Emerging Markets

Markets Misled By Factory Order Book Signal

Stock markets have fallen sharply in what looks to be an over-reaction to a steep deterioration in the ISM survey. The ISM’s manufacturing new orders index
suffered its largest fall in points terms since December 1980, plummeting 13.2 points from 64.4 in December to 51.2 in January. The drop in new orders contributed
to a steep fall in the survey’s headline PMI, which dropped from 56.5 to 51.3.

Analysts had been wrong-footed, having expected the PMI to merely dip to 56.0. The severity of the miss against expectations induced new worries that the US
economy was not as healthy as previously thought. Benchmark equity indices dropped by around 1%. However, the market reaction to the survey looks overblown.

First, analyst expectations were too high to start with. In its report, the ISM noted unusually cold weather was at least partly to blame for the decline. January had seen record low temperatures across swathes of the US, which Markit’s flash PMI (published 23 January) had already shown to have caused a slowdown in manufacturing activity. Analysts should have factored this into their ISM predictions.

Second, the fall in the ISM new orders index needs to be looked at in context of prior months, in which the survey had been signalling far stronger growth of
factory orders than official data had been registering. The ISM new orders index had been running above 60 in the five months prior to January, with an increase to
64.4 in December. To put this in context, the ISM data suggest that the second half of 2013 therefore saw a rise in new orders of a magnitude commensurate with
the sharp rebound from the depths of the financial crisis seen in late-2009. However, official data have recorded a mere 0.2% rise in factory orders between June and November of last year, including a 0.5% fall in October, which is likely to have been linked to disruptions caused by the government shutdown.

Markit’s PMI, in contrast, to the ISM, has tracked official data on factory orders well (see chart). The survey has shown weak growth of orders in the third quarter of last year, with a marked easing due to the October shutdown, after which growth revived in the final two months of the year. January’s final Markit PMI data showed reasonable, if unexciting, growth of orders at US factories. The increase was the weakest for three months (the index dipped from 56.1 in December to 53.9), but once an estimated allowance is made for the number of companies reporting disruptions due to the adverse weather, the underlying trend in new orders appears to have been as strong, if not slightly stronger, than late last year.

The fall in the ISM’s new orders index in January therefore needs to be viewed as a hit from the cold weather plus – and most importantly –a correction from
misleadingly high readings late last year.

Markit is grinding its own axe but their point is absolutely valid. The ISM was clearly off track in recent months. Financial markets will learn to put their trust in Markit’s surveys.

Developed World Leads Global Trade Revival In January

Worldwide PMI™ survey data signalled an increase in goods exports for a seventh straight month in January, indicating that the upturn in global trade flows seen late
last year has persisted at the start of 2014. However, a widespread weakness of exports from emerging markets reveals how the upturn is being largely concentrated in the developed world.

A GDP-weighted aggregated global export orders index derived from the manufacturing PMI surveys conducted by Markit acts as a reliable guide to official trade data, which are only available with a substantial delay. This PMI index fell slightly for a second month running in January, down to a four-month low. However, the decline was at least in part attributable to the weather-related disruption in the US (excluding the US the global index would have remained steady at 52.0), and at  51.2 the index has now been above the 50 level, thereby indicating rising global exports, for seven straight months.

Comparisons with official data indicate how the PMI accurately foretold the upturn in global trade in the second half of last year from the stagnation seen during the second quarter. The January PMI reading is consistent with global exports rising at an annual rate of approximately 8%. The latest available official data registered a 6.9% annual increase in November. Extreme cold weather disrupted US trade flows in January, pushing the world’s largest economy to the foot of the global PMI export orders rankings. Besides the US, the only other countries seeing falling export orders in January were emerging markets, including three of the BRIC economies: China, Russia and Brazil.

China’s exports fell for a second successive month, contributing to the country’s first overall deterioration of manufacturing conditions for six months in January. Russia meanwhile saw exports fall for a fifth successive month.

The decline in Brazil was only very marginal, but adds further to the contrast between the ongoing plight of Asian and South American emerging markets against robust growth in many developed world economies.

The top half of the trade league table was in fact dominated by developed countries and eastern European nations that are benefitting from rising trade with Germany. January’s PMI survey indicates that the eurozone’s largest member state has entered 2014 on a firm footing, with GDP on course to rise by over 0.6-0.7% in the first quarter. The Czech Republic led the overall global trade rankings, followed by the UK, then Germany and the Netherlands.

The export-led revival of eurozone peripheral countries was meanwhile underscored by both Italy and Spain occupying fifth and seventh place respectively. Ireland likewise saw a robust rise in export orders and even Greece enjoyed a modest upturn.

Related: Manufacturing highlights growing developed and emerging market divergences

EM Currencies May Reflect Normalization, Not Crisis

This is the best piece I have seen on the EM crisis.From Robert Sinche, Pierpont Securities, via BloombergBriefs.

(…) Each month the Federal Reserve takes its basket of EM other important trading partner (OITP) currencies and adjusts its value relative to (U.S.) inflation to estimate a real trade weighted value of the U.S. dollar versus the basket of OITP currencies. The latest reading, for December 2013, showed the real trade-weighted U.S. dollar was only about 1 percent above its 30-plus year low set in April 2013, about 15 percent below its average since 1980 and still 30 percent below its recent high in February 2003. After adjustment for relative inflation, the U.S. dollar remains undervalued relative to a basket of EM currencies.

In this context, it should not come as a great shock that U.S. manufacturers are increasingly competitive and that some have been returning production to the U.S. from selected EM countries.

During recent years, Fed initiatives to stimulate the economy through quantitative easing appeared to be a catalyst for a weaker U.S. dollar. While the central bank under Ben S. Bernanke did not pursue a “currency war” with emerging countries, QE did mark a retreat for the U.S. dollar, improving domestic competitiveness and limiting imported deflation pressures. It should not come as a great surprise that the tapering of the pace of Fed asset purchases is triggering a correction in the sharp undervaluation of the dollar.

In this context, is the recent correction in the U.S. dollar versus emerging markets currencies a sign of crisis, or a shift towards a normalized value? After all, based on movements in the nominal trade-weighted U.S. dollar versus OITP currencies, the real trade-weighted dollar increased only about 2 percent during January, taking the index up to the 95- 96 range. Compared to the (real) U.S. dollar surge versus OITP currencies in the 1997-98 Asian currency crisis (a more than 20 percent rise during seven months) or the 2008-09 global economic crisis (a 13.3 percent gain during seven months), the 2-3 percent rise in January is only a minor adjustment. If not for the simultaneous weakening of global equity markets, in some cases, a well advertised and healthy correction, it is not clear the adjustment in EM currencies would be garnering so much attention.

As a result, it appears very unlikely that EM currencies will reverse and rebound any time soon. Instead, the preferable course would be a continued, moderate
decline in many EM currencies (heavyweights China yuan and Hong Kong dollar excluded) that re-establishes more reasonable, competitive values for many
emerging economies. India might be a leading indicator; the rupee fell almost 25 percent versus the U.S. dollar from early May through early September, setting off
sharp adjustments in Indian growth and, particularly, import demand. With a short lag, the economy, including India’s rupee, has stabilized, with data released this
past Monday showing the 3rd consecutive reading above 50 for the HSBC/Markit PMI for Indian manufacturers.

The key for many EM countries will be the policy initiatives taken as their currencies weaken, with those adopting sound monetary and fiscal policies having the
higher probability of benefiting economically from a moderate improvement in competitiveness. For the U.S., conversely, a gradually strengthening dollar versus
many EM producer economies opens the potential for subdued import prices that should help keep inflation below-target, a potential complication for Fed policy makers as the economy slows during the early months of this year.

The Bank of Canada is showing the way, openly letting the CAD decline even after its recent 10% retreat. The Canadian economy needs a lower currency and the BOC is more than happy to let markets do the job.

SOFT PATCH WATCH

EUROZONE RETAIL SALES CRATER IN DECEMBER

This is not in the mainstream media today but it is major stuff. Total retail volume dropped 1.6% MoM in December in the EA17. Over the last 4 months, retail volume is down 1.8%, that is a 5.4% annualized rate! Core sales volume dropped 1.8% in December and is down 1.5% since September (-4.6% annualized). Real sales dropped 2.5% in Germany (-2.4% in last 4 months), 3.6% in Spain (-6.0%), 1.0% in France (-1.2%).

Note that U.S. retail sales are also pretty weak based on weekly chain store sales:

What Do Auto Prices Need to Do? ‘Keep Melting’ Some analysts say prices will need to keep falling if U.S. car sales are going to hit the level needed to mop up all the new vehicles rolling off factory floors.

With rising inventory, increasing production capacity, and slowing demand, February is shaping up to be an important indicator of the health of the auto industry,” Morgan Stanley writes after January’s weaker-than-expected sales. Weather “clearly played a materially negative role,” Morgan Stanley says, particularly for the Detroit Three as much of their sales are in the Midwest and Northeast.

The firm thinks the industry “stands at a cross-road,” where “pricing is going to have to keep melting” if US sales are to get to a seasonally-adjusted annual rate of 17 million sales in the next 12-18 months. The best of the auto replacement cycle is over, Morgan Stanley thinks, with “the incremental buyer moving from someone who needs to replace their car to one who wants to…making bank willingness to lend and credit availability more important than ever.

LOAN DEMAND: UP FOR C&I, DOWN FOR MORTGAGES

The Federal Reserve recently released its Senior Loan Officer Opinion Survey (SLOOS). Conducted each quarter, the survey examines changes in the standards and terms of lending, as well as the state of business and household demand for loans. This quarter’s survey is based upon responses from 75 domestic banks and 21 U.S. branches and agencies of foreign banks. On the commercial lending side, results broadly reflected 1) an easing of lending standards on C&I loans and an increase in demand versus the prior survey; and 2) continued easing in commercial real estate (CRE) lending standards accompanied by the ongoing strengthening of demand. Shifting to the household lending side, the survey’s key takeaways were that 1) a small number of domestic banks tightened standards on prime residential mortgages, even as borrower demand declined for a second consecutive quarter; 2) a small fraction of lenders eased standards on credit card, auto and other loans; and 3) demand strengthened for all three categories, which represents four consecutive quarters of a net increase or flat demand. (Raymond James)

  

The next chart from CalculatedRisk shows the MBA mortgage purchase index. The 4-week average of the purchase index is now down about 14% from a year ago.

U.S. EMPLOYMENT

• Only About One-Third of Labor Force Dropouts Will Return Millions of people have dropped out of the labor force since the start of the recession in late 2007, and only about a third of them will come back in the years ahead when the economy is stronger, the CBO said in a new report released Tuesday. 

(…) Of the 3 percentage point decline in labor force participation since the end of 2007, about 1.5 percentage points is due to long-term trends, mostly the retirement of Baby Boomers, CBO said. The aging of this group has swelled the proportion of the population aged 55 years or older — a group that is less likely to work than younger people. The downward pressure from this group on the participation rate would have happened regardless of the 2007-2009 recession.

Temporary factors — namely the anemic recovery — account for another 1 percentage point of the labor force participation decline, the equivalent of roughly 3 million people, the CBO said. The lack of good job opportunities in a weak economy discourages some people from looking for work, perhaps sending some of them back to school. As the economy strengthens and demand for workers rebounds, these people will re-enter the labor force, the CBO said, predicting that the “dampening effect” this factor has on participation will end by 2018.

Finally, about 0.5 percentage point of the decrease in labor force participation since 2007 was due to people who have dropped out permanently, and not because of demographic trends. These people wouldn’t have left if not for the harsh recession and unusually weak recovery that followed. Some who had trouble finding work decided to sign up for Social Security Disability Insurance instead. Others departed for early retirement or “chose alternative unpaid activities, such as caring for family members, and will remain out of the labor force permanently,” the report said. The report was released Tuesday alongside the CBO’s budget and economic outlook.

Looking ahead, the CBO predicts the participation rate will continue its downward drift downward even after the economy fully recovers. The CBO said the labor force participation rate will stay at about 62.9% in 2014 but fall to 60.8% by the end of 2024.

While those who temporarily stopped looking for work will return to the labor force between 2014 and 2017, that recovery “will be more than offset by the downward pressure on participation stemming from other changes,” especially aging, the CBO said. (…)

• Health Law to Cut Into Labor Force The Congressional Budget Office report forecasts that more people will opt to work less as they seek coverage through Affordable Care Act.

The new health law is projected to reduce the total number of hours Americans work by the equivalent of 2.3 million full-time jobs in 2021, a bigger impact on the workforce than previously expected, according to a nonpartisan congressional report.

The analysis, by the Congressional Budget Office, says a key factor is people scaling back how much they work and instead getting health coverage through the Affordable Care Act. The agency had earlier forecast the labor-force impact would be the equivalent of 800,000 workers in 2021.

Because the CBO estimated that the changes would be a result of workers’ choices, it said the law, President Barack Obama‘s signature initiative, wouldn’t lead to a rise in the unemployment rate. But the labor-force impact could slow growth in future years, though the precise impact is uncertain. (…)

The report indicates that, in effect, some workers will either leave the workforce entirely or cut back on hours because the law lets them get coverage on their own without regard to their medical history, in some cases with a subsidy.

The report also said that in the next few years, some of the hours that were given up would be picked up by the many Americans seeking jobs. (…)

The CBO estimated that insurance premiums on the health-care exchanges were 15% less than originally forecast, and, more broadly, the agency said the recent slowdown in the growth of Medicare costs had been “broad and persistent” and projected “that growth will be slower than usual for some years to come.” (…)

• Graduate School Attendance Is up, but Wage Premium Steady

(…) Roughly 36 million people in the U.S. had some graduate school under their belts (though not necessarily an advanced degree) in early 2013, the Census Bureau said Tuesday. That’s up from 29 million in early 2008, during the recession. (…)

Overall, the number of Americans with at least some college, including undergrad and grad school, rose 11% since 2008 to 121 million in 2013.

But there was a downside. Just as more people received degrees, a lot of students entered graduate programs but never completed them. The number of people with some graduate school but no degree jumped 38% from 2008 to 2013.

The rise in enrollment varied across programs. For example, the number of Americans with an associate’s degree increased almost 19% between 2008 and 2013. Those who had earned a bachelor’s degree, but with no graduate school, climbed just 3%.

A defining feature of the U.S. recovery is that unemployment has remained historically high. That has left many college graduates in jobs outside their fields or that pay less than those workers would earn during healthier times. Workers’ pay, even among many college grads, hasn’t kept up with the rise in prices.

Those with advanced degrees still earn far more, on average, than other workers. But their earnings relative to high-school graduates dipped during the recovery.

On average, Americans with an advanced degree who worked full-time, year-round earned $89,253 in 2012. That’s about 2.7 times more than the $32,630 earned, on average, by high-school grads with no college.

That premium has dipped since 2009, when full-time workers with advanced degrees earned 2.8 times the pay of high-school grads.

Meanwhile, those with only a bachelor’s degree earned, on average, $60,159 in 2012. Those with at least some college or an associate’s degree earned $35,943, and those who hadn’t completed high school earned $21,622.

Cold Weather Heats Natural-Gas Prices

Natural-gas futures jumped nearly 10% Tuesday on expectations another wave of colder-than-average weather will generate even more demand for the heating fuel.

Households across the Midwest and Northeast have consumed record amounts of natural gas this year amid frigid temperatures. Forecasters are calling for cold weather to persist through mid-February, with some predicting below-normal temperatures into March.

The resulting spike in heating demand has revived the formerly sleepy gas market, sending investors scrambling to exit from bets that prices would stay low and into new wagers that futures will rally further.

On Tuesday, natural gas for March delivery shot up 9.6%, to $5.375 a million British thermal units. Futures are within striking distance of a four-year high of $5.557 set last Wednesday.

(…)  Declines in the nation’s natural-gas stockpiles have reawakened supply concerns and injected volatility into the futures market.(…) As of Jan. 24, natural-gas inventories stood at 2.193 trillion cubic feet, 17% below the five-year average level for that week. The EIA is scheduled to release its storage data for the week that ended Jan. 31 on Thursday. (…)

Japanese wage rises remain elusive Base salaries fall adding to Abenomics concerns

(…) Total worker earnings rose 0.8 per cent in December compared with the same month a year earlier, government data showed on Wednesday.(…)

Overtime pay increased by 4.6 per cent in December, Wednesday’s data showed, while bonus pay rose by 1.4 per cent. Base earnings continued to decline, however, falling by 0.2 per cent.

Taking inflation into account, real wages for Japanese workers fell by 1.1 per cent in December and are “unlikely to turn to positive territory in the near future, especially after the consumption tax rate hike,” said Masamichi Adachi, economist at JPMorgan.

In a country where laying off workers is difficult and expensive, compensation levels, rather than jobs, have been the main casualty of economic weakness. Economists say unemployment has now fallen far enough – it hit 3.7 per cent in December, the lowest level since late 2007 – to put natural upward pressure on wages, but it remains unclear how much given that the bulk of the new jobs are lesser-paid part-time or contract positions.

“The secular shift of labour composition in the workforce should weigh on the rise in average wages,” Mr Adachi said.

BAROMETER FATIGUE…

The “Super Bowl Indicator” says that a win for a team from the NFC division (i.e., the Seahawks) means the stock market will be up for the year. Some may laugh, but this theory has been correct 81% of the time.

However, let’s not ignore the balance of the 19%: in 2008, the New York Giants, an NFC team, won the Super Bowl, but the stock market suffered its largest downturn since the Great Depression.

Italy accuses S&P of not getting ‘la dolce vita’ Culture clash triggers $234bn threat over downgrade

(…) Standard & Poor’s revealed on Tuesday it had been notified by Corte dei Conti that credit rating agencies may have acted illegally and opened themselves up to damages of €234bn, in part by failing to consider Italy’s rich cultural history when downgrading the country. (…)

Notifying S&P that it was considering legal action, the Corte dei Conti wrote: “S&P never in its ratings pointed out Italy’s history, art or landscape which, as universally recognised, are the basis of its economic strength.” (…)