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

RETAILING

NEW$ & VIEW$ (4 FEBRUARY 2016): Russia cries dyadya!

Fed official flags tight conditions Expectations of rate rise at March meeting retreat amid market turmoil

(…) Mr Dudley said: “We’re acknowledging that things have happened in financial markets and in the flow of the economic data that may be in the process of altering the outlook for growth and the risk to the outlook for growth going forward, but it’s a little soon to draw any firm conclusions from what we’ve seen.”

Confused smile 6 weeks! And yesterday’s services PMIs showed a sharp slowdown in the economic and employment stalwart (chart from CalculatedRisk).

Via Ed Yardeni:image

Goldman Forecast: No Rate Hike in March

A few excerpts from a research piece by Goldman Sachs economists Jan Hatzius and Zach Pandl: Revising our Fed Call

We … now expect the FOMC to keep policy rates unchanged at the March 15-16 meeting … financial conditions have tightened meaningfully, and officials sound inclined to take more time … We therefore expect the next rate increase in June, and see a total of three rate increases this year.

… our forecasts remain well-above market pricing, which now shows only about a 50% chance that the Fed raises rates at all this year, and a 25% chance that the committee lowers rates. The first full rate hike is not priced in until about August 2017.

6 more weeks to wait!

Eurozone Retail PMI shows fall in sales for third month running

The oil windfall remains elusive in Europe as well. As seen yesterday, core retail sales in the EA19 countries have been flat since August which is the period when Brent prices dropped 50%!

Retail sales in the euro area fell further in January, according to the latest Eurozone Retail PMI®, marking a third straight monthly decline. Each of the three largest eurozone economies saw downturns in sales, with ltaly recording the worst performance overall.

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 – remained below the neutral 50.0 mark in January, registering 48.9. This indicated a modest rate of decline that was little-changed from that recorded in December (PMI at 49.0).

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Sales were up on an annual basis, however, the first time year-on-year sales growth has been recorded since October.

Phil Smith, economist at Markit which compiles the Eurozone Retail PMI survey, said:
“Sales were higher in January than the situation one year ago, although on a monthly basis they have slipped steadily since November. This loss of momentum is largely reflective of a slowdown in Germany, where sales have now fallen twice in the past three months, albeit marginally. Italy has also shown renewed weakness, while France continues to languish amid generally stagnant market conditions.”

OIL

Long but well researched piece worth reading. Some excerpts:

(…) In a “stress” test it conducted in November, the Russian Central Bank estimated that with Ural crude prices below $40 per barrel between 2016-2018, the Russian economy would contract five percent in 2016, inflation would run at 7-to-9 percent, and that these conditions “would also raise risks to inflation and financial stability. (…)

The situation of Russian energy producers is also difficult. The Telegraph (UK) in early January quoted Russia’s deputy finance minister, Maxim Oreshkin, as telling TASS earlier this month that low crude prices could lead to “hard and fast closures in coming months.” The article also said that in the key Soviet-era fields in western Siberia, the annual rate of depletion is averaging 8 percent to 11 percent, while new projects are being curtailed.

According to the Telegraph, Transneft, the Russian crude and product pipeline monopoly, estimated that Russian crude exports could decrease in 2016 by some 460,000 barrels per day, based on producer applications for pipeline capacity.

In an interview with TASS, the Russian news agency last week, Lukoil Vice President Leonid Fedun commented that Lukoil was unlikely to produce the one hundred million tons it produced in 2015. He also said that it made more economic sense to sell one barrel of oil for $50 than two barrels for $30.

The pain for Rosneft, the company which the Russian government hoped would gain the size necessary to compete on equal terms with Western oil majors, is particularly acute. As part of its effort to gain scale, the company in 2013 took on massive debt—$40 billion according to Reuters—to finance its acquisition of Russian competitor TNK-BP for $55 billion.

To help pay down debt, Rosneft, also in 2013, concluded an agreement with Chinese National Petroleum Corporation to supply 400 million metric tons of crude over twenty five years, under which Rosneft was entitled to receive prepayment equal to 30 percent of the contract’s value (Rosneft received RUB 1027 billion in 2015 Q3).

At the end of Q3, Rosneft’s net debt stood at $24 billion. Yet, Alexey Bulgakov, a fixed income analyst at Sberbank CIB estimates that Rosneft may already have accessed the maximum amount of cash it can under the deal, given the decline in price from ~$100-plus per barrel in 2013 to ~$30 per barrel now and the terms of the agreement. And, should crude prices remain at current levels, Rosneft likely cannot generate the cash to cover its investment, interest, and debt repayment obligations. (…)

The Saudis and their Gulf Arab allies also have compelling reasons to consider production cuts to balance the global crude market and raise prices. They depend on revenues from crude and crude product exports as much as if not more so than the Russian government to fund government spending. Like the Russian government, they face serious domestic and international challenges—including wars and domestic tensions—that they counted on the export of crude and crude products to fund.

As a result of lost revenues and deteriorating budget numbers, the government are drawing on foreign currency and sovereign wealth resources, seeking to cut spending, including in such politically sensitive areas as subsidies for individuals and businesses, and to defer or cancel important investment projects (the UAE in recent days suspended the tender process for stage two of a project to build a 1,350 mile railroad from Kuwait the Indian Ocean along the Persian Gulf).
(…)

OPEC dynamics are another important consideration. Other OPEC members—Venezuela, Algeria, Nigeria, Angola and Libya—repeatedly have called for output to be cut. In response, the Saudis have argued that OPEC cuts would be ineffective in the absence of simultaneous cuts from non-OPEC countries members. Were the Saudis and their Gulf Arab allies to reject a sincere Russian commitment to cut production, their credibility and authority within OPEC would suffer perhaps irreparable damage.

Also, for the Saudis, the plans to sell shares in Saudi Aramco and/or its downstream operations could play an important role. The price investors will be willing to pay for shares in these entities will depend on the value they place on the entities, and this value will depend on their assessment of the entities’ management, strategy, and prospects. If, for example, potential investors believe that management, at the behest of the Saudi government, will sacrifice growth, profits, and dividends to achieve Saudi foreign policy goals through low prices, investors’ interest might be tepid at best.

The Russians potentially enter any discussions with a weaker hand. (…) Possibly, if the Russian government believes its hand is weaker, it might consider it advisable to reach agreement expeditiously. After all, the Russian government should take into account that if Russian data during the first quarter shows declines in output and exports, as comments from Russian government and company officials cited above suggest might happen, and Q1 2015 financial reports show intensifying financial pressures on Russian energy companies, Saudis and their Gulf Arab allies might be tempted to decide to maintain pressure on prices and force Russia to absorb the cuts necessary to balance the global crude markets.

But what about Iran, the Saudis’ enemies and the 2016 oil flooders?

(…) Iraq, Algeria, Nigeria and Ecuador would join fellow Organization of Petroleum Exporting Countries members Iran and Venezuela and non-OPEC producers Russia and Oman if talks are scheduled, Venezuela said in a statement after its Oil Minister Eulogio Del Pino held discussions in Iran.

Del Pino, who was in Tehran Wednesday during a tour of OPEC and non-OPEC countries, stopped in Russia this week and held talks with officials including Igor Sechin, chief executive officer of the country’s largest oil producer Rosneft OJSC. Del Pino and Sechin talked about possible coordination to stabilize oil markets, Venezuela’s Oil Ministry said.

“The Russians have historically promised many times to cooperate with OPEC but never have,” Fereidun Fesharaki, chairman of energy industry consultants FGE, said in a Bloomberg Television interview on Thursday. “Nobody really believes that the Russians would actually deliberately cut production.”

As far as I have seen, Iran has not denied this.

EU Cuts Growth Forecast for 2016

The economy of the 19-country eurozone is expected to grow 1.7% this year. While that is a slight improvement from the 1.6% growth in 2015, it is somewhat lower than the 1.8% expansion the commission had forecast in November. In 2017, the eurozone economy will now likely expand 1.9%, the commission said, in line with earlier predictions.

Growth in the 28-country EU is expected stay at 1.9% this year, in line with in 2015, but down slightly from the commission’s November forecast. The commission sees the EU economic output expanding 2% next year, also slightly below the 2.1% forecast earlier. (…)

The commission now expects the rate of inflation in the eurozone to be just 0.5% this year, down from the 1% previously forecast. In 2017, inflation in the currency union is now seen at 1.5%, down from the 1.6% predicted earlier and still below the close-to-2% targeted by the ECB.

In the EU, consumer prices are expected to grow 1.5% this year and 1.6% next year. (…)

Pointing up “The central scenario of a ‘soft landing’ in China is subject to substantial risks,” the commission said. (…)

“The main risks both externally and domestically are ‘political’,” wrote Marco Buti, the director general of the commission’s economy department. “Leadership at the global and European level showing that common actions are agreed and swiftly implemented would be the most effective answer to the present economic woes.”

EARNINGS WATCH
  • 273 companies (71.2% of the S&P 500’s market cap) have reported. Earnings are beating by 4.7% while revenues have surprised by 0.2%.
  • The beat rate is 74% (76% ex-financials).
  • Expectations are for a decline in revenue, earnings, and EPS of -3.2%, -4.8%, and -3.0%. EPS is on pace for -1.6%, assuming the current beat rate for the remainder of the season. This would be +4.4% excluding Energy. (RBC Capital)

Curiously, Thomson Reuters’ estimate for 2015 EPS has increased in recent days from $117.11 on Jan. 29 to $118.33 yesterday.

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Hmmm…

Nerd smile The Arab world’s sentiment indicator:

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Shares in the Swiss bank tumbled 9% on Thursday, after it announced a bigger-than-expected net loss, and suffered wealth management outflows similar to those reported this week by rival UBS Group AG. (…)

UBS, which has sharply reduced its own investment bank, reported billions of dollars in outflows from its core wealth management business, as clients pulled money out amid challenging markets or declined to invest.

On Thursday, Mr. Thiam said, “the environment has deteriorated materially during the fourth quarter of 2015 and it is not clear when some of the current negative trends in financial markets and in the world economy may start to abate.”

Like UBS, Credit Suisse cited a lower level of activity among its clients in the quarter. Credit Suisse’s private banking businesses in Switzerland, and at the international wealth management unit, each reported net asset outflows in the period. (…)

I don't know smile The huge money outflows at CS and UBS do not seem to have found other homes. Could be Middle Eastern sovereigns pulling money out by necessity.

Franklin Resources Inc. said Wednesday that investors withdrew $20.6 billion in the fourth quarter, the latest asset manager to highlight the issue of redemptions. Affiliated Mangers Group Inc. said on Tuesday that it had outflows of $6.8 billion, while Waddell & Reed saw $5 billion in withdrawals, contributing to the biggest drop in its stock since the financial crisis of 2008. 

Money managers are hurt by slumping stock markets worldwide, which have prompted investors to dump anything perceived as risky. The firms are getting squeezed by sovereign wealth funds in need of cash after oil prices plunged, and the shift by investors from active funds to cheaper ones that track indexes. The preference for passive products and exchange-traded funds has created winners, including Vanguard Group Inc. and BlackRock Inc. (…)

The 19-member Standard & Poor’s index of custody banks and asset managers lost 16 percent this year through Feb. 2, bringing the measure back to where it was in April 2013, according to data compiled by Bloomberg. (…)

Aberdeen Asset Managment Plc last month cited the cash needs of sovereign wealth funds as one of the reasons the firm experienced 9.1 billion pounds ($13.2 billion) of withdrawals in the fourth quarter. The wealth funds from oil-producing nations, which boosted their investments when energy prices were high, are taking money back to fill the budget shortfalls created by cheap oil. (…)

Global demand for once sought-after quota to buy Chinese securities has fallen for the first time in the scheme’s decade-long history, even as Beijing, eager to support its currency and equity prices, signals it will offer bigger allocations. (…)

In January the total quota allotted to foreign funds dropped to $81.068bn, down $30m on a month earlier. (…)

Chart: China QFII

In the last three months of 2015, analysts estimate between $150bn and $400bn flowed out of China thanks to fears over renminbi depreciation and the slowing economy. In response, the government has tightened schemes that allow for outbound investment while also temporarily shutting down foreign exchange businesses at three global banks.

NEW$ & VIEW$ (3 FEBRUARY 2016)

U.S. Consumer Spending Flat in December U.S. consumers curbed their spending in December even as incomes rose, showing caution as the year wound to a close amid signs of global economic turmoil.

Personal spending, which measures consumption on everything from sodas to haircuts, was flat in December from a month earlier. Spending climbed an upwardly revised 0.5% in November and was flat in October. Some of the spending weakness came from lower prices for staples such as gasoline and food, while utility bills were unseasonably low in December due to warm weather in much of the country.

Spending on durable goods —items designed to last at least three years—fell 0.9%. Spending on nondurable goods, like clothing and food, fell the same amount. Instead, much of Americans’ spending is going to essentials such as housing, medical care and education.

Incomes rose 0.3% during the month, the Commerce Department said Monday, but those extra earnings were socked away or used to pay down debt. The personal saving rate, or the share of income saved, rose to 5.5% from 5.3% a month earlier, matching a three-year high.

The price index for personal consumption expenditures, the central bank’s favored inflation measure, fell 0.1% from November and was up just 0.6% in December from a year earlier.

Core prices, which strip out food and energy costs, were flat from November and up 1.4% from a year earlier, as prices were slow to climb even without the effect of cheap oil.

Q4’15: real wages: +5.2% a.r.; real disposable income: +3.2% a.r.; real expenditures: +2.0% a.r. (charts from Haver Analytics)

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U.S. Light Vehicle Sales Edge Higher

Total sales of light vehicles during January improved 1.4% m/m to 17.58 million units (SAAR) from 17.34 million in December. The 5.2% y/y increase was prompted by the decline in gasoline prices, strong consumer confidence and low unemployment. Nevertheless, sales remained below the cycle peak of 18.24 million reached in October.

Sales of light trucks continued to pace the market with a 2.1% advance (12.2% y/y) to 10.15 million units. Domestic light truck sales improved 3.2% (7.8% y/y) to 8.62 million. The gain lifted trucks sales to a record 57.7% of the light vehicle market, up from 54.1% in January 2015.

Auto purchases edged 0.4% higher to 7.43 million, but were down 3.1% y/y. Domestic auto sales gained 0.5% (-0.0% y/y) to 5.54 million.

Cyclical peak?

Bespoke Investment has this interesting chart:

Sample

US recession risk haunts markets Indicators show most severe US ‘growth scare’ since Great Recession in 2009

(…) The litany of market indicators that make no sense unless there is a clear and imminent danger of a recession is growing longer.

Long-term inflation expectations are their lowest since the crisis; the spreads on corporate and particularly low-quality high-yield credit are widening; the yield curve — as shown by the gap between two- and 10-year Treasury yields — is the flattest it has been since 2007, showing scant belief that inflation or interest rates will be rising in the years ahead. And of course the stock market is down, while within it defensive stocks like Walmart or Procter & Gamble are far outperforming cyclical stocks that would fare worst in an economic downturn.

These are all market-generated indicators. They show that we are now in at least the most severe US “growth scare” since the Great Recession in 2009, and these financial conditions in themselves heighten the risk of a recession, by making life harder for companies and consumers. Should the recession fears be averted, this also implies that there is a nice rebound to be had from stocks and from betting against bonds.

So what is the possibility of a recession, and how can it be calculated?

According to the US fund manager John Hussman, who writes a widely followed weekly commentary and has been notably bearish in recent years, a recession is now an “imminent likelihood”. He suggests financial markets generally act as leading indicators — which they are doing — followed by data from the industrial economy. Industrial production has fallen in 10 of the last 12 months; historically, going back to 1919, every time it has fallen as many as eight times in such a stretch, there has been a recession.

Over the past 12 months, Alan Ruskin of Deutsche Bank points out, no country’s ISM index has fallen more than that of the US — casting grave doubt on its ability to play the role of the world’s growth locomotive that many had put aside for it.

Mr Hussman adds weakness in retail sales as further evidence, while confirmation would come from worsening unemployment data and from big falls in consumer confidence.

Financial conditions are also important. When banks are making it harder to borrow, it is usually a good sign that a recession is coming — and that is what they are doing. The latest survey of senior loan officers by the Federal Reserve, produced this week, showed a growing majority of banks saying they were tightening their lending standards for commercial and industrial loans, in a way unseen since the crisis, which is a worrying sign — although there was no such tightening for real estate loans or for consumer loans.

Corporate profits provide ample cause for concern. Companies are finding it hard to maintain their profit margins or increase their revenues — again possibly a testament to the strength of the dollar.

However, the evidence that the US is not yet in recession remains strong. Aneta Markowska, of Société Générale, puts the chance that the US was already in recession in December at 3 per cent, using a model based on private employment, real income, real sales and industrial production. Only the last is anywhere near recession territory.

SocGen’s model of recession risks based on economic fundamentals suggest the risk is almost negligible; wage pressures are only just beginning, monetary policy is still very easy and profits made on domestic businesses are still high, while corporate balance sheets are healthy, outside of energy. All of this points to a cycle that does not turn into a downturn until 2018 or 2019.

Credit Suisse conducted a similar exercise, with a similar result as it concluded that the US is not in recession now, and will not be later this year either.

A clear signal that these forecasts were wrong, that would move the models towards a recession signal, would come from the labour market, where the rate of improvement has slowed in recent months.

The labour market provides the strongest evidence that the US is not heading for a recession and forthcoming data will be critical in determining whether this is a growth scare that will blow over — bringing a nice rally with it — or the start of the recession that markets are signalling.

Eurozone Retail Sales Rise for First Time in Four Months

Eurostat said retail sales rose by an expected 0.3% in December from November, and by 1.4% from the final month of 2014. It was the first increase since August. The statistics agency also revised its figures for November, and now estimates that sales were flat, rather than down 0.3%.

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‘No limit’ to Japan easing, says Kuroda BoJ governor signals readiness to take rates further below zero
Oil rises after Russia says open to OPEC meeting

(…) Russian Foreign Minister Sergei Lavrov said if there is consensus among the Organization of the Petroleum Exporting Countries and non-OPEC members to meet, “then we will meet.” (…)

“Russia yesterday reported a rise in its oil production in January to just under 10.9 million bpd (barrels per day), which is a new high since the break-up of the Soviet Union,” Commerzbank said in a report.

“This underlines the need for talks on coordinated production cuts, as OPEC also expanded its oil production in January to a multi-year high.”

EARNINGS WATCH
  • 244 companies (66.0% of the S&P 500’s market cap) have reported. Earnings are beating by 4.9% while revenues have surprised by 0.3%.
  • Expectations are for a decline in revenue, earnings, and EPS of -3.2%, -4.9%, and -3.1% (-2.3% last Friday). EPS is on pace for -1.4% (-0.1%), assuming the current 4.9% beat rate for the remainder of the season. This would be +4.6% (+6.2%) excluding Energy.