Month: February 2018

Did you miss: WITH THE KING OF DEBT, CASH IS KING?

Powell Testimony Boosts Odds of Four Rate Rises in 2018

(…) “My personal outlook for the economy has strengthened since December,” he told members of the House Financial Services Committee on Tuesday in his first Capitol Hill appearance since taking over as Fed chief earlier this month.

“We’ve seen continuing strength in the labor market. We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving up to target. We’ve also seen continued strength around the globe, and we’ve seen fiscal policy become more stimulative,” he said in answer to a question about what could cause the Fed to raise rates more than three times this year.

He added that he “wouldn’t want to prejudge that” outcome. But many investors took his comments as a sign of increased odds the Fed could lift its benchmark federal-funds rate four times in 2018, up from the three moves penciled in by officials in December. (…)

“I would expect the next two years, on the current path, to be good years for the economy,” he said. (…)

In response to questions from lawmakers, Mr. Powell also said Congress should focus on reducing government debt. “We really need to get on a sustainable fiscal path, and the time to be doing that is now,” he said. (…)

Speaking on a panel at the Brookings Institution on Tuesday, Ms. Yellen said the Fed “probably would come out with a higher inflation target now if we were starting from scratch.”

But moving it up is “a tricky business,” she said.

Hmmm…Preparing the overshooting?

Home Sales Declines Not Yet Alarming Economists

Purchases of newly built single-family homes—a relatively narrow slice of all U.S. home sales—fell 7.8% in January after dropping 7.6% in December, according to data released Monday by the Commerce Department. Purchases have declined for four of the past six months.

The January drop bucked the 4.0% growth economists surveyed by The Wall Street Journal had expected. (…)

January is not a key month. Previous 3 months were revised up. The trends is still ok but beware mortgage rates.

Overdue US credit card debt hits 7-year high Mortgage problems add to signs of hardship despite strong economy and tax cuts

(…) Banking sector data show consumers were at least three months behind repayments or considered otherwise distressed on $11.9bn of credit card debt at the turn of the year, a rise of 11.5 per cent during the fourth quarter. More Americans are also failing behind on their mortgages, for which problematic debt levels rose 5.2 per cent over the same period to $56.7bn. (…)

Americans made heavy use of the credit cards in Q4’17 to boost their spending as evidenced by credit card data and the truly low savings rate. We are now getting data that raise flags on the quality of this debt surge, particularly for smaller banks:

Overall charge-offs are not rising but bankruptcy filings are:

Here’s a nasty surprise: mortgage loans getting bad:

This won’t help:

Gas Prices Are Heading Back Toward $3 a Gallon

This summer’s driving season is likely to be the most expensive since 2014, according to OPIS analysts, with drivers expected to pay an average of $2.79 a gallon for gas. That’s nearly 11% higher than the current national average price of $2.518 a gallon, according to AAA. And prices in some cities are likely to top $3 a gallon.

That means the typical driver is likely to pay $167.40 for fuel in April, up from $143.40 a year ago.

Still, that’s peanuts compared to 2014 when gasoline prices averaged $3.64 a gallon in April, and the average driver shelled out $218 in monthly fuel costs, the OPIS analysts note. (…)

Another weak stat to start the year:

U.S. Durable Goods Orders Post Weak Start to Q1

New orders for durable goods slumped in January, falling a larger-than-expected 3.7% m/m (+8.9% y/y) after having jumped soared 2.6% m/m (revised from a 2.9% m/m gain) in December. (…) Aircraft orders were again the primary driver of the swing in transportation orders. Total aircraft orders slumped 32.8% m/m in January after gains of 23.0% m/m and 11.6% m/m in December and November respectively. (…)

Excluding transportation orders, new orders in January were still mediocre and slightly weaker than market expectations, falling 0.3% m/m (+9.1% y/y) following a slightly upwardly revised 0.7% m/m gain in December. (…)

Nondefense capital goods orders and shipments excluding aircraft (core orders and shipments) are the variables in this report that are key indicators of business spending on equipment in the national accounts. They both point to a slow start to Q1. Core capital goods orders slid 0.2% m/m (+8.0% y/y) in January, their second consecutive monthly decline, auguring weaker business spending ahead. Core goods shipments (a good real-time indicator of business spending) edged up 0.1% m/m (10.8% y/y) in January but this was after a solid 0.7% m/m rise in December (revised up from 0.4% initially). This points to continued, though more modest, business spending on equipment in Q1.

Recent regional Fed manufacturing surveys all suggest rising capex…

BTW, the same recent surveys all point to accelerating inflation. Yesterday’s Richmond Fed Survey:

The composite manufacturing index jumped from 14 in January to 28 in February, the second highest value on record, driven by increases in shipments, orders, and employment. The wages index remained in positive territory at 23, while the available skills metric dropped from −10 in January to −17 in February. Despite greater difficulty finding skilled workers, District manufacturing firms saw strong growth in employment and the average workweek in February. Survey results show that manufacturers expect to see continued growth in the coming months.

Manufacturing firms saw growth accelerate for both prices paid and prices received, with each increasing at the highest rate since April 2017. Firms expect prices to continue to grow at a faster rate in the near future.

(…) service sector firms saw a drop in the growth rate of prices paid in February, while growth of prices received continued to accelerate. Looking forward, firms expect to see faster growth in both prices paid and prices received in the coming months.

Uncle Sam’s Trillion-Dollar Customer Is Having Its Doubts Some Japanese investors say they are shifting toward selling U.S. Treasury bonds and other dollar-based debt after fears have picked up that the Trump administration’s budget and other policies add up to a weak dollar.

(…) any questioning in Tokyo of the dollar or of the U.S. Treasury is significant because Japanese holders including the government own nearly $1.1 trillion in Treasury bonds, a close second to China. For years, the U.S. economy has relied on Japan and China to recycle their trade surpluses back into the U.S. by buying American debt. (…)

• Economists continue to be amazed at the level of federal government stimulus pumped into the economy at the time when growth is already strong. (The Daily Shot)

Source: Deutsche Bank

Source: Wells Fargo

There is also this other growing deficit, likely to get much worse with the tax cuts:

• US goods trade deficit hit the worst level in a decade as imports climb. This report is sure to send the White House searching for more trade tariffs to implement. It’s worth mentioning once again that a trade war could accelerate inflation and become a significant risk for the stock market. (The Daily Shot)

• The chart below shows the goods deficit excluding petroleum.

Source: @ReutersJamie (via The Daily Shot)

• Trump’s Worst Economic Idea No good can come of steel and aluminum tariffs.

Tax Changes Could Spur Swap Meet for Used Goods Companies get big tax incentive to buy, sell used airplanes and other goods

(…) The new tax law allows firms to claim an immediate 100% deduction when they buy an asset, including purchases of used equipment that have already been written off by previous owners. (…)

Tax planners say the market for used equipment—including railcars, airplanes and industrial machines—is likely to heat up in the months ahead as firms try to take advantage of changes in the tax law. It could mean a shuffling of assets by companies purely for tax reasons and mergers and acquisitions that exploit new tax edges. (…)

Not difficult to imagine how this new tax quirk, really unnecessary and costly to taxpayers, will be exploited to its maximum…

China Growth Loses Steam as Factory Activity Slips to 19-Month Low The pace of growth in China’s manufacturing activity fell sharply in February as plants closed for the Lunar New Year and demand for Chinese exports waned.

The official manufacturing purchasing managers index, a gauge of China’s factory activity, dropped to its lowest level in 19 months at 50.3 in February from 51.3 in January, the National Bureau of Statistics said Wednesday.

That was well short of a forecast for a 51.2 reading by economists polled by The Wall Street Journal, though it stayed above the 50 mark that separates expansion from contraction. (…)

A drop in new export orders pointed to a less optimistic outlook for a sector that was a major pillar sustaining Chinese economic growth last year, as regulators moved to rein in borrowing across the domestic economy.

Nearly 14% of the 3,000 Chinese companies surveyed in the government PMI poll said the appreciation of the Chinese currency had hurt their business, according to China Federation of Logistics & Purchasing, a government-backed entity that compiled the PMI survey with the statistics bureau.

The federation said the number of firms complaining about a strong yuan has been rising for two months.

China’s official nonmanufacturing PMI, also released Wednesday, fell to a four-month low of 54.4 in February, compared with 55.3 in January, the statistics bureau said. Subindexes measuring new orders, service and construction sectors all dropped in February, though they stayed above the 50 mark. Business activity in the property, security and insurance sectors contracted in February, the statistic bureau said. (…)

China’s big housing markets in deep freeze FTCR China Real Estate Index dips as first-tier city sales slow to crawl

The FTCR China Real Estate Index fell for a fourth straight month to 42.3 in February, dragged by a plunge in sales activity in first-tier cities.

Global Companies Extend Use of Zero-Based Budgeting to Slash Costs

(…) Around 300 large global companies currently use the technique called zero-based budgeting, Accenture said. The professional services firm surveyed 85 of those companies that are included in the Forbes Global 2000 list of top public companies in the world. The surveyed group reported a 57% increase in the usage of zero-based budgeting in 2017 compared to the prior year.

Firms on average saved $280 million per year with the help of zero-based budgeting — a tool that helps finance managers plan each year’s budget as if starting their department from scratch. The approach is contrary to the prevailing method of adjusting the previous year’s spending and forces managers to justify costs and evaluate benefits every 12 months. (…)

More than 90% of surveyed firms used it to reduce their spend on travel, facilities, legal and professional services.

Over half of companies cut their sales and marketing budget applying ZBB. More than 40% of companies slashed their headcount (43%) and their cost of goods sold (42%) by deploying ZBB, the study said.

CFOs can unlock even more savings by combining ZBB with big data analysis and artificial intelligence, Mr. Timmermans said. (…)

THE SAGE OF OMAHA

From Warren Buffett’s letter to BRK shareholders (my emphasis):

• On the willingness to hold cash rather than invest at high multiples:

In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price. That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can-do” types. If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.

Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.

The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed. At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious (…). We also never factor in, nor do we often find, synergies.

Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need. We held this view 50 years ago when we each ran an investment partnership, funded by a few friends and relatives who trusted us. We also hold it today after a million or so “partners” have joined us at Berkshire.

Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.

M&A P/Es have reached nearly 25x net earnings at the end of 2017 from 19.8 in early 2016. Transactions of $1B + were done at 29-30x on average (Factset data). Private Equity funds are now paying 11.2x ebitda:

Source: @apark_, @BainAlerts, @lcdnews; Read full article (via The Daily Shot)

• On hedge funds:

In December 2007, Buffett made a famous bet:

I made the bet for two reasons: (1) to leverage my outlay of $318,250 into a disproportionately larger sum that – if things turned out as I expected – would be distributed in early 2018 to Girls Inc. of Omaha; and (2) to publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be. (…)

Protégé Partners, my counterparty to the bet, picked five “funds-of-funds” that it expected to overperform the S&P 500. That was not a small sample. Those five funds-of-funds in turn owned interests in more than 200 hedge funds.

Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence.

The managers of the five funds-of-funds possessed a further advantage: They could – and did – rearrange their portfolios of hedge funds during the ten years, investing with new “stars” while exiting their positions in hedge funds whose managers had lost their touch. (…)

The five funds-of-funds got off to a fast start, each beating the index fund in 2008. Then the roof fell in. In every one of the nine years that followed, the funds-of-funds as a whole trailed the index fund. (…)

• Finally:

Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.

I love the man!

Summers Warns Next U.S. Recession Could Outlast Previous One

(…) “That suggests that in the next few years a recession will come and we will in a sense have already shot the monetary and fiscal policy cannons, and that suggests the next recession might be more protracted,” he said during a panel with Bloomberg Television’s Erik Schatzker on Wednesday. (…)