The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Invest with smart knowledge and objective odds

NEW$ & VIEW$ (31 JULY 2014)

Growth Rebound Stokes Fed Debate Federal Reserve officials delivered a modestly more upbeat assessment of the economy amid a second-quarter growth rebound and deepening debate inside the central bank about when to start raising interest rates.

Federal Reserve officials delivered a modestly more upbeat assessment of the economy Wednesday amid a second-quarter growth rebound and deepening debate inside the central bank about when to start raising interest rates.

U.S. gross domestic product, a broad measure of the nation’s output of goods and services, advanced at a seasonally adjusted annual rate of 4.0% in the second quarter, the Commerce Department said Wednesday, a significant rebound from a wintry 2.1% contraction during the first three months of the year.

Overall, the economy appears to be neither as weak as was recorded in the first quarter nor as strong as the latest numbers suggest in the second. Compared with a year ago, economic output was up 2.4% last quarter, in line with the modest pace of growth that has characterized much of this recovery. The economy only grew at about a 1% pace for the first half of 2014. (…)

Officials also noted that inflation—which has been running below their 2% goal for two years—is getting closer to the objective and the risks of continued low inflation are diminishing. (…)

The Fed will wait a “considerable time” after bond purchases end before raising rates, the central bank said, reaffirming a position it has had since late 2012.

The Fed also noted that even though unemployment is down, “there remains significant underutilization of labor resources,” by which it means slack that will keep inflation and interest rates low. (…)

Economists from J.P. Morgan Chase and forecasting firm Macroeconomic Advisers project the economy to maintain a growth rate of at least 3% for the rest of the year. The economy hasn’t posted three straight quarters above that mark in nearly a decade.

One Big Factor in the Economic Uptick: Government Spending…

Like it or not, the government comprises about one-fifth of the U.S. economy and so shrinking budgets directly translate to cuts in GDP. In recent years, what little growth the economy mustered came from the private sector.

…but the biggest factor remains private companies:

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(…) this is not just a case of better weather. Evidence indicates that there has also been an underlying improvement in the economy, and that robust growth will be sustained into the third quarter. The most promising signals come from Markit’s PMI surveys, which had surged higher in the second quarter and held at a post-recession high in July. Business clearly continued to boom at the start of the third quarter.

Households are also set to help boost the economy in the third quarter. July survey data showed consumer confidence running at its highest since 2007, with
optimism fuelled by greater job security and rising employment. The unemployment rate has dropped to 6.1%, its lowest since September 2008, with an
average of 231,000 jobs created in each of the first six months of the year so far.

imageLooking further ahead, an outlook poll conducted by Markit showed that business confidence among manufacturing and service sector companies in the US
about their activity levels over the coming year remained buoyant in the summer, unchanged on the optimistic readings seen at the start of the year.

However, while growth is set to continue into the third quarter, the second quarter’s growth surge may be the best we see this year in terms of the rate of expansion.
The same business outlook survey which showed optimism about business activity holding firm on the buoyant picture seen earlier in the year showed future
hiring and investment intentions falling, with companies focusing on cost control more so than at any time since the financial crisis. Many companies attributed this to uncertainties regarding the cost impact associated with new healthcare reforms. (Markit)

Janet Yellen sees first dissent in favour of Fed tightening

Charles Plosser, the hawkish president of the Philadelphia Fed, held out in a nine-to-one vote because he thought the intention to keep rates low for a considerable time after the Fed stopped buying assets did not reflect “considerable economic progress”. (…)

There was less change than expected in other parts of the Fed’s description of the economy, given the run of strong data that culminated on Wednesday with a 4 per cent reading for annualised growth in the second quarter of 2014.

The statement continues to say that household spending is rising moderately while the housing sector is slow. (…)

More stats FYI (and perhaps Mrs. Yellen’s interest):

  • Real final sales to domestic purchasers: +2.8% a.r. in Q2 vs +0.7% in Q1.
  • Core PCE deflator, a Fed’s favorite: +2.0% a.r. in Q2.
  • Nominal GDP: +4.1% Y/Y vs +3.3% in Q1.
  • Nominal Personal Income: +5.9% a.r. in Q2 after +5.0% in Q1.
  • Wages and Salaries: +6.6% after +7.7% in Q1.
  • Nominal DPI: +6.2% a.r. after + 4.9% in Q1.
  • Real DPI: +3.8% a.r vs +3.5% in Q1.

It is now easier to understand this:

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BTW:

Mid-Wage Work Comes Back as U.S. Moves Past Burger-Flipping Jobs

(…) Hiring in such fields [$40-60k] has increased 2.9 percent since the start of 2013, outpacing overall employment, according to research by JPMorgan Chase & Co. That marks a respite in a decades-long shrinking of the middle tier as payrolls picked up at the top end of the scale and in low-wage occupations such as food and retail services. (…)

Some 974,000 middle-income positions have been added this year alone. The increase in the number of jobs at mid-wage occupations since the start of 2013 matches the pace of growth in high-wage fields, according to seasonally adjusted data from JPMorgan.

Employment at lower-wage service occupations fell 0.5 percent since January of last year. (…)

Also consider this looking ahead at the important back-to-school season:

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And also this chart on Corn prices from Trading Charts:

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IF ONLY HOUSING COULD CONTRIBUTE:

Household formation for 2Q declined to a dreadful 0.46m y/y, even more depressed than its five year average of 0.58m. (ISI)

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EARNINGS WATCH

According to RBC Capital, 318 companies (70% of the S&P 500’s market cap) have reported. EPS is on track to rise 8.7% . Earnings ex-financials have surprised by 3.8% so far. Revenues have beaten by 1.2% while margins have contributed 2.6%.

Now, go back to Markit’s survey quoted above. Companies remain very focused on margins.

Euro Inflation Slowed to 0.4% in July, Lowest Since 2009 Euro-area inflation unexpectedly slowed in July to the weakest in almost five years, underscoring the European Central Bank’s concerns that the economy is too feeble to drive price growth.
Euro-Area Unemployment Unexpectedly Declined in June

The jobless rate dropped to 11.5 percent from 11.6 percent in May, the European Union’s statistics office in Luxembourg said today. While that’s still near a record high of 12 percent, it is less than the 11.6 percent median forecast of 31 economists in a Bloomberg News survey.

The number of people out of work dropped a seasonally adjusted 12,000 to 2.9 million in July, the Nuremberg-based Federal Labor Agency said today. Economists forecast a decline of 5,000, according to the median of 31 estimates in a Bloomberg News survey. The adjusted jobless ratewas unchanged at 6.7 percent, the lowest level in more than two decades.

Italy’s unemployment rate fell to 12.3 percent in June in a positive sign for Prime Minister Matteo Renzi’s economic program. Youth unemployment rose to a record high.

The jobless rate rose dropped from 12.6 percent in May, the Rome-based national statistics office Istat said in a preliminary report today.

Surprised smile Joblessness among those between the ages of 15 to 24 rose to 43.7 percent in June from 43.1 percent in May, today’s report also showed. That was the highest since records started in 1977.

Merkel Gives Putin a Blunt Message The frayed relationship between German Chancellor Angela Merkel and Russian President Vladimir Putin shows the disintegration of a decadeslong effort by both nations to bind the World War II adversaries to each other.

(…) The aftermath of the Flight 17 crash on July 17 reinforced a growing frustration in the chancellery and in the German Foreign Ministry: Mr. Putin wasn’t delivering on promises to exercise his influence on the separatists and get them to seriously negotiate a cease-fire.

Since then, Ms. Merkel has put her weight behind sweeping sanctions against Russia’s banking, military, and oil sectors. EU diplomats approved the measures on Tuesday. (…)

Russia lashes out at EU sanctions Moscow warns ‘irresponsible step’ will push up energy costs
Russians Back Strong Stance on Ukraine

Russians largely back their country’s tough stance on Ukraine, which earned Russia more economic sanctions from the U.S. and Europe this week. Nearly two-thirds of Russians surveyed before the latest round of sanctions believe Russia needs to have a “very strong position” in relations with its neighbor. One in five Russians still believe their country needs to have good relations with Ukraine by all means.

Most Russians Believe Russia Should Be Firm With Ukraine

Philippines Raises Benchmark Rate for 1st Time in 3 Years The Philippines raised its benchmark interest rate for the first time since May 2011, guarding against inflation risks even as economic growth slowed.
Most hedge funds fail

Most hedge funds fail: their average life span is about five years. Out of an estimated seventy-two hundred hedge funds in existence at the end of 2010, seven hundred and seventy-five failed or closed in 2011, as did eight hundred and seventy-three in 2012, and nine hundred and four in 2013. This implies that, within three years, around a third of all funds disappeared. The over-all number did not decrease, however, because hope springs eternal, and new funds are constantly being launched. (John Lanchester in the New Yorker via FT Alphaville)

Buyout Shops Look to Rivals for Deals Private-equity firms are increasingly buying companies from each other, a shift driven in part by the relative simplicity of completing such acquisitions.

NEW$ & VIEW$ (30 JULY 2014)

Home-Price Growth Slows

A survey covering 10 major U.S. cities increased 9.4% in the year ended in May, said theS&P/Case-Shiller Home Price Index survey released Tuesday. The 20-city price index increased 9.3%.

On an unadjusted basis, the 10-city index and the 20-city composite each increased 1.1% in May over April. Seasonally adjusted, both indexes declined 0.3%.

Consumer Confidence Surges

Generally pretty useless because it is coincident but these breakdowns are interesting:

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image(Haver Analytics)

U.S., EU Turn Up Heat to Punish Russia Over Ukraine The U.S. and the European Union adopted sweeping economic sanctions against Russia to punish Moscow’s unbending stance in the Ukraine conflict.

The trade and investment restrictions that EU governments, after much agonizing, agreed upon mark a major escalation of sanctions against Russia, which so far have been mostly token measures targeting individuals. New measures hitting Russia’s banks, oil industry and military could increase financial strains in its already sluggish economy while withholding technology that the nation’s modernization relies on.

The U.S. followed the EU’s move by announcing similar sanctions against Russian banks as well as the energy, arms and shipping sectors.

(…) Despite the growing economic squeeze on Russia—with its unpredictable fallout for the EU’s own markets, trade and growth—many EU officials believe they have only limited influence over the Kremlin.

Some EU officials voiced fears on Tuesday that Mr. Putin appears to be preparing Russians for international isolation. In Russia too, analysts said Mr. Putin was more likely to increase aid to the rebels in Ukraine in response to Kiev’s military offensive than he was to back down.

“There are no signs that we will soon get another chance to find a political solution” to the Ukraine conflict, said Gernot Erler, the German government’s coordinator for Eastern European issues. The governments in Moscow and Kiev are both “digging in,” he said.

(Bespoke Investment)

 
Banks in Euro Zone Ease Credit Standards

According to the ECB’s quarterly bank-lending survey, credit standards on loans to businesses eased for the first time since 2007. The difference in the percentage of banks reporting tighter lending standards and those reporting looser ones was -3%, the ECB said. That compared with a slight net tightening in the first quarter.

Bank lending to households and businesses was down 1.7% compared with a year earlier, the ECB said last week. That compared with a 2% annual decline in May. The improvement from May was due to a slight pickup in lending to households and a more modest drop in business lending.

According to Wednesday’s survey, banks continued to make it easier for households to obtain loans. Meanwhile, “net demand continued to be positive for loans to both enterprises and households and recovered further,” the ECB said.

Spain Growth Beats Bank of Spain Estimate Even as Prices Fall Spanish second-quarter growth beat the Bank of Spain’s estimate as economists say domestic demand supported a recovery in the euro region’s fourth-largest economy even as prices fell this month.

The Madrid-based National Statistics Institute today said that gross domestic product rose 0.6 percent from the first quarter, more than the forecast of 0.5 percent released last week by the Bank of Spain. Consumer prices fell 0.3 percent from a year ago in July, INE said in a separate release.

Households had no savings in the first quarter for the first time since the start of the series in 2000, INE data showed on July 2. Gross available income fell 2.7 percent from a year ago while spending rose 1.9 percent, it said.

Pointing up Spanish retail sales rose in June from a year ago by 0.2 percent, INE said yesterday. That’s the third straight month it’s increased, and the longest period of gains since 2007.

But Spanish retail sales sank 0.7% M/M in June after jumping 2.1% in the previous 2 months. (Chart from Haver Analytics)

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Bonds Surge From U.S. to Germany on Outlook for Record-Low Rates Bonds are rallying from the U.S. to Germany to Australia amid speculation the Federal Reserve will disappoint investors looking for signals it’s moving closer to raising interest rates from a record low.
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David Bowers: 3 reasons why the bond bull market is ending

(…) First, we believe that a major regime shift in the conduct of monetary policy is under way, with negative implications for bonds. (…)

They now need central banks to adopt “debtor friendly” monetary regimes committed to robust nominal GDP growth, and tolerant of higher wage growth. This is no longer a world where inflation is capped at 2 per cent; it is one where 3-4 per cent inflation is openly discussed .

The second reason why yields may have troughed is that the US labour market is tightening faster than expected. (…)

True, payrolls have not grown as rapidly or as dramatically, which suggests some impact from a declining participation rate. But what is striking is how the short-term unemployment rate (people out of work for less than six months) is just 0.7 percentage points away from its all-time low.

This has been an important leading indicator of wage growth. It would not surprise us if wages grew in excess of 3 per cent in 2015 – consistent with recent National Federation of Independent Business surveys that show US firms under growing pressure to raise compensation.

Stronger wage growth and an unemployment rate below 5.5 per cent are likely to bring forward expectations of a normalisation of US monetary policy. The more the Fed drags its feet, the more twitchy bond investors could get.

The third reason is that bond yields are starting to be constrained by their historical relationship to trend core inflation and to trend nominal GDP. Over the past 40 years, 10-year yields have never gone below trend core inflation (defined as its five-year compound average growth rate) apart from a brief moment in 2012.

With trend inflation currently 1.7 per cent and rising, it looks unlikely that yields will fall back to 2012’s 1.4 per cent trough. But, more importantly, yields are starting to be constrained by trend nominal GDP. For 45 years they have rarely traded below 70 per cent of trend nominal GDP, or more than 40 per cent above it.

This relationship has survived five years of quantitative easing, and currently indicates a floor for yields at around current levels. Should trend nominal GDP head towards 5 per cent, we would expect that “floor” to move up towards 3.5 per cent. (…)

Mohamed El-Erian: Preserve gains against market shakeouts

(…) However, high market valuations render investor portfolios more vulnerable to policy mistakes, market accidents and exogenous shocks. To help protect themselves, investors should consider enhancing the resilience of their portfolio management, in four ways.

First, when it comes to continuing to generate attractive risk-adjusted returns, sector- and security-specific portfolio differentiation (or what is known as “alpha” in the marketplace) is now even more important given the more limited scope for positive market-wide moves (“beta”). Investors need to be more event driven, including opportunities related to M&A (which will continue to grow to levels not seen since the global financial crisis) and disruptive technologies.

Second, rather than benefit from Fed actions, some foreign markets have struggled to navigate adverse spillover Fed effects. Within this group, the better-managed emerging economies (such as Mexico), as well as those likely to respond better after initial slippages (such as Brazil) remain attractive, warranting greater global diversification of equity portfolios with excessive home bias.

Third, and more generally, investors need to resist the temptation of adding risk based only on relative valuations. They also need to ensure the risk they are taking is warranted by current market prices. If they fail to do so, they will end up exposed to what investors in high-yield bonds have discovered the hard way in recent weeks – namely, how an obsession with relative values leads to overextended absolute valuations and, subsequently, discomforting market corrections.

Finally, this is the time to build greater flexibility in asset allocations. This can take the form of larger cash buffers, cash equivalents and other short-dated liquid bonds, all of which facilitate portfolio repositioning to exploit what is likely to be a series of quite indiscriminate market shakeouts.

For more sophisticated investors, this can be achieved through option positions that monetise as market volatility picks up and valuations dip.

EARNINGS WATCH

We are now two-thirds into the season as 66% of the S&P market cap have reported (281 companies). RBC Capital now sees EPS up 8.9% Y/Y (8.8% yesterday). Ex-Financials: +3.9%.

Consensus was +4.9% heading into the quarter.