NEW$ & VIEW$ (4 FEBRUARY 2014)

THE BLAME GAME IS ON

The media and analysts are tripping over themselves to explain the recent setback:

  • Growth Fears Hit Stocks European and Asian stocks fell Tuesday, following a sharp selloff the previous day in the U.S., as jitters about global growth continued to weigh on investors.

European and Asian stocks fell Tuesday, following a sharp selloff the previous day in the U.S., as jitters about global growth continued to weigh on investors.

Signs of a sharp slowdown in U.S. manufacturing on Monday reignited concerns about the health of the world’s largest economy, a further worry for investors who have already been spooked by the turmoil in emerging markets over the past two weeks.

Sentiment worsened markedly in Asia, where the Nikkei Stock Average fell 4.2%, leaving it 14% lower in the year to date—currently the worst performer among major global markets. A strengthening of the yen against the dollar after the poor factory data weighed heavily on Japan’s exporters. (…)

Goldman’s Global Leading Indicator’s January reading and the latest revisions to previous months paint a significantly softer picture of global growth placing the global industrial cycle clearly in the ‘Slowdown’ phase. They add, rather ominously, While the initial shift into ‘Slowdown’ (which we first noted in October) had a fairly idiosyncratic flavor, the recent growth deceleration now looks more serious than in previous months. Of course, as we noted yesterday, Jan Hatzius is rapidly bringing his optimistic forecasts back to this slowdown reality.

Swirlogram solidly in “slowdown” phase…

Yesterday’s U.S. ISM shook edgy investors even though Friday’s Markit U.S. PMI was not bad at all. Ed Yardini agrees with me and shows some evidence:

Perplexing PMI

Yesterday’s report was unexpectedly weak, with the overall index plunging from 56.5 during December to 51.3 last month, led by even bigger dives in the production index (from 61.7 to 54.8) and the new orders index (from 64.4 to 51.2).

The chairman of the Institute for Supply Management, which conducts the survey, blamed the weather for some of the weakness in the results. The eastern half of the US is experiencing one of its 10 coldest winters on record, with thousands of local records for cold already tied or broken. So the M-PMI hit an ice patch rather than a soft patch.

I’m not sure that makes sense. Why would orders be down so much just because the weather was bad? More perplexing is that the average of six regional business surveys showed solid gains last month, although they too were mostly hit by the bad weather. Furthermore, Markit reported yesterday that its final M-PMI for the US dipped from 55.0 during December to 53.7 last month. No big deal.

ISI’s Ed Hyman keeps the faith:

We still remain constructive and think US GDP is on 3% trajectory, AND despite EM pass through fears, globally the synchronized expansion remains in place.

The soft patch theme remains quite possible, however. Housing is weaker, retail is slowing and car sales may have seen their best time this cycle.

U.S. Vehicle Sales Continue to Decline as Weather Turns Frigid

Temperatures below zero in some parts of the U.S., and just unseasonably cold elsewhere in the country, took their toll on light vehicle sales last month. Unit motor vehicle sales slipped 1.0% to 15.24 million (SAAR, +0.1% y/y) during January, according to the Autodata Corporation. Sales have fallen 7.1% from the recovery high of 16.41 million in November.

The decline in overall sales was a function of fewer auto purchases, off 4.6% to a 7.30 million annual rate (-6.0% y/y). Sales of imported autos declined 12.3% to 2.17 million (-2.8% y/y). Sales of domestics fell 2.4% to 5.12 million (-7.4% y/y).image

CalculatedRisk quotes WardsAuto’s slighly lower estimate:

Based on an estimate from WardsAuto, light vehicle sales were at a 15.14 million SAAR in January. That is down slightly from January 2013, and down 2.5% from the sales rate last month.

I have been warning that auto sales could well have reached a cyclical peak as we should not expect a repeat of the excesses of the early 2000s.

large imageU.S. Construction Spending Growth Moderates

The value of construction put-in-place ticked 0.1% higher in December (5.3% y/y) following a revised 0.8% November increase, initially reported as 1.0%. For all of last year, growth in construction activity moderated to 5.5% from 8.1% in 2012.

Private sector construction activity jumped 1.0% (8.0% y/y) in December following 1.7% growth in November. Residential building surged another 2.6% (18.3% y/y) as single-family home building activity jumped 3.4% (21.6% y/y). Spending on improvements gained 2.0% (12.0% y/y) while multi-family building rose 0.5%, up by roughly one-quarter y/y. Nonresidential building activity declined 0.7% (-1.7% y/y) following its 2.4% November jump.

Offsetting the private sector gains was a 2.3% decline (-0.7% y/y) in the value of public sector building activity. The shortfall reflected outsized declines in many components but spending on highways & streets surged 1.8% (11.3% y/y). Spending here accounts for 30% of total public sector construction activity.

The U.S. government’s spending on construction tumbled 14.2% to $23.49 billion in 2013, the Commerce Department said Monday. That was the sharpest decline in records dating back to 1993, enough to return spending to 2007 levels.

Washington’s clash over government spending took a bite out of federal expenditures last year. A series of cuts known as the sequester slashed spending by tens of billions of dollars early in the year, until a deal to restore some of the reductions this year.

Spending by state and local governments, which account for a much larger portion of total construction expenditures, fell by 1.6% to $247.69 billion last year. That was more than the 1.2% decline for the category in 2012, but less than the 6.6% drop in 2011.

 
Falling Prices Hurt Firms American companies are struggling with falling prices for some key products amid intense competition and pressure from cost-conscious customers.

Executives from companies as varied as General Electric Co. GE -3.10% , Kimberly-Clark Corp. KMB -3.55% and Royal Caribbean Cruises Ltd.RCL -3.23% said some prices slipped in the last three months of the year—sometimes significantly.

Falling prices for adhesives weighed on Eastman Chemical Co. EMN -2.37% , cheaper packaged coffee dragged on Starbucks Corp. SBUX -3.02%, and “value and discounts” hit McDonald’s Corp. in the fourth quarter in what the fast food chain called a “street fight” for market share. XeroxCorp. XRX -4.06% is eyeing acquisitions that can “help us be more competitive on price pressure. (…)

Not every company reported price drops. 3M Co. said prices increased 1.4% in the fourth quarter, attributing the gain to research gains and adjustments made in emerging markets designed to offset currency devaluation. Harley-Davidson Inc. HOG -0.75% said price increases helped boost motorcycle revenues by 1.4% in the quarter even as shipments fell 1%. Altria Group Inc. MO -3.15% said a 13.2% rise in income for cigarettes and cigars in 2013 came “primarily through higher pricing.”

But the trend is evident in government data. While economic growth in the fourth quarter came in strong, helped by expanding consumer spending, firms aren’t raising prices. For the last two years, the consumer-price index has increased less than 2%, the first time in 15 years it has been that low in consecutive years. And in the year since December 2012, the consumer-price index for goods, excluding food and energy, declined 0.1%. (…)

That said: Chief Executives in U.S. More Confident on Economy, Survey Shows

The Young Presidents’ Organization sentiment index climbed to 63.5 from 60.5 in the previous three months. Readings greater than 50 show the outlook was more positive than negative. (…)

Fifty-two percent of executives surveyed said the economy has improved from six months ago, up from 38 percent who said so in October. Nine percent said the economy will worsen, down from 20 percent last quarter. (…)

Fifty-eight percent of chief executives in the YPO survey expect conditions to improve in the next six months, up from 42 percent in the previous period.

The Dallas-based group’s outlooks for demand, hiring and capital investment also advanced. The gauge of sales expectations for the coming year rose by 2.9 points to 68.7. The employment index climbed to 59.9 from 58.9.

Globally, business confidence grew in most regions. The YPO’s Global Confidence Index also rose to the highest level since April 2012.

The nonprofit service organization’s findings for the U.S. are based on responses from 2,088 global chief executives, including 940 in the U.S., to an electronic survey conducted during the first two weeks of January.

G-20 Inflation Rate Falls The rise in consumer prices slowed across the world’s largest economies in December, fueling concerns that too little inflation, rather than too much, could threaten the global economy’s fragile recovery.

The Organization for Economic Cooperation and Development Tuesday said the annual rate of inflation in its 34 developed-country members rose to 1.6% from 1.5% in November, while in the Group of 20 leading industrial and developing nations it fell to 2.9% from 3.0%.(…)

The European Union’s statistics agency Tuesday said producer prices rose 0.2% from November, but were 0.8% lower than in December 2012. Prices had fallen in both October and November, by 0.5% and 0.1%, respectively. Excluding energy, producer prices were flat on the month and fell 0.3% when compared with December 2012. (…)

In addition to the euro zone, inflation rates fell sharply in two of the largest developing economies during December, to 2.5% from 3.0% in China, and to 9.1% from 11.5% in India.

However, inflation rates rose in the U.S., Japan and Brazil.

HOW ABOUT THE BAROMETER BAROMETER?

Winter Weather Worries

Winter weather can negatively impact economic activity and the labor markets as freezing temperatures and mounds of snow keep consumers at home and workers off the job.  But what sort of impact does the weather have on the markets?  Generally speaking, less economic activity and a softer labor market should hurt stocks.  But using data from the National Oceanographic and Atmospheric Administration’s National Temperature Index (NTI), we found that cold weather during the winter months (December, January and February) does not have a meaningful implication for stock market returns.  (…) As shown, that correlation isn’t very robust. 

In months that are abnormally cold, there is a small correlation between the NTI and the S&P 500, but it peaks in December…and December still has positive average returns in chilly months!  The second chart shows that cold weather is also a bad predictor of the next month’s returns.  The correlation between the NTI in a given winter month with cold weather and the month following is actually negative, but still very low.

Devil  I.BERNOBUL, a good friend and an all-star croquignole player, sees verbal inflation and self-serving complacency in this comment from John Mauldin in his Jan. 26 comment:

My friend, all-star analyst, and Business Insider Editor-In-Chief Henry Blodget makes a compelling point: Anyone who thinks we need a ‘catalyst’ for a market crash should brush up on their history… There was no ‘catalyst’ in 1929. Or 1966. Or 1987. Or 2000. Or 2008…”

Blodget’s point is as compelling as his investment recommendations as head of the global Internet research team at Merrill Lynch during the dot-com bubble. The reality is that when equity valuations get on the high side, nervous investors tend to hold on as long as they can, waiting for reasons to sell to show up. These reasons are often not what one would expect at the time but they are enough to shake investors confidence. Once markets begin to waver and the media amplify the fears, the negative momentum feeds on itself. This time, it was the EM problems that started the turn.

 

U.S. ISM Index Plunges Under Heavy Weather

Widespread snowstorms in the U.S. helped limit factory operations last month. The Composite Index of Manufacturing Sector Activity from the Institute for Supply Management dropped sharply to 51.3 during January from a revised 56.5 in December, initially reported as 57.0. Earlier figures were revised due to new seasonal factors. The latest reading was well below expectations for a slip to 56.0 as measured by the Action Economics Survey.

A lower reading for new orders provided the greatest drag on last month’s factory sector activity as it fell to 51.2 from 64.4. In addition, the production component fell to 54.8 from 61.7 and employment dropped to 52.3 from 55.8. Inventories were drawn down at a faster rate as indicated by the lower inventory series. It fell to 44.0, the lowest level since December 2012. Finally, the supplier delivery series moved up to 54.3 indicating the slowest product delivery speeds since June 2011.

New export orders index fell to 54.5, the lowest reading since September while the order backlog reading dropped to 48.0, its lowest level since August. Imports declined to 53.5, the lowest level in twelve months.

The prices paid index series indicated further improvement in pricing power with a rise to 60.5, the highest level since February of last year. Twenty eight percent of firms raised prices while seven percent lowered them. (Haver Analytics, chart from CalculatedRisk)

 

MARKIT U.S. MANUFACTURING PMI AT 53.7 IN JANUARY

Adjusted for seasonal influences, the headline U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) registered 53.7 in January, down from an 11-month high of 55.0 during December. The latest reading was the lowest since last October, but remained above the neutral 50.0 value and pointed to a solid improvement in business conditions.

imageU.S. manufacturers indicated that output and new business growth rates slowed in January, with some attributing this to disruptions from the extreme weather conditions at the start of the year. The slowdown also reflected in part a drop in new export orders for the first time since last September. Nonetheless, manufacturers remained positive in terms of their staff hiring in January, with employment levels rising for the seventh successive month.

January data signalled a further expansion of manufacturing production levels, although the latest rise was the least marked for three months. Survey respondents commented that output had been disrupted by extreme weather conditions at the start of 2014, with a number of firms noting delays in the receipt of inputs from suppliers.

In line with the trend for output, levels of new work received by U.S. manufacturers rose at the slowest pace for three months in January. Weaker overall growth of incoming new business partly reflected softer export demand at the start of the year. Latest data signalled a drop in new orders from abroad for the first time in four months, although the pace of decline was only slight.

Slower new order growth helped alleviate pressures on capacity at U.S. manufacturers, as highlighted by a drop in backlogs of work for the first time since August 2013. Reduced levels of unfinished work also reflected ongoing job creation in the manufacturing sector, with employment growth sustained at a solid pace in January.

Manufacturers responded to weaker new business gains by increasing their input buying at a slower rate in January. Nonetheless, supplier lead-times lengthened markedly amid disruptions from extreme weather conditions. On the inflation front, average input costs and factory gate charges both increased at slower rates in January.

Large manufacturers (more than 500 employees) were the weakest performing of the three company size categories monitored by the survey in January, with business conditions improving at the slowest pace for a year-and-a-half. Nonetheless, in line with the trend seen across other company size groups, a positive trend in employment numbers was sustained at the start of 2014.

By market group, intermediate goods producers recorded the strongest improvement in business conditions, followed by companies operating in the investment goods category. The weakest improvement in business conditions was posted by consumer goods producers in January. Latest data indicated that net job creation was maintained across all three market groups at the start of the year.

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Website Changes. Introducing BEARNOBULL.COM

It has been 5 years and there is a need for changes.

The name NEW$-TO-USE is no longer a good reflection of the blog content. While I will continue to post the pertinent facts in a logical and useful manner, my views and analysis are just as important, at least as a proportion of the total content.

Given widespread subjective and biased reporting and analysis across the blogosphere, there is a clear need for objective, rational and honest reporting and analysis and I want my blog to be distinctly in that camp.

I strive for objectivity, being no bear, no bull, unless clearly justified and supported by facts. This is not a forecasting game. It is a game of probabilities, risk vs reward, which we play according to our own situation that our personal level of risk aversion should dictate.

My reporting and analysis shall bear no bull and I will always denounce biased reports and analysis when I see them ‘cause I bear no bull. Neither should you.

I also improved the layout:

  • The main section is wider, enabling larger charts. I love charts, they save words and they provide useful and critical perspective.
  • The sidebar is much less busy as I moved many info and links to the top menus which, I believe, makes it easier to find important reference posts.
  • I have also set a page dedicated to the Rule of 20 Barometer chart which I will update regularly. The page can be easily accessed with the tab on the top menu.
  • My track record is also available from a top menu tab.
  • There will be fewer posts per page, reducing load time and scrolling.
  • Reading on a mobile phone is greatly improved.

Comments and suggestions are welcome.

This blog remains totally open and free. The only revenues the blog gets is from your interest (i.e. harmless clicks) in my advertisers’ banners and from your use of the Amazon search box on the sidebar to purchase from Amazon.com (BNB gets a small cut). These revenues don’t come even close to covering the cost of research and blog maintenance, so donations are really appreciated. They are useful to everybody since all revenues are reinvested in research material.

TO MY SUBSCRIBERS

Thank you again for your constant interest. I am truly honoured. I will try to ensure a smooth transition to BEARNOBULL.COM. However, if you don’t receive your daily e-mail from BEARNOBULL.COM by February 15, I would truly appreciate if you re-subscribed. The subscribers list will never, ever, be used for anything else.

TRANSITION

Launching a new blog with a different theme and platform is a lot of work and carries some transition risks. For this reason, I will be publishing on both NEW$-TO-USE.COM and BEARNOBULL.COM for about 2 weeks, monitoring the transition to ensure fluidity and continuity. Please do not hesitate to contact me if anything is wrong or annoying at your end.

Red heart These changes and improvements would not have been possible without help from my sweetheart Suzanne. She is an outstanding contributor to this new platform with her creativity, artistic sense and uncompromising professionalism.

Take a look at www.bearnobull.com.

 

“LEAVING CAPE TOWN”

There is no better title than Josh Brown’s post title of January 12 to express the capitulation of the CAPE Ratio (Shiller P/E) advocates.

When I wrote QUIBBLES on January 7, I was not aware that John Hussman was in fact reacting to a December 2013 post in Philosophical Economics. Josh Brown explains:

Over the last few months, there’s been a radical rethinking of the utility of CAPE and a huge battle has been taking place in the financial blogosphere as a result, sucking in nearly every thought leader and serious investment writer in the process. Jesse Livermore, a pseudonymous blogger writing at Philosophical Economics, has really blown the debate wide open, beginning with what I consider to be one of the most notable financial blogposts of 2013 (see Fixing the Shiller CAPE from December 13th).

Nobody should be surprised that after having totally missed the fourth longest and fifth most powerful bull market of the last 100 years, the bears draped into professor Shiller’s CAPE would decide to do a more thorough inspection of the fabric that made them so comfortable and confident during the past several years but which is making them feel totally naked now. Analytical help is also coming from many sources which, now that the evidence is so clear, are coming out of the closets to expose to the world the hidden flaws of the CAPE approach.

These are much more than mere quibbles.

Too bad for all the investors who missed this generational bull because of religious beliefs of these well mediatized disciples. Religions can often blind the smartest people, making them so confident that they possess the Truth that they see no reason to dig below the  surface to better understand the inner workings of their formula.

I don’t agree with each and every specific “flaws” now attributed to the CAPE, finding that the digging may be getting too “accountingly” complex. We should not get over-zealous and totally dismiss what is after all a valid valuation concept that may eventually, but not very soon, become useful again. I also don’t agree with al the ways and means by which the data could be “adjusted”. Once you take this path, there’s no ending.

The most important problems with the CAPE now being exposed are essentially the same one I have been mentioning for many years and detailed in my 2012 post The Shiller P/E: Alas, A Useless Friend:

  • “Reported earnings” are not as “pure” as people believe and are far from providing the long-term consistency that the CAPE advocates pretend.
  • Notwithstanding the above, one has to question the relevance of the CAPE considering that upon close analysis (some people finally objectively did this), its long-term helpfulness in investment decision making leaves a lot to be desired.

Funnily, another important flaw in the current readings of the CAPE remains elusive to everybody. It is important since it will impact the CAPE ratio for another 5 years. To repeat myself:

Many of the companies that recorded huge losses in 2008-09 either went bankrupt or were substantially restructured or acquired. As a result, a conceptually valid valuation method such as the Shiller PE, measuring 10-year average earnings against a current index, is thus including in its denominator, during 10 years, the huge losses recorded by companies that are no longer included in its numerator, these companies having in fact been replaced by other, profitable, companies.

Humongous or very large losses were recorded in 2008 by companies such as AIG, GM, Merrill Lynch, Marshall & Ilsley, MBIA, Wachovia, all companies then part of the S&P 500 Index but no longer. Their losses still impact the 10 year average earnings even though they have no contribution to the actual index value. The losers are long gone but their losses remain!

This is like assessing a baseball team’s current batting line-up using 10-year data that includes the dismal stats of now deceased players. How useful is that?

It will be very interesting to see how the exodus from CAPE town will impact demand for equities. Can we expect that investors who up to now religiously refused to sin will get back into equities as they undrape? Some wavering CAPE priests have been preparing their followers for their possible defrocking in the advent of a market correction. In fact, some have already capitulated, conveniently blaming the central banks for rendering their religious beliefs useless, possibly just as these turncoats’ own business began to be impacted by their unfortunate asset mix of the past 5 years.

Interestingly, as a result, a new wave of cash-rich equity investors could prevent the still useful Rule of 20 to correct as much as during the previous two major corrections since 2009 when the S&P 500 Index fell 13% (2010) and 15% (2011) as the Rule of 20 P/E failed to cross the 20 level and retreated back to 15-16. You might want to read TAPERING…EQUITIES before betting too much on this possibility.

image

Note: The link to Josh Brown’s post will lead you to several interesting articles on this fascinating matter if you have time for that.

 

NEW$ & VIEW$ (3 FEBRUARY 2014)

Slow Income Growth Lurks as Threat to Consumer Spending A slowdown in U.S. income growth could short-circuit the surge in consumer spending that propelled the economic recovery in recent months.

As the holiday shopping season wrapped up, personal consumption rose a seasonally adjusted 0.4% in December from a month earlier, the Commerce Department said Friday. With a 0.6% increase in November, the final two months of 2013 marked the strongest consecutive gains since early 2012.

The upturn came while incomes were flat during the month. Real disposable income, which accounts for taxes and inflation, advanced just 0.7% during 2013. That was the weakest growth since the recession ended in 2009. (…)

Across 2013, the Commerce Department’s broad measure of spending on everything from haircuts to refrigerators was up 3.1% from the prior year. That was the weakest annual increase since 2009 and below the 4.1% growth seen in 2012.

But the pace of spending was substantially stronger in the final six months of last year. Economic growth in the second half of 2013 represented the best finish to a year in a decade. Consumer spending, which makes up more than two-thirds of the nation’s gross domestic product, was the primary driver. (…)

The personal saving rate fell to 3.9% in December from 4.3% in November. (…)

Friday’s report showed subdued inflation across the economy. The price index for personal consumption expenditures—the Fed’s preferred inflation gauge—rose 1.1% in December from a year earlier. While the strongest since August, the figure remains well below the central bank’s 2% inflation target. (…)

A separate Labor Department report Friday said employment costs in the last three months of 2013 were 2% higher than a year ago. Annual cost increases typically exceeded 3% before the 2007-09 downturn wiped out millions of jobs. (…) (Chart and table from Haver Analytics)

Try to see anything positive from the table. I suspect that spending data for the last few months of 2013 will be revised lower in coming months. In any event, the income side is desperately weak.imageLast 3 months of 2013:

  • Personal Income: +0.1%
  • Disposable Income: –0.2%
  • Real Disposable Income: –0.3%
  • Consumption Expenditures: +1.1%
  • Real Expenditures: +0.9%

Bloomberg Orange Book comments from retailers about January performances were mostly negative and suggest future weakness. Wal-Mart pared its sales forecast based on curtailment of the food stamp benefit program and other specialty apparel retailers issued statements of concern. (BloombergBriefs)

Makes you wonder about this Bloomberg article: Global Earnings Are Poised to Accelerate in 2014 as U.S. Consumers Spend More

Meanwhile:

China’s Manufacturing Activity Slows

The official manufacturing PMI fell to 50.5 in January, from 51.0 in December, the federation said. The January PMI was in line with the median forecast by economists in a Wall Street Journal poll. (…)

The new orders subindex dropped to 50.9 in January from 52.0 in December, and the subindex measuring new export orders declined to 49.3 from 49.8, the statement said.

The employment subindex dropped to 48.2 from 48.7, while the output subindex fell to 53.0 from 53.9. Mr. Zhang said the fall in the new orders subindex shows weakness in domestic demand.

The subindex measuring the operation of large firms of the official PMI, heavily weighted towards larger state-owned enterprises, dropped to 51.4 from 52.0, while the one measuring smaller firms fell to 47.1 from 47.7. (…)

The HSBC China Manufacturing PMI, which is tilted toward smaller companies, fell to a final reading of 49.5 in January from 50.5 in December, HSBC said Thursday.

In another sign of slower momentum among factory owners, profit at major Chinese industrial enterprises grew at a slower pace, expanding by 6% in December from the same month a year earlier to 942.53 billion yuan ($155.6 billion), a reduction from November’s 9.7% increase, official data released earlier in the week showed

Moscow casts doubt over Russian growth
GDP rose 1.3% in 2013 just missing government forecasts

Gross domestic product increased by 1.3 per cent in 2013, narrowly missing the government’s most recent forecast of 1.4 per cent, the Federal Statistics Service in its preliminary GDP estimate said on Friday. (…)

The economy ministry said while the economy was past its lowest point, it was unclear whether it could grow by 2.5 per cent this year as forecast earlier. Most banks and independent economists are more pessimistic than the government and estimate growth this year to stay well below 2 per cent. (…)

“In the first quarter, we expect growth on a level around 1 per cent. In the second quarter, growth will be higher, probably somewhere around 2 per cent or 1.5 per cent,” Andrei Klepach, Mr Ulyukayev’s deputy, said in remarks carried by Russian news agencies. “We can stick to our forecast of 2.5 per cent, although it is possible, if you take the current trends, that growth might be lower.”

However, the decline of the rouble, which has fallen to its lowest against the dollar in five years amid the recent emerging markets currency jitters, could alter that calculation, as a weaker currency makes its exports more competitive.

“In our view, a lower rouble rate is better for economic growth,” said Mr Klepach. “But it would be worse for both growth and inflation if there were bigger volatility.”

In a survey published last week, MNI, an affiliate of Deutsche, said the weakening rouble was helping Russian businesses and respondents were the most positive on exchange rate conditions in January since the survey began last March.

Materially Slower Spending Growth by Emerging Market Countries Will Be Felt

Emerging market economies are of increasing importance to mature economies, such as the US. For example, the share of US merchandise exports shipped to emerging markets has risen from 2003’s 44% to 2013’s prospective 55% of US merchandise exports. During the first 11 months of 2013, US exports to emerging markets grew by 4.6% annually, which compared most favorably to the -0.5% dip by exports to advanced economies.

image

The faster growth of US exports to emerging markets is consistent with 2013’s much faster 4.7% growth of the emerging market economies compared to the accompanying 1.3% growth of advanced economies. Moreover, this phenomenon is hardly new according to how the emerging markets outran mature economies for a 14th straight year in 2013. Since year-end 1999, the average annualized rates of real economic growth were 6.1% for the emerging markets and a sluggish 1.8% for the advanced economies. By contrast, during the 14-years-ended 1999, the 3.7% average annual growth rate of the emerging markets was much closer to the comparably measured 3.1% growth of the advanced economies. (Figure 1.)

imageEmerging markets are acutely sensitive to industrial commodity prices
Emerging market economies can suffer to the degree major central banks succeed at curbing product price inflation. Though it’s difficult to separate the chain of causation, the 0.74 correlation between the growth of Moody’s industrial metals price index and emerging market country economic growth is much stronger than the price index’s 0.28 correlation with the growth of advanced economies. In fact, the 0.74 correlation of emerging market country growth and the base metals price index is far stronger than the 0.19 correlation between the growth rates of emerging market and advanced economies.
According to the above approach, the percent change of Moody’s industrial metals price index is relative to the price index’s average of the previous three years. The recent industrial metals price index trailed its average of the previous three years by -8%. (Figure 2.)

The latest decline by industrial metals prices suggests that the emerging market economies will grow by less than the 5.1%, which the IMF recently projected for 2014. When the aforementioned version of the percent change for the industrial metals price index is above its 8.3% median of the last 34 years, the median yearly increase by emerging market economic growth is 5.9%. By contrast, when the base metals price index grows by less than 8.3% annually, the median annual increase for emerging market growth drops to 3.7%. (Moody’s)

As U.S. debates oil exports, long-term prices slump below $80 Long-term U.S. oil prices have slumped to record discounts versus Europe’s benchmark Brent, with some contracts dropping below $80 in a dramatic downturn that may intensify producers’ calls to ease a crude export ban.

imageOil for delivery in December 2016 has tumbled $3.50 a barrel in the first two weeks of the year, trading at just $79.45 on Friday afternoon, its lowest price since 2009. That is an unusually abrupt move for longer-dated contracts that are typically much less volatile than prompt crude. For most of last year, the contract traded in a narrow range on either side of $84 a barrel.

The shift in prices on either side of the Atlantic is even more dramatic further down the curve, with December 2019 U.S. crude now trading at a record discount versus the equivalent European Brent contract. The spread has doubled this month to nearly $15 a barrel, data show.

The drop in so-called “long-dated” U.S. oil futures extends a broad decline that has pushed prices as much as $15 lower in two years. It also coincided with an abrupt drop in near-term futures, which fell by nearly $9 a barrel in the opening weeks of 2014 amid signs of improving supply from Libya.

But while immediate prices have rebounded swiftly thanks to strong demand amid frigid winter weather and new pipelines that may drain Midwest stockpiles, longer-term contracts have not.

The unusual speed, severity and persistence of the decline has mystified many in the oil industry. Brokers, analysts and bankers have offered a range of possible explanations: a big one-off options trade in the Brent market; new-year hedging by U.S. oil producers; liquidation by bespoke fund investors; or even long-term speculation on a deepening domestic glut.

Regardless of the trigger, however, it may be cause for growing alarm for crude oil producers, who are increasingly concerned that falling prices will crimp profit margins if U.S. export constraints are not eased. Producers say this would hand over some of their rightful profits to refiners who can freely export gasoline and diesel at world prices. (…)

EARNINGS WATCH

Amid all the EM turmoil and the barometers of all kinds, let’s pause for a moment to take a look at the main ingredient, half way into the earnings season.

  • Factset provides its usual good rundown:

With 50% of the companies in the S&P 500 reporting actual results, the percentages of companies reporting earnings and sales above estimates are above the four-year averages.

imageOverall, 251 companies have reported earnings to date for the fourth quarter. Of these 251 companies, 74% have reported actual EPS above the mean EPS estimate and 26% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is
above the 1-year (71%) average and the 4-year (73%) average.

In aggregate, companies are reporting earnings that are 3.6% above expectations. This surprise percentage is above the 1-year (3.3%) average but below the 4-year (5.8%) average.

The blended earnings growth rate for the fourth quarter is 7.9% this week, above last week’s blended earnings growth rate of 6.3%. Upside earnings surprises reported by companies in multiple sectors were responsible for the increase in the overall earnings growth rate this week. Eight of the ten sectors recorded an increase in earnings growth rates during the week, led by the Materials sector.

The Financials sector has the highest earnings growth rate (23.7%) of all ten sectors. It is also the largest contributor to earnings growth for the entire index. If the Financials sector is excluded, the earnings growth rate for the S&P 500 falls to 4.9%.

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

In aggregate, companies are reporting sales that are 0.1% below expectations. This percentage is below the 1-year (0.4%) average and below the 4-year (0.6%) average.

The blended revenue growth rate for Q4 2013 is 0.8%, above the growth rate of 0.3% at the end of the quarter (December 31). Eight of the ten sectors are reporting revenue growth for the quarter, led by the Health Care and Information Technology sectors. The Financials sector is reporting the lowest revenue growth for the quarter.

At this point in time, 54 companies in the index have issued EPS guidance for the first quarter. Of these 54 companies, 44 have issued negative EPS guidance and 10 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the first quarter is 81% (44 out of 54). This percentage is above the 5-year average of 64%, but slightly below the percentage at this same point in time for Q4 2013 (84%).

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For Q1 2014, analysts are expecting earnings growth of 2.2%. However, earnings growth is projected to improve in each subsequent quarter for the remainder of the year. For Q2 2014, Q3 2014, and Q4 2014, analysts are predicting earnings growth rates of 8.5%, 12.4%, and 11.9%. For all of 2014, the projected earnings growth rate is 9.6%.

Note that the 2.2% growth rate expected for Q1’14 is down from 4.3% on Dec. 31. The 9.6% growth rate for all of 2014 is down from 10.6% on Dec. 31.

Pointing up Data can vary depending on which aggregator one uses. Factset’s reports are the most complete but the official data still come from S&P.

  • Half way into the season, S&P’s tally shows a 69% beat rate and a 20% miss rate.

Importantly, Q4’13 estimates rose from $28.77 On Jan. 23 to $29.23 on Jan. 30. S&P also detailed the impact of two large pension adjustments at AT&T and Verizon: their gains added $0.94 to the Q4’13 operating EPS while they cost the Index $1.26 in Q4’12. Taking these out, just for growth calculation, Q4’14 EPS would be up 16% YoY if the remaining 250 companies meet estimates, up from +12.2% in Q3 and +3.7% in Q2. The economic acceleration is thus translating into faster profit growth and still rising margins.

We should keep in mind, however, that easy comparisons account for a big part of the strong earnings growth. Comparisons are particularly easy for three companies – Bank of America, Verizon, and Travelers. Exclude these three companies and total earnings growth for the S&P 500 companies that have reported drops to +6% from +12.0%.

Nonetheless, Zack acknowledges that if remaining companies meet estimates

Total earnings in Q4 would be up +9.6% on +0.7% higher revenues and 79 basis points higher margins. This is a much better earnings growth picture at this stage of the reporting cycle than we have seen in recent quarters. In fact, +9.6% growth is the highest quarterly earnings growth rate of 2013.

Zacks provides another useful peek at earnings trends with actual dollar earnings instead of per share earnings.

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Trailing 12m EPS are now seen reaching $108.28 after Q4’13 (+5.9% QoQ) and $110.64 after Q1’14, assuming Q1 estimates of $28.13 (+9.2%) are met. They have been shaved 0.6% in the last week.

  • The Rule of 20 P/E barometer, a far more useful barometer than the January barometer, has retreated back into the “lower risk” area at 18.2x, down from 19.7x in December 2013. This is the third time in this bull market that the Rule of 20 P/E (actual P/E on trailing EPS + inflation) has refused to cross the “20 fair value” line after a rising run, a rare phenomenon that last occurred in the early 1960s. image

In all the media frenzy about the recent equity markets setbacks, the U.S. earnings trend should take center stage. Rising earnings remain the main fuel for bull markets, over and above QEs of all kinds. Notice the sharp uptrend yellow line in the chart above. This line plots where the fair value of the S&P 500 Index based on the Rule of 20. In effect, it is derived from multiplying trailing 12m EPS by (20 minus inflation) or 18.3 at present using core CPI. It is the difference between the yellow line and the actual S&P 500 Index (blue line) that is measured by the thick black line (actual P/E + inflation).

Deep undervaluation is reached when the thick black line, the Rule of 20 barometer, is below 17.5 (historical lows around 15). Extrapolating 3 months down with trailing EPS at $110.64, the Rule of 20 P/E would be 17.8x if the Index remains at 1782 and inflation is stable at 1.7%. This would dictate a fair value of 2025 on the Index, +13.6% from current levels. On the other side, a decline in the Rule of 20 P/E to the 15-16x range would take the Index down 11-17% to 1470-1580. Taking the mid-point downside risk of 14%, the upside/downside is nearly identical, not a compelling risk/reward ratio to increase equity exposure just yet.

The S&P 500 Index is now sitting on its 100 day m.a.. It has held there four times since June 2013. The 200 day m.a. is at 1705 and is still rising. At 1700, the Rule of 20 P/E would be 17.1x. At that point, upside to fair value would be 19% and downside to the 15.5x level would be 10%. Unless the economic picture, or inflation, change markedly between now and the end of April, I consider the 200 day m.a. to be the worst case scenario in the market turmoil.

Eurozone Bank Earnings Weigh On Stocks

Banks saw the heaviest losses, with poorly-received updates from Lloyds Banking Group andJulius Baer dragging on the sector.

Data showing a faster-than-expected expansion in euro-zone manufacturing in January did little to lighten the mood, as investors focused on the latest disappointments in a downbeat earnings season.

SENTIMENT WATCH

Not since the early summer of that year has the S&P 500 experienced a standard correction of at least 10 per cent. This type of pullback, like a gardener pruning roses in late winter in order to encourage healthy growth in the spring, is what many professional investors would like to see this year.Red rose (…)

Surprised smile Alhambra Investment Partners this week said not only has margin debt hit a record, there has been a massive rise in overall leverage. (…) The firm estimates that total margin debt usage last year jumped by an almost incomprehensible $123bn, while cash balances declined by $19bn. “This $142bn leveraged bet on stocks surpasses any 12-month period in history.” (…)

A torrent of margin calls and larger ETF outflows can easily feed on itself and may well prompt a far stronger corrective slide in stocks than investors expect. Wilted rose

 Ghost Trader’s Almanac –  every down January on the S&P 500 since 1938, without exception, has preceded a new or extended bear market, a 10% correction, or a flat year.

  • Fingers crossed Most Expect Stock Turmoil to Pass A spate of bumpy, uncertain trading has knocked the Dow Jones Industrial Average down 5.3% from its Dec. 31 record. It is threatening to hang around for a while, many money managers say. The big question is how much worse it could get. The widespread belief is, not much.

    Get used to it.

    A spate of bumpy, uncertain trading has knocked the Dow Jones Industrial Average down 5.3% from its Dec. 31 record. It is threatening to hang around for a while, many money managers say. The big question is how much worse it could get.

There is just about everything in this last WSJ piece…and just about nothing with any substance.

ANOTHER BAROMETER…

If you are of the statistical type, you should buy the Stock Trader’s Almanac and drown yourself in numbers and, often, stupidity. Here’s the Decennial Cycle from Lance Roberts, to help you keep the faith ;

There is another piece of historical statistical data that supports the idea of a market “melt up” before the next big correction in 2016 which is the decennial cycle. 

The decennial cycle, or decennial pattern as it is sometimes referred to, is an important one. It takes into account the stock market performance in years ending in 1,2,3 etc. In other words, since we just finished up 2013 that was the third year of this decade. This is shown in the table below.

decennial-cycle-011414

This year, 2014, represents the fourth year of the current decade and has a decent track record. The markets have been positive 12 out of 18 times in the 4th year of the decade with an average return for the Dow Jones Industrial Average since 1835 of 5.08%. Therefore, there is a 66% probability that the end will end positively; however, that does not exclude the possibility of a sharp dip somewhere along the way.

Open-mouthed smile However, looking ahead to 2015 is where things get interesting.  The decennial pattern is certainly suggesting that we take advantage of any major correction in 2014 to do some buying ahead of 2015.  As shown in the chart above, there is a very high probability (83%) that the 5th year of the decade will be positive with an average historical return of 21.47%. 

The return of the positive years is also quite amazing with 10 out of the 15 positive 5th years (66%) rising 20% or more.  However, 2015 will also likely mark the peak of the cyclical bull market as economic tailwinds fade and the reality of an excessively stretched valuation and price metrics become a major issue.

As you will notice, returns in the 6th and 7th years (2016-17) become substantially worse with a potential of negative return years rising.  The chart below shows the win/loss ratio of each year of the decennial cycle.

Decennial-cycle-011414-2

AND MORE ON THE JANUARY BAROMETER

OK, this will be the end of it. Promise. But I thought it was relevant and, I must admit, a little interesting. Cyniconomics introduces the “JAJO EFFECT”:

Our argument begins with four observations (we’ll get to theories in a moment):

  1. Market sentiment often changes during the earnings reporting season – in which most of the action occurs in the first month of the quarter – and these sentiment shifts tend to persist.
  2. Individual investors tend to pay extra attention to their positions early in a quarter, reacting to the past quarter’s results and then looking ahead to the next performance period.
  3. Professional money managers often refine their strategies prior to client reviews or board meetings, which typically occur after results for the prior quarter become available.
  4. Investors (individuals and professionals) are even more likely to rethink strategy in January, partly because it marks a new annual reporting period but also because it tends to be a time for planning and reflection. (How are you doing on those resolutions, by the way?)

These observations are admittedly vague, but we suspect they’re relevant to stock performance. They suggest that the first month of a quarter may set the market’s tone in subsequent months. In the context of today’s markets, they tie into a few questions you may be asking about early 2014 volatility:  Is January’s market drop merely noise on the way to another string of all-time highs, or is there more to it than that? For instance, doesn’t it seem a little ominous that we stumbled out of the gates this year despite sentiment being rampantly bullish? Does this tell us to be cautious going forward?

If you happen to read the Stock Trader’s Almanac, you’ll connect our questions to the “January barometer” (…). The Almanac’s founder, Yale Hirsch, coined the term in 1972 when he presented research showing that January’s return is a decent predictor of full-year returns. He concluded: “As January goes, so goes the year.”

We’ll take a closer look at the January barometer below, while testing two variations drawn from the observations above.

“Downsizing” the January barometer

First, we doubt that any carryover of January’s performance is likely to persist for an entire calendar year. Based on the idea that quarterly reporting cycles may have something to do with these types of anomalies, it doesn’t seem right to think that January’s events should still be relevant near the year’s end.  The first month of a quarter may offer clues about the next quarter or two, but probably not three or four quarters later after investors have shifted focus to subsequent corporate earnings and investment performance reports.

In fact, even without quarterly reporting cycles, you may still question why January would continue to be a “barometer” by the third or fourth quarter.  You may expect to find lower correlations of January returns with the year’s second half than with the first half, and this is exactly what we see:

jajo effect 1

Note that the 33% correlation for the “downsized” January barometer is very high for these types of relationships. It’s comfortably significant based on traditional tests (the F-stat is 8.2).  By comparison, the correlation of January’s return with the 11 months from February to December is still high at 28% but less significant (the F-stat falls to 5.1).

Here’s a scatter plot and trendline for the year-by-year results:

jajo effect 2

The chart shows that 54% of the years with negative January returns included negative returns from February to June (13 of 24), while only 9% of the years with positive January returns were followed by negative February to June returns (8 of 60). In other words, the probability of a down market between February and June was six times higher after a down market in January.

Do years or quarters hold the key to the calendar?

Second, we considered whether April, July and October also qualify as barometers, based on our speculation that the January barometer is partly explained by quarterly phenomena.

In particular, we calculated correlations with subsequent returns for all 12 months to see if the beginning-of-quarter months stand out:

jajo effect 3

Needless to say, the correlations fit the hypothesis, with the four highest belonging to January, April, July and October. The odds of this happening in a purely random market are nearly 500 to 1. Call it the “JAJO effect.”

(…) If stocks don’t recover strongly by month’s end – say, back to the S&P 500′s 2013 close of 1848.36 – the odds favor continued weakness. As January goes, so goes the first half of the year.

 M&A — Best Start to Year Since 2011

Companies and funds inked $228.2 billion worth of acquisitions this month, the highest volume of activity since 2011, according to Thomson Reuters. (…)

Deal making volume is up 85% from January 2013 when all three indexes wrapped up January with gains between 4% and 6%. Yet all that could change quickly, and a big start to the year doesn’t necessarily translate into a big year for M&A.

By mid-February 2013, it looked like M&A was back in a big way — $40 billion worth of deals were announced on one day that month. Despite a 30% plus pop in stock indexes in 2013, M&A activity ended the year far below the pre-crisis peak years.

Still a big difference so far in 2014 is that overall deal making has been wide and deep — crossing industries and regions. Many of the big deals have been corporations buying up other corporations, and the stock market has mostly applauded buyers for making deals. (…)

The winning banks so far? Morgan Stanley takes the top spot for announced global M&A. Credit Suisse is right behind Morgan Stanley. The bank served as an adviser to Lenovo on both of its $2 billion plus bids for U.S. companies in the past two weeks – Motorola Mobility and IBM‘s low-end server business.  Behind them: Goldman Sachs, Bank of America, Deutsche Bank and then Citi. J.P. Morgan, typically a powerhouse deal maker, is in the 10th spot.

 

EUROZONE PMI POINTS TO STRONGER EXPANSION

At 54.0 in January, a shade higher than the flash estimate of 53.9, the seasonally adjusted Markit Eurozone Manufacturing PMI® confirmed the strongest rate of expansion in the eurozone manufacturing sector since May 2011. The headline PMI has risen in each of the past four months and has signalled growth since July last year. The improved performance of manufacturing was underpinned by solid expansions in production, new orders and new export orders, all of which rose at the fastest rates since April 2011. At its current level, the Output Index is signalling quarterly growth of at least 1.0%.

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The base of the recovery also broadened in January. Greece’s PMI moved back into growth territory for the first time since August 2009, joining the ongoing expansions seen in Germany, Italy, Spain, the Netherlands, Austria and Ireland.

imageThe upturn was led by Germany, where growth hit a 32-month record. Rates of increase also remained solid in the Netherlands and Austria – despite a sharp easing in the Netherlands – while Spain was the only nation except Germany to see its rate of expansion quicken.

Apart from stabilisation in a number of domestic markets, companies attributed further expansion to rising levels of new export business as global market conditions continued to strengthen. With France and Greece both seeing returns to growth for new export business, all of the nations covered by the survey reported concurrent increases in exports for the first time since May 2011.

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Job creation was recorded for the first time in nearly two years during January. Although the pace of growth in payroll numbers was modest, it was still the steepest since September 2011. Rates of manufacturing job creation accelerated in Germany (two-year record), Italy (32-month high) and Ireland (two-month peak), while employment also rose in Spain and Austria following periods of decline. Meanwhile, job losses slowed in France and Greece, but the Netherlands reported a decrease in staffing levels for the first time in five months.

Higher employment represented a response by manufacturers to improved demand and the sharpest rise in backlogs of work for almost three years, both of which suggested that the expansion in output could run further in the coming months. Signs of rising confidence were also provided by the steepest increase in input purchasing since mid- 2011.

Price pressures were relatively muted during January. Input costs rose at the slowest pace for four months. The rate of output price inflation, meanwhile, was only moderate and the weakest since last October. Germany, Italy and Austria were the only nations to report higher selling prices.