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

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COMMERCIAL REAL EST

NEW$ & VIEW$ (6 JULY 2016)

U.S. Factory Orders Backpedal in May

New orders to manufacturers declined 1.0% (-0.2% y/y) during May following a little-revised 1.8% April gain. A 0.9% decline had been expected in the Action Economics Forecast Survey. Durable goods orders fell 2.3%, which was roughly the same as in the advance report, and paced by a sharp drop in transportation sector bookings.

Nondurable goods orders, which equal shipments, improved 0.3% (-4.6% y/y) led by a steady 2.4% increase (-30.7% y/y) in petroleum refinery shipments. Apparel shipments jumped 1.9% (13.6% y/y), but basic chemical shipments were off 0.5% (+3.9% y/y). Durable goods shipments eased 0.2% (+0.2% y/y) led lower by fewer motor vehicle shipments.

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Mortgage Rates at Record Lows

30 Year Fixed

The Refinance Index increased 21 percent from the previous week to the highest level since January 2015. The seasonally adjusted Purchase Index increased 4 percent from one week earlier. The unadjusted Purchase Index increased 4 percent compared with the previous week and was 23 percent higher than the same week one year ago.

Reis: Office Vacancy Rate declined in Q2 to 16.0%

Reis reported that the office vacancy rate declined to 16.0% in Q2, from 16.1% in Q1. This is down from 16.5% in Q2 2015, and down from the cycle peak of 17.6%. (…)

Apartment Rents Rise at Slower Pace

Rents increased by 4% in the second quarter over the same time last year, according to real-estate researcher Reis Inc. That was less than the 5% year-over-year growth in the fourth quarter of last year, which marked the biggest jump in rents since the dot-com boom in the early 2000s.

Another research firm, Axiometrics Inc., showed an even sharper slowdown in year-over-year rent growth, to 3.7% in the second quarter from 5.1% in the same period last year. (…)

The vacancy rate was essentially flat in the second quarter, hovering around 4.5%, according to Reis.

More than 127,000 new apartments were filled in the second quarter, easily exceeding the 67,550 units that were built during the period, according to MPF.

Ninja Time To Take The Fed’s Warning Seriously: CMBS Has “Greatest Ever Monthly Delinquency Increase”
Sterling hits 31-year low amid resurgent Brexit jitters  Pound touches $1.2798 as government bond yields fall deeper into uncharted territory

GBP070516(Bespoke Investment)

Euro Area Retail Sales Are Soft and So Is the Outlook

Retail sales volumes in the euro area in May grew by a solid 0.4% but in the wake of a 0.2% gain in April and after a 0.6% drop in March. Over the last three months, retail sales are still contracting on balance in the EMU. The picture is much weaker for nonfood sales where sales are falling at a 4% annual rate over three months and up by only 0.4% over 12 months.

Motor vehicle registrations also show flagging momentum as sales slow more over each subsequently shorter horizon. Over each of the last two months, registrations are lower, falling by 2.2% in May and by 0.5% in April, but after a 1.1% rise in March. Registrations over three months are falling at a 6.2% annual rate.

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Markit Eurozone Retail PMI®: Sales plummet in Italy but rise across Germany and France

June saw contrasting trends in retail sector performance across the single currency area, according to the latest Markit Eurozone Retail PMI®. While there were slight increases in sales across both Germany and France, the overall picture was darkened by a sharp and accelerated reduction in sales in Italy.

The headline Markit Eurozone Retail PMI – which tracks month-on-month changes in like-for-like retail sales in the bloc’s biggest three economies combined – registered 48.5 in June, down from May’s 50.6. It was the index’s third sub-50 reading – signalling a drop in sales – in the past four months. Sales were also down compared with the same month one year before, albeit only slightly.

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U.S. RETAIL SALES?

The Thomson Reuters Same Store Sales Index is expected to come in at -1.4% for June 2016, weaker than June 2015’s 0.5% result. (…) June marks the second month of the retail industry’s second quarter. Our Thomson Reuters Quarterly Same Store Sales Index, which consists of 80 retailers, is expected to post 0.9% growth for Q2 (vs. 1.4% in Q2 2015).

CEBM Research China July survey snippets:

imageThe CEBM Developer Sales Expectations Index plummeted from 9% in May to -82% in June (Chart 1). The sharp decline in sentiment was attributed to several factors: 1) a gradual fulfillment of demand for a second home by upgrading and investment buyers who purchased earlier in the year; 2) the continual release of localized control measures in cities whose real estate markets began to overheat in early 2016; 3) large-scale developers have recently completed mid-year sales campaigns to meet 1H16 sales targets, thus respondents expect a seasonal downturn in sales volume in July.

Despite the massive decline in sales sentiment, the price expectations index increased slightly M/M, in part because developers expect monetary policy conditions to remain accommodative. Going forward, housing prices in major tier two cities are expected to maintain steady appreciation.

Looking at activity by city tier: home buying enthusiasm in 1st Tier cities continues to cool; new starts and sales in 2nd Tier cities softened; and 3rd and 4th Tier cities remain plagued by inventory overhang. (…)

The New Starts Expectations Index has dropped from 55% to 8% over the previous month. The deterioration in developer sentiment displayed provides further support to our previous forecast that China’s real estate industry has likely reached a cyclical inflection point with conditions expected to weaken in 2H16. (…)

While export volume remains sluggish, survey feedback indicates that import volume is continuously increasing, helped along by the RMB’s appreciation against the currencies of its South American trade partners. This has resulted in an influx of raw material, agricultural, and non-durable consumer goods imports. Meanwhile we continue to see evidence of labor intensive manufacturing moving abroad to South East Asia impacting the production networks of foreign enterprises operating in areas like Suzhou. (…)

Ceteris Non Paribus:

Chinese firms have announced more than $3.9 billion in overseas acquisitions in the pharmaceutical, biotechnology and health-care sectors this year, a pace on track to exceed last year’s record total and a tenfold increase from the amount spent in all of 2012, data compiled by Bloomberg show.

That surge is driven by Chinese tycoons and businesses seeking to diversify in the face of slowing growth at home and a government push to upgrade the “Made in China” brand. In the domestic market, many of these companies are grappling with a fragmented drug industry with close to 5,000 manufacturers and aggressive competition that is pushing down generic drug prices. Success overseas would allow them to expand their portfolios, find new areas of growth and provide a ready-made entry into developed markets that have high regulatory standards. (…)

(… ) London-listed Just Eat Plc. will join German retail chain Metro AG, logistics company Hermes Group, and U.K. food delivery startup Pronto Technology Ltd., in trialing delivery using self-driving robots. Starship Technologies, the company that makes the droids, said Wednesday that Just Eat and Pronto will be using the robots in London, while Metro and Hermes will deploy them in Dusseldorf, Germany, and Bern, Switzerland, as well as another undisclosed German city. (…)

How Accurate are the Projections of Analysts on Second Half Earnings Growth Rates?

After five straight quarters of year-over-year earnings declines (assuming the index reports a decline in earnings for Q2 2016), analysts in aggregate are predicting earnings growth will return to the index starting in Q3 2016.  But, how accurate are the projections of analysts on earnings growth for the second half of the year at this point in time?

Over the past five years (2011-2015) by June 28, analysts have overestimated the actual earnings growth for the second half of the same year by nearly 5 percentage points (4.7 percentage points).

If this average overestimation is subtracted from the estimated earnings growth rate of 4.2% for the second half of 2016, the actual earnings decline for the second half of the year would be -0.5% (4.2% – 4.7% = -0.5%).

Utility Stocks Are More Dangerous Than They Look The biggest driver of good times at utilities is low interest rates—and that is a problem, writes Ken Brown.

Companies that produce electricity have never been so popular. Buyers love the sector for its 3.3% dividend yield and for its terrific recent performance. The sector is up 21.9% this year, making it the second-best sector in the market, trailing only telecom, which yields 4.2%, according to FactSet.

Besides the yields, the utility industry is enjoying strong fundamentals that have boosted profits. When executives at electric utilities dream of the perfect world, it probably looks something like today. Sadly, dreams never last forever. (…)

Low rates also have boosted utilities’ profits. That is because regulators allow utilities to make a specific return on their investments. Utilities borrow a lot, so rates matter. But regulators have lagged behind the reality. So rates are being set as if utilities were borrowing at higher rates than they really are. The difference is profit.

The second benefit for the industry has been lower energy prices. Energy accounts for roughly two-thirds of consumers’ electric bills, and utilities just pass along those costs. But when utility bills are low overall, regulators are more likely to be generous when they negotiate rate increases, according to Morningstar utilities analyst Travis Miller.

Finally, there is the benefit of having more valuable shares, which makes it cheaper to raise capital. “Your cost of equity has gone down and your cost of debt has gone down,” Mr. Miller said. (…)

Investors also don’t appear to understand the difference between fully regulated utilities that are relatively safe and unregulated businesses that are vulnerable to the whims of the marketplace. Typically, the best-run regulated utilities trade at 10% premiums to the industry, but now the least and most risky are valued almost the same. Southern Co., the big southeastern U.S. utility, is well run, highly profitable and has friendly regulators, yet it trades at a price/earnings ratio of 21, just below the industry average.

Utilities fans also haven’t noticed the fields of windmills in places like West Texas and solar panels sitting on suburban rooftops. The U.S. will rely on fossil fuels and nuclear power to generate electricity for decades to come, but the rise of alternative energy is already being felt by utilities. Alternative energy accounts for about 13% of electricity generation in the U.S., according to the U.S. Energy Information Administration, with wind power jumping by one-third in the past 12 months.

The issue is the U.S. doesn’t need much more electricity than its already producing. For utilities, it means they are shutting down plants, mostly nuclear and coal. While consumers will pay some of the cost, companies also will take a hit.

The longer-term risk is demand destruction caused by alternative energy and, potentially, batteries. In Texas, the wind blows at night when power demand is low. Texas has so much wind power that utility TXU Energy gives away electricity during those hours. Analysts at Bernstein Research argue that in a few years, batteries will be cheap and powerful enough that homeowners can store the night time power and use it during the day to cut their energy bills to zero. The same could be true for some homes with rooftop solar. (…)

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. (…)

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