U.S. retail sales fell in December as unseasonably warm weather undercut purchases of winter apparel and cheaper gasoline weighed on receipts at service stations, the latest indication that economic growth braked sharply in the fourth quarter.
The Commerce Department said retail sales slipped 0.1 percent after increasing 0.4 percent in November. For all of 2015, retail sales rose just 2.1 percent, the weakest reading since 2009, after advancing 3.9 percent in 2014.
Retail sales excluding automobiles, gasoline, building materials and food services fell 0.3 percent after a 0.5 percent gain the prior month. These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product. (…)
Furthermore, these core sales were revised lower in both November (+0.5% vs +0.6%) and October (+0.1% vs +0.2%). Core sales are up 0.3% for all of Q4. So where is Waldo?
He is still shopping but warm weather is keeping him (her) out of apparel stores and goods deflation keeps masking the real trends.
Sales of discretionary goods such as cars, furniture, building materials, health and personal care, and sporting goods are up 5.5% YoY on average in December, from +4.8% in November and +5.3% in October. Sequentially, the average gain in these five categories +9.5% annualized in Q4!
Department stores are clearly hurting but on-line sales are up 7.1% YoY in Q4 and at a 14.4% annualized rate on a sequential basis. Restaurant sales are also booming. The weak sales at electronic stores are mainly due to deflating prices.
CalculatedRisk sums it all with this chart. Nominal sales ex-gas are up 4.0% YoY in a goods deflation environment. In spite of all the headlines, the U.S. consumer is spending the oil windfall.
The growth picture was further darkened by other data on Friday showing industrial production fell in December, dragged down by cutbacks in utilities and mining output.
(…) industrial production fell 0.4 percent last month, primarily as a result of declines in utilities and mining output, after declining 0.9 percent in November. Unusually warm weather, which saw a drop in demand for heating, caused utilities output to drop 2.0 percent.
Industrial production fell at an annual rate of 3.4 percent in the fourth quarter.
Total output has declined for 3 consecutive months at a 6.1% annualized rate. Materials are very weak but warm weather has decreased Utilities output at a 40% annual rate in Q4. Manufacturing output is actually up 0.8% a.r. in Q4 even with the strong USD and the on-going inventory correction.
Another report from the Commerce Department showed business inventories fell 0.2 percent in November – the largest drop since September 2011.
While this contributes to a weaker GDP in Q4, it sets a lower base for production entering 2016. The problem is that retail inventories have yet to decline, being +5.4% YoY. Inventories are particularly high at car dealers, building materials and garden supplies and apparel stores, the latter being the only weak group at present.
As a result of the weak data, JP Morgan slashed its fourth-quarter GDP growth estimates from a 1.0 percent annual rate to only a 0.1 percent pace. Goldman Sachs cut its forecast by three-tenths of a percentage point to a 1.1 percent rate. The economy grew at a 2 percent pace in the third quarter.
A fifth report from the Labor Department showed its producer price index slipped 0.2 percent after increasing 0.3 percent in November. In the 12 months through December, the PPI declined 1.0 percent after falling 1.1 percent in November. December marked the 11th straight 12-month decrease in the index.
Core prices were up 0.3% from a year earlier.
Producer prices fell 1.0 percent in 2015, the weakest since the series started in 2010, after rising 0.9 percent in 2014.
Coming on the heels of a report on Thursday showing a steep drop in import prices in December, weak producer prices suggest that an anticipated rise in inflation will probably fall well short of the Fed’s 2 percent target.
If you were looking for signs of hope for the manufacturing sector in today’s Empire Manufacturing report, you didn’t get it. Heading into the report for January, economists were expecting the headline index to come in at a level of -4, so there was hope that it could possibly beat expectations and get back into the black. In the end, though, there was no such luck. In fact, at a level of -19.37 this month’s report was the weakest reading since April 2009. Needless to say, things aren’t getting any better for the manufacturing sector in the region. Expectations for the next six months dropped even more, falling from 35.7 down to 9.5. That 26.1 point decline in the index was the second largest in the report’s history (2001), behind only the 61 point decline in September 2001 when the entire region came to a complete standstill in the aftermath of the 9/11 attacks.
(…) New Orders and Shipments collapsed and fell to their lowest levels since the last recession, but every other component besides Delivery Times increased, including a big jump in Average Workweek (although that component did collapse last month). On the expectations side of the table, January’s numbers were not nearly as constructive, with six out of nine declining.
Finally, one trend to note regarding the monthly Empire Manufacturing report is just how bad economists have been at forecasting it. Over the last six months, the actual reported number has been weaker than expected five times, and in three of those cases by quite a lot. In fact, the only time since 2001 that economists have been this far off the mark to the downside was in October 2011. As shown in the chart below, over the last six months the actual reported number for the Empire Manufacturing report has been an average of nine points below the consensus estimate. Broken clocks have been more accurate.
The Philly Fed’s Aruoba-Diebold-Scotti Business Conditions Index (hereafter the ADS index) is a fascinating but relatively little known real-time indicator of business conditions for the U.S. economy, not just the Third Federal Reserve District, which covers eastern Pennsylvania, southern New Jersey, and Delaware. Thus it is comparable to the better-known Chicago Fed’s National Activity Index (more about the comparison below).
Named for the three economists who devised it, the index, as described on its home page, “is designed to track real business conditions at high frequency.”
Using 3-month moving averages:
Stating the obvious:
Fed Almost Certain to Keep Rates Steady at Next Meeting Fed officials, facing an economic jumble as 2016 begins, will almost certainly keep rates steady at a policy meeting this month and turn their focus toward a potential cliffhanger decision about whether to lift them when they gather again in March, Jon Hilsenrath writes.
(…) In recent communications with clients, Ray Dalio of hedge fund Bridgewater Associates LP, which manages $154 billion, argued that the Fed should stand pat for now and be “agnostic” about raising rates later this year, according to a person familiar with the matter. Jeffrey Gundlach, who runs asset manager DoubleLine Capital LP, has said the Fed shouldn’t be considering boosting rates any time soon and was premature raising rates last month. (…)
Still, the disconnect between investors and the Fed was shown in stark relief Friday. As the Dow Jones Industrial Average plunged 391 points and Barclays PLC reduced its estimate of U.S. growth in the fourth quarter of last year to 0.3%, Federal Reserve Bank of San Francisco President John Williams called the U.S. economy “dynamic, “resilient” and “in good shape.” (…)
Some on Wall Street say investors’ hand-wringing is overdone and the Fed should stick to its guns and keep raising rates. Barclays Chief Economist Michael Gapen noted that U.S. labor markets, which have been a reliable indicator of future economic growth, show no sign of weakness. (…)
“We’ve got this situation where the stock market has become fascinated with what the Federal Reserve does and really thinks the Federal Reserve is there to help the stock market,” said Mr. Inker of GMO. “It could be that the Federal Reserve would like that relationship to change.”
(…) Tumbling commodity prices and economic sluggishness will continue to limit profit growth, according to many of the nine strategists participating in Barron’s 2016 Roundtable panel discussion in the magazine’s Jan. 18 issue. Respondents see flat to modest gains for U.S. equities ahead as slow U.S. expansion won’t be enough to shake the headwinds from global economic turmoil and the fall in energy prices. (…)
Jeffrey Gundlach, founder and chief executive officer of DoubleLine Capital, told Barron’s the Fed may be forced to ease again after lifting rates one more time, given the uncertainty in the economy. Investors shouldn’t ignore the divergence between junk bonds and the S&P 500 Index, which is pointing to a bear market, he said. (…)
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Goldman Sachs Sees Oil Bull Market Being Born in Today’s Crash
Oil will turn into a new bull market before the year is out as the price rout shuts down sufficient production to erode the global glut, according to Goldman Sachs Group Inc.
The crash in U.S. oil futures — which sank back below $30 a barrel on Friday to a new 12-year low — will send the nation’s shale-oil boom spinning into reverse in the second half of the year, the bank said in a report. As U.S. production slumps by 575,000 barrels a day, global oil markets will tip from surplus to deficit, Goldman predicts. (…)
The market will signal it’s ready to rally when the forward price curve, which currently shows a steep discount on immediate commodity supplies, starts to flatten out, the analysts said. The end of that discount would demonstrate that there’s enough demand to whittle down oil that’s piled up in storage tanks, they said.
“A flat curve near cash costs is historically the buy signal for passive investors and we believe the current bear market will end the same way,” Currie and Courvalin said. “Such a signal is what will shift us to being bullish commodities.”
(…) The re-emergence of Iran, which claims it can swiftly boost production and exports by 500,000 barrels a day, threatens to add to the glut of oil that has pushed prices to a 12-year low of less than $30 a barrel. It comes as relations between Iran and Saudi Arabia, Opec’s largest producer and de facto leader, have soured.
UN inspectors said on Saturday that Iran had dismantled significant elements of its nuclear programme, paving the way for the country to increase exports of its crude to global markets after nearly four years under economic and financial sanctions.
However while Iran is now able export oil worldwide — rather than just to a handful of countries, as it was permitted to do under sanctions — other restrictions remain in place that may stall the return of energy companies.
Iranian officials have said they expect to ramp up production by 1m b/d within six to seven months of the removal of sanctions, and to return to 3.4m b/d within 12 months — although international energy analysts consider this ambitious. (…)
Iran’s crude exports have fallen to around 1m b/d, compared with a pre-sanctions high of more than 3m b/d in 2011. (…)
Having tested export infrastructure in recent months, Tehran has signalled the lifting of sanctions would mean Iran could immediately sell more oil abroad. But those involved in its oil sector are more realistic.
“Like an engine that has been switched on after a long time on standby, it does not work like it used to in an instant,” said one Iranian shipping executive. “From our banking and payments systems to marketing operations, this will all still take time.”
Although some market observers say Iran’s full return to the international markets is already reflected in low crude prices, others believe it could exert further downward pressure.
“Given the market is currently well supplied, Iran is likely to have to offer favourable terms, such as longer payment windows and discounts, to secure buyers. This is particularly true for heavy crudes, given the heavy crude market is currently saturated,” say analysts at Energy Aspects.
Shipbrokers say there are about 24 of the biggest oil tankers, which can hold as much as 50m barrels of oil, waiting off the coast of Iran ready to resume business.
“Key to watch short-term is how quickly Iran unloads the oil — mainly condensate [an ultralight type of oil] — in storage,” said Robin Mills, head of consulting at Manaar Energy. (…)
“The immediate impact is on Russia and Saudi Arabia for sales in Europe,” said Fereidun Fesharaki chairman at Facts Global Energy, a consultancy.
Although Iran may make some minor concessions on price in new oil sales, it is trying to limit discounts. Investments in foreign refineries and other deals could be used to sweeten sales, officials have said. Under sanctions Iran bartered oil for goods to avoid losing out on price. (…)
Tehran hopes to send around 200,000 b/d to buyers in Greece, Spain and Italy, one person familiar with the matter said. Agreements for sales of around 500,000 b/d collectively are already in place for Turkey, India and South Africa, among others, he added.
Iran has also made regular shipments to Bashar al-Assad’s government in Syria.
Longer term, Iran crucially needs to attract at least $100bn in foreign investment and new technologies to rescue its domestic energy industry.
It is a big prize for energy groups that want to tap into Iran’s vast reserves, amounting to 260bn barrels of oil equivalent. Representatives from companies such as Total, Eni and Mitsubishi have been to Tehran in recent months. (…)
Oil-market stability will be achieved through cooperation among major producers but this will likely take time, Saudi oil minister Ali al-Naimi said Sunday, signaling the world’s top petroleum exporter is still not prepared to take sole responsibility for propping up the oil price.
“As you know, the oil market has witnessed over its long history periods of instability, severe price fluctuations and petro-economic cycles. This is one of them,” Mr. Naimi told an energy gathering in Riyadh. “Market forces, as well as the cooperation among the producing nations, always lead to the restoration of stability. This, however, takes some time.”
The minister added that even though the global oil market has been “undergoing a period of instability for more than 12 months now…I’m optimistic about the future, the return of stability to the global oil markets, the improvement of prices and the cooperation among the major producing countries.” (…)
This morning:
Rokneddin Javadi, chief of the state-owned National Iranian Oil Co., said it may take nine months before Iran signs its first new oil-export deal following the implementation of an agreement on its nuclear program.
Mr. Javadi said Iran still plans to boost its output by 1 million barrels a day but cautioned this could take time because of continued restrictions on its banks.
“Currently, we are studying problems faced by domestic banks to this end. Once they are resolved, production and overseas sales of crude will increase,” Mr. Javadi was quoted as saying by the oil ministry’s Shana news agency. (…)
Amir Hossein Zamaninia, an Iranian deputy oil minister in charge of commerce and international affairs, said the production increase will be “managed…to minimize the negative impact” on oil prices. Iran is also considering bartering its oil for European goods and investing in refineries to lock in buyers. (…)
“I think the Iranians are going to find it a lot more difficult to re-create the financial links” with Western firms than they think, said Richard Nephew, a former top U.S. State Department negotiator with Iran, now at the Brookings Institution, a think tank.
The low oil price is another problem for Western businesses there, said Peter Harrell, a former U.S. State Department official who oversaw sanctions.
“Most major oil companies are looking to cut capital spending for the near term, not to increase capital spending over the next year or two,” Mr. Harrell said.
U.S. oil companies face hurdles when working in Iran. American citizens likely won’t be allowed to have business dealings with Iran and the use of U.S.-origin technology will be prohibited. Firms are studying how to set up foreign subsidiaries that comply with sanctions.
Ultimately, U.S. companies may sit out opportunities in Iran until the outcome of the U.S. presidential election is known, business officials said. (…)
Oman is the first major non-OPEC oil producer to say it would slash its output in coordination with other countries, as the resumption of Iranian exports of crude weighed heavily on oil prices on Monday.
Oman would be ready to cut 5% to 10% of its total crude oil production, if other producers were willing to do the same to stabilize the oil market, said Mohammad bin Hamad al-Rumhy, on the sidelines of a conference in Abu Dhabi on Monday.
“Oman is ready to do anything that would stabilize the oil market,” the minister said. “5% or 10% is what I think we need to cut and everyone has to do the same.” (…)
Oman is the largest oil producer in the Middle East outside the Organization of the Petroleum Exporting Countries, producing about 1 million barrels a day. But it lacks the financial reserves its Persian Gulf neighbors have to tackle a prolonged period of low oil prices. (…)
(…) Given the focus on China at the moment, it is tempting to assume that the price falls in the financial and oil markets reflect serious concerns about weakening in the Chinese economy. This analysis is too simplistic. Although it is a big consumer of commodities, China buys only about a tenth of the global supply of crude.
Although, in the decade ending in 2014, growth in Chinese consumption accounted for 48% of the total growth in global oil demand.
There is not much sign of sharply slowing economic growth, and hence demand, from the US and Europe which between them make up around 40 per cent of worldwide oil consumption. A much more likely reason for falling prices has been the buoyancy of supply owing to US shale and also the decision by Saudi Arabia and other producers to keep pumping out crude rather than restricting output.
(…) Broadly speaking, a fall in the oil price transfers income from economies more likely to save it to those more likely to spend it, and from capital-intensive industries to ones that are labour intensive.
Certainly there are some risks. The beneficial effects of the fall in the oil price that began in 2014 seem to have been slower to come through than have the negative impacts. Given that inflation is very low in economies like the eurozone and Japan, there is always the chance that the one-off effect on consumer prices will feed through into inflation expectations, increasing the chance of a slide into the malign sort of deflation.
Overall, however, the boost to real incomes for most people and companies from cheaper oil is welcome.
The impact of lower oil prices on the financial sector, on the other hand, is considerably more negative. In theory, the hit to banks that have lent to energy producers should be offset by those lending to energy consumers. In practice, however, the concentrated nature of the former, through the threat of bankruptcy, may create an asymmetry which means the financial sector as a whole loses.
So be it. There is no reason that regulators should rush to help out banks which have exposed themselves unduly to a notorious volatile sector and taken a hit accordingly. Central bankers, though, need to keep a close eye on the functioning of the credit channel and the effect on inflation expectations. In this context, the US Federal Reserve’s decision to raise interest rates last month looks even more premature than it did at the time. At the very least, the Fed should signal that the next move is as likely to be down as it is up.
It says something about the uncertainties of the global economy and the threat of deflation that a fall in the oil price provokes fear as well as rejoicing. Undoubtedly there are downsides from violent swings in the price of a key commodity. But in the main, cheaper crude is a development to be welcomed.
CHINA
(…) Mr. Li said China achieved “rather sufficient” employment in 2015, expanding by a wider margin than expected. China exceeded its target of creating 10 million urban jobs. (…)
Progress is already being made in restructuring, he said, with services now accounting for half the economy and consumption contributing nearly 60% of economic growth.
In the statement, Mr. Xiao defended his handling of successive market meltdowns, blaming the “abnormal volatility” on “an immature market, inexperienced investors, imperfect trading system, flawed market mechanisms and inappropriate supervision systems.” (…)
Mr. Xiao chastised listed companies for “exaggerated storytelling” to hype up stock prices, and urged market participants to cultivate a stronger sense of social responsibility and to “huddle together for warmth”—or cooperate in the greater interest—when times are bad.
In an example of such huddling, scores of Chinese-listed companies have issued statements during the past few weeks saying their controlling stakeholders won’t unload shares. Some of those companies say privately they released the statements at the request of exchange officials. (…)
The public has questioned Mr. Xiao’s professional chops before. In a candid interview with Hong Kong’s Phoenix TV in 2012, he admitted to terrible math skills and said “the only thing I did right in my entire life is to marry my wife”—leading to some snarky comments that it was time for Mr. Xiao to resign and attend to domestic affairs.
SENTIMENT WATCH
The selling has been intense, and European stocks officially entered bear market territory on Friday when the Stoxx Europe 600 Index closed down 20 percent from its record high in April. Now global equities have lost more than $14 trillion, or 20 percent, since June. The pace of the drop has been so fast it’s unraveled about half of the rally since a low in 2011. Investors have fled into the U.S. Treasury market, and pushed the yield on the 10-year note below 2 percent for the first time in months. (…)
“It comes down to one basic fear, which is the global economy,” said Russ Koesterich, global chief investment strategist for BlackRock Inc., which manages $4.5 trillion. “What people are afraid of is this isn’t investors overreacting, but reflects a fundamental deterioration in growth.” (…)
There’s a list of things that could change the zeitgeist. Central banks could step in. Consumers could start spending more of the money they’re saving on energy costs. Oil could, as oil often does, go back up. In fact, a report just out from Goldman Sachs Group Inc. predicts the crash in crude futures prices will turn the glut into a deficit by the second half of the year.
Growth in China — where the benchmark Shanghai Composite plunged an additional 3.6 percent on Friday — could always pick up, and there could be a signal next week when the government is expected to report that retail sales rose 11.3 percent in December. (…)
In the U.S., stocks are experiencing the second correction in five months. The Standard & Poor’s 500 Index has dropped 8 percent, marking the poorest beginning for a year in data going back to 1927, and the Chicago Board Options Exchange Volatility Index, a measure of investor fear known as VIX, surged 48 percent. (…)
“The market is manic depressive,” Howard Marks, a co-founder of Oaktree Capital Group LLC, the world’s biggest distressed-debt investor, said in an interview on Bloomberg Television. “It swings from seeing only the positives to seeing only the negatives and from interpreting everything positively to interpreting everything negatively.” (…)
(…) A big part of why is that in the run-up to 2008, people didn’t appreciate how much debt had built up in the system. This amplified the pain of losses, led to a seizing up of debt markets and blew big holes in bank balance sheets.
The U.S. economy and financial system are in a very different place. Notably, debt ratios within the U.S. aren’t nearly as high outside the government.
Consider households, which were at the epicenter of the mortgage crisis. At the end of 2007, household debt levels equaled 130% of income, according to Federal Reserve figures. Today, that has dropped to 103% as of last year’s third quarter.
Further, thanks in large part to super low interest rates, households are now devoting 15.3% of income to meeting debt and other financial obligations versus 18.1% in 2007.
Similarly, U.S. banks today are in far better position to absorb losses than during the financial crisis. The 31 financial institutions in the latest annual “stress test” administered by the Fed had $1.1 trillion in common equity capital at the end of 2014 compared with $459 billion at the start of 2009.
Banks’ common equity capital ratio, which measures the buffer banks have relative to risk-weighted assets, was 12.5% at the end of 2014. This is more than double the 5.5% ratio in 2009’s first quarter. (…)
True, there are areas where debt is a concern. U.S. government debt was equal to 101% of gross domestic product in the third quarter versus 63% in late 2007. The same is true for major countries and regions around the world such as the European Union, Japan and China.
China is the wild card. It borrowed huge amounts to stimulate its economy, leading to serious overcapacity in everything from factories to luxury apartments. The unwinding of this binge is one of the causes of the current market turmoil.
A hard landing in China could reverberate around the world, and into the U.S., in ways that still aren’t known. So the more serious problem for the U.S. economy is probably how stress-induced weakness in overseas economies might ripple. Declines in import prices will further cool inflation the Fed already deems too low.
What’s more, unlike in 1998, when the Fed cut its target by 0.75 percentage point as part of its efforts to calm financial markets, the central bank today has little scope to cut rates. To stimulate the economy it would have to again tap unconventional policies, which aren’t nearly as effective.
Another area of concern is the amount of dollar-denominated credit that has been extended to nonbanks outside of the U.S.—such as dollar-denominated corporate bonds. This reached $9.8 trillion by the middle of last year, which compares with $5.3 trillion at the end of 2007, according to the Bank for International Settlements.
The combination of a stronger dollar, weakening demand and, in cases such as commodities, falling prices, are making this debt hard to pay off. Crucially, though, this step up in overseas lending has been driven by non-U.S. banks and bond investors. There is plenty of financial stress here, but it isn’t centered in the U.S.
Importantly, sparks for the current market bonfire, such as plummeting oil prices, are mostly understood. Markets have undergone commodity crashes before. Eventually, these lead to supply destruction, which results in markets coming into balance and prices stabilizing.
In 2008 and 2009, by contrast, one of the biggest problems was that investors didn’t understand what was happening, the kinds of products that were blowing up, or the interconnections between them and financial firms.
For now, the storm doesn’t appear to have the force of a cataclysm. After 2008, many investors have come to fear that every episode in financial markets is another black swan. They should remember there are white ones, too.
Chairman and Chief ExecutiveLaurence Fink said in an interview early Friday that the market is “going through a correction phase and is doing it rapidly.”
“Could we still see further erosion in the near term?” he added, “Sure.” But “over a 12-month period I think the markets are going to be fine, probably higher from where they are today.”
A key contributor to recent weakness is the behavior of consumers around the world, Mr. Fink said. Households aren’t investing or spending their energy-related savings as oil and commodity prices globally continue to plunge, he said. His concern is that a U.S. retirement gap is making the situation worse.
“We always knew we were under-saving as a country and we knew it would be a problem in the future. Could the future be today?” (…)
(Bespoke Investment)
(…) In the past 30 years, there have been only three 20 per cent falls in the S&P that did not overlap with a recession. All involved financial accidents.
The first came with the Black Monday crash of October 1987, when the S&P fell 33 per cent, and regained its prior high in just under two years.
The second came in the autumn of 1998, when the Russian default crisis, followed by the meltdown of the Long-Term Capital Management hedge fund, forced the S&P down 22.5 per cent. It recovered all its lost ground within six weeks of hitting bottom.
Finally, in 2011 the S&P fell 21.6 per cent during the political stand-off over raising the US federal debt ceiling, the decision by Standard & Poor’s to downgrade US sovereign debt, and the eurozone crisis. It regained all its losses within five months of hitting bottom.
So the argument that the damage should not be bad if we avoid a recession is reasonable. But why exactly did markets rebound?
In all three cases, the Federal Reserve eased monetary policy, when it had intended to tighten. In 1987, there were three rate cuts, not reversed for almost a year. Rates ended that cycle two percentage points higher than they were on the eve of Black Monday. LTCM also triggered three rate cuts. In 2011, with rates already at zero, the Fed responded with “Operation Twist” to try to push down bond yields.
So a bet that the market will rebound once it has fallen a few more percentage points is also — history suggests — a bet that it will successfully prompt the Fed into changing course and cutting rates.
That is quite possible. But it would be a very big deal for this Federal Reserve, having only just started to raise rates, to admit a mistake and head back. The governors will need a lot of convincing.
Then we should check the confidence that the US can avoid a recession. Outside of manufacturing, which is in global recession, the economy does look robust. But signals such as poor retail sales growth, tightening loan standards or rising spreads on high-yield credit all suggest at least some concern about a weakening economy.
Finally, look at other possible drivers of a rebound. Sentiment is bombed out, as the initial reception to companies announcing their earnings underlines.
Brokers have been writing down their earnings forecasts for the fourth quarter of last year. This creates an easier bar for companies to clear, and positive earnings surprises have often in the past led to a rally. This happened most clearly in October of last year, when stocks rebounded impressively on the back of earnings that were slightly down on a year earlier, but better than expected.
But judging by the reception for the few companies to have reported so far, investors are so rattled that this trick will not work. The roll call of companies to have beaten their earnings estimates for the fourth quarter now includes Alcoa, Intel, Citigroup and Well Fargo. In all cases, they accompanied their earnings announcement with less than rosily optimistic forecasts for the year ahead — and were immediately punished with sharp falls in their share price.
Without assurance that revenues will stay robust for the rest of the year, investors want out.
Where does this leave us? If the US tips into recession, a serious bear market is possible. Assuming it does not, then we need to wait until investors lose their faith that a recession will be avoided, and push down stocks enough (probably by about 20 per cent) to force the Fed into backtracking.
EARNINGS WATCH
Factset:
With 6% of the companies in the S&P 500 reporting actual results for Q4 to date, more companies are reporting actual EPS above estimates (78%) compared to the 5-year average, while fewer companies are reporting sales above estimates (47%) relative to the 5-year average. In aggregate, companies are reporting earnings that 4.6% above the estimates. This surprise percentage is slightly below both the 1-year (+4.9%) average and the 5-year (+4.7%) average. In aggregate, companies are reporting sales that are 0.1% above expectations.
The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for Q4 2015 is now -5.7% [unchanged from one week ago]. The blended revenue decline for Q4 2015 is now -3.3%.
If the Energy sector is excluded, the estimated earnings growth rate for the S&P 500 would increase to -0.1% from -5.7%. If the Energy sector is excluded, the estimated revenue growth rate for the S&P 500 would jump to 1.0% from -3.3%.
At this point in time, 7 companies in the index have issued EPS guidance for Q1 2016. Of these 7 companies, 6 have issued negative EPS guidance and 1 has issued positive EPS guidance.
This past week marked a change in the aggregate expectations of analysts from slight growth in year-over-year earnings (0.1%) for Q1 2016 to a slight decline in year-over-year earnings for Q1 2016 (-0.6%).
Thomson Reuters’ still sees Q1’16 EPS positively at +0.7% but this is down from +2.3% on Jan.1. TR sees Q4’1 EPS down 4.7%.
TR’s tally of pre-announcements for Q4 has not deteriorated last week.
U.S. Bank Stocks Fall, Baffling Some Financials fall despite good earnings season, optimism about U.S. economy
U.S. recession fears rattled financial stocks anew Friday even as a generally strong bank-earnings season continued, baffling some executives who said they see few signs of worry for the U.S. economy.
The largest victim was Citigroup Inc., whose shares slumped 6.4%. The stock posted its worst one-day decline in four years, even after the nation’s fourth-largest bank by assets reported its biggest annual profit in nearly a decade. (…)
On Friday, Morgan Stanley fell 4.4%, Bank of America shed 3.5% and Goldman Sachs GroupInc. lost 3.6%. J.P. Morgan Chase Inc., which rose 1.5% Thursday after posting strong quarterly results, lost 2%.
The KBW Nasdaq Bank Index of large U.S. commercial banks fell 2.9% Friday, greater than the 2.2% fall in the S&P 500. The bank index has lost almost a fifth of its value in the past six months. (…)
Regional-bank shares also declined. Many of those companies lent heavily to U.S. oil and gas drillers, which have been under pressure amid the collapse in oil prices. For example, Oklahoma lender BOK Financial Corp. declined 4%. (…)
Citigroup, the fourth biggest by assets, said on Friday morning that it had recorded a 32 per cent rise in non-performing corporate loans in the fourth quarter from the previous year, mainly related to its North American energy book. Wells Fargo, the number three by assets, said net charges came to $831m in the period, up from $731m in the third, mainly due to oil and gas.
A day earlier JPMorgan Chase, the number one, said it was “watching closely” for spillover effects. If oil stayed around present levels of $30 a barrel, it said it would be forced to add up to $750m to reserves this year — which is roughly one-third of the benefit it expects from higher net interest income. (…)
Until now, the big banks had made generally reassuring noises about their energy portfolios, many of them stressing the investment-grade quality of their loan books and the seniority of their positions within borrowers’ capital structures.
But the tone of discussions this week, the beginning of the banks’ earnings season, was markedly different.
(…) Many banks pulled in their horns in October, during the last round of twice yearly revaluations. According to a survey carried out in the autumn by Haynes and Boone, a Houston-based law firm, companies’ credit lines were set to be cut by an average of 39 per cent. They seem likely to shrink further this April.
“Companies have a tendency to draw on bank lines once other options dry up,” said Devi Aurora, a senior director at Standard & Poor’s in New York. As they reached borrowing limits, “we think losses will begin to show up for the banks”. (…)
Many cash-strapped producers have sold what assets they can, while bond and equity markets — both rattled by China — are offering much flimsier support. Hedges, too, are falling away, and becoming much more expensive to renew, said Kristen Campana, a partner at Houston-based law firm, Bracewell & Giuliani. (…)
For the banks, the damage is not likely to be contained to energy books. In the past, energy downturns have hurt regional economies. Marianne Lake, chief financial officer of JPMorgan, said the bank was sensitive to “knock-on effects” in industrials and transportation, but was not seeing any broad portfolio effects for now.
But analysts expect the effects of job cuts to show up before long. On an earnings call last month, Royal Bank of Canada said it had detected some “early signs of stress” in its retail businesses in energy-dependent communities in Alberta, where the unemployment rate has risen by about half over the past year, to 7 per cent.
“It’s a similar phenomenon in the US,” said Brennan Hawken, a banks analyst at UBS. “Do you really want to be a credit card underwriter right now in the Dakotas?” (…)
Some analysts still scoff at the idea that the collapse of the energy sector could really hurt the big banks, noting that direct energy exposures are in the range of 2 to 4 per cent — versus about one-third for residential real estate. They note that lower oil has positive effects too, as consumers feel more flush from a fall in petrol costs.
“People hate banks and they want to see them suffer,” said Dick Bove, analyst at Rafferty Capital Markets. “But it [the energy sector pressure] is not going to have the impact that people are hoping for. This is not 2008.”
But Fred Cannon, global director of research at Keefe, Bruyette & Woods, said bigger banks had better brace themselves. “If it spills into the broader economy, and it starts looking like Texas in the 1980s, it could be a different story,” he said.
(…) [Zerohedge] got confirmation from a second source who reports that according to an energy analyst who had recently met Houston funds to give his 1H16e update, one of his clients indicated that his firm was invited to a lunch attended by the Dallas Fed, which had previously instructed lenders to open up their entire loan books for Fed oversight; the Fed was shocked by with it had found in the non-public facing records. The lunch was also confirmed by employees at a reputable Swiss investment bank operating in Houston.
This is what took place: the Dallas Fed met with the banks a week ago and effectively suspended mark-to-market on energy debts and as a result no impairments are being written down. Furthermore, as we reported earlier this week, the Fed indicated “under the table” that banks were to work with the energy companies on delivering without a markdown on worry that a backstop, or bail-in, was needed after reviewing loan losses which would exceed the current tier 1 capital tranches.
In other words, the Fed has advised banks to cover up major energy-related losses.
Why the reason for such unprecedented measures by the Dallas Fed? Our source notes that having run the numbers, it looks like at least 18% of some banks commercial loan book are impaired, and that’s based on just applying the 3Q marks for public debt to their syndicate sums.
In other words, the ridiculously low increase in loss provisions by the likes of Wells and JPM suggest two things: i) the real losses are vastly higher, and ii) it is the Fed’s involvement that is pressuring banks to not disclose the true state of their energy “books.”
Naturally, once this becomes public, the Fed risks a stampeded out of energy exposure because for the Fed to intervene in such a dramatic fashion it suggests that the US energy industry is on the verge of a subprime-like blow up.
Putting this all together, a source who wishes to remain anonymous, adds that equity has been levitating only because energy funds are confident the syndicates will remain in size to meet net working capital deficits. Which is a big gamble considering that as we first showed ten days ago, over the past several weeks banks have already quietly reduced their credit facility exposure to at least 25 deeply distressed (and soon to be even deeper distressed) names.
However, the big wildcard here is the Fed: what we do not know is whether as part of the Fed’s latest “intervention”, it has also promised to backstop bank loan losses. Keep in mind that according to Wolfe Research and many other prominent investors, as many as one-third of American oil-and-gas producers face bankruptcy and restructuring by mid-2017 unless oil rebounds dramatically from current levels.
However, the reflexivity paradox embedded in this problem was laid out yesterday by Goldman who explained that oil could well soar from here but only if massive excess supply is first taken out of the market, aka the “inflection phase.” In other words, for oil prices to surge, there would have to be a default wave across the US shale space, which would mean massive energy loan book losses, which may or may not mean another Fed-funded bailout of US and international banks with exposure to shale.
What does it all mean? Here is the conclusion courtesy of our source:
If revolvers are not being marked anymore, then it’s basically early days of subprime when mbs payback schedules started to fall behind. My question for bank eps is if you issued terms in 2013 (2012 reserves) at 110/bbl, and redetermined that revolver in 2014 at 86, how can you be still in compliance with that same rating and estimate in 2016 (knowing 2015 ffo and shutins have led to mechanically 40pc ffo decreases year over year and at least 20pc rebooting of pud and pdnp to 2p via suspended or cancelled programs). At what point in next 12 months does interest payments to that syndicate start to unmask the fact that tranch is never being recovered, which I think is what pva and mhr was all about.
Beyond just the immediate cash flow and stock price implications and fears that the situation with US energy is much more serious if it merits such an intimate involvement by the Fed, a far bigger question is why is the Fed once again in the a la carte bank bailout game, and how does it once again select which banks should mark their energy books to market (and suffer major losses), and which ones are allowed to squeeze by with fabricated marks and no impairment at all? Wasn’t the purpose behind Yellen’s rate hike to burst a bubble? Or is the Fed less than “macroprudential” when it realizes that pulling away the curtain on of the biggest bubbles it has created would result in another major financial crisis?
The Dallas Fed, whose new president Robert Steven Kaplan previously worked at Goldman Sachs for 22 years rising to the rank of vice chairman of investment banking, has not responded to our request for a comment as of this writing.
Pretty bad stuff if all true!
Large banks are not a huge concern however (from UBS):
The increase in corporate NPLs is not solely due to energy sector woes. Banks that are less exposed to the energy sector are still displaying a modest uptick in overall C&I loans from last December (Figure 10). (…)
(…) It is no secret to regular readers of our publications that we believe the credit cycle is quite advanced. As discussed in our HY outlook, we estimate that nearly $1tn of speculative-grade credits are at risk of default over the next downturn, as the stock of low-quality credit has soared. Recent contagion in US HY from energy woes has severely impacted ex-energy spreads while shutting down bond-market financing for low-quality credits. Our leading measure of non-bank liquidity has now even surpassed the weakness seen during the Eurozone crisis. These developments are a negative headwind for investment-grade corporates in 2016.
High-grade credits are also not without blemish; the post-crisis macro paradigm of Fed quantitative easing and the investor bid for yield has greatly expanded the size of risky BBB corporates. The total IG corporate universe has grown 110% from $2.08TN in Jan 2009 to $4.35TN today; the amount of BBB debt has ballooned 181% from $0.77TN in Jan 2009 to $2.17TN today (Figure 1). Hence, nearly 63% of the increase in US IG debt has come from the growth of more risky BBB-rated securities. BBB non-financial credits now make up 41% of the total IG market, the highest level ever outside of a recession (Figure 2).
Finally, leverage levels are high and climbing higher. The median IG firm’s net debt to EBITDA ratio easily surpasses that realized in 2007, and is quickly closing in on late 1990s levels (Figure 3). Combine these headwinds with market volatility and growing market illiquidity and it is no surprise to find IG credit spreads at historically wide levels (Figure 4).
With that said, high-grade issuers do face tailwinds that high-yield firms do not. Our credit based recession indicator is still only signalling a 16% probability of a US recession through Q3’16. This provides some comfort that US IG spreads will remain relatively insulated from near-term weakness in high-yield. In addition, our recession probability is low precisely because high-grade firms still face historically low borrowing costs, due to low Treasury yields and a terming out of debt profiles. The recent uptick in spreads has not materially increased interest burdens for highgrade companies, unlike for junk firms. Lastly, the foreign bid for US IG paper from EUR & JPN investors is currently insatiable and should continue to support medium tenor IG corporates. The foreign bid for US HY cannot compare.
Weak U.S. data deluge points to sharply slower growth
A welcome fall in the price of crude oil
BlackRock Chief: Markets Will Be ‘Fine’
Exclusive: Dallas Fed Quietly Suspends Energy Mark-To-Market On Default Contagion Fears
