Edge and Odds

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)

Edge and Odds

Invest with smart knowledge and objective odds

Month: June 2015

NEW$ & VIEW$ (30 JUNE 2015): Housing Springs Up.

U.S. Pending Home Sales at Highest Level in Nine Years A forward-looking indicator of home sales rose to its highest level in more than nine years in May, a sign the housing market is gaining traction after a shaky start to the year.

The National Association of Realtors said Monday its index of pending home sales increased 0.9% to a seasonally-adjusted 112.6, the highest level since April 2006. The index tracks contract signings, which usually close within two months.

The April index was revised down to 111.6 from 112.4. (…)

Pending home sales rose 6.3% in the Northeast and 2.2% in the West but fell 0.6% in the Midwest and 0.8% in the South. (Chart from Haver Analytics)

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Eurozone Inflation Rate Eased in June

The European Union’s statistics agency Tuesday said consumer prices in June were 0.2% higher than a year earlier, a reduction in the rate of inflation from 0.3% in May, and further away from the ECB’s target of just under 2%.

The core annual rate dropped to 0.8% from 0.9% as the rise in services prices slowed to 1.0% from 1.3% on the year.

Japanese industrial production on course for second quarter downturn

Having risen a buoyant 1.2% in April, some payback in May was always likely, but the 2.2% drop in Japan’s industrial production seen last month was far larger than consensus expectation of a 0.8% decline. The disappointing data call into question Japan’s ability to sustain its rebound from last year’s brief recession, corroborating the bout of renewed weakness seen in the country’s manufacturing PMI survey.

The official data mean that, having risen 1.6% in the first quarter, industrial production is currently on course to drop by 1.6% in the second quarter, wiping out all the gains from the positive start to the year. Even a strong number in June will do little to improve the second quarter performance. The government’s survey indicates that manufacturers expect to increase production by 1.5% in June, but that will merely take the overall quarterly decline to 1.5%.

The official data follow the flash manufacturing PMI, which fell below 50 to finish off the worst quarter for two years in June.

The data flow in recent months is therefore suggesting that the pace of economic growth slowed significantly in the second quarter compared to the surprisingly strong 3.9% annualised expansion recorded in the first three months of the year. Consumer spending has continued to be hit by last year’s sales tax rise and exporters are struggling in the face of sluggish demand in overseas markets.

Fingers crossed However, rays of hope were provided by a stronger than expected 1.7% rise in retail sales during May (taking sales 3.0% higher than a year ago). A similar upturn was seen in the PMI survey’s measure of orders for consumer goods, which hit a 14-month high in May. The services PMI – which is more domestically-influenced than the export-led manufacturing PMI – has also been signalling modest growth in April and May. More will become known about the strength of demand and economic growth momentum heading into the third quarter with the publication of final PMI data for manufacturing and services this week.

Part of Japan’s problem is China:

China can meet growth challenges, premier says

China is capable of “maintaining mid- to high-speed growth” despite challenges, Premier Li Keqiang said on Friday.

The nation’s economic fundamentals were performing well, Li said, adding that the economy is running “within a reasonable range“.

He said major economic indexes since May, including those for industrial production, investment, consumption, and exports and imports have remained stable or increased, while employment has also improved. (…)

China is getting a strong tail wind from lower oil prices which is helping lower inflation close to 1% YoY while wages are rising at a much faster pace. Hopefully this will shortly revive consumer demand as:

  • China Auto Sales Volume Y/Y Growth Drops Into Negative Territory

Starting in 2Q15, auto sales volume growth has dipped into negative territory. Year-over-year sales volume growth for the month of May was reported at -0.4%, an uncommonly low growth number within the period that official statistics for auto sales have been available. Given the falling sales volume in Q2, YTD Y/Y sales volume growth was only 2.2% in May. In recent years, annual sales volume growth expectations have been set within a range of 5% to 10%. This year, however, sales growth has fallen below the lower limit for expected sales growth.

Looking at auto sales volume composition, sedan sales volume growth decelerated significantly in Q2. In the month of May, sedan sales volume growth was -10%, approaching a historical low of -12% recorded in 2008, during the Global Financial Crisis. Looking at truck and transport van sales volume, a recovery from -20% growth in the beginning of the year has been observed. However Y/Y growth during May remained in negative territory at roughly -10%. The SUV segment has been the lone bright spot in terms of sales volume growth: monthly Y/Y sales growth and YTD Y/Y sales growth has been maintained at an elevated level of 40%. (CEBM Research)

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  • Bloomberg GDP tracker points to 6.5% growth

Our GDP tracker put growth at 6.55 percent year on year in May, up from 6.4 percent in April. That reflects a slight acceleration in industrial output, underpinned by rapid growth in infrastructure spending. A turnaround in property sales is another hopeful sign. We believe growth will stabilize in the months ahead. (…)

Overcapacity in industry and empty apartments in the property sector dent the prospects for investment. Our calculations suggest fundamental demand in the real estate sector is about 8 million units a year. Supply is currently about 10 million units. A contraction in construction as supply comes into line with demand is another reason to be pessimistic about medium-term growth.

Throw a shrinking working-age population into the mix and it seems that even with successful reform, the engines of growth will continue to sputter. Our forecast puts potential growth in 2020 at about 6.5 percent. Others are less optimistic, with a vocal minority expecting a much sharper slowdown on a scenario of reform failure and financial sclerosis.

China at pains to calm stock market Rules drafted to let state pension funds invest in equities

(…) Earlier on Tuesday, the Asset Management Association of China issued a statement titled: “Beautiful sunlight always comes after wind and rain,” urging members to “seize the investment opportunity” following a near 25 per cent fall in the Shanghai market over the past fortnight.

“As we pursue personal profit, we should also pay attention to others’ profits and not abandon our integrity as we grab for riches, not kill the goose that laid the golden egg,” the industry body said.

The government itself has also been intervening to soothe fears of a stock market collapse. Late on Monday, China’s securities watchdog said that an “excessively fast correction” was not healthy, while the finance and social security ministries published draft rules that would permit the state pension fund to buy stocks. Such a move could allow up to Rmb600bn ($97bn) to enter the market. (…)

In addition, there were indications that Central Huijin, the main state-owned financial holding company, had moved to anchor demand for blue-chip stocks by buying Rmb10bn in large-cap exchange traded funds on Monday.

Meanwhile, the S&P 500 Index has dropped 3.5% since June 18 to sit on its still rising 200 day m.a.. Coincidentally, this is right on the Rule of 20 fair value line. Fingers crossed

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GREEK PRIMER

Good piece from Deutsche Bank if you want to know a lot more about the Greek tragedy (HT ben Hunt).

NEW$ & VIEW$ (29 JUNE 2015): Turmoil!

U.S. Consumer Spending Soared in May

Consumer spending rose 0.9% in May from a month earlier, the biggest jump since August 2009, the government said Thursday. The bulk of the increase came on goods, including everyday items such as groceries and big-ticket purchases like cars. Spending on services rose modestly.

Consumers’ incomes—including wages as well as government benefits—grew a healthy 0.5% last month, the same as April, marking the best two-month stretch of income growth since early 2014.

(…) the price index for personal consumption expenditures-picked up in May but were up just 0.2% from a year earlier. Core prices, excluding food and energy costs, were up 1.2% over the year.

Any doubt that wages are accelerating? (table from Haver Analytics)

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From Ed Yardeni:

China Rate Cut Hacks a Perilous Path Central bank’s response to stock market’s nose-dive sets a dangerous precedent

The Shanghai Composite is off nearly 22% from its peak just over two weeks ago, including a 3.3% fall on Monday. (Chart from BI)

Shanghai Composite

After Chinese stocks cratered Friday—the culmination of a 10-trading-day run that erased nearly a fifth of the stock market’s value—China’s central bank sprang a surprise quarter-point interest rate cut along with a loosening of bank reserve requirements Saturday.

Responding so obviously to the stock market sets a dangerous precedent.

While most assumed the government found great virtue in the bull market to help companies raise capital and deleverage balance sheets, Saturday’s move removes whatever pretense some may have had that market forces were the main driver of Chinese stocks.

The PBOC cited persistently high borrowing costs in the real economy for the cut. That is true. Banks have been reluctant to cut rates and the effect of very low inflation means real, price-adjusted rates have fallen only slightly.

But if this was the rationale, then the central bank should have moved earlier in the month when May’s sluggish inflation data was released, notes Standard Chartered. But back then, the stock market was near its recent high point. (…)

But fear of a pause in stimulus became a factor behind the stock market selloff. Chinese investors know the good times will last only so long as the easing does. (…)

The real question becomes, how long is the PBOC willing to keep this up? Given how poorly supported stocks are by the fundamentals, and given how much margin leverage isembedded in investors’ positions, withdrawal of state support will give a shock that could prove calamitous.

It remains prudent for central banks to keep the stock market in mind when making policy moves. But making stocks the implicit target of central bank policy, as China now has, sets the economy on a perilous path.

This reporter was obviously not present in October 1987 when the Fed immediately reacted after the crash. Even though fewer than 10% of Chinese households own shares (U.S. = 50%) drops of this magnitude can hurt the economy and it is appropriate for the central bank to try to mitigate the impact.

(…) hectic activity at brokerages and trading firms has been a direct support to an otherwise sluggish economy. According to research firm Capital Economics, this alone boosted the economic growth rate by half a percentage point in the first quarter, when GDP was up 7% from a year earlier. Losing this support could cut a full percentage point off the annual growth rate, Capital Economics estimates.

Rising stock prices have also encouraged a wave of equity issuance, which has helped wean companies off dependence on debt finance. If this avenue closes, China will find it that much harder to cut debt levels.

The pain could spread further if stock losses cause a wave of defaults for those who borrowed money to invest. There is some 2.2 trillion yuan ($354 billion) of margin financing in the market currently, which Goldman Sachs estimates is equivalent to 12% of free float market cap of marginable stocks, or 3.5% of GDP. The investment bank’s strategists, in a note on Monday, called both these ratios “easily the highest in the history of global equity markets.” (…) (WSJ)

Capital outflows, then and now

(…) compared to 2012 everything is certainly much, much more ring-fenced.European bank exposures being an excellent case in point.

TURMOIL

If Atlantic salmon fishing on the Québec North Shore is any indication, this will be a tough summer. I was lucky to land (and release) four salmons but many of my buddies, all good fishermen, were skunked. Lots of rain prior to our arrival muddied the Moisie River, quieting the fish which perhaps did not know its way upstream.

Investors must feel the same with Grexit looming, China crashing and the Fed beginning the rehab from financial heroin overdose. Given today’s opening (2080), U.S. equities remain overvalued at 18.7x trailing EPS and 20.4 on the Rule of 20 P/E.

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The S&P 500 has broken its 100 day m.a. which is flattening. Next “support” is the still rising 200 day m.a. at 2054, last tested on February 2nd. European equities are off 6.2% from their April peak.

The Q2 earnings season begins in 2 weeks (even though 13 companies have already reported: 10 beats, 3 misses). Estimates continue to edge lower but only marginally. It is also reassuring that earnings preannouncements are not getting worse. Fingers crossed

The U.S. consumer is back which will alleviate any fear of a significant economic slowdown.

Not to say that U.S. equities are not vulnerable; extreme valuation levels are always dangerous. Just to say that the U.S. economic background should not be a negative factor.

Iran nuclear talks delayed by disagreements Nuclear negotiations held up by arguments over draft accord

(…) there have since been continued disagreements over core elements of the potential agreement, including the pace at which sanctions will be lifted and the access that international inspectors will have to Iran’s nuclear facilities, especially military sites.

Mr Zarif’s departure from Vienna on Sunday comes after Iran’s supreme leader Ayatollah Khamenei laid out a series of red lines last week that appeared to be unacceptable to the world powers Iran is negotiating with.

In his speech, Mr Khamenei said sanctions relief under any deal would need to be immediate and there would be considerable limits on where international inspectors would be allowed to visit in Iran.

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