Edge and Odds

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)

Edge and Odds

Invest with smart knowledge and objective odds

Month: February 2016

NEW$ & VIEW$ (24 FEBRUARY 2016): Housing: Old Normal; Oil: New Normal.

U.S. Home Sales Rise 0.4%, Continuing Growth Path Sales of previously owned homes increased modestly in January to their highest level in six months, a sign of continued solid momentum in the U.S. housing market.

Sales of previously owned homes, which account for the bulk of home-buying activity, rose 0.4% in January from the prior month to a seasonally adjusted annual rate of 5.47 million, the fastest sales pace since July, the National Association of Realtors said Tuesday. Sales were up 11% in January from a year earlier, the largest annual jump since July 2013. (…)

Existing-home sales appear to have stabilized after dropping 8.1% in November then rebounding 12.1% in December, a gyration that the Realtors group blamed on delayed closings after the introduction of new federal mortgage rules.

The National Association of Realtors said there were 1.82 million existing homes available for sale at the end of January, down 2.2% from a year earlier and a 4-month supply at the current sales pace. (…)

The S&P/Case-Shiller Home Price Index, covering the entire nation, rose 5.4% in the 12 months ended in December, greater than its 5.2% increase in November.

Month-over-month price gains were modest, giving some indication that momentum may slow heading into 2016. Seasonally adjusted, Miami had lower prices this month than last and 10 other cities saw smaller increases in December compared with November, according to Case-Shiller.

I am not sure I am seeing the “continued solid momentum” the WSJ headline sees:

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CalculatedRisk has this LT chart which suggests that we could be at a cyclical peak if we consider the 2003-05 period as an aberration. This could be the “old normal”.

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Much is said about the low inventories but that could also be the “old normal” helping understand why supply is not rising along with prices.

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In reality, we need renters to decide that it is best to buy. But these people are pretty rational…

…and those who are not are largely dismissed by lenders…

RICHMOND FED

Fifth District manufacturing activity slowed in February, according to the most recent survey by the Federal Reserve Bank of Richmond. Shipments and the volume of new orders decreased modestly this month. Manufacturing hiring continued to increase at a modest pace, while average wages grew mildly and the average workweek lengthened slightly.

Retail sales increased moderately, as shopper traffic rose sharply. In contrast, revenues decelerated at other services firms. Retail inventories flattened and big-ticket sales softened.

Saudi Oil Minister Says No to Production Cuts

Ali al-Naimi, Saudi Arabia’s powerful petroleum minister, told the elite of the global energy industry here Tuesday that demand for oil remains strong but that for prices to recover, excess supply will still need to be curbed. That rebalancing, he said, will start as low prices squeeze out the production of oil that is the most expensive to extract and sell. (…)

“The producers of these high-cost barrels must find a way to lower their costs, borrow cash or liquidate,” Mr. Naimi told the IHS CERAWeek gathering, which included top executives from many of the world’s biggest oil companies and senior officials from big producing countries. (…)

Saudi Arabia could produce oil profitably at $20 per barrel, Mr. Naimi asserted, a level well below current prices. “We don’t want to, but if we have to, we will,” he said. (…)

“There is no sense in wasting our time seeking production cuts,” he said. A freeze, he said, would slowly allow the ample inventories of crude oil to shrink, but “it’s going to take time.” (…)

Hours before Mr. Naimi’s address, Bijan Zanganeh, Iran’s oil minister, called the Saudi Arabia-Russia pact “ridiculous.” His remarks helped send global prices lower. (…)

Obviously, talks with Iran and Irak got nowhere…

Meanwhile, U.S. gasoline demand was up 2.8% YoY in December.

Gasoline Volume Sales

J.P. Morgan: What’s Even Scarier Than Oil? Superlow interest rates remain the biggest threat to banks

(…) Granted, energy is a worry. J.P. Morgan said in its presentation that it expects to add around $500 million this quarter to reserves against losses on the energy book. And should oil stay around $25 a barrel for 18 months, it could require an additional $1.5 billion of reserves. That spooked investors who drove the shares down sharply. (…)

Assume, for example, that the Federal Reserve sticks to the pace of tightening implied by its latest forecasts for where short-term rates are likely to end up in coming years. As of December, these projected four rate increases in 2016 and more afterward, bringing the federal-funds rate to around 3.25% at the end of 2018 from 0.375% now.

In that blue-sky scenario, J.P. Morgan would earn an additional $10 billion or so of net interest income in 2018.

Unfortunately for banks, the Fed’s projections looks increasingly divorced from reality. The market now expects a much more gradual pace—perhaps no increases this year and just a one quarter-point increase per year in 2017 and 2018. Under this “dovish Fed” scenario, J.P. Morgan estimates that it would reap $6 billion of additional net interest income in 2018. This could help to boost net profit by around almost one-third.

Consider, though, if the Fed stays on hold through 2018, an unlikely, but not outlandish, scenario. J.P. Morgan said it could still increase net-interest income by, for example, adjusting the mix of its assets. But it would only gain about $3.5 billion in additional income.

Granted, that is better than interest income falling. It isn’t enough, though, to get investors excited about bank stocks, and certainly not enough to justify a rerating of its valuation.

So until the prospects for Fed movement brighten, bank stocks will be stuck cowering under the covers.

S&P sees growing corporate repayment risk Asian companies must repay almost $1tn of debt over next four years

Asia Pacific companies are on the hook to repay almost $1tn of debt over the next four years — more than half of it priced in US dollars, according to a report by Standard & Poor’s that also highlights the rise in repayments due from riskier, junk-rated companies. (…)

The report covers the $961.4bn of debt coming due that is rated by S&P. Of that, more than two-fifths must be repaid in the next two years. (…)

Just over 80 per cent of outstanding bonds from emerging market borrowers are denominated in dollars, while a further 6 per cent is in euros. (…)

By contrast, just 58 per cent of borrowing by developed market groups based in Australia, New Zealand and Japan, is in dollars or euros. (…)

More than 20 per cent of non-financial institution debt is junk-rated, while 4 per cent of financial institution debt is junk-rated. Repayments of $8.6bn fall due in 2016, while repayments almost double next year — then double again to $30.9bn by 2019.

This Is Why Kyle Bass Is Wrong on China Collapse, Says CICC The Chinese investment bank’s economists published an 11-page rebuttal of hedge-fund manager Bass’s assessment earlier this month where he stated that the nation’s banking system may see losses of more than four times those suffered by U.S. lenders during the 2008 credit crisis.

CICC says Bass is getting it wrong in three main areas: by comparing a “vastly different” Chinese economy to that of Japan’s in 1990; by using the ratio between loans and economic output as a complete measure of leverage in China; and by using a measure of foreign-exchange reserves that underestimates the true figure.

There are “several factual errors in Mr. Bass’s research,” Hong Liang, Beijing-based chief economist at CICC, and Eva Yi wrote in a report Tuesday. “Although we do not share Mr. Bass’s assessment of a violent debt-deflation cycle accompanied by severe FX depreciation in China in the near future, we acknowledge that China’s current macro challenges are daunting.”

This critique comes one week after their CICC colleague Mao Junhua wrote his own research taking issue with Bass’s assessment of nonperforming loans. The hedge-fund manager, who successfully bet against mortgages during the subprime collapse, said earlier this month that in the event that the Chinese banking system loses 10 percent of its assets because of bad loans, the nation’s banks will see about $3.5 trillion in their equity vanish, according to a letter to investors obtained by Bloomberg.

“We chose to write the rebuttal simply because it caused quite a bit of stir among our clients,” CICC’s Yi wrote in an e-mailed response to questions. “We take it as our responsibility to decipher through the noise and provide a balanced view on China macro-related issues.”

When asked to respond via e-mail, Bass pointed to a Feb. 17 Goldman Sachs Group Inc. report, in which the firm flagged the potential for a 9 percent bad-loan ratio in China’s banking system, more than the official reported level of 1.7 percent. The ability of industrial companies to cover their interest payments had deteriorated to levels in line with 2003, which is when banks last reported a 9 percent bad-loan ratio, according to the report.

(…) Others have also disagreed with Bass’s views including Larry Hu, an economist at Macquarie Group Ltd. in Hong Kong. He said this month that the hedge-fund manager’s estimate for bank losses could be too large as it implied a true bad-loan ratio for China banks at 28 to 30 percent.

Meanwhile, Eclectica Asset Management’s Hugh Hendry has taken issue with Bass’s forecast for a major devaluation in the yuan against the dollar. Policy makers in China wouldn’t risk such a drop because of the impact on consumption, Hendry said at a conference last week.

Here’s What Buffett Wouldn’t Do, and Maybe You Shouldn’t Either

Investing:

  • Don’t be too fixated on daily moves in the stock market
  • Don’t get excited about your investment gains when the market is climbing
  • Don’t be distracted by macroeconomic forecasts 
  • Don’t limit yourself to just one industry
  • Don’t get taken by formulas
  • Don’t be short on cash when you need it most
  • Don’t wager against the U.S. and its economic potential

Management:

  • Don’t beat yourself up over wrong decisions; take responsibility for them 
  • Don’t have mandatory retirement ages
  • “Don’t ask the barber whether you need a haircut” because the answer will be what’s best for the man with the scissors
  • Don’t dawdle
  • Don’t interfere with great managers
  • Don’t succumb to the attitudes that undermine businesses
Fingers crossed Fly, fly again: SpaceX goes back to sea

“Rockets are hard,” says Elon Musk, founder of SpaceX, who speaks from experience. Tonight his firm is due to launch SES-9, a communications satellite, into orbit—and will then make its latest attempt to land the first stage of a Falcon 9 rocket on a drone-ship stationed in the Atlantic. SpaceX achieved a successful touchdown on a terrestrial landing-pad in December, but its sea-landing attempts (which are necessary for some launch trajectories) have all failed. The first stage accounts for around 70% of the $54m cost of a Falcon 9, so recovery and reuse could slash the cost of access to space. Last month Mr Musk told The Economist that he thinks first-stage airframes could be reused 100 times, and engines at least ten times. Reusability is vital if he is to achieve his long-term goal of offering one-way trips to Mars for less than $100,000—something that he terms “very doable”. (The Economist)

NEW$ & VIEW$ (23 FEBRUARY 2016):

Chicago Fed: Economic Growth Picked Up in January

Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) rose to +0.28 in January from –0.34 in December. Two of the four broad categories of indicators that make up the index increased from December, and two of the four categories made positive contributions to the index in January.

The index’s three-month moving average, CFNAI-MA3, increased to –0.15 in January from –0.30 in December. January’s CFNAI-MA3 suggests that growth in national economic activity was somewhat below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

The CFNAI Diffusion Index, which is also a three-month moving average, ticked up to –0.11 in January from –0.17 in December. Thirty-nine of the 85 individual indicators made positive contributions to the CFNAI in January, while 46 made negative contributions. Forty-five indicators improved from December to January, while 39 indicators deteriorated and one was unchanged. Of the indicators that improved, 14 made negative contributions. [Download PDF News Release] (…)

When the CFNAI-MA3 value moves below -0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun. Conversely, when the CFNAI-MA3 value moves above -0.70 following a period of economic contraction, there is an increasing likelihood that a recession has ended.

The next chart highlights the -0.70 level and the value of the CFNAI-MA3 at the start of the seven recession that during the timeframe of this indicator. The 1973-75 event was an outlier because of the rapid rise of inflation following the 1973 Oil Embargo. As for the other six, we see that all but one started when the CFNAI-MA3 was above the -0.70 level.

CFNAI and Recessions

Auto DOT: Vehicle Miles Driven increased 4.2% year-over-year in December

Travel on all roads and streets changed by 4.2% (10.6 billion vehicle miles) for December 2015 as compared with December 2014. The seasonally adjusted vehicle miles traveled for December 2015 is 268.5 billion miles, a 4.0% (10.4 billion vehicle miles) increase over December 2014. It also represents a 1.4% change (3.7 billion vehicle miles) compared with November 2015.

Canada deficit could triple Trudeau’s limit

Canada’s deficit could be triple the C$10bn cap promised by Justin Trudeau in his campaign after the new government warned of a worse than expected impact from the slide in oil prices.

Canada is now on track for a deficit of C$18.4bn in the year starting April 1, which does not include new stimulus to be unveiled in the federal budget on March 22, said Bill Morneau, finance minister.

After adding widely anticipated spending measures, the deficit could run up to C$30bn. (…)

The finance department cut its outlook for growth from 2 per cent to 1.4 per cent for 2016, “reflecting the impact of sharp declines in crude oil prices” and “elevated uncertainty” in the global economy since its November update. (…)

(…) “Ottawa can clearly afford a moderate fiscal boost without doing lasting damage to the long-term debt outlook,” BMO Nesbitt Burns chief economist Douglas Porter and senior economist Robert Kavcic said in a report on Mr. Morneau’s update.

“The federal debt-to-GDP ratio has dipped in each of the past two years, and remains relatively low at 31 per cent,” they added. (…)

Including those measures, the 2016-17 deficit would equal only about 1.5 per cent of GDP, which is “hardly a blow-up,” said CIBC World Markets chief economist Avery Shenfeld. (…)

Older Women Reshape U.S. Job Market Faced with greater debt and less savings, more female workers are delaying retirement, a shift that’s helping to transform America’s economy.

Since the start of the most recent recession in December 2007, the share of older working women has grown while the percentage of every other category of U.S. worker—by gender and age—has declined or is flat.

In 1992, one in 12 women worked past age 65. That number is now around one in seven. By 2024, it will grow to almost one in five, or about 6.3 million workers, according to Labor Department projections. (…)

Overall, older Americans are better off financially than the previous generation. In 2013, households headed by adults age 62 and older had a median net worth 40% higher than similar households in 1989, adjusted for inflation, thanks to more two-income households, stocks and real-estate equity among wealthier families. Poverty rates among older Americans are down.

Net worth for households headed by adults 35 and younger, by contrast, have fallen 28% over the same period, according to the Federal Reserve Bank of St. Louis. (…)

Older Americans also have more debt than in the past. For example, half of all homeowners ages 65 and older with a mortgage owed about $88,000 in 2013, up from $43,400 in 2001. (…)

Still, among those who remain employed, the need for money was the most cited reason for working, exceeding those who work for enjoyment by a nearly 2 to 1 margin, according to a survey published in 2014 by AARP. (…)

Low interest rates have made retirees more insecure about their ability to live well longer.

More Americans are worried about their quality of life in retirement. Confidence about being able to save enough to ensure “a desirable standard of living” dropped this year, according to a new report. The worry was particularly strong among women.

Some 52 percent of individuals surveyed view their retirement prospects negatively, down 3 percentage points from last year. Only 47 percent of women said they were saving enough for their golden years, compared with 57 percent of men. (…)

More Subprime Borrowers Are Falling Behind on Their Auto Loans

(…) Delinquencies on subprime auto loans packaged into bonds rose in January to 4.7 percent, a level not seen since 2010, according to data from Wells Fargo & Co. (…)

Thumbs up BlackRock Warns Bond Traders They’re Underestimating the Fed

(…) “Will the central bankers wait out all of 2016?” Russ Koesterich, the global chief investment strategist for New York-based BlackRock, wrote in a report Monday. “Probably not, yet this is exactly what the futures market is suggesting. Inflation has strengthened, suggesting that the central bank may not be quite as dovish as the market expects.” (…)

Thumbs down The Fed Prepares to Dive By John Mauldin
Ghost Kyle Bass, a sharpshooting short-seller The hedge fund chief is betting on a vicious fall in the renminbi, writes Stephen Foley

(…) “Everyone has this embedded belief that China can pull off the ‘triple lindy’ every time they want to do it,” says the former springboard diver, “but our view is they are going to have to have a reset.” (…)

Yet, thanks to a 12-page dissection of China’s banks, shadow banks and central bank re­serves sent to investors in his $1.7bn hedge fund Hayman Capital last week, it is Mr Bass who has given the most strident, forensic and colourful voice to those who suspect China will be forced to revalue the currency sharply lower.

“What we are witnessing is the resetting of the largest macro imbalance the world has ever seen,” he wrote. Banking system losses could be four times as big as those on subprime mortgages in the US during the financial crisis, and the central bank does not have the reserves to plug the hole and defend its currency. “China’s back is completely up against the wall today” and the country is “on the precipice of a large devaluation”. Economists and Beijing have challenged the alarming analysis; Zhou Xiaochuan, the People’s Bank of China governor, gave a rare interview to insist capital outflows were evidence of economic rebalancing rather than capital flight.

This is all of a piece with previous declarations by Mr Bass. Since the Great Recession he has predicted sovereign debt crises in Ireland, Greece, Portugal, Spain, the UK, Switzerland and France. He has compared the Japanese economy to a “Ponzi scheme” . Armageddon does not always come — he admits he was wrong on Switzerland and the UK; and Japan is notably still standing, though a devaluation of the yen meant his bet eventually made money overall there. Hayman’s returns since the financial crisis have been modest by the standards of the greatest hedge fund investors and 2015 was, by his own admission, one of his worst. But enough of Mr Bass’s predictions have come true to justify taking him seriously. One manager of a fund of hedge funds says investing with Mr Bass is like funding a “think-tank” on how to navigate the global economy. (…)

How Vulnerable Is Europe to China’s Slowdown?

(…) Unlike Latin America, a China-related sharp fall in exports isn’t likely in Europe. That’s not to say there aren’t European industries that are vulnerable to China’s problems. China takes 8.1 percent of Europe’s raw metals exports, 8.5 percent of its wood and paper, and 10.4 percent of raw materials used to make textiles. In Germany, 10 percent of machinery and transport exports go to China, and those China-bound machinery and transport products make up 5 percent of the country’s total exports.  

Overall, however, Chinese demand accounts for just 1 percent of Europe’s GDP, while demand in the rest of non-Japan Asia accounts for another 1 percent. The euro area’s exports to China fell nearly 5 percent last year and yet overall exports rose 9 percent, with exports to developed economies driving much of the growth. As a result, analysts in Credit Suisse’s Global Markets division are skeptical that “the direct effects of a further slowdown in domestic demand in China or other emerging markets would deliver a severe, further, downside shock to euro area growth.”  

Given the international reach of Europe’s banking system, the risk of financial contagion originating in China and finding its way into the EU cannot be dismissed. In the last quarter of 2015, more than 50 percent of Chinese banks saw an increase in the number of non-performing loans. That’s a concern for European banks that have lent money to Chinese banks, as well as borrowers who could see their access to credit decline if banks grappling with China-related losses pull back on domestic lending. French and German banks have the most direct exposure to China, having increased their loans to Chinese banks in recent years.    

But the vulnerability of French and German banks – which hold some €40 billion and €30 billion in Chinese assets, respectively – pales in comparison to that of the Spanish banking system. While Spanish banks lend little to China, at least in comparison to their French and German counterparts, they do have a large exposure to Latin America, which is suffering from declining Chinese demand for commodities. Spanish banks held about €350 billion worth of Latin American and Caribbean assets last year. Credit Suisse said there’s already some evidence that credit conditions in Spain have begun to deteriorate. “In the event of a more severe financial crisis across the emerging markets asset class, it is possible that credit conditions for Spanish banks [will] tighten,” said the bank’s Global Market division analysts. 

Outside of banking, perhaps the greatest China-related obstacle facing Europe is psychological. For starters, Credit Suisse’s Global Risk Appetite index is in ‘panic’ mode. What’s more, Germany’s Ifo Institute reported late last month that its monthly confidence index dropped from 108.6 in December to 107.3 in January. An earlier survey by Credit Suisse found that concerns about China and Asia topped European executives’ list of worries last year. It remains to be seen whether those concerns will translate into declining investment, or whether European business leaders will concentrate on the half of the glass that is still full.  

Credit Suisse economists believe there is much to be said for the latter point of view. Europe’s outlook – and, by extension, the outlook for European equities – appears promising for a number of reasons, including anticipated easing by the European Central Bank, an improving labor market, and strong consumer demand, buoyed by a nearly 50 percent drop in the oil price in euro terms. Since Europe isn’t much for oil production, low energy prices should boost corporate margins, investment, and employment as well as household income. Fiscal conditions are finally easing, and credit conditions are loosening, too. Credit Suisse expects the euro area economy to grow 1.8 percent this year – up from 1.5 percent in 2015 and double the 0.9 percent growth rate of 2014 – and, for now, economists remain “relatively sanguine” about China’s problems dealing any kind of blow to that forecast.

Contact: edgeandodds [at] gmail.com