U.S. Consumer Spending Flat in August U.S. consumers tapped the brakes in August, signaling slower but sustained growth for a key pillar of the economy.
PCE was bound to slow down after +0.4% in July, +0.5% in June, +0.4% in May and +1.0% in April, totalling +7.1% annualized in 4 months as the savings rate declined from 6.2% in March to 5.6% in July (5.7% last month).
The personal-consumption expenditures price index rose only 0.14% from the prior month (+1.0% YoY). Core PCE prices rose 0.18% from the prior month and are up 1.7% YoY. Interestingly, PCE headline inflation is identical to PCE-core inflation during the past 6 months at 1.7% annualized. That is in spite of the fact that CPI-Food-at-home is –1.9% YoY and CPI-Energy is –9.2% YoY.
Last September 19, I wrote about the large, unusual gap between CPI and PCE inflation, arguing that the gap between the two gauges (core) was mainly due to measures of health care and shelter costs and that the gap would likely close in the near future. So far this year, core CPI is up 1.54% (+2.3% annualized) while core PCE inflation is up 1.27% (+1.9% annualized). Last two months: +0.34% vs +0.30%). Nonetheless, the YoY gap is unchanged at 0.6%.
RESTAURANT BIZ IS CONTRACTING
Dining out is among the most discretionary consumer expenditures:
Due in large part to declines in both same-store sales and customer traffic, the National Restaurant Association’s Restaurant Performance Index (RPI) fell below 100 in August. The RPI stood at 99.6, down 1.0 percent from a level of 100.6 in July.
“Broad-based declines in the current situation indicators caused the RPI to fall below 100 for the first time in eight months,” said Hudson Riehle, senior vice president of research for the National Restaurant Association. “Restaurant operators reported soft sales and traffic in August, along with corresponding dips in the labor indicators. While the Expectations component of the index remains in expansion territory, it too has trended downward in the past several months.” (…)
The Current Situation Index stood at 98.6 in August, down 1.9 percent from a level of 100.4 in July. The August reading represented the lowest value since February 2013. After three consecutive months of mixed results, same-store sales reports took a downward turn. Only 30 percent of restaurant operators reported a same-store sales increase between August 2015 and August 2016, while 53 percent reported a sales decline.
Similarly, operators reported a net decline in customer traffic. Only 21 percent reported an increase in customer traffic between August 2015 and August 2016, while 59 percent reported a traffic decline. August represented the fourth consecutive month in which restaurant operators reported a net decline in customer traffic.
Deflationary “food-at-home” prices while restaurant prices keep rising may discourage people to dine out.
Meanwhile, restaurant margins must be expanding merrily given that the PPI-Finished Consumer Foods is down 4.0% YoY with crude foods down 23.1%. However, with traffic down during the last four months and sales now turning south, restaurant operators will need to manage their staff in order to protect margins. Employment in the restaurant industry has grown by over 1 million employees since 2013, averaging nearly 35,000 new jobs per month over the last 31 months. Growth has slowed to 11,600 new jobs per month since March 2016.
The share of subprime auto loans backing bonds that were at least 60 days behind on payments climbed to 4.86% in August, up from 3.98% a year earlier, according to Fitch Ratings. Annualized net losses reached 8.89%, up from 7.02% a year prior. (…)
A surge in new auto leases is resulting in more used cars on the market, which is pushing down some auto values. Leases accounted for 31% of new-car financing in the first quarter compared with 19% in the first quarter of 2010, according to Experian Automotive. (…)
Subprime auto-loan lenders are increasingly comprised of smaller companies that have launched in recent years. AmeriCredit and Santander Consumer USA’s subprime loans accounted for 54% of outstanding subprime auto loan securitizations as of August, according to Fitch, down from 84% in 2013. A report by Moody’s Investors Service earlier this year said that small lenders have been leading the increase in subprime auto bond issuance and are also the main driver of losses.
Canada’s Big Bet on Stimulus Draws Global Attention In the global struggle to boost growth, a Canadian experiment in fiscal spending is providing a test case for some of the world’s biggest economies.
Prime Minister Justin Trudeau’s Liberal government unveiled a plan last spring to spend heavily on tax benefits and infrastructure, with $120 billion Canadian dollars (US$91.39 billion) going into infrastructure over the next decade, including about one-tenth of that on short-term projects.
It’s a bold bet to inject life into an economy struggling with a rout in commodity prices, especially crude oil, which was once Canada’s top export. It also highlights the limits of monetary stimulus, since the country’s central bank cut rates twice in 2015, to 0.5%, and has acknowledged—as its counterparts around the world have—that monetary policy becomes a less powerful tool when interest rates are already low.
Mr. Trudeau’s big infrastructure spend will be largely financed by a bigger deficit, which is projected to reach C$29.4 billion this fiscal year, or about 1.5% of gross domestic product. (…)
Finance Minister Bill Morneau has said the new spending—which during the first two years includes about 40% for infrastructure and most of the remainder for child benefits and other social transfers—should add 0.5% to Canada’s economic growth in the fiscal year ending 2017 and 1% in the fiscal year ending 2018. Economic growth in Canada, which averaged around 3% during the decade leading up to 2008, was just 1.1% in 2015 and the Bank of Canada has said it expects 2016 growth to come in around 1.3%. (…)
BTW, Canada’s government debt is among the lowest in the world at 94% of GDP (U.S.: 107%, Japan: 233%)
Rates of expansion in output and new orders accelerated further, rising at rates rarely achieved since the middle of 2014. The domestic market remained a prime driver of new business wins, while the weaker sterling exchange rate drove up new orders from abroad.
At 55.4 in September, up from 53.4 in August, the seasonally adjusted Markit/CIPS Purchasing Managers’ Index® (PMI®) rose to its highest level since June 2014. Furthermore, the rebound in the PMI level since its EU-referendum related low in July has been sufficient to make the third quarter average (52.3) the best during the year-to-date.
September saw manufacturing production expand at the quickest pace since May 2014. Growth was led by the consumer goods sector, where output rose at the quickest pace in one-and-a-half years. There were also substantial and accelerated increases at intermediate (11-month high) and investment (eight-month high) goods producers. (…)
UK manufacturers reported improved demand from clients in Asia, Europe, the USA and certain emerging markets. (…)
Higher import costs, a by-product of the weak exchange rate, led to a further substantial increase in average purchase prices in September. Manufacturers passed on part of the rise to clients in the form of higher charges. Output price inflation remained well above the series average.
Sterling Sharply Lower on Brexit Trigger News The British pound slumped Monday after after Prime Minister Theresa May said the U.K. would kick off the process of separating from the European Union by the end of March.
Opec deal: How Riyadh and Tehran poured oil on troubled waters How sworn enemies reached a pact on crude production
(…) “It is a massive deal for the oil market that Saudi Arabia and Iran can set aside the poisonous regional rivalry that has dominated the relationship in recent years,” said Bill Farren-Price, an energy industry consultant. “It shows the extent both sides wanted and needed to get a deal done.” (…)
The Iranians believe they have secured a target of 3.9m-4m b/d. Meanwhile, Saudi won a commitment from other members to pursue cuts, even though some are bristling.
“These countries need to understand there is a greater reward for them to freeze at these levels,” said one Opec source. “It is all about the distribution of the misery.” (…)
(…) But even after OPEC’s agreement, most now don’t see a rebalancing until the middle of next year, or even later. Global inventories are near record levels, and OPEC has been outflanked by shale producers that have weathered oil’s collapse and can boost output when prices rise. (…)
Countries outside of OPEC now account for 58% of the world’s total output, which in the second quarter ran at 95.9 million barrels a day, above estimated demand of 95.6 million barrels a day, according to the International Energy Agency. (…)
In July, the most recent period for which data are available, stockpiles of crude oil and refined products held by countries in the Organization for Economic Cooperation and Development topped 3.1 billion barrels, up 15% from two years earlier, according to IEA data. Non-OECD stockpiles also stand near records, according to Bernstein Research estimates. (…)
Some investors say the consensus is too bearish and think the glut will ease. They note that companies have cut hundreds of billions of dollars in spending on oil and natural-gas production since 2014, and that 2017 might mark the first-ever third straight year of declining energy spending, according to the IEA. (…)
The global oil cost curve
From Goldman Sachs via The Daily Shot
Fitch Ratings is reducing its 2016 US high yield bond default rate forecast to 5% from 6% and expects the overall 2017 rate to finish at 3%, below the 4.1% historical average. Crude oil prices stabilizing in the mid-$40s that aided the challenged energy sector, coupled with improving conditions in the high yield market, contributed to Fitch lowering this year’s expected rate.
The YTD default total stands at $63.5 billion, and Fitch expects the figure to end 2016 at roughly $75 billion, down from the previously anticipated $90 billion. Default volume has dropped noticeably in the third quarter, with just $10.1 billion thus far, compared with $34.7 billion in the prior quarter. The August TTM default rate is at 4.9%, while the energy rate is at 15.8%. (…)
Secondary bid levels strengthened significantly from earlier in the year. Currently, $75 billion of issues are bid below 70, a striking difference from the $280 billion seen in mid-February. In addition, the high-yield distress ratio has declined for six straight months and is at its lowest level since last June, while ‘CCC’ rated corporate spreads have tightened more than 800 basis points since mid-February.
The 2017 3% forecast is slightly above the nonrecessionary 2.2% average and translates to roughly $45 billion of defaults. This rate would be comparable to the volume posted in 2015.
The 2017 high-yield maturity wall is relatively low, with $64 billion coming due. Furthermore, just $17 billion is rated ‘CCC’ or lower, which is the rating category that accounts for the vast majority of near-term defaults.
The amount of energy defaults, coupled with a lack of new issuance, caused the ‘CCC’ outstanding universe to fall to $242 billion (16% total market) at the end of August from $288 billion in February. (…)
Fear ups and downs as illustrated by Bespoke Investment:
Senior officials rally behind Deutsche Bank Shares rise as German lender nears settlement with US justice department
(…) Sentiment was boosted after the AFP news agency reported that Deutsche was close to a $5.4bn deal with US authorities — far below the initial $14bn demand from the authorities that sparked the worries about the bank’s capital levels. (…)
(…) The bank has insisted that its immediate problem, the $14bn fine from the States, can be paid without resorting to a state rescue – and in any case, as Cryan told Bild this week, the bank can probably follow the example of several US banks and negotiate the penalty down to a more manageable figure.
Some analysts, such as Kian Abouhossein at JP Morgan, think even a $4bn settlement “would put questions around [its] capital position”. (…)
(…) At the end of 2008, Deutsche’s total assets as measured by international accounting standards were 69 times as large as its total equity. Now, that leverage multiple has been slashed to 27 times—meaning it has more than twice the equity per euro of assets on its balance sheet than it did back in 2008. Losses are less harmful because its balance sheet has more support. (…)
On the strictest view of its capital base, which is to only count the equity that qualifies when all postcrisis changes come fully into force in 2019, Deutsche had €43.5 billion ($48.82 billion) of common equity tier 1 capital at the half year. That gives it a capital ratio of 10.8%. By 2019 that needs to get to 12.25%. (…)
If a bank gets into real trouble, one of the first things that happens is that a set of junior bonds, known as Cocos, get converted into fresh equity. This typically would happen if the bank’s capital ratio drops to 7%. For Deutsche, that would mean losing more than €15 billion of equity.
The fear swirling around Deutsche was sparked by news that U.S. prosecutors had made an initial proposal that it pay $14 billion to settle mortgage-bond probes. But the bank already has put aside €5.5 billion of reserves for settling lawsuits.
To drop to that 7% capital ratio trigger point, the mortgage settlement and other losses would have to amount to almost €21 billion. Actually, the loss would have to be bigger than that because Deutsche would first also not pay any bonuses to its bankers (or pay them in stock or other instruments). In 2015, total variable pay was worth €2.5 billion. (…)
Deutsche’s real problems are longer term with its costs, its profitability and the capital hurdle it must clear by 2019. That isn’t helped by reports of hedge funds taking their business elsewhere.
This will cut revenues further, which as J.P. Morgan analysts point out could force the bank to seek fresh equity soon. (…)
(…) The International Monetary Fund had pointed at Deutsche back in July, describing it as the world’s most systemically risky bank. In an unusual analysis that looked at the influence of banks’ share price volatility on each other, it found that movements in Deutsche’s share price carried over to rivals more than was true for any other big bank. It is a second-hand measure, but it could be seen as a proxy for the intricacy of the bank’s counterparty relationships and the fallout that could be expected in a disaster scenario. (…)
First, more robust regulatory defences have been put in place during the past eight years. Capital levels are three or four times what they were, liquid asset reserves are vast — €215bn in Deutsche’s case — and monitoring has been stepped up. Deutsche, along with 50 other European banks, went through a region-wide stress test over the summer. It emerged in 42nd place, relatively weak, but still better than some had feared.
Second, this is Germany’s biggest bank, with a brand that hammers home the connection with its domestic market. Whatever a politically pressured Angela Merkel might have to say in public, there can be little doubt that if it became necessary, the German chancellor would bail out the country’s biggest bank — albeit within the limitations of European law and its requirement that market conditions are respected and bondholders bear some burden, too. (…)
Either way, the situation would be Deutsche specific. Contagion across the sector would be illogical, since counterparties should be safe.
All of that said, there is another kind of contamination that has been gradually spreading across much of the banking sector, especially in Europe. The root cause is not Deutsche Bank, or any other commercial entity, but central banks such as the ECB. Their zero interest rate policies have added to all the other pressures on banks and left them unable to generate anything like the level of profitability that equity investors would like.
Whatever happens with Deutsche’s DoJ settlement, expect depressed share prices to persist at Germany’s biggest bank — and across much of the sector — for a good while yet.
(…) Before the end-of-week rally, Deutsche’s common stock traded for around a quarter of its book value, weighed down by the market’s massive haircut from the stated value of its assets, as well as the uncertainty about how many pounds of flesh could be extracted by regulators.
That isn’t all. “The elephant in the room is DB’s $60 trillion derivatives book,” writes Michael Lewitt, editor of the Credit Strategist letter. This sum represents the gross exposure of the bank’s contracts, many of which are long positions that would be offset by short exposures, resulting in a much smaller net position. That’s in a perfect world, he contends. If, in a financial crisis, counterparties can’t meet their obligations, this netting of positions won’t occur. In any case, “DB’s net exposures are sufficiently large to blow up the financial system,” Lewitt warns.
The deep discount to book also reflects the potential for a highly dilutive capital issuance. In catch-22 fashion, that in turn makes it harder to raise needed equity to bolster the balance sheet. And politics also preclude a bailout. Germany, which has mandated austerity for other euro-zone countries, would find it difficult to bail out its biggest banks, Gimme Credit’s Shanley observes. (…)
“Dollar funding stress is back,” according to Citigroup’s money-market research team. The negative headlines last week sharply pushed up European banks’ funding costs, resulting in the highest spike in dollar borrowings from the European Central Bank since the European crisis of 2012-13, they write. (…)
IT’S HALLOWEEN MONTH
From Barron’s Randall Forsyth:
October has a fearsome reputation for stock investors from the crashes of 1929 and 1987, but, according to the Stock Trader’s Almanac by Jeffrey and Yale Hirsch, the month actually is a “bear killer.” October “turned the tide in 12 post–World War II bear markets: 1946, 1957, 1960, 1962, 1974, 1987, 1990, 1998, 2001, 2002, and 2011.” But the best Octobers followed horrid Septembers. The month just concluded managed to end basically flat on the S&P 500, with the boost from a nice 0.8% gain on Friday.
There is one important exception the Hirsches note: October is the worst month in election years, according to their records, which date back to 1950. The S&P 500 averages a 0.7% decline and the Dow industrials average a 0.8% decline. But the more-volatile Nasdaq and Russell 2000 small-cap index do appreciably worse, with average setbacks of 2.1% and 2.6%, respectively. (…)
(…)After a climb led by shares of utilities and telecommunications companies, which tend to do well during times of anxiety because they are seen as relatively stable, technology stocks surged: They led the S&P 500 with a 12% gain over the past three months and propelled the tech-heavy Nasdaq Composite Index to fresh highs with a 9.7% quarterly gain. The S&P 500 rose 3.3% and the Dow Jones Industrial Average climbed 2.1%.
As tech has gained, investors have begun pulling back from the traditional havens of utilities, which fell 6.7% for the quarter, and telecommunications stocks, which lost 6.6%. Several analysts said the rotation into sectors that depend more on growth suggests an improved outlook on the U.S. economy. (…)
“Cash is paying nothing, bonds are paying nothing, and that’s funneling money to equities,” said David Kelly, chief global strategist at J.P. Morgan Asset Management. “That makes me still an equity bull.” (…)
In effect, other than IT, no other sector is really charging up (chart from Ed Yardeni):
This in spite of pretty optimistic investors as these Ned Davis Research charts reveal (charts via Evergreen GaveKal)
More relevant charts from Ed Yardeni: