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)

Invest with smart knowledge and objective odds

THE DAILY EDGE (30 April 2018): So! What to do?

Ninja Posted yesterday: TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL
Consumers Cool U.S. Economic Growth, but Business Thrives Economic growth slowed in the first quarter, as consumers reined in spending even after tax cuts fattened the wallets of many households.

Gross domestic product—the value of all goods and services produced in the U.S., adjusted for inflation—expanded at an annual rate of 2.3% for the months January through March to $17.4 trillion, the Commerce Department said Friday. That marked a slowdown from the 3% growth rate registered during the final nine months of 2017. (…)

The annual growth rate has been below 2% on average since 2000. (…)

Nonresidential fixed investment, reflecting business investment in buildings, equipment, software and more, grew at a 6.1% rate. That was faster than the expansion’s 4.6% average. Business investment is a key driver of worker productivity and longer-run wage growth. (…)

Household outlays increased at a 1.1% rate in the first quarter, pulling back from the fourth quarter, when they rose at a 4.0% rate on strong holiday spending and consumers replacing property such as cars damaged by late-summer hurricanes. The saving rate rose from the fourth quarter to the first, meaning households pocketed added disposable income from tax cuts rather than spending it.

image

Pointing up The price index for personal-consumption expenditures increased at a 2.7% pace in the first quarter, matching the fourth quarter’s pace. Core prices, which exclude volatile food and energy categories, rose at a 2.5% rate. (…)

Core PCE, the Fed’s preferred inflation gauge, went from +1.3% annualized in Q3’17 to +1.9% in Q4’17 to +2.5% in Q1’18. It is still +1.7% YoY in Q1’18 but that infers that March was +2.0% following January and February at +1.5% and +1.6% respectively. This is a scary acceleration!

In this table from Advisor Perspectives, the last column should read 2018 Q1. Note how weak Durable Goods were in Q1’18 after the strong, hurricanes-induced, Q4’17 but even averaging the last 2 quarters we only get +0.35% quarterly or +1.5% annualized, down from +2.4% annualized in Q2-Q3’17. Also note the very weak Nondurables.

The Labor Department on Friday reported that the employee cost index—its comprehensive measure of pay and benefits—was up 2.7% from year earlier. That was its biggest gain since 2008.

That increase doesn’t reflect the extra money many people are taking home as a result of the tax cut.

(…) it is possible that households have reached a transition point where they will be devoting more of what they make toward saving and paying down debt.

Indeed, while the personal saving rate—the share of after-tax income that doesn’t get spent—rose to 3.1% from 2.6% in the first quarter, the savings rate was above 5% just two years ago. (…)

image

MORE ON U.S. INFLATION

After this morning’s consensus-topping GDP data, which showed real growth of 2.3% annualized in Q1, the U.S. output gap is now almost closed according to Congressional Budget Office estimates of potential. In theory, that means price pressures will intensify. True, the Fed’s preferred measure of inflation, the core PCE deflator, currently shows an annual inflation rate of less than 2%. But expect the latter to rise as the output gap eventually moves into positive territory. Also warranting optimism that the Fed will finally hit its 2% inflation target is the tightening labour market which is pushing up costs. As today’s Hot Charts show, the private sector’s employment cost index, which takes into account wages, salaries and benefits, rose again in Q1 and is now growing at the fastest pace since 2008. (NBF)

image

EVEN MORE ON U.S. INFLATION

Sorry to insist but Friday also saw the release of the all inclusive (wages and benefits) Employment Cost Index for Q1’18: +0.84% QoQ = +3.4% annualized. YoY it is +2.7% (private companies: +2.9%), from +2.4% (+2.6%) one year ago and +1.9% (+2.0%) two years ago.

Pretty clear trend, even scarier given current low unemployment rate and ever rising labor shortage. Note how private wages have started to increasingly outpace total wages.

image

Companies are loosening up on wages seeing their improved pricing power.

The Fed could well find itself way behind the curve pretty soon.

(…) Projections released at their meeting last month show all 15 participants expected annual core inflation of at least 2% by 2020, and more than half of them see it rising to at least 2.1% next year and staying there through 2020.

This was the first time officials have projected inflation exceeding the Fed’s 2% target, signaling they don’t expect to pick up the pace of rate increases in the case of a modest and temporary overshoot. (…)

Still, officials haven’t said how much or for how long they would let inflation go above 2% before moving to raise rates more aggressively to bring it down. “We haven’t agreed on that,” said Fed Chairman Jerome Powell at a news conference last month. (…)

Surprised smile Initial unemployment claims

cratered to 209k last week. The four-week moving average is now 229k (-14% YoY), almost a 50-year low (1969!). Relative to the labor force, we are in uncharted territory with 12 million workers (annualized) claiming new unemployment insurance payments, a low 1.4% of the labor force. It won’t be long the U.S. will run out of unemployeds.

image

Maybe Congress will wonder why maintain this costly program for such a small slice of the population. After all, the Administration, in its infinite wisdom and always caring for the bottom 90%, recently proposed to change the food stamp program to save some $13B per year distributed to some 42 million Americans.

“Under the proposal, households receiving $90 or more per month in SNAP benefits will receive a portion of their benefits in the form of a USDA Foods package, which would include items such as shelf-stable milk, ready to eat cereals, pasta, peanut butter, beans and canned fruit, vegetables, and meat, poultry or fish,” the budget reads.

According to the Department of Agriculture, the program would send food boxes to 16.4 million households, representing 81% of SNAP households. The boxes would account for half of the benefits for the household and the rest would be put on their Electronic Benefit Transfer card.

The USPS, which, during the 1990s, lost volume from the monthly food stamp checks going electronic, could make up for it with food boxes sent monthly throughout the USA. No doubt the USPS can deal with all the logistical challenges in a snap! What kind of food in the box? Which producers? Size? Dietary issues? Etc. Plus these mundane issues:

Would boxes be delivered door-to-door? Would people have to be home to receive Harvest boxes — a likely challenge for shift workers? Or would people have to visit a distribution center? What happens to elderly or disabled individuals? What about transportation costs, or accessibility, particularly in rural areas?

Harvest boxes would also be less reliable, because delivery can easily be interrupted while transferring benefits to a debit card rarely is. This is particularly relevant during events such as natural disasters, which Vollinger says SNAP has tackled effectively because of its ability to electronically distribute emergency benefits through EBT. (Vox)

But these are boring matters for another day.

Allow me this last one from this WSJ article Energy, a Bright Spot in Nafta Talks, Bogged Down by Dispute Over Rule Change

(…) U.S. businesses, however, including some energy companies, are balking at Washington’s pursuit of an unrelated rule change that would weaken or end Nafta’s protection of U.S. investments in Mexico or Canada from government intervention.

At issue is the Investor-State Dispute Settlement, which allows a U.S. business to take legal action if a foreign government harms the company’s investment in that country. For example, if the Mexican government nationalized, say, a U.S-owned oilrig in Mexico, the measure would give the American company the right to appeal to adjudicating panels set up under Nafta.

The protections are valued by a variety of U.S. industries, from manufacturing to financial services. But they are especially vital to the U.S. energy sector. Energy sector investments typically require substantial investment “before the first barrel comes out,” said Mexican Finance Minister José Antonio González Anaya, a former chief of Mexico’s state oil giant Petróleos Mexicanos, in an interview.

U.S. Trade Representative Robert Lighthizer is proposing the three member countries eliminate the Nafta protections, saying they create an incentive for U.S. companies to invest internationally and move jobs overseas. “Why is it a good policy of the United States government to encourage investment in Mexico?,” asked Mr. Lighthizer at a Congressional forum late last year. (…)

Yes! Why is it a good policy for any government to put their citizens at legal and financial risks in order to coerce them into investing only where Big Brother deems acceptable?

This is the same Lighthizer, totally focused on autos and steel, who renegotiated the “horrible” trade agreement with South Korea, claiming victory for

(…) extending the 25% U.S. tariff on Korean truck exports for another 20 years through 2041. This is the upside down world of Trump trade logic in which punishing American consumers with higher prices is a virtue. The tariff had been scheduled to phase out by 2021. Korean companies will probably evade the tariff by building more trucks in the U.S. and exporting the parts instead. (…)

Mr. Lighthizer is also trumpeting Seoul’s acceptance of a 30% cut in its steel exports to the U.S. This is a defeat for American steel users who are already paying higher prices despite the country-specific exemptions from Mr. Trump’s world-wide 25% tariff on imported steel. Reducing supply can have the same effect as a tariff in raising domestic prices. (…) (WSJ)

The problem is that this belies the claim that the steel protection was just a means to induce negotiation that would lower overall barriers. As the negotiations conclude, the barriers remain. (Forbes)

Meanwhile, Canada and Mexico have both negotiated trade agreements with the European Union, Australia, Chile, Japan, Malaysia, New Zealand, Peru, Singapore and Vietnam, giving companies in these countries lower tariffs and better access to America’s closest trading partners.

Why is it a good policy of the United States government to incite the rest of the world to invest and trade easily among themselves while trying to prevent Americans to invest and trade easily with the rest of the world?

Foreign Investors Lose Some Hunger for U.S. Debt Foreign investors’ appetite this year for U.S. debt hasn’t grown at the same pace as the government’s borrowing needs, which some analysts worry could push bond yields higher and eventually threaten to slow economic growth.

Investors in a broad category known as “indirect bidders,” which includes both mutual funds and foreign investors, have been winning the smallest percentage of the bonds they’ve bid for since 2011, according to bidding data for recent Treasury bond auctions. The average percentage of the auctions won by this group fell for the first time since 2012, a decline some analysts attribute to both lower demand from investors outside the U.S. and their recent tendency to post less-aggressive bids. (…)

While the percentage of Treasurys held by foreign investors has declined, such buyers remain crucial to the bond market, holding roughly $6.3 trillion of government debt. Even simply rolling over maturing bonds at the auctions requires foreign investors’ participation. They have bought at least 17% of government auctions each year since 2014, maintaining their support for the primary market during a period where the share purchased by bond dealers has consistently declined. (…)

Foreign holdings of Treasurys rose last year for the first time since 2014, keeping pace with the increase in government debt outstanding. In February, they climbed to $6.29 trillion of the $14.7 trillion of then-outstanding U.S. government debt, the Treasury said April 16, up from $6.26 trillion the prior month.

China’s holdings rose by $8.5 billion to $1.18 trillion while, Japan’s fell by $6.5 billion to $1.06 trillion. (…)

A separate set of Treasury figures known as allotment data shows foreign demand fell below its five-year average in March, after rising to a 21-month high in February. And the backdrop for this year and the foreseeable future is more challenging. (…)

China exporters see business slow as recovery fades FTCR China Export Index at 20-month low as Washington and Beijing tussle over trade

(…) The FTCR China Export Index fell 1.1 points to 54, the lowest level since August 2016 (52.5) as respondents reported a gloomier outlook and slower volume growth. Our April freight, consumer and labour readings also weakened.  This was the 22nd month in a row that the index has been above 50, signalling improving conditions among exporters. However, key sub-indices such as those tracking volumes and prices had been trending lower even before tension between Washington and Beijing flared up over Chinese trade policies. (…)

The BlackRock Investment Institute tracks China’s economy using high frequency indicators. Bothe the GPS and Nowcast levels are pointing to slower growth:

BlackRock-Chart-China (2)

China’s slowdown is inevitable but it must be orderly given high debt levels. HNA is one of China’s gigournous zombies scrambling to deleverage:

Borrowing costs surged to about $5bn for the full year, up from $2bn in the first half of 2017, triggering the liquidity crisis that rippled through the conglomerate between November to late January. Borrowing costs exceeded its earnings before interest and taxes, and topped the ranks of non-financial companies in Asia during that period, according to Bloomberg data. 

BTW, BlackRock’s GPS for the Eurozone has also crested:BlackRock-Chart-Eurozone

…unlike that for the U.S.:BlackRock-Chart-United States

While Japan looks weaker as The Daily Shot illustrates:

 Britain and the EU Are Pulling Back From the Cliff—For Now The moment of greatest risk for post-Brexit trade disruption looks like it will be pushed off to 2021

Fears have receded that economic relations between Britain and the European Union will fall off a cliff edge in 11 months’ time when the U.K. leaves the bloc. The risk of big trade disruption has been lessened because negotiators have agreed on a 20-month transition period post-Brexit during which the rules of U.K.-EU engagement will remain essentially unchanged. (…)

SENTIMENT WATCH

SentimenTrader’s AAII Bull Ratio moving average has reached the “excessive pessimism” area:

image@sentimentrader

Tiho Brkan (The Atlas Investor) uses SentimenTrader’s AIM Model which combines the advisor and investor sentiment models.

(…) The two standard deviations, negative below the mean. In other words, when the sentiment drops into a ridiculously low bearish territory, relative to where it was, let’s say three to six months ago, the way that it compiles the indicator I’m sure, that’s about 10% or below single digits. And we just had that.

So over the last decade in particular, whenever sentiment dropped to single digits, and the economy continued to expand as it has over the last nine years, that was a buying opportunity. So that happened during the Flash Crash in May to July 2010. And in July, the sentiment indicator signaled a buying opportunity. And then the same thing happened once again in August 2011, during the Eurozone debt crisis. And the debt ceiling saga that was going on in the U.S. Congress, that was a buying opportunity. And then we had the Chinese devaluation and the oil bottom, in August 2015, and January to February of 2016. Those were single digit readings, and those were great buying opportunities too. And we just got one last week.

So it remains to be seen whether this one is going to give us the same results as the previous ones during this bull market. One thing that I want to note, is that during 2007 to 2009, sentiment would drop to ridiculously low levels as well. But when the downtrend is in full force, all that sentiment can really indicate is just a really oversold condition, to the point where we will have some kind of relief rally. But it didn’t stop the bears continuously pushing prices lower, and lower, lower, until we finally got to some kind of decent valuation, relative to where we were.

For its part, Lowry’s Research argues that the transition from bull to bear has followed a very consistent pattern of investors selling over-extended stocks near peaks over the last 100 years, which pattern is nowhere to be seen this time.

But the day of reckoning is approaching as the SPY is nearing the end of the wedge, surfing on its 200d m.a….

spy

The 200-day moving average remains positive across the world:

Here’s a nice challenge via Lance Roberts:

May Begins Worst 6-Months Of The Year

Jeffrey Hirsch of “Stocktraders Almanac,” recently penned the following note:

“May officially marks the beginning of the “Worst Six Months” for the DJIA and S&P. To wit: “Sell in May and go away.” May has been a tricky month over the years, a well-deserved reputation following the May 6, 2010 “flash crash” and the old “May/June disaster area” from 1965 to 1984. Since 1950, midterm-year Mays rank poorly, #9 DJIA and NASDAQ, #10 S&P 500 and Russell 2000, #8 for Russell 1000. Losses range from 0.1% by Russell 1000 to 1.9% for Russell 2000.

For the near term over the next several weeks the rally may have some legs. But as we get into the summer doldrums and the midterm election campaign battlefront becomes more engaged, we expect the market to soften further during the weakest two quarter stretch in the 4-year cycle.”

Just as a reminder, it pays to be more cautious in summer months.

Surprised smile EARNINGS WATCH

Factset’s summary:

Overall, 53% of the companies in the S&P 500 have reported earnings to date for the first quarter. Of these companies, 79% have reported actual EPS above the mean EPS estimate, 6% have reported actual EPS equal to the mean EPS estimate, and 15% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (74%) average and above the 5-year (70%) average.

If 79% is the final percentage for the quarter, it will mark the highest percentage of S&P 500 companies reporting actual EPS above estimates since FactSet began tracking this metric in Q3 2008.

In aggregate, companies are reporting earnings that are 9.1% above expectations. This surprise percentage is above the 1-year (+5.1%) average and above the 5-year (+4.3%) average.

In terms of revenues, 74% of companies have reported actual sales above estimated sales and 26% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above the 1-year average (70%) and well above the 5-year average (57%).

In aggregate, companies are reporting sales that are 1.7% above expectations. This surprise percentage is above the 1-year (+1.1%) average and above the 5-year (+0.6%) average.

The blended, year-over-year earnings growth rate for the first quarter is 23.2% today, which is higher than the earnings growth rate of 18.5% last week.

The blended, year-over-year sales growth rate for the third quarter is 8.4% today, which is higher than the growth rate of 7.6% last week.

At this point in time, 47 companies in the index have issued EPS guidance for Q2 2018. Of these 47 companies, 26 have issued negative EPS guidance and 21 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 55% (26 out of 47), which is well below the 5-year average of 74%.

image

Thomson Reuters’ tally shows blended earnings up 24.6% in Q1, 22.7% ex-Energy. Amazing! (Chart below from Bloomberg)

Nerd smile So! What to do?

On the one hand, sentiment, technicals and earnings tracking say go…on the other hand, rising inflation and interest rates, high volatility, so-so valuations, sell in May and go away say no…Confused smile

  • This highly volatile market is not comfortable. People are obviously nervous about interest rates, inflation and profit margins amid an apparent cost push cycle.
  • But valuation has improved to a neutral Rule of 20 P/E while earnings are truly booming thanks to a lot more than tax reform. Overall, margins are still rising even excluding tax reform.
  • Technicals are not negative per the EMA and the 200d m.a. (holding and still rising) and per Lowry’s analysis (favorable supply/demand and breadth).
  • We got sentiment back on the plus side but it is very volatile.

Sentiment and technical factors play on the short term volatility of equities. Fundamentals dictate the medium to longer term trends: inflation and interest rates are currently troublesome so late in the cycle (oil, wages, commodities and a tightening Fed). But profits are very, very strong and are not showing peaking signals just yet. Based on current evidence, profits will be winning the race against inflation and interest rates for at least another 3-6 months and we have yet to get negative signals from credible recession indicators.

The S&P 500 Index has declined 7% from its January 26 peak of 2866 (it actually corrected 11.8% from top to bottoms reached Feb. 9 (2529) and Apr. 4 (2547)). Since then, trailing earnings have increased 13% from $128 to $145 (tax-reform adjusted) and seem set to reach $152 by mid-summer after Q2. This is a very powerful backwind from the most fundamental variable for equities: profits.

The headwinds are rising inflation and interest rates, impacting earnings multiples. Inflation is up from 1.8% to 2.1%, a 16.7% advance while interest rates are up 30% (3m bills) and 25% (10Y Ts) since yearend.

And we have a fragile consumer with little savings, slow real wage growth, rising fuel prices and a tightening Fed.

And we have a highly indebted corporate America facing rising interest rates through 2019, hoping the fragile consumer keeps consuming and costs remain manageable.

But we also have tax reform which provides a bounty of cash to profitable companies and strong fiscal incentives to boost capex, do M&A and/or buy back equities (share repurchases for the quarter were up about 34% vs Q4’17, and up 43% YoY, based on the 25% of S&P 500 companies filing quarterly reports so far, according to data from S&P Dow Jones Indices).

In all, this does not look like a cycle end just yet. Maybe the best scenario would be a slowing economy leading to contained inflation and a more cautious Fed. Corporate America has shown it can grow profits in a slow-mo economy.

Cautiously positive. But also read TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL 

No Volatility Here: Cash Makes a Comeback After years of producing pitiful returns, money-market funds and even bank savings accounts offer improved yields…and a safe place to park funds.

Yields on money-market funds and other cash sanctuaries are approaching 2%, levels not seen in almost a decade. (…)

The average is 1.5%, almost a point above the level a year ago, according to Crane Data. Taxable funds now have a 0.50 percentage point yield edge over bank deposits, reports iMoneyNet. Investors have noticed—money-fund assets went from $2.6 trillion to $2.8 trillion over the past year. (…)

Another good cash proxy: Treasury bills. A three-month yields 1.78%; a six-month, 1.96%, and a one-year, 2.23%. Brokers such as Fidelity and Schwab don’t charge commissions or fees to buy T-bills, and interest is exempt from state and local taxes. (For direct purchases, go to Treasurydirect.gov.) (…)

@trevornoren

AN INTERVIEW WITH STRONG VIEWS!
Auto Jim Chanos on Tesla’s ‘stunning’ accelerated rate of executive… Short-seller Jim Chanos, Kynikos Associates founder, shares his thoughts on Tesla, Elon Musk and the mass exodus of the company’s top executives.
LIKE MOTHER, UNLIKE DAUGHTER!

Money Stock Fever Grips India, as Millions of New Investors Pile In A campaign by the Indian government is encouraging millions of citizens to open bank accounts and invest some of their nest eggs in the stock market, part of a financial-reform effort to push cash into the economy.

NEW$ & VIEW$ (14 MARCH 2016): Sentiments!

U.S. Import Prices Fell 0.3% in February Prices for imported goods fell last month in a sign that global economic weakness, the strong dollar and cheap oil may continue to curb overall U.S. inflation.

Import prices decreased 0.3% in February from the prior month after falling a revised 1% in January, the Labor Department said Friday. It was their eighth consecutive monthly decline (…).

Import prices were down 6.1% in February from a year earlier, the 19th straight annual decline but the smallest annual drop since December 2014. (…)

Prices for non-petroleum imports decreased 0.1% in February from the prior month and were down 2.9% on the year.

But excluding both fuels and food, import prices ticked up 0.1% last month from January, their first increase since May 2014. They fell 2.5% from February 2015. (…)

Friday’s report also showed export prices in February fell 0.4% from the prior month and were down 6.0% from a year earlier.

 large image large image

Euro-Area Industrial Production Surges Most Since 2009

Output jumped 2.1 percent in January from December, helped by growth in Germany, France and Italy, the Eurostat statistics office in Luxembourg said on Monday. From a year earlier, production rose 2.8 percent, the biggest annual jump since 2011.

Here’s the meat from Eurostat:

image

image

High five Markit’s Eurozone manufacturing PMI dropped from 52.3 to 51.2 in February:

imageManufacturing production rose at the slowest pace for a year, as rates of expansion in new business and new export orders eased to the weakest since April 2015 and January 2015 respectively. (…) The subdued performance of the ‘big-two’ nations also weighed on the euro area PMI, with growth in both Germany and France only slightly above the stagnation mark. The rate of expansion in German manufacturing output was the slowest since December 2014, as growth of both new orders and new export business eased further.

China Economic Data Paints Gloomy Picture Industrial production weaker than forecast for first two months of 2016, while retail sales miss usual Lunar New Year jump

Industrial production grew 5.4​% in January and February compared with a year earlier, down from December’s 5.9% pace, according to government data released Saturday, and just below the 5.6% forecast by economists polled by The Wall Street Journal. Meanwhile, retail sales clocked 10.2% growth in the two-month period, slower than December’s 11.1% increase. (…)

One area that did pick up was investment in factories, buildings and other fixed assets, which increased a faster-than-expected at 10.2​% year-over-year in January and February, compared with a 10% increase for all of 2015. Economists said that boost came largely from government spending on infrastructure and from investment in parts of the overbuilt property market. (…)

Jiang Yuan, an economist with China’s National Bureau of Statistics, said makers of steel, cement and tobacco reduced output in response to slack demand. (…)

Housing sales rose 49.2% year-over-year during the January-to-February period, compared with a 16.6% increase for all of 2016, the statistics agency said. Property investment growth is up 3% so far this year, compared with a 1% increase for all of 2015. (…)

China Speeds Up Bad-Loan Help for Banks Chinese regulators are speeding up ways to help banks shed bad loans, but some of the measures risk keeping “zombie” companies afloat while making lenders even more strapped for capital.

A main feature in a plan outlined by central-bank and regulatory officials over the weekend would be to let banks sell dud loans to investors either by repackaging them as securities or transferring them to special asset-management companies that handle distressed debt.

Senior executives at China’s Big Four state-owned banks say regulators are also exploring ways for banks to exchange bad loans for equity in certain too-big-to-fail companies—a potentially controversial step that they say could saddle banks with near-worthless stock and squeeze their liquidity.

Bank of China Ltd., one of the top four lenders, recently agreed to become the largest shareholder in a publicly traded shipbuilder under the yet-to-be-disclosed plan, people close to the bank say. (…)

Current banking rules generally forbid commercial banks from taking stakes in nonfinancial entities. But regulators, led by the powerful government commission overseeing state assets—known as the State-owned Assets Supervision and Administration Commission, or SASAC—are pushing for changes in the rules to help heavily indebted state companies cut debts. Corporate debt now amounts to 160% of China’s gross domestic product, according to Standard & Poor’s Ratings Services. That is up from 98% in 2008 and compares with a current U.S. level of 70%. (…)

But many bankers think such swaps should only be allowed on a limited scale. By exchanging loans for equity that would be worth little if the companies already are struggling to pay off debts, banks would be required to sharply bump up the amount of capital they set aside against such equity holdings, which are considered more risky than loans. That would strain their liquidity.

“It doesn’t sound like a great idea to save zombie companies with zombie banks,” saidLarry Hu, China economist at Macquarie Securities, a Sydney-based investment bank.

Pointing up The FT’s Lex column details two harbinger deals: 

(…) Focus is returning. On Monday, Hong Kong-listed SOEs Citic Limited and China Overseas Land and Investment announced details of a property asset reshuffle. In a deal worth nearly $5bn, conglomerate Citic will sell its residential property projects to developer Coli in return for new shares and Coli’s commercial real estate assets.

For 1.6 times 2015 book value, versus its own valuation of 1.4 times, Coli will add 50 per cent to its land bank in top tier cities, such as Beijing and Shenzhen, where land is increasingly scarce. Citic, for its part, offloads the development burden but maintains an interest in the upside through its one-tenth stake in Coli. Not perfect focus, perhaps, but a good way to encourage further rationalisation in the sector.

China’s property blue-chips have been busy. In the second of two deals outlined on Monday, Hong Kong and Shenzhen-listed developer China Vanke said it will buy projects from Shenzhen Metro, an unlisted state-owned enterprise which develops the city’s metro lines, for between $6bn and $9bn in total.

Full terms have not been disclosed, but the deal looks canny. Vanke is in the midst of a control battle with an “unwelcome” major shareholder, Baoneng group. If Vanke issues new shares to fund most of the purchase, as it has intimated, Shenzhen Metro could end up with one-fifth of the enlarged share capital, Credit Suisse estimates. This would dilute Baoneng’s stake, putting more of the company in friendly shareholders’ hands. The market liked the strategy: Vanke’s H shares rose 10 per cent. The company says it is in talks for other deals. A lack of available prime land in China is spurring consolidation. Expect more.

Iran oil production increase

Iran plans to increase production to 4 million barrels a day, an increase of 33 percent over February’s output, before it will join other suppliers in seeking to balance the global oil market.

Gavyn Davies After negative rates, central bank alchemy

(…) A recent research paper by Claudio Borio at the Bank for International Settlements argues that bank profitability is damaged in a non linear way when interest rates fall and yield curves flatten, and that applies in spades when rates go negative. Borio says that negative rates “could cripple banks’ margins, profitability and resilience”. The markets cannot be expected to ignore such profound effects on the financial system.

Negative rates should therefore be shelved by the central banks as a policy tool. They might even be counter-productive.

However, that does not mean that there is nothing left in the locker, as Mr Draghi demonstrated on Thursday. The announcement included new purchases of corporate bonds, opening the way for future purchases of private sector assets, where the potential is very large [1].

More important in the immediate term, the package used a massive new TLTRO to inject liquidity and reduce banks’ funding costs, thus protecting the profitability particularly of the weakest parts of the banking sector in the face of negative rates.

It will simultaneously increase the likely size of the ECB’s balance sheet to 40-50 per cent of GDP, depending on the take up of the TLTRO (see this Fulcrum analysis of the measures). This is much larger than the size of the ECB balance sheet at the previous peak in the euro crisis of 2012:

The effectiveness of this method to protect the banks was reflected in the jump in their share prices after the ECB meeting. But it cannot be used again and again, because the maximum size of the TLTROs is limited. Mr Draghi therefore conceded that the ECB is probably now at the effective zero lower bound. Central bankers have been searching for it, and now they have found it.

The ECB’s massive shift back to an earlier form of “alchemy” will be an acid test for the future of unconventional monetary easing. There are certainly legitimate doubts about its effectiveness. But at least it is not going down a path that is actually counter-productive.

SENTIMENT WATCH
Stocks Rise as Investor Confidence Improves Global stocks were mostly higher, extending a month-long rally spurred by rebounding commodities prices, central bank stimulus and improving U.S. economic data.

(…) Stocks around the world have risen for the last four weeks, rebounding from steep losses earlier in the year as commodities prices showed signs of stabilizing and U.S. economic data improved. Wall Street is now close to where it started the year as fears around a U.S. recession have sharply diminished. (…)

(…) Below, we chart the credit default swap spread for the investment grade (“Main”) and high yield (“Xover”) CDS indices tracking European corporate default risk.  As shown, default risk pricing has plummeted off recent highs over the last month or so.  Given the introduction of several new ECB policies yesterday (expanded QE; purchases of nonfinancial, investment grade corporate debt; new refinancing programs; incentives to reduce the impact of negative interest rates on banks and spur lending) we think the outlook for European credit and equities is quite constructive.  

031116 CDS031116 CDS

Standard & Poor’s 500 Index constituents are poised to repurchase as much as $165 billion of stock this quarter, approaching a record reached in 2007. The buying contrasts with rampant selling by clients of mutual and exchange-traded funds, who after pulling $40 billion since January are on pace for one of the biggest quarterly withdrawals ever.

While past deviations haven’t spelled doom for equities, the impact has rarely been as stark as in the last two months, when American shares lurched to the worst start to a year on record as companies stepped away from the market while reporting earnings. (…)

Companies executing repurchases through Bank of America Corp. have bought about $9 billion of shares in 2016, the second-busiest start to a year since the bull market began in 2009, the bank said in a research note last week. Other trading clients have been net sellers, with hedge funds leading the pack, dumping $3.5 billion.

Assuming Bank of America maintains a roughly 8 percent share in the total buyback pool since 2009 and the pace of transactions lasts through the end of March, corporate repurchases may reach $165 billion this quarter, data compiled by Bloomberg show. That would bring the 12-month total above $590 billion, an amount that’s higher than the record $589 billion in 2007. (…)

Should the current pace of withdrawals from mutual funds and ETFs last through the rest of March, outflows would hit $60 billion. That implies a gap with corporate buybacks of $225 billion, the widest in data going back to 1998. (…)

After rising an average 37 percent in the previous five years, repurchases grew less than 4 percent in 2015. During the last two decades, there have been two times when earnings contractions lasted longer than now. Both led companies to slash buybacks, with the peak-to-trough drop reaching an average 62 percent. (…)

Wait! Wait! Somebody must be buying stocks here!

In mid-January, the S&P 500 Index (SPX) slipped back into correction territory, small-caps officially entered a bear market, and the number of self-proclaimed bulls hit its lowest point in more than a decade, per the American Association of Individual Investors (AAII) survey. Since then, however, the bulls have re-emerged with a vengeance — and these tidal waves of optimism have historically preceded major S&P rallies.

Specifically, the number of self-identified AAII bulls has surged nearly 109% during the past nine weeks. Since 1987, this is just the 19th occurrence where the number of bulls has more than doubled in such a short span, according to Schaeffer’s Quantitative Analyst Chris Prybal. The last time this happened was October 2010, which preceded a one-year (252-day) rally of 66.6% for the S&P 500 Index.

What’s more, the SPX has averaged a one-year return of 49.1% following these signals, and has been positive a whopping 83% of the time. For comparison, SPX’s average one-year return is 8.6% since 1987, with 77% positive. In fact, the last time the S&P was negative one year after this signal was 2006, just before the dawn of the financial crisis — and the index was only 0.3% lower one year out.

Further, across all time frames that we measured, the S&P has outperformed following a massive rush of AAII bulls. For instance, 10 days after a signal, the index has averaged a gain of 1.6%, and has been positive 72% of the time. The SPX’s anytime 10-day return since 1987 is 0.3%, on average, with just 59% positive. This, combined with the fact that March and April are historically good times to be long, could suggest even more upside ahead for stocks.

160311AAII1

160311AAII2

Fred sent me this link before what seemed like a weekend during which I could finally relax after months of hard work with our house renovations…83% probabilities with an average positive return of 60% vs –6% average negative return after 12 months! Unbelievable!

I did not believe it.

I have previously written on investor sentiment surveys before…

…essentially to lay down the facts and show that these surveys are generally not useful when sentiment is positive but have been useful when investors are generally bearish in a contrarian sense which is what one would expect given crowd theory. I mentioned the recent negative (bullish) sentiment readings in UPGRADING EQUITIES TO 3 STARS on Feb. 16:

Some of the best conditions for a meaningful rally are present: significant undervaluation coupled with very negative sentiment and media narratives.

The AAII sentiment index has since materially reversed as this chart from Ed Yardeni illustrates. The contrarian in me would want to curb his enthusiasm as a result but Schaeffer’s article suggests to “comfortably” keep surfing on this sentiment reversal for another 12 months. This after the S&P 500 Index clocked in +12% in 4 weeks. And this given the notoriously fickle and volatile AAII members feelings.

image

The Bearnobull in me always checks out the facts. FYI:

  • I have not found how Schaeffer calculates the SPX rates of return. First on the list is 10/28/1988 with a declared +65.3% return over the following 12 months. The SPX closed at 279 in Oct. 1988 and at 340 twelve months later for a 21.9% gain. Last on the list is 10/22/2010 with a declared +66.6% return over the following 12 months. The SPX closed at 1185 in Oct. 2010 and at 1255 twelve months later for a +8.4% gain. Other spot checks yield the same puzzling discrepancies. For example, the 5/2/2008 signal is said to have preceded a 7.4% advance in the SPX during the following 12 months. As most investors know, the SPX closed at 1413.90 on May 2, 2008, slid 53% all the way down to 666.79 on March 6, 2009 to bounce to 877.52 on May 1, 2009. There is just no way to find a positive return during that period unless one begins on March 6, 2009.
  • Interestingly, however, the percent positives remain at 83% even though the average positive was a much more modest +8.5%, in line with the average 12-month return since 1987. The average negative was –23.7% but there were only 3 of them.
  • There were 7 sentiment surges during the 4 years between 10/1988 and 10/1992 while the SPX rose 50%. There are many overlapping periods here.
  • Same between 8/2000 and 4/2003 when there were 4 sentiment surges within 32 months for a net SPX gain of 1.8%, assuming one had money left after losing 34% during 2000 and 2001.
  • There were also 3 sentiment surges between 4/2009 and 10/2010 while the SPX gained 36% in 18 months.
  • One could sum up this 22-year period in 3 big blocks: 1988-1992 (7 sentiment surges in 4 years ), 2000-2003 (4 in 2.5 years) and 2009-2010 (3 in 1.5 years). These 3 periods totalling 98 months (out of a total 264 months) contribute 14 of the 18 identified occurrences. In total, this means 14 sentiment surges in 8 years. Investors seem to get bullish 1.7-1.8 times per year. Remember that before there is a surge, there normally is a collapse. Here’s a chart (from Bespoke Investment) illustrating the moodiness of AAII members during a period when it was best to stay calm and pretty well invested…

The Investors Intelligence index, created in 1963, is more useful. It studies more than 100 regularly published advisory investment newsletters, assessing their stance on equity markets. Here’s what I wrote in 2010,

I have analyzed 30 years of data plotting the II bull-bear % difference against the DJ Total Stock Market Index of 5000 US stocks. Extreme readings are above +/-25%. However, I have easily identified 11 periods when the “contrary” indicator rose to cross the extreme +30% level which were followed by strongly rising markets. Obviously not useful on that side of the ledger.

There were only 9 extreme negative readings (bullish signals) since 1980. The numerous 1981-82 readings <-25%, taken together, could be seen as indicating a major bottom, but only if you survived the 3 false signals between the fall of 1981 and the actual mid-1982 much lower low. The 1988 signal was good. The early 1990 signal was too early but the one in mid-1990 was excellent. The two signals in 1994 proved great, like the ones in late 2008.

Overall, never mind the extreme positives, they are essentially useless. The extreme negatives (bullish) are few but generally very good although some require patience and staying power. Ed Yardeni has the 2 smart charts on II:

image

image

Buying cheap equities when everybody is negative is the best winning formula. This is why I spend most of my time on valuation, earnings and sentiment. The Rule of 20 keeps beating every other valuation methods I know while using no forecast, only trailing data. The II bull/bear ratio combined with a thorough monitoring of media narratives provide the sentiment input.

The next chart illustrates the extreme valuation swings investors can “safely” exploit, “buying low” and “selling high” using trailing data, discipline and patience.

image

THE INTELLIGENT INVESTOR: Cash Is Now a Sin

(…) Until the late 1990s, fund managers kept much more set aside for a rainy day; between 1986 and 1995, stock funds held an average of 9% in cash. But, as of this Jan. 31, the average U.S. stock fund had only 2.9% of its assets in “liquid assets” (cash and other readily saleable securities), according to the Investment Company Institute, a trade group for the fund industry.

Why have funds been shedding cash? The answer to this seemingly small question reveals bigger truths about how markets are likely to behave in the next downturn. The ascendancy of index funds, those autopilot portfolios that hold all the stocks in a market, has made holding cash into something like a sin. In the next severe decline, only those with cash will be able to buy — but many fund managers won’t be in that group.

For active stock pickers, the math is cruel: All else equal, if stocks rise 20%, then a fund with a tenth of its assets in cash will generate only an 18% gain before expenses. So the more cash stock pickers hold, the likelier they are to underperform in a bull market — and to turn off existing and future investors.

And with the Federal Reserve squashing interest rates toward zero after the financial crisis, cash no longer adds anything to fund returns.

But might this trend have gone too far?

“My preference is always to give my managers room to duck,” says David Snowball, editor of Mutual Fund Observer, a non-profit website that analyzes fund performance. “I would much rather outsource the decision on when to hold or invest cash to someone who is paid to obsess about it on my behalf.”

If you’re going to use any active stock pickers at all, surely you should trust them not only to pick which stocks to buy but also when to buy them — and when to let cash build instead.

A few fund managers still do that, but it isn’t easy to go against the grain. (…)

In 2009, 4.1% U.S. stock funds had at least a quarter of their assets in cash, according to Morningstar; today, only 1.6% do. (…)