Note to readers: First, thank you for all the nice comments on HARD HAT ZONE and THE RULE OF 20: THE HISTORICAL RECORD. Second, sorry if I have been late in reading them and, for new commenters, “approving” them for publication on the post. There is a bug somewhere and I cannot find it. I often see comments only when going into the blog’s dashboard which I tend to do infrequently due to time constraints. And even then, I do not always succeed in letting them reach the blog. Sorry about that. But I do appreciate the feedback.
(…) “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months,” Ms. Yellen said in remarks delivered here Friday. (…)
“Our decisions always depend on the degree to which incoming data continues to confirm the [Fed’s] outlook,” she said. (…)
Officials began the year expecting to raise rates four times in quarter-point increments but have delayed moving them because economic growth disappointed in the first half of the year and because they were uncertain about developments overseas and about the strength of the U.S. job market after some soft reports.
Ms. Yellen said her worries had dissipated, thanks in part to “solid” consumer spending and a job market rebound after a spring slump in hiring.
“While economic growth has not been rapid, it has been sufficient to generate further improvement in the labor market,” Ms. Yellen said. Broad measures of labor-market slack are improving, even though the unemployment rate has been steady most of the year near 5%, she added.
(…) Ms. Yellen highlighted the range of possibilities for rates in the years ahead, noting there is a 70% probability rates could be anywhere between zero and 3.25% at the end of 2017 and between zero and 4.25% at the end of 2018.
“The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted,” she said. (…)
There you go! 70% on 0.0%-3.25%. That’s an almost certain uncertainty.
Federal Officials Say No Thanks to Negative Rates Fed officials don’t think negative rates are needed in the U.S. because the economy and job market are improving and they are hoping they will never have to use them in the future given their uncertainty about whether the policy works.
But Ms. Yellen and other FOMC members and staff are looking in the rear-view mirror. Here’s up-to-date data to make you much less certain about the “continued solid performance of the labor market” and the overall economy:
Markit’s flash U.S. Services PMI declined from 51.4 to 50.9 in August, its lowest level since February.
Softer business activity growth was mainly linked to muted new business gains in August. Reflecting this, latest data signalled that new work expanded at the slowest pace since May and remained much weaker than its post-crisis trend. This contributed to a renewed slowdown in job creation during August, with payroll numbers rising at the least marked rate since December 2014. Some firms reported that subdued demand conditions and the need to cut costs had led to more cautious staff hiring plans and the non-replacement of leavers.
“Subdued demand and the need to cut costs”: as much as I can remember, this is the first time corporate America mentions the need to cut costs in such surveys. Why the need? Because margins are getting squeezed and 2017 budgets call for cost cutting (see HARD HAT ZONE). How to cut costs? Mainly staff.
The seasonally adjusted Markit Flash U.S. Composite PMI Output Index posted 51.5 in August, down slightly from 51.8 in July. As a result, this signalled only a modest expansion of private sector output, with the latest reading in line with the average recorded in 2016 so far.
Commenting on the flash PMI data, Chris Williamson, Chief Business Economist at Markit said:
The ongoing lacklustre economic growth signalled by the flash PMI suggests GDP growth is failing to accelerate in the third quarter from the weak 1.2% pace seen in the second quarter. Historical comparisons indicate that the PMI is signalling an annualised GDP growth rate of just under 1% in the third quarter, based on the data for July and August.
This is the first data set for Q3 with two months in. Markit’s PMI has been a pretty good forecaster on GDP and has rarely been too low.
While not as dire as the recent analysis by Deutsche Bank which calculated that a recession over the next 12 months is more than likely, with odds rising to 60%, overnight JPM released its latest recession probability analysis, and – somewhat unexpectedly following the last two stellar job reports and a full court political press that the recovery has rarely been stronger going into the election – now sees a 37% chance of a recession in the next 12 months. This is the highest recession probability calculated by Jamie Dimon’s bank during the current economic cycle, and matches the odds first laid out in early July. (…)
But don’t worry, the Fed is prepared:
Yellen Says Fed Could Expand Its Use of Bond Purchases The central bank’s main tool for fighting the next recession could be bond-purchase programs, Federal Reserve Chairwoman Janet Yellen said.
She cautioned however that “with long-term interest rates already quite low, the net stimulus that would result might be somewhat reduced.”
(…) there was no mention in her comments of negative interest rates, an approach tried by the Bank of Japan, European Central Bank and other central banks in Europe. (…)
Ms. Yellen said the Fed isn’t considering changing its 2% inflation objective. Nor is the Fed considering an economic growth target to set monetary policy (…)
Instead she argued that the main tools in the Fed’s box—bond-buying and statements about the likely path of rates, known as forward guidance—remain adequate. (…)
Ms. Yellen leaned on a recent research paper by Fed senior economist David Reifschneider, which argues that bond purchases and low-rate promises ought to be enough for the Fed to manage even a fairly severe recession. (…)
Hmmm…here’s what ZIRP and $4.3 trillion in bond purchases have done since 2010: +2.1% since the end of the last recession in 2009, down from +2.8% and +3.6% during the previous two recessions respectively. Growth has averaged +1.7% during the last 7 quarters.
U.S. Corporate Profits Climb as GDP Ticks Down A key measure of corporate profits rose this spring for a second straight quarter alongside modest growth in the overall economy, though U.S. businesses remain under pressure from global weakness and other forces.
Household outlays surged this spring at their strongest pace in a year and a half, but business investment declined for the third straight quarter. The result was a modest 1.1% annualized economic growth rate in the second quarter, according to revised Commerce Department data released Friday.
Company earnings also remain under pressure, potentially restraining investment in the coming months. A key measure of corporate profits rose 4.9% in the second quarter, but gains this year haven’t been enough to offset a drop last year. Second-quarter profits were down 2.2% compared with a year earlier. (…)
Overall economic growth has been tepid since late last year, with GDP advancing at a modest pace of 0.9% in the fourth quarter of 2015 and 0.8% in the first quarter of 2016. But U.S. growth has been poised to accelerate over the summer; forecasting firm Macroeconomic Advisers on Friday predicted GDP would expand at a 3.2% rate in the third quarter, the best performance in two years. (…)
Friday’s report showed slightly weaker second-quarter GDP growth compared with the government’s initial estimate last month of 1.2%. Growth in consumer spending this spring was revised up, offset by larger declines than had been previously estimated for residential construction and government expenditures.
Consumer spending jumped at a 4.4% annual rate in the April-to-June period, the strongest gain since the fourth quarter of 2014. But fixed nonresidential investment, a measure of business spending on equipment and other items, declined at a 0.9% pace following larger drops in the prior two quarters. The slump partly reflects weakness in the domestic energy industry because of low prices for oil and other commodities. (…)
U.S. Durable-Goods Orders Rebounded in July, Jumping 4.4% Demand for long-lasting factory goods rebounded in July—with durable-goods orders leaping 4.4%—in a sign the manufacturing sector could continue to stabilize in the second half of the year.
(…) Much of the uptick was due to civilian aircraft orders, but orders for core capital goods—the kind of business investment that has been conspicuously absent for the past few years——posted their largest gain since January, suggesting firms may finally feel comfortable making the large-scale investments that signal confidence in future demand.
A closely watched proxy for business investment, new orders for nondefense capital goods excluding aircraft, rose for the second-straight month, up 1.6% from June. (…)
The data suggest the manufacturing sector is firming in the second half of the year, coming on the heels of other recent reports suggesting the U.S. manufacturing sector stabilized in July. A Federal Reserve report showed manufacturing output posted its largest monthly advance in a year in July. And the Institute for Supply Management’s gauge showed manufacturing activity expanding in July for the fifth-straight month. (…)
Sorry, but the data makes no such suggestion other than to show that June and July were up after the collapse between November 2015 and May 2016.
YoY, U.S. manufacturing has been in recession for almost 2 years.
Markit’s flash U.S. manufacturing index declined from 52.9 in July to 52.1 in August:
Although solid growth of output was sustained, total new orders expanded at a slower rate in August. Data indicated that relatively subdued domestic demand was a reason behind softer growth in overall new work, as export sales increased at the fastest pace in 23 months.(…) Manufacturing employment increased only slightly
during August. Furthermore, it was the weakest rate of payroll growth seen for four months. (…) Meanwhile, stocks of finished goods and purchased items both fell as companies generally adopted cautious inventory policies.
This upbeat view was included in the WSJ account of the Q2 GDP report:
“Inventories were a major drag on growth in the second quarter, but now that businesses have better aligned inventories with demand, that should lift and inventories will add to growth in the near term,” PNC Financial Services Group chief economist Stuart Hoffmansaid in a note to clients.
But here are the facts. The first chart is for all businesses. The following 2 charts are for total manufacturing (left) and durable goods manufacturing. Inventories are not even close to be “better aligned with demand”:
And from the carriers’ mouth:
The amount of freight carried in July by the for-hire trucking industry, as measured by ATA’s monthly For-Hire Truck Tonnage Index, dipped 2.1 percent in July from June, ATA reported Aug. 23.
July’s dip follows a 1.6 percent dip in June. Compared to the same month last year, tonnage was up 0.3 percent. Year to date, tonnage is up 3.2 percent, ATA notes.
“On a monthly basis, tonnage has decreased in four of the last five months and stood at the lowest level since October during July,” said ATA Chief Economist Bob Costello. “This prolonged softness is consistent with a supply chain that is clearing out elevated inventories. Looking ahead, expect a softer and uneven truck freight environment until the inventory correction is complete. With moderate economic growth expected, truck freight will improve the further along the inventory cycle we progress.” (…)
So, let’s not bet too heavily that “inventories will add to growth in the near term.” Same is happening in Emerging Markets BTW:
The world economy remains in a funk. Global trade volumes contracted for the second consecutive quarter in Q2, highlighting weak overall demand. Industrial production grew last quarter as higher output in emerging markets more than offset declines in advanced economies. But because sales remained soft, much of that extra output went into inventories. As today’s Hot Charts show, the ratio of industrial production to exports in emerging economies surged to its highest level since the 2009 global recession. That does not bode well for production and hence economic growth in emerging markets in the second half of the year, particularly if exports remain weak. (NBF)
Sales of existing homes declined 3.2% (-1.6% y/y) during July to 5.390 million units (AR) after an unrevised June rise to 5.570 million. The decline erased the increases during the prior three months.
Sales of existing single-family homes fell 2.0% last month (-0.8% y/y) to 4.820 million. Sales of condos & co-ops dropped 12.3% (-8.1% y/y) to 570,000, the lowest level since February.
Weakness in sales occurred in most regions of the country.
The number of existing homes on the market declined 5.8% y/y to 2.130 million.
US mortgage applications for house purchase are slowing
Millenials not looking to work are obviously not thinking of buying a house just yet (chart via The Daily Shot):
Factset’s weekly summary:
- Earnings Growth: For Q2 2016, the blended earnings decline for the S&P 500 is -3.2%. The second quarter marks the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since Q3 2008 through Q3 2009.
- Earnings Revisions: On June 30, the estimated earnings decline for Q2 2016 was -5.5%. Seven sectors have higher growth rates today (compared to June 30) due to upside earnings surprises, led by the Information Technology and Consumer Discretionary sectors.
- Earnings Guidance: For Q3 2016, 77 (72 last week) S&P 500 companies have issued negative EPS guidance and 33 (30) S&P 500 companies have issued positive EPS guidance.
For Q3, Factset sees EPS down 2.1% from +0.4% last June 30th. Thomson Reuters is at –0.5% from +2.0%. Revisions are similar from a different base. For 2016 as a whole, Factset sees $118.50 and TR $117.97.
But trailing EPS are now $115.20 and the rule of 20 P/E is 21.1. Did you miss THE RULE OF 20: THE HISTORICAL RECORD last week?
(…) Bloomberg Intelligence breaks China’s total debt into four components: bank, corporate, government, and household. Bank debt has decreased slightly in relation to the size of the country’s economy over the past 10 years, to 19 percent of GDP in 2015. Corporate debt, meanwhile, jumped to 165 percent of GDP from 105 percent. Government debt rose to 22 percent of GDP. Household debt has increased to more than 40 percent of GDP, a rise of 23 percentage points.
Despite that rapid growth, household debt in China is far below levels in the U.S. before the subprime crisis. At its 2007 peak in the U.S., household debt reached almost 100 percent of GDP. What’s more, in China household savings are twice as large as debt. (…)
Another big difference between China today and the U.S. during the subprime bubble is that Chinese residential properties are typically purchased with significant down payments. According to the China Household Finance Survey, the average household debt in urban areas amounted to only 11 percent of home value in 2012. Mortgage debt remains comparatively rare. That showed up in the survey data: The median household debt was zero percent. The same survey also found that if housing prices were to decline 50 percent, less than 14 percent of mortgages would exceed the value of the properties. Given China’s high savings rate and low leverage, it seems unlikely that households would cause a financial crisis. (…)
While certain industries and enterprises have a lot of debt, Chinese companies’ average leverage isn’t high, according to a recent International Monetary Fund working paper. Since 2006, listed companies that aren’t state-owned have reduced median liabilities to 55 percent of common equity. At state-owned enterprises, however, median leverage has been unchanged at about 110 percent. Leverage has increased at the tail end of the distribution, driven by rising debt at companies in construction, mining, real estate, and utilities. An increasing share of debt is attributed to a few companies with high leverage ratios.
China is different from other markets in an important way. Many large corporations and nearly all the major banks are state-owned. In other words, the debtors and creditors are ultimately owned by the same entity. (…)
Fortunately for the rest of the world, China has a high savings rate. Capital controls aren’t fully lifted, making capital flight difficult. The government has almost complete control of the banking industry. In addition, China’s listed banks get about 70 percent of their funds from deposits. In comparison, U.S. investment banks in 2008 relied heavily on short-term money-market funding.
Such circumstances make it unlikely that China’s debt will spark a global crisis in the near future.
Will Today’s Dividend Rock Stars Stay on Top? Even as some managers have used holdings of dividend-paying stocks to post outsized returns, the trend has led to concern from many that the area has become overheated.
(…) Overall, assets in mutual funds and exchange-traded funds focused on dividend-paying shares have swelled to $672.6 billion, nearly double the $367.3 billion in assets those funds held at the end of 2011, according to Morningstar. (…)
(…) Government bonds, dividend-paying stocks and emerging-market securities have been bid up in the global search for yield. In an unusually quiet market, any shift in sentiment could send investors who have piled into similar positions all heading to the exits at the same time. (…)
September is typically the weakest month of the year; since 1928, the S&P 500 has dropped in September 56% of the time.
(…) In the first week of the fiscal third-quarter reporting season, Bank of Montreal, Royal Bank of Canada, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank all surpassed expectations with their quarterly profits. (Bank of Nova Scotia and National Bank of Canada conclude the reporting season for the big banks next week.)
Combined, they reported profits totalling more than $7.9-billion, or $7.4-billion after adjusting for one-time gains such as asset sales. This adjusted figure, which illustrates the banks’ underlying operating performance, was up 6.6 per cent from last year – a strong showing at the best of times, but remarkably strong given the low expectations.
In the case of CIBC, a standout, profit rose more than 8 per cent from last year after subtracting a gain from the sale of its stake in American Century Investments. Its profit on a per-share basis was nearly 14 per cent above the consensus estimate from analysts.
“It’s nice when everything comes together,” said Kevin Glass, CIBC’s chief financial officer. “All businesses performed well.”
To be sure, some of the profit drivers this quarter might not repeat next quarter. For example, the capital markets divisions of all four banks that reported results this week produced double-digit growth due to a pickup in corporate financing activity. Profits from this area, though, are notoriously lumpy.
The banks also benefited from ongoing efforts to cut costs, which are making them more efficient. BMO, which kicked off the reporting season on Tuesday, said its expenses during the quarter had risen just 2 per cent from last year, excluding the impact of the U.S. dollar. (…)
The two-year slump in crude oil prices is affecting the ability of energy companies to repay their loans. Earlier this year, many observers were concerned that the banks could be on the hook for huge loan losses. These concerns are now subsiding. BMO, RBC, CIBC and TD set aside a total of $1.3-billion to cover bad loans in the third quarter. While these provisions for credit losses are up substantially from last year, and the banks are reluctant to declare that the worst is over, things are moving in the right direction.
Provisions declined by nearly 10 per cent from the previous quarter, partly because of stabilizing oil prices. As well, bad loans represent, on average, less than 0.3 per cent of the banks’ total loans, which is at the low end of the historical average. (…)
Meanwhile, the banks remain confident that their exposure to Canada’s housing market is on solid ground.
“We continue to feel good about the quality of our portfolio, about our standards, about the quality of our [loan] originations,” Teri Currie, group head of TD’s Canadian personal banking, said during a conference call.
Laura Dottori-Attanasio, CIBC’s chief risk officer, put the downside risk into perspective. She said that under a particularly bleak scenario where house prices tumbled 30 per cent and the Canadian unemployment rate soared to 11 per cent, the bank would face less than $100-million in additional losses on a residential mortgage portfolio of $172-billion. Within that portfolio, 57 per cent of mortgages are insured, down from 65 per cent last year. The uninsured portion of the mortgage book would be largely unaffected. (…)
But the outlook remains skeptical among many others. Short sellers haven’t eased up on their bearish bets, given that the level of short interest on bank stocks remains high. And while analysts have been raising their target prices on bank stocks in response to the upbeat quarterly results – they’ve boosted their targets by an average of more than 3 per cent – most haven’t altered their tone.
Of course, the skeptics on Canadian banks have a point: The economy is struggling, tapped-out consumers don’t have a lot of room to expand credit card debt and regulators are determined to cool an overheating housing market that has served the banks well in recent years.
But as this week’s results demonstrate, the banks are very good at navigating these obstacles. The burden of proof, it seems, has shifted to the skeptics. (…)