TAXES

U.S. Economy Hits Speed Bumps The U.S. economy entered 2015 on the most robust streak of consumer spending in years, yet when the first growth figures for 2014 came out they underscored the lack of vigor in the current expansion.

The report offered both hope and red flags for the world’s largest economy. Households, boosted by a surge in hiring and a slide in gasoline prices, went on their biggest spending spree in almost nine years in the fourth quarter amid signs of rising consumer confidence.

But U.S. companies suffered a dual blow. Imports rose briskly as Americans bought foreign goods that were effectively made cheaper by the strengthening dollar. And the slumping world economy tamped down demand for U.S. exports. That caused the trade gap to widen, slicing a percentage point off economic growth.

Businesses also reined in capital spending, particularly on equipment, after stepping up such outlays in the spring and summer.

In effect, a pretty good report notwithstanding media headlines: strong but not too strong to scare the Fed and everybody else. Growth in the second half of the year averaged 3.8%. Final sales to domestic buyers remained very firm at 2.8% in Q4 even as they slowed from 4.1% in the prior quarter. (Chart below from Doug Short)

How about the savings from lower gas prices averaging about $60 a month for the average consumer or more than many workers have received in pay raises in years.

A survey of 4,500 consumers conducted for Visa Inc. in early January found that consumers are hanging onto roughly half of their gasoline savings. Another 25% is being used to reduce debt, while the rest is being spent on small purchases like groceries, clothing and fast food.

“We haven’t seen the extra savings from lower gas prices translate into additional discretionary consumer spending,” said Ajay Banga , chief executive of MasterCard Inc., on a conference call Friday to discuss quarterly earnings.

Yet,

• Both Visa and MasterCard said in earnings reports last week that consumers spent more money on their credit cards and debit cards in the fourth quarter, but the lower gas prices put a lid on the companies’ growth rates.
• Nominal consumer spending grew at a 3.7% annual rate in Q4 versus 4.2% in the third quarter. Excluding energy-related purchases, nominal spending grew at a 4.9% rate in the fourth quarter, down from 5.5% in the third quarter.
• In real terms, the 4.3% Q4 annual rate was the fastest since 2006.
• Spending in restaurants have surged as this CalculatedRisk chart shows:

Perhaps a larger part of the spending is paid cash. 

Americans Are Feeling Better About the Economy-a Lot Better

The report noted that sentiment is up 20% since July—just as oil prices start to swoon. Importantly, the gains over the past half year were as large for households earning less than $75,000 as they were for consumers making more than that.

U.S. Initial Unemployment Insurance Claims Plunge to 2000 Low

Initial claims for unemployment insurance dropped to 265,000 during the week ended January 24 from 308,00 during the prior week, revised from 307,000. It was the lowest level of claims since April 2000. Adjusting for the timing of the Martin Luther King holiday may have been a factor in the decline, according to a government spokesman. The four-week moving average of initial claims declined to 298,500. During the last ten years there has been a 76% correlation between the level of claims and the m/m change in nonfarm payrolls.

Employers Not Seeing Pressure to Lift Wages Falling unemployment isn’t putting much pressure on U.S. companies to boost compensation for their workers.

The employment-cost index, a broad gauge of wage and benefit expenditures, rose a seasonally adjusted 0.6% in the fourth quarter from the prior quarter and 2.2% from a year earlier, the Labor Department said Friday. Wages and salaries, which account for about 70% of compensation costs, rose 2.1% from a year ago. Benefit costs rose 2.6%.

During the previous economic expansion, from 2001-07, overall compensation gains averaged about 3.5%. Since the latest expansion began in mid-2009, they have averaged 1.9% year over year. (Chart from FT Alphaville)

But the pressure cooker is beginning to steam (Goldman Sachs):

(…) leading indicators for wage growth have been pointing up. In fact, it’s striking how closely different survey measures agree with one another. Exhibit 4 shows that leaders of large businesses (per the Duke University CFO survey), small business owners (according to NFIB), and households (from the U. Michigan and Conference Board surveys) are all planning for higher wages. This has translated into a substantial improvement in our GS Wage Leading Indicator, which stood at 3.0% in December. Most components underlying our leading indicator refer to expected growth over the next six months to one year. The improvement in survey expectations has also coincided with anecdotes—such as those found in the Fed’s Beige Book—of increased wage pressure for experienced and/or skilled workers, although overall wage pressures continue to be mild.

GREXIT

Greece will no longer deal with ‘troika’ Finance minister sets adversarial tone for bailout negotiations

Yanis Varoufakis also said Greece would not accept an extension of its EU bailout, which expires at the end of February, and without which Greek banks could be shut off from European Central Bank funding. (…)

Speaking at a business conference, Mr Schäuble said Germany was ready to co-operate but only on the basis of current agreements, which involve Athens completing structural reforms in return for financial support. “We’re prepared for any discussions at any time but the basis can’t be changed,” he said. “Beyond that, it is hard to blackmail us.” (…)

If the bailout is not renewed before February 28, Greece will lose access to desperately needed ECB credit lines for its banks, raising the possibility of a liquidity crisis that could trigger “a credit event” similar to the forced closure of Cypriot banks in 2013 and the imposition of the eurozone’s first exchange controls. (…)

Angela Merkel rejects more debt relief for Greece

“There has already been voluntary debt forgiveness by private creditors, banks have already slashed billions from Greece’s debt,” Merkel said in an interview with the Hamburger Abendblatt newspaper.

“I do not envisage fresh debt cancellation,” she said.

Europe’s creditors play with ‘political fire’ in pushing Greece to the brink “The creation of the euro was a terrible mistake but breaking it up would be an even bigger mistake. Anything could happen,” warns former IMF bail-out chief

(…) When the crisis first erupted in 2010, and re-erupted in 2012, Europe lacked a firewall. The conflagration threatened to spread instantly from Greece to Portugal, Ireland, and beyond.

This time Mr Schäuble thinks they are ready. “We face no risk of contagion, so nobody should think we can be put under pressure easily. We are relaxed,” he said. (…)

Prof Ashoka Mody, a former IMF bail-out chief in Europe and now at Princeton University, said hints by ECB members that they may pull the plug on Greek banks are “extremely irresponsible” and beyond the proper authority of these officials.

“They are supposed to be the guardians of financial stability. I have never heard of such outlandish threats before. The EU authorities have no idea what the consequences of Grexit might be, or what unknown tremors might hit the global payments system. They are playing with fire,” he said. (…)

Marc Ostwald from Monument said Grexit would open a Pandora’s Box. “They are all playing down the risk but once you throw Greece out, you are setting a precedent that nobody wanted to set. How could Cyprus stay in the euro given its dependence on Greek banks? As we have just seen with the Swiss franc, once the system buckles the markets will go after the next victim like a plague of locusts,” he said.

The ECB would shield Portugal from immediate Grexit fall-out, but corrosive doubts would be planted. As the Portuguese newspaper Publico wrote in an editorial entitled “Portugal is not Greece, but…”, the country has the same afflictions of crushing debt, low-growth, and lack of competitiveness within EMU.

Combined public and private (non-financial) debt is 380pc of GDP, the highest in Europe, making the country acutely vulnerable to debt-deflation dynamics. Nor is it still viewed as an austerity poster child by Berlin. “The reforms have stalled. Behind the scenes they have put a halt to cuts. It is surprising that people haven’t paid attention to this,” said Raoul Ruparel from Open Europe. (…)

“Europe is sleepwalking into a very dangerous situation,” said Hans Redeker from Morgan Stanley. “Diplomacy is breaking down and we are seeing same sort of emotional behaviour that led to the misjudgements of 1914.”

“The EU always said that the currency union is irrevocable. Once you destroy that faith, the eurozone becomes little more than a fixed-exchange system, an ‘ERM3’ with currency tail-risk always a nagging doubt. We think the euro would fall to $0.90 to the dollar very fast,” he said.

The stakes are high. Greece is a NATO member on the edges of Europe’s “arc of instability”, a string of conflicts, civil wars, and failed states that stretches from Ukraine, through the Levant to Libya. Critics say it would be an act of strategic vandalism to push Greece over the abyss into this maelstrom.

“To believe that you can talk about Grexit and then contain the after-effects, takes a degree of unprecedented silliness,” said Mr Varoufakis.

Yet that is exactly where this spectacular game of chicken going to until one side or the other blinks.

The WSJ has a somewhat more optimistic view:

As Greece and EU Clash, Clues on a Deal Emerge Despite finance ministers’ frosty exchanges, prospects are seen for a compromise that would share pain between Athens and its creditors.

The options for a compromise, likely to become more concrete once negotiations get under way in February, include tweaking Greece’s budget constraints and debt-service burden while revamping how Europe monitors Greek compliance. (…)

Hints that Greece under Syriza might lean more strongly toward Moscow have made Europe’s foreign-policy elite as nervous as its financial crisis managers this past week. (…)

“On the economics, there is room for compromise,” said a senior German official. “The question is the politics: What can Syriza live with, and what can get through parliaments in Germany, Finland and elsewhere?” (…)

Syriza is expected to present its detailed economic policies to Parliament on Feb. 7-9, aiming to convince creditors that it can be trusted to reform the country.

(…) the tricky part will be satisfying both Germany’s desire for controls and Greece’s desire to take ownership of its own policies.

Mr. Schäuble has long been a skeptic about whether Greece can repair itself enough to ever thrive in the eurozone, according to people familiar with his thinking. He is unlikely to signal any flexibility toward Greece before Feb. 15, when a state election in Hamburg could show gains for the antibailout party Alternative for Germany, one of these people said. (…)

OIL

OPEC January Crude Output Rises on Gains From Iraq

Here’s OPEC’s official stuff for December:

OPEC says it produced 30.2 million barrels a day of crude oil in December, up 140,000 barrels from the previous month, despite declining demand for the cartel’s output. Saudi Arabia made further reductions to selling prices for Europe and the U.S., and Iraq production is at or near four million barrels a day, according to London oil brokerage PVM Oil Associates Ltd. The market has seen back-to-back supply inventory surges in domestic oil stockpiles in the past two weeks, with production reaching a new 31-year high.

And Bloomberg’s estimates for January:

Production by the Organization of Petroleum Exporting Countries climbed 483,000 barrels a day to 30.905 million a day this month, led by gains in Iraq, Saudi Arabia, and Angola, according to a Bloomberg survey of oil companies, producers and analysts.

Iraqi production rose 200,000 barrels a day to 3.9 million this month, the biggest gain after Saudi Arabia, according to the survey. Last month’s total was revised 183,000 barrels higher to 30.422 million a day because of changes to the Iraqi and Ecuadorian estimates.

Output in Saudi Arabia, OPEC’s top producer, climbed 220,000 barrels a day to 9.72 million. Shipments to China increased as lower prices encouraged crude storage, according to a person familiar with the matter.

Angolan production increased 190,000 barrels a day to 1.81 million, the third-biggest advance in January. Eni began first production from the West Hub development project in Block 15/06 in December.

Iranian production rose 10,000 barrels a day to 2.78 million this month, the first increase since June.

Libyan output fell 150,000 barrels a day to 300,000 in January, the lowest level since June and the biggest decline in the survey.

Russia GDP Seen Shrinking 3% Russia’s economy minister said Saturday that the country’s gross domestic product is expected to shrink by 3% in 2015 with oil prices at $50 a barrel and an estimated capital outflow at $115 billion, Russian news agencies reported.

The government previously predicted the decrease in GDP at 0.8%. Inflation in 2015 is now forecast to stand at 12%, up from the previous estimate of 7.5%, Alexei Ulyukayev said, Russian news agencies reported.

EARNINGS WATCH

From Factset:

With 227 companies in the S&P 500 reporting actual results for Q4 to date, the percentage of companies reporting actual EPS above estimates (80%) is above the 5-year average, while the percentage of companies reporting actual sales above estimates (58%) is slightly below the 5-year average. In aggregate, companies are surpassing earnings estimates by 3.4%.

As a result of the upside earing surprises reported over the past week by Apple and other companies, the blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings growth rate for Q4 2014 is now 2.1%. This growth rate is above the estimate of 1.7% at the end of the fourth quarter (December 31).

Apple was the largest contributor not only to the increase in dollar-level earnings for the Information Technology sector, but also to the increase for the S&P 500 index as a whole. On January 27, Apple reported actual EPS of $3.06 for Q4 2014, which was 17.5% above the mean EPS estimate of $2.60. Due to the magnitude of the surprise and the company’s weight in the index, Apple accounted for just over 2.5 billion (or 51%) of the $5.0 billion increase in earnings for the S&P 500 index over the past week.

If Apple is excluded, the blended earnings growth rate for the S&P 500 for Q4 2014 would drop to 0.3% from 2.1%.

  If the Energy sector is excluded, the blended earnings growth rate for the S&P 500 would rise to 5.1% from 2.1%.

In effect, a reasonably good season notwithstanding media headlines.

The blended revenue growth rate for Q4 2014 is 1.4%, which is above the estimate of 1.2% at the end of the fourth quarter (December 31).

If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would jump to 4.0% from 1.4%.

For Q1 2015, 37 S&P 500 companies have issued negative EPS guidance and 9 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance for Q1 2015 is 80% (37 out of 46), which is above the 5-year average of 68%.

But lower than the 81.5% negative ratio at the same time last year. In fact, as of Feb. 3rd, 2014, there were 44 negative preannouncements against 10 positive.

Looking at future quarters, analysts have lowered estimates for Q1 2015 and Q2 2015. The estimated earnings and revenue growth rates for both of these quarters are lower today compared to the estimates on December 31. Most of these downward estimate revisions have occurred in the Energy sector. Despite the estimates reductions, analysts are looking for record-level EPS over three of the next four quarters (Q1 2015 – Q4 2105). Analysts also expect net profit margins to continue to rise (based on per-share estimates) in 2015.

So far, earnings revisions have mainly impacted Energy and Materials:

Bespoke tallies all NYSE companies:

Companies as Negative Since the Depths of the Financial Crisis

Below is a chart showing the spread between the percentage of companies raising guidance versus lowering guidance for each quarterly earnings season going back to 2002.  So far this earnings season, the spread between companies raising versus lowering guidance is -8.6 percentage points.  As shown, this is by far the worst reading of the current bull market, and it’s close to the two extremely negative levels we saw in the fourth quarter of 2008 and the first quarter of 2009.  

A negative guidance spread is nothing new for this bull market.  As you can see, from 2011 through 2014, we saw negative spreads every single earnings season.  The first quarter of 2014 is the only time over the last three years that the spread has been positive, and it was just barely positive at that.  That being said, the spread so far this season is much worse than any of the other negative spreads seen in recent years.  It looks like either companies were caught way off guard or they are throwing in the towel on 2015.  Looking on the bright side, though, this gives the market a big opportunity to surprise on the upside.

You may think that all of the negative guidance is coming from the Energy sector, but that’s not actually the case, and is among the sectors that are lowering guidance the least.  As shown below, Consumer Staples has seen the highest percentage of companies lowering guidance at 37.5%.  20% of Health Care companies have lowered guidance, while 17.5% of Consumer Discretionary companies have lowered.  Clearly, companies in the consumer sectors have negative outlooks even in the face of a big drop in oil prices. 

Bespoke numbers are much different than Factset’s which only considers S&P 500 companies…

The “official” S&P numbers are up-to-date to Jan. 30th and include 226 companies. Q4’14 estimates have collapsed 6.3% to $27.64 from $29.51 only one week ago. Q1’15 estimates have declined 2.3% while Q2’15 have been revised 1.5% lower. Full year 2015 EPS are now seen 1.3% lower at $119.76.

From a Rule of 20 point of view, the decline in trailing EPS after Q4’14 is a big event. The last time trailing EPS declined was after Q3’12 (flat yellow line in chart below). The earnings lull lasted 6 months and did not prevent the S&P 500 Index from appreciating 13%. The Rule of 20 P/E (black line) was 16.3 in November 2012 vs 19.1 currently.  The 50 bps decline in the inflation rate helped deflate the headwind, something we might also witness this time around.

Importantly, the earnings headwind seems currently mainly limited to energy companies which will react to trends in oil prices. So far, nothing points to a general earnings malaise in the U.S.. The 5.1% apparent gain in EPS ex-Energy in Q4’14 is encouraging, especially when considering the forex headwind faced by U.S. multinationals.

U.S. companies face billions in Venezuela currency losses, Reuters analysis shows  At least 40 major U.S. companies have substantial exposure to Venezuela’s deepening economic crisis, and could collectively be forced to take billions of dollars of write downs, a Reuters analysis shows.

At least 40 major U.S. companies have substantial exposure to Venezuela’s deepening economic crisis, and could collectively be forced to take billions of dollars of write downs, a Reuters analysis shows.

The companies, all members of the S&P 500, and including some of the biggest names in Corporate America such as autos giant General Motors (GM.N) and drug maker Merck & Co Inc (MRK.N), together carry at least $11 billion of monetary assets in the Venezuelan currency, the bolivar, on their books. (…)

The problem is that the dollar value of the assets as disclosed in many of the companies’ accounts is based on either the rates at 6.3 or 12 and only a limited number of transactions are allowed at those rates. The assets would be worth a lot fewer dollars at the 50 rate in the government system and the dollar value would almost be wiped out at the 190 black market rate. (…)

Diaper and tissue maker Kimberly-Clark Corp (KMB.N) recently announced a charge of $462 million for its Venezuelan business, leading to a fourth-quarter loss for the company, after it concluded that the appropriate exchange rate was the SICAD 2 exchange rate at 50 rather than the 6.3 it had previously used. (…)

Ford Motor Co (F.N) and oil services company Schlumberger NV (SLB.N)  took big-ticket hits to their quarterly profits because of their Venezuelan operations. Ford took a fourth-quarter charge of $800 million and Schlumberger $472 million. (…)

Another S&P 500 company to switch to the 50 rate from 6.3 in recent weeks was industrial gases producer Praxair Inc (PX.N), which took a fourth-quarter charge of $131 million as a result. It also said the switch will hurt its revenue and earnings in 2015. (…)

Most of the S&P 500 bolivar exposure is concentrated among 10 companies that have disclosed about $7.3 billion in assets linked to the country’s currency system, according to the Reuters analysis of their latest quarterly financial statements.

But if those companies used Venezuela’s SICAD 2 currency rate, the one at about 50 bolivars to the dollar, their assets would decline by as much as $5.8 billion. All of these companies currently either use the rates at 6.3 and 12. (…)

GM, which ranked No. 1 out of the group analyzed, with $1.5 billion in Venezuela exposure, said it is closely monitoring conditions there.(…)

SENTIMENT WATCH

Shake Shack IPO Tests Big Chains Shares of fast-casual chain Shake Shack, rocketed up 119% on their first day of trading from their initial public offering price of $21 each, ending at $45.90 and giving the operator of 63 restaurants a valuation topping $1.6 billion.

(…) Shake Shack’s valuation equates to nearly $26 million per existing restaurant. By comparison, McDonald’s valuation of about $91 billion equates to $2.5 million for each of its 36,258 global outlets. (…)

From my Dec. 30th post:

(…) According to the filing, Shake Shack plans to use the IPO proceeds to buy interests in a private partnership owned by investors including Mr. Meyer and private-equity firms Leonard Green & Partners LP and Select Equity Group LP, all of which own more than 5% of Shake Shack. (Alliance Consumer Growth, which invested in 2013, also owns a stake of at least 5%.)

That partnership then will use some of the money it receives to repay a credit facility led by J.P. Morgan Chase & Co., which is a lead bank on the IPO with Morgan Stanley .

The credit facility will be used in part to fund a $22 million payout to private investors before the IPO.

Some of the money going to the partnership also will be used to fund new restaurants and renovate existing ones, the company said. It said it plans to open 10 new U.S. Shake Shacks a year starting in 2015 for the “foreseeable future.”

After the IPO, the private investors also will continue to get payments from Shake Shack equal to 85% of certain tax benefits the company might receive, an arrangement known as a “tax receivable agreement,” according to the filing. The company said it expects the payments to be significant.

Robert Willens, an independent tax analyst in New York, said the arrangements are common and can be controversial. But, he said, if they are “fully disclosed and…reflected in the IPO price, it’s probably not that objectionable.” (…)

BTW:

There are Shake Shacks in Lebanon. And Saudi Arabia, Russia, and other countries. There are 27 international Shake Shacks in all, and they are licensed locations, not company operated. The filing says the international locations paid license fees of approximately $3.5 million in fiscal 2013. More could be coming. As the filing says: “we continue to attract substantial interest from potential international licensees around the world and have identified opportunities to expand our licensing footprint in existing and new international markets.”

How do you like your shareholders: rare or well-done?

Obama Takes Aim at Corporate Taxes Obama is making an opening bid on overhauling corporate taxes and linking it to infrastructure spending in his 2016 budget plan.

President Barack Obama is making an opening bid on overhauling corporate taxes and linking it to boosting infrastructure spending, a move that could clear a rare path toward common ground in a deeply divided capital.

Mr. Obama wants U.S. companies to pay a 14% tax on the approximately $2 trillion of overseas earnings they have accumulated, a White House official said Sunday. They would face a 19% minimum tax on future foreign profits. Companies could reinvest those funds in the U.S. without paying additional tax.

In making the pitch in his 2016 budget plan due Monday, the president is elevating two issues that previously gained traction with lawmakers of both parties: changing the tax code on overseas profits and raising spending on highways and transit systems. (…)

• Can a Deal Be Reached?

(…) While a mandatory tax on existing overseas profits is at odds with some recent proposals in Congress, some leading Republican tax writers have embraced such an approach in recent years. That suggests it could become part of a deal to overhaul the tax system and help pay for big new domestic infrastructure investments. (…)

Mr. Obama’s 19% rate for future foreign earnings also seemed high to some. “I don’t think there is any real chance” for that world-wide rate, given GOP priorities, said William Gale, a tax expert at the left-leaning Brookings Institution. Still, the plan appears designed to encourage companies not to park profits in tax havens, because they would get a credit for foreign tax paid up to 19%, noted Alan Viard, an expert at the conservative American Enterprise Institute who favors a lower rate on foreign earnings with no credit for foreign taxes.