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: April 2016

NEW$ & VIEW$ (8 APRIL 2016):

Economists Trim Estimates for Growth Forecasters in The Wall Street Journal’s monthly survey of economists trimmed their estimates for 2016 employment gains and for economic growth amid market volatility and signs of a cautious consumer.

The average forecast in the survey calls for growth in gross domestic product of 2.1% in the year ahead, down from an estimate of 2.4% last month. The markdown was most dramatic for the start of the year: The economy is likely to grow at a 1.3% annual pace in the first quarter, down from an estimate of 2.1% a month ago. (…)

Recession Odds / Average probability of the U.S. economy entering recession in the coming 12 months

The Atlanta Fed GDPNow latest forecast for Q1: +0.4% (new forecast to be released today)

Evolution of Atlanta Fed GDPNow real GDP forecast

  • Don’t worry #1: A San Francisco Fed paper last year pointed out that a “statistical quirk” is partly responsible for weak 1Q real GDP. This “statistical quirk” suggests that the U.S. economy will appear to reaccelerate in 2Q of this year. In 1Q of last year real GDP growth was +0.6%. It accelerated to +3.9% in 2Q. In a remarkably consistent pattern over the past 5, 10, and 20 years, US real GDP growth on average has slowed -2 percentage points in 1Q versus 4Q, and then accelerated +2 percentage points in 2Q. For example, over the past 20 years, real GDP growth on average was +3%, +1%, and +3% in 4Q, 1Q, and 2Q, respectively. (EvercoreISI)

  • Don’t worry #2:

Fed’s Yellen Joins With Predecessors to Calm Recession Fears Federal Reserve Chairwoman Janet Yellen and three former Fed leaders sought to dispel worries the U.S. is heading back toward recession despite concerns about slow global growth and the expansion’s advancing age.

Ms. Yellen, joined Thursday in an unusual gathering in New York by former Fed Chairmen Ben Bernanke, Alan Greenspan and Paul Volcker, described an economy that is progressing without breeding obvious new financial bubbles that could derail growth.

“This is an economy on a solid course, not a bubble economy,” Ms. Yellen said. It has made “tremendous progress” from the damage of the 2007-2009 financial crisis.

“The domestic U.S. economy is moving forward,” Mr. Bernanke added. “I don’t see any particular reason to believe a recession is any more likely in 2016 than it was in 2015 or 2014.” Though the U.S. expansion is already older than the average post World War II expansion, he said expansions don’t die of old age. Instead, they reverse when imbalances throw off spending and investment. Messrs. Greenspan and Volcker largely concurred. (…)

Taken altogether, their comments marked a sign of guarded confidence from a quartet of the world’s most powerful economic policy makers, past and present, at a moment with political undertones. Republican presidential front-runner Donald Trump has argued the U.S. is a bubble economy heading toward severe recession. The Fed’s own critics have argued its low interest rate policies and repeated bond-purchase programs have inflated financial asset prices and made them prone to decline. (…)

“I don’t think December was a mistake,” Ms. Yellen said. “We remain on a reasonable path.”

Financial bubbles are often marked by large increases in private sector debt and overvalued asset prices. “We certainly don’t see those imbalances,” she said. (…)

Slow and slower

China is not alone slowing down as this U.S. GDP growth chart from Doug Short illustrates:

Real GDP with Regression

Apartment-Rental Market Is Losing Steam The apartment-rental market cooled in the first quarter, according to three research companies, suggesting a six-year housing boom might be coming to an end.

The national vacancy rate, which has risen for three consecutive quarters, hit 4.5% in the first three months of the year, up from a recent low of 4.2% in the second quarter of 2015, according to market research firm Reis Inc.

Average rents, meanwhile, increased by 4.1% to $1,248 in the first quarter from a year earlier, compared with the 2015 first quarter’s 5% increase, according to Axiometrics Inc., an apartment research company.

Potentially most alarming to housing economists: Demand for new apartments in the first quarter was about half its typical level. The number of occupied new apartments across the country climbed by just over 20,000 units in the first quarter, compared with the five-year average of about 40,000 for the quarter, according to apartment tracker MPF Research. The firm’s analysts said they aren’t sure if the unexpectedly sharp drop will turn into a long-term trend. (…)

The reports also tend to reflect larger, more expensive buildings owned by national apartment companies. For middle-class renters, the pain of rising rents is unlikely to ease soon because fewer apartments are being built in that price range.

Nonetheless, many of the country’s largest and hottest rental markets already are struggling. New York, San Francisco, Denver and Houston are all softening due to a flood of new construction and renters balking at prices that have risen sharply in recent years.

Developers in those markets are offering concessions such as a month or more of free rent to lure renters. In New York, the share of Manhattan rentals offering such concessions rose to nearly 14% from about 5% a year earlier, according to the Elliman Report by real-estate appraiser Jonathan Miller. The median rental price declined by 2.8% to $3,300, bringing an end to 24 consecutive months of rent increases, the report said. (…)

In San Francisco, the market has pulled back from the nation’s second hottest to the middle of the pack. In the first quarter, the city dropped to No. 20, with rent growth of just over 5%, according to Axiometrics. In the 2015 first quarter, rents posted an annual growth of nearly 13%.

Obama Readies Flurry of Business and Economic Regulations Burst of rule making follows weeks in which the administration targeted tax inversions, imposed new rules on brokers and advanced restrictions on corporate relations with union organizers.

The Obama administration is racing to make final a flurry of regulations affecting broad swaths of the economy, further riling U.S. businesses in an election season that has already been tough on corporate interests.

Planned moves—across labor, health, finance and the environment—range from overtime pay for white-collar workers to more obscure matters such as requiring food makers to disclose added sugar on cartons of flavored milk. (…)

Business uncertainty from Washington may not change anytime soon. Presidential front-runners in both parties have shown greater hostility toward business in some ways, with Democrats promising stiffer regulation and Republicans calling for new tariffs or an end to subsidies.

In his first seven years, Mr. Obama issued 392 regulations deemed “major,” meaning each carries an expected economic effect exceeding $100 million annually. Forty-seven more sat on the drawing board for this year. The tally issued already tops the totals during the eight-year tenures of George W. Bush, at 358, and Bill Clinton, at 361, according to an analysis by George Washington University’s Regulatory Studies Center. (…)

SENTIMENT WATCH
Earnings Season: Why Investors Are Too Bearish As earnings season approaches, bearish investors remain pretty skeptical about the market’s recent rally.

(…) Of course, earnings estimates have a propensity for falling too far just before the reporting period begins. Companies often hurdle the lowered bar. The S&P 500 has risen during three of the previous four earnings seasons, according to John Butters at FactSet.

While such positive “surprises” are nothing new, the market’s reaction to a better-than-expected round of earnings might not be typical. With pessimism, and short interest, so high, earnings surprising to the upside could prolong the recent rally.

The bears may be growling, but the bulls might have the last laugh.

Stock ETFs add sixth week to streak of inflows: Lipper Exchange-traded fund investors showed continued confidence in U.S. markets, delivering stock ETFs based in the country $3.5 billion and their sixth straight week of net new cash during the latest week, Lipper data showed on Thursday.

Stock mutual funds in the United States, by contrast, posted $328 million in outflows in the week that ended April 6, according to the data. (…)

Inflows into stock funds were focused on those invested in U.S.-based companies, which took in $2.3 billion following two weeks of outflows. International stock funds attracted just $888 million, Lipper said. (…)

NEW$ & VIEW$ (7 APRIL 2016): “Global” risks feared globally.

Split Fed sees ‘appreciable’ global risks Minutes show policymakers divided over timing of next rate rise

Many Federal Reserve policymakers were warning of “appreciable” risks to the US economy from global developments at their latest meeting as a deeply divided body of officials debated how soon to further increase short-term interest rates. (…)

The minutes suggested those advocating caution outnumbered those seeking action this month, supporting market perceptions that the Fed will not move until its June meeting at the earliest. (…)

Public statements have pointed to disagreements among officials, however, with a number of regional Fed presidents putting forward a bullish view of America’s prospects. (…)

The minutes shed further light on these disagreements, with policymakers differing for example over whether the US is nearly at full employment and how much weight to put on a recent pickup in inflation and subdued inflation expectations. (…)

“Several participants expressed the view that the underlying factors abroad that led to a sharp, though temporary, deterioration in global financial conditions earlier this year had not been fully resolved and thus posed downside risks,” the minutes said.

It was noted, for instance, that weak growth overseas could lead to a further appreciation in the dollar, something that would drag on exports and inflation.

The fact that the Fed has limited room to cut rates if the US economy slows was also a major consideration for a number of policymakers. (…)

ECB says willing to act as Draghi warns on global uncertainty
Pointing up Draghi’s Big Bazooka Is Misfiring

(…) Despite central banks doing just about everything bar throwing money from helicopters, companies still won’t deploy cash. Global capex fell about 10 percent in 2015, according to Standard & Poor’s, and could shrink another 4 percent this year. That’s driven by the ailing commodities sector. But if energy and materials are excluded, capex still shrank 2 percent last year.

What’s gone wrong? In a world marred by low growth and industrial overcapacity it’s hard for companies to generate a return exceeding their WACC and this is clearly slowing investment. (…)

Good BB piece with charts. This also not helping:

Sad smile German economic growth remains sluggish amid near stagnation of manufacturing

Germany’s composite Output Index (produced by Markit from its manufacturing and service sector surveys) fell to an eight-month low of 54.0 in March, pointing to a slowdown in economic activity at the end of the first quarter. The survey data are nevertheless still signalling modest, albeit unspectacular, GDP growth of approximately 0.4% in the opening quarter of 2016.

Modest GDP growth signalled

Worryingly, the forward-looking indicators suggest that growth could slow even further in coming months. The amount of new work received by businesses rose at the weakest rate since last August, which in turn resulted in a more cautious approach with regards to hiring. Although employment continued to rise during the month, the rate of job creation equalled February’s near one-year low, with goods-producers cutting payroll numbers for a second consecutive month. Moreover, levels of work outstanding rose only marginally, which could lead to a further slowdown of jobs growth in coming months.

Germany’s mighty service sector continued to grow at a steady pace throughout the first quarter, leading the economy’s expansion, although failed to gain traction from prior months. There have been reports recently from survey participants that the large inflow of refugees led to increased activity, especially with regards to building new shelters. This development was also reflected in recently strong construction PMI numbers, with the index reaching its highest level since the first quarter of 2011 in February, before slowing in March.

Meanwhile, the manufacturing sector grew at a snail’s pace during the past two months, thereby highlighting how the sector is struggling in an uncertain global economic environment. Despite ticking higher from February’s 15-month low, at 50.7, the PMI signalled a near-stalling of manufacturing.

Steady services growth contrasts with weak manufacturing

(…) The strong euro clearly has some negative side effects. First, it makes imports from overseas cheaper, which will add additional downward pressure on inflation and lead to ‘import substitution’. Second, exports will be more expensive. This is particularly bad news for Germany’s more export-oriented manufacturers, who are already struggling in the current global economic environment. Markit’s PMI New Export Orders Index fell to an eight-month low in March, signalling a near-stagnation of foreign sales. With the exception of the marginal decline in July 2015, it was the lowest reading in over a year. (…)

More global risks:

IMF Warns of Possible Crises for Emerging Markets Hit by Outflows An exodus of cash from emerging markets in recent years is closely tied to developing economies’ slower growth rates and could end with financial crises in the countries involved, the International Monetary Fund says.

(…) “Much of the decline in inflows can be explained by the narrowing differential in growth prospects between emerging market and advanced economies,” the IMF said in a study included in its World Economic Outlook publication. “Both weaker inflows and stronger outflows have contributed to the slowdown.”

Flows to 45 key emerging markets have fallen off by more than $1 trillion since 2010, withhalf of the drop coming from China, the world’s second-biggest economy, and Russia, which has faced international sanctions and a precipitous drop in energy prices, the IMF said. (…)

Collectively, the reversal in capital flows is equivalent to an outflow of 1.2% of gross domestic product in the most recent four quarters, compared with an inflow of 3.7% of their GDP in 2010. The slowdown occurred in three-quarters of the economies the IMF studied.

It is the third major pullback in three decades for the emerging markets, and it comes at a time when the extra growth offered by emerging markets contracted by 0.75 percentage point, the IMF said. (…)

SENTIMENT WATCH
U.S. Braces for Worst Earnings Season Since 2009 Crisis: Chart

U.S. corporate profits are expected to drop the most in 6 1/2 years in the first quarter, led by a wipeout in the embattled energy sector. Earnings for companies in the Standard & Poor’s 500 Index will fall 9.8 percent year-over-year, which would be the sharpest decline since the third quarter of 2009 and a fourth consecutive quarter of contraction, according to Bloomberg data. Results will be insufficient to justify current stock valuations, says Alex Bellefleur, head of global macro strategy and research at Pavilion Global Markets.

Wait, wait! There is a potential silver lining:

Weak U.S. earnings expectations set stage for stock gains

When Wall Street’s quarterly earnings season kicks in to high gear next week, hundreds of companies will vie for the bragging rights that come from “beating the Street” – showing revenues and profits that are higher than analysts expected.

That hurdle may be unusually easy to clear this quarter, as analysts, who saw oil prices and stocks collapse at the start of the year, went really negative on the first quarter of 2016.

While the majority of companies typically beat forecasts, the bar for positive surprises may be even lower this time around, with analysts expecting profits of S&P 500 companies to be down 7.4 percent from a year ago, according to Thomson Reuters data.

With a handful of early reports coming in well above expectations and some evidence of stability in two company-hurting trends – falling oil prices and a rising dollar – some strategists are predicting enough positive news in an otherwise negative earnings season to boost stocks at least in the short term. In order words: First quarter earnings will be bad, but maybe not that bad.

(…) roughly 80 percent of S&P companies that have already declared first-quarter results are beating expectations. That is higher than usual, and includes strong performance from a diverse group of companies, including Lennar Corp (LEN.N), FedEx Corp (FDX.N) and Adobe Systems Inc (ADBE.O). (…)

It was “an absolute collapse in expectations,” said Jonathan Golub, chief equity strategist at RBC Capital Markets in New York.

The drop in analysts’ views between Jan. 1 and now was almost triple the typical 3.5 percent preseason decline, he said, and “about as bad as we’ve ever seen, with the exception of the period going into the ’08-09 crisis.” (…)

Could be overdone. But a problem remains: unless earnings beat by 8-9%, highly unlikely, EPS will still be down YoY in Q1, dragging trailing earnings lower. Unless inflation diminishes markedly, the Rule of 20 fair index value will keep falling. The yellow line of the chart below peaked in March 2015 at 2174, falling 4.4% to its current 2079. If Q1’16 EPS drop 5%, trailing EPS will decline 1.2% to about $116.00, bringing “fair value” to 2053. Given current high valuations, investors would need a lot of faith in the economic environment to drive equities much higher. Central bankers are certainly not helping on that matter!

image

Another reason to be careful on building too high beat expectations is that smaller companies seem to be struggling. Here’s a great chart from the NFIB via Zerohedge charting the current margin squeeze. This helps explain why small and mid-cap stocks keep underperforming larger caps.

Meanwhile, this support may also be fading:

Mega deals morph into mega problems for Wall Street

(…) Some of the mega transactions that had champagne corks popping in boardrooms are running into antitrust problems and, in the case of pharmaceutical firm Pfizer Inc’s (PFE.N) $160 billion takeover of rival Allergan PLC (AGN.N), political opposition to a deal that envisaged the biggest drug company in the United States moving to Ireland to lower its taxes. (…)

The political uncertainty and antitrust concerns mean that firms will think twice about future tie-ups that consolidate industries and move tax dollars offshore. (…)

But the consequence of greater consolidation is increased scrutiny by antitrust officials. That was exemplified on Wednesday by the U.S. government filing a lawsuit to stop Halliburton from buying Baker Hughes, arguing the combination of the No. 2 and No. 3 oil services companies would lead to higher prices in the sector.

The Justice Department and Federal Trade Commission (FTC), which enforce antitrust law, have filed lawsuits to stop an unusually high number of deals in the past 18 months. FTC officials are in court this week to block a merger between Staples Inc (SPLS.O) and Office Depot Inc (ODP.O).

“It isn’t just the number of proposed deals that makes this a unique moment in antitrust enforcement; it’s their size and their complexity,” U.S. Attorney General Loretta Lynch said in a speech on Wednesday.

“This represents a remarkable shift toward consolidation and it presents unique challenges to federal enforcers in our work to maintain markets that serve not just top executives and majority shareholders, but every American.”

In Europe, meanwhile, talks between Orange SA (ORAN.PA) and Bouygues SA (BOUY.PA) to create a dominant French telecoms operator collapsed last week, amid competition concerns and a stand-off between Martin Bouygues and French Economy Minister Emmanuel Macron about the clout the billionaire would have gained in the former state monopoly, according to people familiar with the matter.

For bankers, scuttled deals cost money.