8 in March, rising from minus 12 in December, the central bank said in Tokyo today, as companies said they’ll cut investment by the most since the global recession.

Storm cloud  Turkey’s economy slows sharply  Data highlight Turkish government unease with central bank policy

Storm cloud  Russian Fourth-Quarter Growth Probably Fell to 3-Year Low


Q1’13 earnings season is about to begin.

March was a relatively quiet month for guidance from S&P 500 companies, as just eight companies issued quarterly EPS guidance for Q1 2013 and 22 companies issued annual EPS guidance for the current fiscal year during the month.

If 78% is the final percentage, the Q1 2013 quarter will have the highest percentage of companies issuing negative EPS guidance since FactSet began tracking the data in Q1 2006. (Factset)


Pointing up  The only silver lining in the above table is that March was a quiet month for quarterly negative guidance. However, as Factset points out, negative annual guidance has stepped up in recent weeks.

For the current fiscal year overall, 168 companies have issued negative EPS guidance and 77 companies have issued positive EPS guidance. As a result, the overall percentage of companies issuing negative EPS guidance to date for the current fiscal year stands at 69%. This marks the third consecutive month that the percentage of negative EPS guidance has increased, as companies in the index transition to issuing annual guidance for 2013 as the new current fiscal year (instead of 2012).



S&P Milestone Marks Embrace of Stocks

(…) Individual investors, who have spent the better part of the last several years shunning U.S. stocks, are showing signs of returning to the market. So far this year, U.S. stock-focused mutual funds—excluding exchange-traded funds—have taken in $32.6 billion, according to Lipper. Investors had pulled a net $445 billion from domestic stock mutual funds from 2007 through the end of 2012. (…)

“Despite the recent rise in equity markets, we believe an enormous gap exists between the apparent bullish consensus on equities and effective low positioning in equity markets,” Didier Duret, chief investment officer for the private bank of Dutch financial services giant ABN Amro, told clients last week. Mr. Duret increased his exposure to stocks, particularly riskier ones with more growth potential.

I wonder if Mr. Duret reads Doug Short who recently graphed the current level of investor leverage:

The chart below illustrates the mathematics of Credit Balance (the sum of Free Credit Cash Accounts and Credit Balances in Margin Accounts minus Margin Debt) with an overlay of the S&P 500.


And now this:

Betting the House on the Stock Market

Lenders say a growing number of luxury homeowners are turning to a prerecession tactic of withdrawing equity from their homes. And just like during the housing bubble, many of these affluent borrowers aren’t using this cash to renovate their homes. Instead, they’re pumping it into investments, including the stock market, other real-estate purchases or even using the money to purchase art, which they expect will generate large returns going forward. In other cases, they’re choosing to use this cash to pay for their children’s college tuition or other expenses that they’d otherwise finance with higher-interest debt.

Bullish Sentiment Unchanged This Week

The “Not-So-Great Rotation”

(…) Fund flow data has yet to show a large-scale shift away from bonds, even as rates rose in the early part of the year. ICI data shows that the net new investment of $53 billion in bond mutual funds in the first two months of this year slightly exceeds the $52 billion for stock funds. The steady continuing demand for debt held up in January and February despite respective annualized losses of 1.7% and 0.8% for Treasuries and investment grade corporate debt in the Barclays indices. The hangover from the last market crash and the increasing popularity of ETFs has produced a cumulative $467 billion worth of outflows from stock mutual funds in the past five years. During that same period, $1.1 trillion worth of net new investment went into bond funds, as global investors retained a strong premium for US dollar debt.


A subset of the fund flow data that tracks changing asset allocations shows only marginal evidence of an investor shift from bonds to stocks. The total monthly flows sum up the cash going into or out of funds and the net exchanges of one type of fund for another. Year-to-date net exchanges out of bond funds and into other fund classes of $4 billion are nearly mirrored by $5 billion in flows into stock funds from other funds (…)

Rather than siphoning assets from bonds, cash for equities has come in large part from money market funds. Total current retail and institutional money market funds outstanding of $2.4 trillion represents a dramatic fall from its 2009 peak of $3.6 trillion. (…) If investor psychology continues to heal in the wake of two sharp market crashes in the past dozen years, the $11 trillion sitting in money funds and bank deposits is a more likely source than bond holdings for stock investment.


NEW$ & VIEW$ (25 MARCH 2013)

Cyprus, Spain, money flows and other Eurozone woes. Canadian slump. South Korea, Vietnam seek stimulus. Inflation watch. Yield bubble. Sentiment watch.

Cyprus Gets New Bailout

Cyprus secured a bailout from its international creditors early Monday, ending a week of financial panic that threatened to see the small island nation become the first government to leave the euro zone.

The deal lines up €10 billion ($13 billion) in financing for the government and shuts Cyprus’s second-largest bank, Cyprus Popular Bank PCL, imposing steep losses on deposits with more than €100,000, European officials said. The country’s largest bank, Bank of Cyprus PCL, will also be downsized aggressively, with large depositors there taking a hit.

Officials said the level of losses for large depositors may not be clear for several weeks, when experts from the EU and the International Monetary Fund have had time to run their calculations.

But the deal doesn’t include any losses for smaller depositors or depositors in other Cypriot banks, a proposal that derailed an initial attempt to reach a pact last week.

Spain Brings Pain to Investors

The Spanish government will impose heavy losses on investors at nationalized banks and hire external advisers to help it manage these banks’ assets.

The restructuring terms announced by the FROB will impose losses of up to 61% at Spain’s largest nationalized banks. At Bankia SA, the largest of the institutions and the only one that is publicly traded, shareholders will be nearly wiped out and junior bondholders will lose around 30% of their original investment.

The FROB also said it would reduce the value of preferred shares in other ailing banks—Catalunya Banc’s by 61%, Banco Gallego’s by 50% and NGC Banco’s by 43%—and then convert them into ordinary shares.

Nonetheless, imposing losses on investors is one of the politically difficult steps required of Spain in exchange for just over €40 billion in EU aid because most of those who made investments in the troubled lenders were small depositors.

Many of these small savers have taken to the streets to protest their expected losses in recent months, claiming they were misled into believing that that they were buying low-risk savings products, not risky bonds or shares.

Eurozone break-up edges even closer (Wolfgang Münchau)

(…) What happened last week is a fitting example of European political leaders, in a most unprofessional pursuit of narrow national interests, failing to defend the common good.

(…)  the single biggest risk ultimately stems from the eurozone’s repeated policy errors. Their effect is slow but cumulative.

Of those, the most damaging has been the policy of asymmetric adjustment through austerity. Banks in Cyprus are falling now because the Greek state and Greek banks fell earlier, and because the eurozone forced a private-sector involvement. In Italy, it was also austerity that turned a recession into a depression. That, in turn, transformed an anti-euro, anti-establishment protest movement into the single largest political party in the Italian parliament at the last elections. There is a good chance that its leader, Beppe Grillo, could end up with an absolute majority if Italy were to hold another round of elections later this year.

If austerity in the south had at least been compensated by fiscal expansion in the north, the overall fiscal stance of the eurozone would have been macroeconomically neutral. But since the north joined the austerity, the eurozone ended up with a primary fiscal surplus in a recession. In such an environment, economic adjustment simply does not take place. Without that, there can be no solution to the crisis. (…)

JPMorgan On The Inevitability Of Europe-Wide Capital Controls  Excerpts from a ZeroHedge post on a JP Morgan analysis:

(…) The obvious risk is the impact that these capital controls will have on deposits in other peripheral countries. (…) While a modest deposit tax might be acceptable to large depositors, a freeze of deposits for an un identifiable time period would likely be unacceptable to most large depositors such as corporations and institutional investors. (…)

But it is not only bank deposits that are at risk. A broader retrenchment in funding markets is possible given the confusion and inconsistency last weekend’s decision created for investors relative to previous policy decisions:

1) In the case of Cypriot banks, depositors are hit while senior bond holders are spared, so seniority is not respected.

2) Deposits of foreign branches are protected while deposits of domestic branches are hit. This is the opposite of what happened to Iceland.

3) In the case if Ireland which also had a big banking system relative to the size of its economy, only sub debt holders, accounting for a very small portion of total creditors, were hit. No depositors were hit, in either domestic or foreign branches.

4) In the case of SNS sub debt holders were wiped out and reports suggest that the Dutch government came close to imposing losses on senior bond holders and was only prevented from doing so because of unsecured intergroup loans between SNS bank and Reaal insurance that would be subjected to the same losses as senior bond holders.

But beyond the confusion and inconsistency, all these trends and the case of Cyprus in particular, are not only showing bailout fatigue on the part of creditor nations, especially in Netherlands where economic conditions have been deteriorating rapidly, but they are also pointing to a shift towards bailing in private creditors in future sovereign bailouts or bank resolutions to avoid using taxpayers’ money.(…)

In what we view as another ill-conceived and ill-timed move, the Spanish Minister of Finance & Public Administration announced this week a tax or bank levy (probably 0.2%) to be imposed on bank deposits, without details on which deposits will be affected or timing.

This is adding to the Cypriot crisis in sparking deposit outflow risks.

The FT’s Gavyn Davies is more optimistic:

(…) After all, everyone knows that Cyprus is a special case, given the size of its banking sector relative to GDP, its exposure to foreign depositors of questionable virtue and its concentration of bank lending to the collapsed Greek economy.

No other economy has that combination of disadvantages, which has made a conventional bank rescue impossible for the Cypriot government, and unacceptable to the rest of the eurozone, especially Germany. Bank depositors in Spain and Italy will presumably be aware of these unique features, and therefore more willing to view it as a special case.

That said, four of the features of the reported deal are setting unfortunate precedents for the future.

First, the way in which the bank failures have been handled shows that the eurozone is still very far removed from a workable banking union. (…)

Second, the principle of divorcing the debt of governments from that of banks (and thus breaking the “diabolical loop” which threatened to bring down Spain last year), was very rapidly thrown out of the window in Cyprus. (…) German Finance Minister Schauble even went as far as to say that in other countries small deposits are safe “only on the proviso that the states are solvent”. Does that not drive a coach and horses through the separation of banks and governments, which was one of the principle promises made by eurozone leaders at their crucial summit of June 29, 2012?

Third, there is the possibility that investors will view any haircut on large depositors not as a special tax, or a bail in of creditors, but as a capital levy on investors. (…)

Fourth, there is the fact that direct controls over the exit of capital from a eurozone member will have occurred for the first time in Cyprus. (…) Indeed, it seems to breach one of the basic principles of a single currency in the first place. (…)

Thinking smile  Mood Sours in Northern Europe  Falling confidence among companies in the euro zone’s biggest northern economies in March suggests those nations are increasingly vulnerable to the problems afflicting the bloc’s southernmost nations.

German business confidence deteriorated unexpectedly in March, as the closely watched Ifo index dropped for the first time in five months.

The business confidence index for France’s manufacturing industry hovered at 90 in March, statistics agency Insee said Friday. The index covering export order books fell to minus-40 in March from minus-34 in February, it said.

Confidence fell among manufacturers in the Netherlands in March, to an index reading of minus-4.8 from minus-3.6 the previous month, the Dutch statistics agency also said Friday.

In Belgium, business confidence fell to its lowest level since September 2009, with the Belgian National Bank’s measure at minus-15.0, down from minus-11.0 in February.

More on Germany

imageThe average reading of the IFO expectations index in
the first quarter is consistent with a 0.5% GDP rise.
The IFO signal is therefore stronger than that of the
PMI, which is currently pointing to a 0.3% GDP
increase in the first three months of the year.

Although both surveys indicate a return to economic growth in the first quarter, the concern is that the weakening of the IFO adds confirmatory support to the message form the PMI that the German economy is losing momentum again, and could see a renewed weakening of growth in the second quarter. The composite PMI has now fallen for two consecutive months, down sharply from a peak of 54.4 in January to 51.0 in March. (Markit)

More on France

imageIneichen Research & Management AG

TNT Express cuts 6 percent of jobs to face future alone

Dutch express delivery firm TNT Express said it will cut 4,000 jobs and focus on Europe after a failed $7 billion takeover by United Parcel Service.


After ending 2012 with a thud, Canadian retailers didn’t exactly ring in the New Year. Volume sales were unchanged in January, and are now down 0.9% in the past year and a hefty -2.2% annualized in the past six months. Coupled with sagging factory shipments, GDP looks to retrace only half of December’s 0.2% decline.

Even if growth picks up moderately in February and March, it will struggle to top 1% annualized for a third consecutive quarter. The Bank of Canada expected 2.3% growth in Q1. At least its view that low rates “will likely remain appropriate for a period of time” is on the money. (BMO Capital).


Storm cloud  South Korea Minister: 2013 Growth Likely Slower

South Korea’s new finance minister said the country’s economy will likely grow at a slower pace than expected this year, requiring an economic stimulus to be announced as early as next week.

The government in December forecast the domestic economy would grow 3.0% in 2013 following a 2.1% expansion in 2012.

South Korea Escalates Concern With Japan Policies on Yen

(…) Appointed by Park on March 22, Hyun said in his inaugural speech he would use “all possible measures to speed the economic recovery,” and indicated that government support would come as early as this month.

“We need to factor in the yen problem as we think about policy measures, as exports and domestic demand are two big pillars of our economy,” Hyun said on March 23. Stabilizing foreign-exchange markets should always be an important part of government policy, since currency moves can be a source of shocks, he said.

Storm cloud  Vietnam Cuts Interest Rates to Aid Growth After Inflation Slowed

The State Bank of Vietnam lowered the refinance rate to 8 percent from 9 percent and the discount rate to 6 percent from 7 percent, according to a statement on its website. It also reduced the cap on dong deposit interest rates to 7.5 percent from 8 percent. The new rates are effective March 26.

Vietnam’s central bank lowered interest rates six times last year, with the last reductions taking effect Dec. 24.


I have begun an “Inflation Watch” feature, even though world fundamentals are not conducive to an acceleration in world inflation as Moody’s points out:

Both the recent slowing pace of Chinese industrial activity and the eurozone’s seemingly chronic malaise will limit the upside for global inflation. The year-over-year percent change of Moody’s industrial metals price index shows unexpectedly strong positive correlations with both the eurozone’s composite PMI and the yearly percent change of China’s industrial production.



Nonetheless, U.S. labor costs are creeping up, along with employment.


The U.S. has strongly benefitted from imports of deflationary Asian products between 1995 and 2005. Non-fuel import prices (chart below) have been steadily rising since in spite of the lasting severe economic crisis that reduced world demand growth.


So, conditions are in place for higher inflation should U.S. employment keeps strengthening. To be monitored, given the impact inflation has on equity valuation (see the Rule of 20)


Investors are not well paid for the level of sovereign risk in the U.K. or France.

Update On Sovereign Risks

In a recent Special Report, BCA Research’s Global Fixed Income Strategy service has updated its sovereign risk analysis. According to the results, fiscal constraints due to heavy debt loads in the U.S., Japan, and the U.K. are depressing their sovereign risk scores. Meanwhile, peripheral Europe is on the mend.

Although the sovereign ranking methodology is not intended to predict spreads, the relationship between CDS spreads and our sovereign risk score highlights that the risk fundamentals in Spain, Italy, France and the U.K. are similar. However, investors are not well-compensated for the risks in the latter two countries.

Cyprus Crisis Is Credit Negative for all Euro Area Sovereigns (Moody’s)

Euro area policymakers’ handling of the Cyprus crisis to date, the increased risk tolerance apparent in their actions, and the uncertainty that a more uncompromising and less predictable approach to crisis management creates for investors’ assessment of risk, are credit negative for euro area sovereigns.

Yet: Investors embrace big eurozone bond sales  Issuance from periphery on track for best quarter since crisis began

(…) Governments on the eurozone’s stricken rim have sold €28.2bn worth of bonds so far this year, according to Dealogic, almost double the amount over the same period last year and making it the best start to a year since the first three months of 2010. (…)

The European periphery’s companies and banks have also benefited from the buoyant bond markets, and have sold €31.9bn worth of bonds so far this year, already making it the best quarter since early 2011. (…)

Junk Bond ETF Yields May Fall Below 5% Amid Scramble for Income

Yields in junk bond ETFs are threatening to fall below 5% for the first time ever as strong demand for speculative-grade corporate debt in a low-rate environment keeps pushing yields down.

FT’s Gillian Tett had a good piece March 14:  Remember lessons of 2007 in rush for junk Warnings over high yield ‘overheating’ are growing

(…) But while those tumbling yields have sparked debate, what has received less attention is the issue of maturity transformation. In previous decades, it was taken for granted that the type of people investing in high-yield debt or bank loans were mostly medium- to long-term investors, such as pension funds or life assurance groups, if not banks themselves.

But mutual funds and exchange traded funds have increasingly started gobbling up risky corporate debt on a significant scale. By late last year, assets in high-yield funds were running at about $350bn, having almost doubled in three years. And, although those flows reversed slightly in February, money is now flooding into bank loan funds.

(…) Federal Reserve figures show that funds are now buying more than two-thirds of all corporate credit debt, up from a quarter in 2007.

(…)  And if anything causes a panic among retail investors, the money that has been backing all those corporate loans and bonds could vanish overnight – revealing another maturity mismatch, and funding gap.

Now don’t get me wrong: I am not forecasting that this flight will happen. Although there were four weeks of outflows from high-yield mutual funds in February – or after Mr Stein’s speech – some $820m flooded back in the first week of March; investors are (thankfully) not exiting this sector in panic now. So far, the short-term money that has gone into the corporate debt world does not appear to be associated with too much leverage; this makes the picture notably different from the asset-backed commercial paper market or repo sector in 2007. (…)

Tett says that

Some bankers insist that this behaviour is benign, given that default rates remain low.

Pointing up  Here’s Moody’s on default rates, just as the U.S. economy seems to be doing better:

There was a similar number of rating changes for the US over the past week, 16, compared to the week prior, 18, but there is a substantial drop in the number of positive rating changes. Only four, 25%, were upgrades this week. The changes have been leaning slightly toward the down side of 50% over the past few weeks, but the 25% this past week certainly does not move toward a positive view of corporate credit quality. (…) In Europe rating change activity has increasingly moved to speculative grade industrial companies from investment grade financial companies and only two out of 10 changes were upgrades.

Confused smile  Congress weighs corporate debt tax reform
House looking at limiting interest payments’ tax deductibility

US lawmakers are considering limiting the tax deductibility of interest payments for businesses, a measure that would dramatically transform corporate finance in America by reducing the bias towards debt in the tax code.


Nike rallied 11 percent to a record after the world’s largest sporting-goods company reported a rebound in profitability. Tiffany rose 1.9 percent after posting better- than-estimated profit amid increased demand in the Asia-Pacific region.


Schwab’s Lyz Ann Sonders, always a good read, compares some market data for 2007 and 2013 concluding that

most of the better comparisons are many of the traditional stock market barometers, including earnings, valuation, technical conditions and inflation.

Then and Now: The Good

She goes on…

The news out of Cyprus was the trigger for the slight pullback the market’s experiencing as I write this report. The story will have to play out, but we don’t feel this represents the type of exogenous shock that could undermine the US stock market for any extended period of time.

Although the eurozone crisis keeps policy uncertainty elevated, US policy uncertainty has been coming down sharply of late.

Less US Policy Uncertainty…failing to point out that U.S. policy uncertainty remains far above 2007. She then lists all the items supporting the bullish case:

  • Thanks to better economic readings lately, many economists are upping first-quarter real gross domestic product (GDP) estimates; some as high as 3%.
  • “Don’t fight the Fed” (or most other global central banks).
  • Housing is firing on nearly all cylinders
  • Unemployment claims (a fellow leading indicator with the stock market) are at a five-year low.
  • Household net worth is on track to take out its prior all-time high this quarter.
  • Industrial production and retail sales have been particularly strong (primary source of higher GDP forecasts for first quarter).
  • Small business confidence is ticking up.
  • Earnings revisions turning higher.
  • Moderate, but persistent employment gains.
  • Consumer financial obligations (mortgage/credit card payments, etc.) relative to disposable personal income are near record lows.
  • The credit-card delinquency rate is at record low by wide margin.
  • Highest year-to-date stock mutual fund inflows in seven years.
  • About 90% of S&P 500 stocks are above their 200-day moving averages.

Typical of most economists, she spends precious little time on earnings and P/Es, assuming that a growing economy will automatically lift earnings. Longer term, yes. But, remember what Keynes said…


Sonders’ only reference to earnings is a statement that earnings revisions are turning higher. This is not supported by any of the earnings aggregators that I follow. S&P’s most recent update (March 21) shows Q1’13 estimates down 6 cents in the last 5 weeks (2 cents in the last week) to $25.51. Here are S&P’s charts:

image image

Factset wrote on March 22:

The estimated earnings growth rate for Q1 2013 is -0.7% this week, slightly below last week’s growth rate of -0.6%.

Sonders continues, stating that

Shorter-term, the next worry for investors is whether we’re going to see a fourth consecutive mid-year slowdown in the economy. (…)

There are some reasons to hope for a break in that cycle given many of the factors noted in the bulleted list above. But meaningful weakness the past three years didn’t rear itself until the April-May time frame (as you can see below via the Citi Economic Surprise Index comparisons), so we’ll have to wait and see.

No Sign of Weakness Yet This Year

The problem with that is her first bullet point above. The fact that most economists, including the Fed, have become more optimistic on the economy is, in itself, a reason to worry. The jury remains out for now. ISI’s weekly company surveys diffusion index has been a reliable canary in the past.


Recently, the big surprise in the U.S. has been the resiliency of consumer spending in the face of a big fiscal drag, delayed tax refunds and higher gas prices. Americans have obviously dipped into their savings (and cut restaurant outings). Just in case you want to hang your hat on a low savings rate, here’s the long term chart:




NEW$ & VIEW$ (21 MARCH 2013)

Cyprus. Gloomy U.K. cuts corporate taxes and frees BOE. U.S. architectural billing index surges.

Annoyed  ECB Sets Deadline for Cyprus Deal

“The governing council of the European Central Bank decided to maintain the current level of Emergency Liquidity Assistance (ELA) until Monday, 25 March 2013.

“Thereafter, Emergency Liquidity Assistance could only be considered if an European Union/International Monetary Fund program is in place that would ensure the solvency of the concerned banks,” it said.

Cyprus orders banks to shut until Tuesday
Infighting hampers search for alternative plan


And why Cyprus matters.


U.K. Paints Glum Picture on Growth

U.K. Treasury chief George Osborne slashed the country’s growth forecasts and admitted the government would have to borrow more than planned.

The Office for Budget Responsibility on Wednesday lowered its growth forecast for the U.K. for this year and next, citing weak exports and weak consumer spending. The government’s independent forecaster said it now expects growth of 0.6% in 2013 and 1.8% in 2014.


UK cuts taxes to revive stagnant economy
Government seeks ‘activism’ from Bank of England


Finance minister George Osborne used his annual budget on Wednesday to announce he would cut the main rate of corporation tax by 1 percentage point to 20 per cent by April 2015, down from 28 per cent when the government came to power.

Osborne Gives BOE More Leeway on Inflation Target

U.K. Treasury chief George Osborne unveiled changes to the Bank of England’s inflation-fighting mandate, paving the way for incoming governor Mark Carney to deploy more of the central bank’s formidable firepower to lift the U.K. economy out of stagnation.

The new remit permits the BOE to allow inflation to stray from its 2% target if the economy is in trouble, provided the MPC clearly sets out the arguments for doing so and how quickly it intends to get inflation back to target.

More significantly, the new mandate gives the MPC the power to deploy whatever tools and policies it sees fit to meet its inflation objective, including policies aimed at easing the flow of credit to the private sector, and making use of Fed-style guidance on the future path of interest rates and the size and pace of its efforts to stimulate growth through bond purchases.

Open-mouthed smile  ABI Continues to Improve at a Healthy Pace

With increasing demand for design services, the Architecture Billings Index (ABI) is continuing to strengthen. The American Institute of Architects (AIA) reported the February ABI score was 54.9, up slightly from a mark of 54.2 in January. This score reflects a strong increase in demand for design services. The new projects inquiry index was 64.8, higher than the reading of 63.2 the previous month – and its highest mark since January 2007.

“Conditions have been strengthening in all regions and construction sectors for the last several months,” said AIA Chief Economist, Kermit Baker, PhD, Hon. AIA. 


Surprised smile  CURRENCY WARS: Will Canada join as its manufacturing sector shrinks?

image(BMO Capital)


Thumbs down  FedEx Profit Declines 31%

[image]FedEx Chief Executive Fred Smith said the latest quarter was “very challenging for FedEx Express” due to continued weakness in international airfreight markets, industry overcapacity and customers opting for less expensive and slower international transit.

Fiscal 3Q13 (ending Feb 2013) showed EPS of $1.23 (ex $0.10 business realignment costs) in fiscal 3Q13, below the $1.38 consensus and the guidance range of $1.25-1.45.

In the conf. call:

“Our lower-than-expected results for the quarter and reduced full-year earnings outlook were driven by third quarter international revenues declining approximately $100 million versus our guidance primarily due to accelerating customer preference for lower-yielding international services, lower rate per pound and weight per shipment,” said Alan B. Graf Jr., FedEx Corp. executive vice president and chief financial officer. “We expect these international revenue trends to continue. We have other actions under way beyond those already included in our profit improvement program. Some of these additional actions may involve temporarily or permanently grounding aircraft, which could result in asset impairment or other charges in future periods.”

Pointing up  Corporate cost cutting is hitting Fedex, at an accelerating rate. A company like Fedex is used extensively by most corporations. This suggests to me that corporations are struggling to maintain margins, even voluntarily opt for slower deliveries. So Fedex has to struggle to cut its own costs.

Meanwhile, the company sees Q4 EPS of $1.90-$2.10 vs. $2.13 consensus and $6.00-$6.20 vs. $6.35 consensus for FY13. Guidance is thus cut 1.4-10.8% for Q4.

FDX dropped 6.9% yesterday.

Thumbs down  Oracle’s Sales Stall; Stock Falls 8%

The numbers for Oracle’s fiscal third quarter—which included flat profit and a 1% decline in total revenue—fell short of Wall Street estimates and interrupted a string of solid results from one of Silicon Valley’s most consistent performers. (…)

Oracle, which had predicted that hardware sales would start to grow by the end of the current fiscal year, said Wednesday that revenue for the business declined 23% to $671 million in the third period.

And while Oracle said in December that hardware revenue should start growing in the quarter ending in May, it now forecasts significant drop.

And this from ZeroHedge:

As FedEx rained on the market’s parade modestly today (with its biggest drop in 18 months and heaviest volume since Jun 2010), it is the ‘crash’ in Caterpillar’s sales that should be more worrisome. Just as the economies of the world are supposed to be getting ready to re-surge and expectations are set for a second half renaissance, it seems that in reality, corporations that build stuff, mine stuff, and move stuff are not buying in anticipation. As the following chart suggests, perhaps CAT is yet another canary in the global economic decline coalmine?

Inventory levels at dealers remain high, orders are down, and the dealers have reacted by slowing or stopping orders from CAT to work off inventory.