Month: May 2016

Janet Yellen Sees Rate Hike Coming Soon Federal Reserve Chairwoman Janet Yellen on Friday signaled the central bank will likely raise interest rates within months if the U.S. economy keeps gaining strength.

(…) “It’s appropriate…for the Fed to gradually and cautiously increase our overnight interest rate over time, and probably in the coming months such a move would be appropriate,” she said during a panel discussion at the Radcliffe Institute for Advanced Study at Harvard University. (…)

One reason for action: After a couple of weak quarters, “growth looks to be picking up from the various data that we monitor,” Ms. Yellen said. (…)

Forecasting firm Macroeconomic Advisers on Friday projected growth in gross domestic product, a broad measure of the goods and services produced across the economy, would accelerate to a 2.5% annual rate in the second quarter from the first quarter’s 0.8% pace. (…)

A key measure of corporate profits—after taxes, without inventory valuation and capital-consumption adjustments—rose at a 1.9% pace in the first three months of 2016 after declining the prior two quarters, the Commerce Department said Friday. (…)

Investors on Friday afternoon saw roughly a 61% chance that the Fed would raise rates either in June or July, up from 56% a day earlier, according to fed-fund futures tracked by CME Group. (…)

Two forces that have weighed on business earnings and the broader economy seem to be fading: the energy slump and the strong dollar. (…)

The New York Fed Nowcast Model:

“growth looks to be picking up from the various data that we monitor,” Ms. Yellen said.

Hmmm…other than the recent good housing stats…

• David Rosenberg calculates that over the past month, just 42% of the incoming economic reports have come in above expected while 55% have disappointed.
• Markit’s Services PMI declined -1.6 in May to 51.2%, bringing the composite PMI down to just 50.8%, which Markit claims is consistent with less than +1% real GDP growth. The composite PMI for employment declined -0.9 to just 51.7%, which Markit claims is consistent with payroll employment of just +128k.
• NBF adds that

net job gains in the help-supply agencies industry has turned negative for the first time in the current expansion on a six-month annualized basis. In the past, such a development has always preceded a sharp deceleration in the pace of overall job creation. Consequently, we see non-farm payrolls growing only 90,000 in May, the weakest showing since March of last year (our call also accounts for the impact of the Verizon strike which depressed payrolls by 35,100 in May according to the BLS strike report).

• See also Moody’s comment on employment at the end of this post.
• Real capital goods shipments were revised down a stunning -6.0%, and April increased just +0.2%. So on balance, they’re down -5.8% from where they were. And 2Q is on track to decline -2.2% q/q a.r. (ISI)
• Citigroup’s economic surprise index remains well into negative territory (Ed Yardeni).

• Highly economy sensitive Transportation stocks remain in a downtrend, opening a dangerous gap with the main indices (Ed Yardeni).

Verizon, unions agree to pay raises, new jobs to end strike A tentative deal between Verizon Communications Inc and leaders of striking unions includes 1,400 new jobs and pay raises topping 10 percent, the company and unions representing about 40,000 workers said on Monday, hoping to end a walkout that has lasted nearly seven weeks.

The CWA said Verizon agreed to provide a 10.9 percent raise over four years while Verizon put the increase at 10.5 percent. According to the CWA, both numbers are correct, with the union’s calculation including compounded interest as subsequent raises are determined from a new base salary. (…)

Iata warns of slowdown in air travel Trade body signals cautious outlook for passenger traffic

(…) Tony Tyler, the outgoing director-general of Iata, signalled a more cautious outlook for passenger traffic after growth in April of just 4.6 per cent over the same period last year — the lowest pace since January 2015. It is the second consecutive month of sharply slower growth after February’s 8.6 per cent increase.

While some of the slowdown could be attributed to the terrorist attacks at Brussels’ airport and metro in March, there were still signs that underlying traffic growth could be slowing, he said. Excluding the attacks, April’s traffic growth was estimated at 5 per cent. (…)

The April slowdown follows growth in the first quarter of 6.4 per cent, still below Iata’s forecast for a rise in traffic of 6.9 per cent this year. That target, and its projection for global fleet expansion of 7.1 per cent, may now have to be revised when members gather for the annual meeting this week in Dublin. (…)

China Fixes Yuan at More Than Five-Year Low

The People’s Bank of China set its daily reference rate for the yuan at 6.5784, the weakest level since February 2011 and 0.45% lower than Friday’s fixing point. Onshore, the yuan is allowed to trade 2% above and below the so-called fix. (…)

The onshore yuan has weakened 6% against the dollar since August, when a shift to a market-determined exchange rate and a devaluation prompted months of volatility in the yuan and worries of capital flight from mainland China. (…)

The Wall Street Journal has reported that since January the PBOC has quietly retreated from the more market-orientated exchange rate and resumed adjusting the yuan’s daily value higher or lower based on whatever suits Beijing best.

China Default Chain Reaction Threatens Products Worth 35% of GDP

The risk of a default chain reaction is looming over the $3.6 trillion market for wealth management products in China.

WMPs, which traditionally funneled money from Chinese individuals into assets from corporate bonds to stocks and derivatives, are now increasingly investing in each other. Such holdings may have swelled to as much as 2.6 trillion yuan ($396 billion) last year, based on estimates from Autonomous Research this month. (…)

Those concerns have become more pressing this year after at least 10 Chinese companies defaulted on onshore bonds, the Shanghai Composite Index sank 20 percent and China’s economy showed few signs of recovery from the weakest expansion in a quarter century. (…)

The outstanding value of WMPs rose to 23.5 trillion yuan, or 35 percent of China’s gross domestic product, at the end of 2015 from 7.1 trillion yuan three years earlier, according to China Central Depository & Clearing Co. An average 3,500 WMPs were issued every week last year, with some mid-tier banks, such as China Merchants Bank Co. and China Everbright Bank Co., especially dependent on the products for funding. (…)

“We’re starting to see layers of liabilities built upon the same underlying assets, much like we did with subprime asset-backed securities, collateralized debt obligations, and CDOs-squared in the U.S.,” Charlene Chu, a partner at Autonomous who rose to prominence in her former role at Fitch Ratings by warning of the risks of bad debt in China, said in an interview on May 17. (…)

The most common source of funds for repayment of WMPs is the issuance of new WMPs, Fitch analysts Jack Yuan and Grace Wu wrote in March. That leaves the products vulnerable to any sudden drop in demand, a risk alluded to in 2012 by Xiao Gang, then chairman of Bank of China Ltd., when he warned of “Ponzi scheme” dangers for the industry. (…)

For a Gadfly commentary on banks’ exposure to WMPs, click here.

Suncor Resumes Oil-Sands Operations After Wildfire Shutdown

SENTIMENT WATCH

Are The Bulls Back?

Intriguing charts from Lance Roberts’ blog:

Individual investors are actually heavy in equities…

…in fact, very heavy!

Yet they ain’t bullish…

…but look again, they are also not bearish. Only 30% AAII bears! Same scarcity of bears from the Investors Intelligence survey:

Here’s the reason: they are up to their ears in higher yielding securities:

Bernanke’s gambit worked! Joe Public has gone wild on yield stocks while professional investors (please do not confuse with “smarter investors”) have been net sellers all the way up. This next chart combines sentiment for individual and professional investors. A contrarian might want to buy equities at this high bearish level, but note how this last jump in bearishness has not occurred along with a decline in equities.

Meanwhile, nobody is bullish and money is flowing out of equity funds like a torrent, yet markets are up on rising volume.

The pros are bearish while fully invested Joe Public reaches for yield one hand pinching his nose and the other hand crossing fingers unsure of what he would prefer Yellen to do.

Q1’16 EPS ended the quarter down 5.1%, a slight beat from the expected –7.1%. EPS are seen down 3.5% in Q2, up 2.6% in Q3 and up a big and doubtful 9.8% in Q4. Last week, I commented that it would be unwise to bet too heavily on this Q4 estimate since it assumes that margins will be back to their Q2’15 and Q3’15 peaks of 10.4% from 9.7% in Q1’16. I failed to mention that it also rests on sales rising 4.4% YoY, a rather radical improvement after +0.8% during the first nine months of the year. Analysts must have a direct link with a pretty merry Santa.

Moody’s has no such link but instead looks at history which makes it very doubtful about this anticipated Q4 sales surge, arguing that declining capital goods orders will incite executives to become more cautious in coming months and pare down hiring activities which, likely, will negatively impact consumer spending during the second half of the year.

We are ending May on an uptrend about to retest the previous tops. The 100 day m.a. has perked up but the 200 day m.a. keeps edging down and is now 4.3% below the S&P 500 Index level.

More fundamentally, the Rule of 20 PE is back at 20 which has proven a formidable barrier since October 2009. Q2 earnings don’t seem likely to provide much boost to investor enthusiasm so the impetus needs to come from lower inflation or from better sentiment. Lower inflation does not strike me as very positive at this point in time. As to sentiment, if I were data dependent to judge its evolution, I would be worried…unless, perhaps, I monitor the same “various data” the Fed monitors.

Hold Your Nose and Buy Europe

(…) According to index provider MSCI, U.S. stocks have lost 1.4% over the past year, including dividends. But Europe is down 12%, and emerging markets have fallen a sickening 21.8%.

With Brazil near chaos, much of Europe only millimeters away from recession, a state-lubricated debt binge in China, a chance that Britain may withdraw from the European Union and negative interest rates in much of the world outside the U.S., these markets are awash in bad news. (…)

Consider price to book value, a measure of corporate net worth. Since 1970, according to data from MSCI, the average price to book value of European stocks has been about 25% below that of U.S. stocks. As of April 30, it is 40% lower. The dividend yield on European stocks, historically about one-third higher than in the U.S., is 69% higher.

In emerging markets, where MSCI’s data begin in 1995, the price to book is only half that of U.S. stocks, about a tenth below its historical average. Dividend yields are roughly one-third higher than in the U.S. (…)

Here we go again on the cheap Europe theme, last promoted by GMO’s Ben Inker in Ditch the Good, Buy the Bad and the Ugly on early 2015 to which I replied in Don’t Be A Jerk! European markets have since lost 13% while U.S. equities have been flat. In fact, Euro-ex-UK equities have significantly underperformed U.S. equities over 1,3,5 and 10 years (last 10 years: +6.9% USA vs +2.7% Euro-ex=UK in US$, +3.0% in euro).

Yes, European companies have a lower price-to-book ratio. But they also have a lower return on book (ROE). EU GDP has grown 0.7% annually over the last 5 and 10 years compared with +2.2% and +1.6% for the U.S. respectively.

In spite of their big underperformance, EU equities are not selling at a lower relative P/E than they have historically as this RBC Capital illustrates.

So what would anybody with reason bet that this dysfunctional entity will outperform the USA. You not only need to be a mad contrarian with a very high risk tolerance (i.e. have a lot of money or manage other people’s money), you also need to get pretty lucky in coming years in order to overcome all the EU problems. Inker advised “If You’re Going To Be a Jerk, at Least Be a Contrarian Jerk”. My advice is the same: don’t be a jerk! As I concluded last year:

If you live in a relative world and manage other people’s money, you may be able to find some justification in selling the U.S. and buying Europe. Maybe you will be lucky enough and Draghi’s latest gambit will have finally worked, Greece will have paid its debt, the banks will be back on their feet, the Euro will be 1.50, France will be a strong harmonious country and Merkel will have been re-elected with her strongest majority ever.

Being a contrarian does not necessitate being a jerk. Being a contrarian on Europe is investing in “something” nobody really knows what it is, what it should be, how it can be and how it will be. It is like buy a company with too many CEOs thinking differently and all managing in different directions. You may think you are a contrarian investing in it, but you are just being “a contrarian jerk”.