Edge and Odds

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Edge and Odds

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TAXES

NEW$ & VIEW$ (28 APRIL 2014)

Auto Vehicle Sales Forecasts: Solid in April

The automakers will report April vehicle sales on Thursday, May 1st.  Sales in March were at a 16.3 million seasonally adjusted annual rate (SAAR), and it appears sales in April will be above 16 million (SAAR) too.
Here are a few forecasts:
From J.D. Power: April New-Vehicle Retail Sales Showing Growth, With Consumer Spending at Record-Level Pace

New light-vehicle retail sales are expected to reach their highest levels for the month of April since 2005, according to a monthly sales forecast developed jointly by J.D. Power and LMC Automotive. … Total light-vehicle sales in April 2014 are expected to reach 1.4 million units, a 4 percent increase from April 2013. [16.1 million SAAR]

Note: In April 2014, there was one more selling day than in April 2013 (26 days vs. 25 last year).
From Edmunds.com: Car Sales Settle into a Groove in April, Says Edmunds.com

Edmunds.com … forecasts that 1,401,606 new cars and trucks will be sold in the U.S. in April for an estimated Seasonally Adjusted Annual Rate (SAAR) of 16.2 million. … The forecast anticipates that the auto industry will enjoy its best April performance since dealers sold 1,444,587 vehicles in April 2006.

From TrueCar: April SAAR to Hit 16.2 Million Vehicles, According to TrueCar; 2014 New Vehicle Sales Expected to be up 8 Percent Year-Over-Year

New light vehicle sales in the U.S. (including fleet) are expected to reach 1,382,000 units, up 7.5 percent from April 2013 and down 10.0 percent from March 2014. … Seasonally Adjusted Annualized Rate (“SAAR”) of 16.2 million new vehicle sales is up 9.2 percent from April 2013 and down 0.5 percent over March 2014.

Inflation Expectations Hold Steady—For Now

According to Friday’s consumer sentiment survey put out by Thomson-Reuters and the University of Michigan, consumers think inflation will be 3.2% a year from now, little changed from expectation readings so far this year. (Consumers almost always think inflation is running higher than the government’s official measures. The consumer price index, for instance, shows prices are up just 1.5% in the past year.)

Changes in gasoline prices tend to color how consumers view inflation. That’s not a surprise since gas prices are very visible and drivers tend to fill up frequently. Prices at the pump have been rising lately. Add in the price jump for some grocery items—most notably beef and pork—and it would not be surprising if inflation expectations edge up in coming months.

Coffee price climbs to 26-month high Brazilian production forecasts revised downwards 

Sad smile CEO ‘Post-Weather’ Optimism Collapses To 5-Month Lows

Sentiment among CEOs, based on Bloomberg’s excellent Orange Book index of their executive comments, had reached 14 month high levels in mid-April as everyone was optimistic about a post-weather pent-up-demand bounce in everything from car-buying to burger-flipping. As Bloomberg’s Rich Yamarone notes, optimism was the most widespread in the housing, automotive and transportation industries.

The last week has seen the ugly reality hit home as Sentiment collapsed at its fastest pace since the government shutdown and dropped to 5-month lows. Common pessimistic issues include: unfavorable currency exchange rates, higher-priced food and uncertainties in Russia and Ukraine.

Germany Debates Tax Cuts Amid Rapid Rise in Revenue

News this week that tax receipts had risen an annual 7.2% in March and 3.7% during the first quarter—faster than the 3.3% rise economists had expected for the full year—has sparked a debate about whether to lighten one of the world’s heaviest household tax burdens.

Peter Ramsauer, a member of Chancellor Angela Merkel‘s alliance of conservative parties and chairman of parliament’s economics committee, said in a recent interview with the Bild newspaper that it was high time ordinary Germans were rewarded for their hard work.

Economists have latched onto the conversation, with many blaming high taxes and social security contributions for the fact that consumption in Europe’s largest economy has remained anemic despite record-low unemployment and respectable rates of growth.

Combining income tax and other levies on wages that fund the country’s welfare system, Germany had the second-highest tax burden on labor in 2013 among the 34 members of the Organization for Economic Cooperation and Development. (…)

Advocates of tax cuts in parliament say an easy way to do this would be to address the issue of bracket creep, whereby workers whose pay barely tracks the rate of inflation can slip into higher tax brackets and end up worse off. (…)

Both conservative and left-leaning members of Ms. Merkel’s cross-party coalition have now spoken in favor of tackling bracket creep, the main questions being when to do it and how to plug the hole this would blow in the budget—either through fresh debt, spending cuts or higher taxes on the rich.

The government sounded a cautious note this week, saying planned increases in welfare spending meant there would be no money to return to taxpayers this year or next. “At present…we don’t see any leeway that would allow us to tackle the problem,” said government spokesman Steffen Seibert.

Governments turn to indirect taxation Thirteen countries raise rates in 15 months, survey shows

Thirteen countries have increased indirect tax rates since January 2013 while none has cut them, according to a survey of about 130 countries by KPMG, the professional services group. It said: “Around the world, countries have shifted and continue to shift to indirect tax, rather than direct tax, to boost revenues”.

Corporate tax rates rose in nine countries but fell in 24. KPMG said in most countries, rates appeared to have stabilised after a decade of decline, although most tax authorities were attempting to increase revenues by pursuing more audits and investigations.

(…) “The increases in indirect tax rates are arguably evidence of it becoming the ‘tax of choice’ for governments around the world who are looking to raise much needed income.” Its attractions included its low cost of collection. (…)

Indirect tax was also becoming increasingly complex, as a result of constant changes to rules and rates, combined with an “increasingly aggressive and adversarial” approach to its collection and payment.

KPMG said companies were facing growing pressure to disclose to tax authorities what they were paying in tax and where those taxes were being paid.

It said country-by-country reporting of tax payments, already mandatory for companies in the extractive industry and the banking industry in the EU “will grow on a global basis over the next decade”.

It also urged companies to respond to increased public scrutiny of their tax affairs with greater transparency over how much they were contributing to society through tax. It said: “Do not become complacent: this issue is not going away.”

Asia’s Export Engine Sputters For decades, Asia fueled its development by selling products to the West. That engine is now sputtering, threatening to sap the region’s economic expansion.

Combined exports from Asia’s four export powerhouses—China, Japan, South Korea and Taiwan—slid 2% in the first three months of this year from the same period last year.

China’s drop is particularly striking. Beijing reported Friday that its first-quarter current-account surplus, which measures all trade and one-time transfers, shrank to a three-year low. (…)

This sluggishness reflects a sharp shift in the global economy. For decades, going back to the 1960s, Asian economies led by Japan, then South Korea, Taiwan and China, became the world’s factory floor, marshaling cheap labor to propel a wave of exports.

Today, it is unclear whether exports can still provide that oomph. Overall growth is slowing in many Asian nations, forcing policy makers to ponder whether demand from their own consumers can fill the void. (…)

Theories for the shift proliferate. Prominent among them: The U.S. recovery this time is different. In the five years since emerging from recession, growth in all goods and services in the U.S. has averaged just 1.8%, half the pace of the previous three expansions. (…)

Growth in U.S. consumer spending, meanwhile, has been stuck at roughly 2% for more than two years as Americans pay down debt, compared with well over 3% a decade ago. That means less demand for Asia’s exports, which are dominated by manufactured goods, especially electronics.

Imports by the U.S. from China, Japan, South Korea and Taiwan grew by just 1% in 2013, down from 13% in 2004.

Another theory for the export slump: The fruits of Asia’s successes—higher wages, better living standards—have made it too expensive as a manufacturing hub. That has been true for years in Japan, Taiwan and South Korea as they moved up the value chain. Today, their car makers and electronics firms have set up facilities overseas to benefit from cheaper wages.

Now, even China appears to be losing business in lower-end manufacturing as wages rise and exporters of clothes and cheaper electronics shift to less costly countries such as Vietnam and Bangladesh.

For these less-developed nations, the export path remains open if they can supply enough workers with the education and skills to seize it. But investors in Vietnam already complain of a shortage of skilled workers, underscoring the challenge to even poorer nations like Myanmar, Cambodia and Laos.

Elsewhere in Asia, leaders are addressing the challenge of weaning their economies from exports. (…)

The problem for Asia is that structural overhauls often put a brake on economic growth before they pay off. (…)

Pointing up To juice exports, policy makers in several Asian countries have nudged their currencies lower recently to make their goods cheaper abroad.

The U.S. Treasury Department has criticized China’s moves to decrease the value of the yuan 3% so far this year. The IMF said this month that government interventions may have pushed South Korea’s won 8% below its real market value.

But the more Asian exporters try to find an escape by weakening their currencies, the higher the risk of a currency war.

European earnings forecasts still founder Expectations for results proving wildly too high

For the fourth year in a row, consensus expectations for European companies’ earnings growth at the beginning of the year have proved wildly over-optimistic.

In the last four weeks, consensus earnings forecasts for Peugeot, Rémy Cointreau and Air France-KLM have all been downgraded, by 40 per cent, 11 per cent and 8 per cent, respectively, according to Bloomberg. (…)

Thomson Reuters’ IBES consensus forecasts for European earnings growth in 2014 have moved from 13 per cent at the start of the year to 8 per cent. (…)

A strong euro, wobbles in the emerging markets from Turkey to South Africa, a US swathed in snow, not to mention rising geopolitical tension between Russia and the west over Ukraine all provided reasons for gloom during the first quarter of 2014. But investors should nevertheless take with a pinch of salt the number of companies reporting that they have “beaten” expectations, given that these have fallen so sharply over the quarter.

Even so, just over half the 101 companies of the 374 Stoxx600 European companies that have reported so far on their first quarter performance have disappointed consensus earnings expectations, according to Bloomberg.

The last four years are not the only examples of analysts being over-bullish.

“Going back 25 years, analysts have been too optimistic about earnings growth in 20 years out of the 25 and by 8 percentage points on average over the whole period,” said Mr Nelson. (…)

SENTIMENT WATCH

Fifty-six percent of Big Money respondents call themselves bullish or very bullish about U.S. stocks today, down from 68% six months ago. The percentage of poll respondents who say they are neutral has swelled to 35% from 24% six months ago and 19% a year ago. Only 8% of respondents self-identify as bears in the current poll, the same percentage as last fall.

Seventy-three percent of Big Money managers consider the market fairly valued, up slightly from last fall. Another 18% say stocks are overvalued, versus 14% in our prior survey. More than 40% predict that the market’s price/earnings multiple will expand in the next 12 months, as investors become even more willing to pay up for earnings growth.

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Seventy-one percent of Big Money managers predict that stocks will be the best-performing asset class in the next 12 months, while 12% look for the biggest gains to come from real estate, and 5% expect cash to be No. 1. Over five years, 81% of managers favor equities, 8% like real estate best, and 6% say that commodities will outperform everything else.

On a geographic basis, 60% of the managers expect the U.S. to do best in the next year; 23% think Europe will shine brightest, and 14% look for the biggest gains to come from emerging markets. Expectations differ over five years, however, when almost half the managers expect emerging markets to be back on top.

The Big Money crowd has little affection for gold, with 66% calling themselves bearish on the yellow metal. Their year-end consensus forecast for gold is $1,326 an ounce, up just 3% from last week’s $1,293.

They reserve their greatest disdain, however, for bonds, which have enjoyed a storied run and could deliver diminishing returns in the future, especially when the Fed begins to raise interest rates again. Almost 90% of poll participants are bearish on the investment prospects for U.S. Treasuries, with 80% downbeat on U.S. corporate issues. More than half the managers—55%, to be exact—expect their fixed-income portfolios to generate negative total returns in the next 12 months.

Nearly 80% of managers expect the Fed to start raising interest rates in 2015, with most eyeing the year’s second or third quarter as the kickoff period.

Another 7% see the change in policy coming in the first quarter of 2016, although 8% don’t expect a rate hike until after 2016, given what they see as the economy’s still-precarious state.

Alarmingly, 54% of managers predict that share prices will slide when the Fed raises rates again.

  • Highflying Small Caps Get Clipped Last year’s blistering rally in shares of smaller companies may have cooled off, but many investors say the group still appears pricey.

(…) this year, the Russell 2000 is down 3.5% while the S&P 500 has gained 0.8%. Even the Nasdaq Composite Index, which took a drubbing from a dive in biotechnology and technology stocks, performed better than the Russell, declining 2.4%.

Last week, when the S&P 500 fell less than 0.1%, the Russell lost 1.3%.(…)

The Russell 2000 is at trading around 19 times the expected earnings of its components for the next year, according to Russell Investments. At the start of 2013, the earnings multiple on the Russell was 15.1.

Current valuations are well above their long-term averages. Since the start of 1994, small caps have traded at an average price/earnings multiple of 16.9, according to Russell. Over the last five years, the average has been 15.8. (…)

However, individual investors haven’t yet soured on small U.S. stocks. Traditional mutual funds investing in small caps have taken in $3.1 billion this year, according to Morningstar, on top of the $16.4 billion last year. (…)

Large speculators such as hedge funds are betting $2.8 billion this month that theRussell 2000 Index will fall. That’s the most since 2012 and the highest versus average levels since 2004, according to data compiled by Bloomberg and Bank of America Corp. (…)

Valuations in the Russell 2000 rose above levels from the 1990s technology bubble. While small-cap shares are usually the first to benefit when economic growth picks up, the selloff reflects a loss of faith by professional investors in the five-year equity rally. (…)

The Russell 2000 last month reached a valuation of 10.8 times its members’ annual earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg. That was the highest since at least 1995 and compares with an average weekly ratio of 7.7 times Ebitda, the data show. The valuation was at 10.2 at the end of last week.

The Russell 1000 Index for larger stocks such as Apple Inc. and Exxon Mobil Corp. trades at 8.7 times Ebitda, close to the highest since 2001. The small-cap index carries an 18 percent premium relative to the large-cap measure, after reaching 23 percent in March and climbing to 26 percent in September, according to the data.

What concerns you about corporate profit margins?

Corporate profits are the mother’s milk of stock prices. First, we’ve had this lengthy improvement in corporate productivity, and that’s likely near complete. We’ve had years of fixed-cost reductions by corporations, and that’s also likely over, because they’ve cut to the bone. If the employment market gradually tightens, labor costs will rise, pressuring margins. Both interest expenses and effective tax rates will have to rise as central banks normalize monetary policy and the U.S. sees the need to reduce its deficit. And a very costly regulatory policy is likely to continue, increasing corporate costs. And finally, the quiescent capital-spending cycle will ultimately be awakened. With that, amortization and depreciation costs will ascend. (…)

At another important top, in early 2000, the market leadership rotated from high tech to value stocks—exactly what has happened in the past two months. Leadership changes are often the sign of a market correction or bear market.

What in particular will pressure the markets?

Disappointing global economic growth, weaker-than-consensus earnings, and a contraction of the price/earnings multiple, compared with a 25% expansion last year. Those will be the culprits for a negative return this year. The consensus view is missing, among other things, the vulnerability of the middle class, which provides an important source of economic growth. It’s missing the economic vulnerability of our young people. It’s missing our addiction to low interest rates, both in the public and private sectors. It’s missing the consequences of higher rates and the risks to profit margins, probably my biggest concern. And it’s missing the widening gap between the haves and have-nots—and the economic and social consequences over time.

Another Way to Gauge the U.S. Economy Gross output takes into account intermediate transactions overlook by gross domestic product.

How often have we been told that consumer spending accounts for more than two-thirds of the economy, based on the measure called “gross domestic product”? That two-thirds share would be news to many job holders, since most of us don’t earn our money from enterprises that sell directly to consumers.

Of the 125.3 million job holders in the private sector, just 15.3 million are in retailing. Add the millions of others who directly serve consumers in other ways, and you’ll still find that those who work in businesses that sell to other businesses (or to the government) constitute the majority.

The vital importance of business-to-business transactions in the U.S. economy has been captured in a data series released on Friday by the Bureau of Economic Analysis, called “gross output.” BEA Director Steve Landefeld, whose 19-year stewardship has led the agency in many creative directions, told me last week that while he believes gross output is of value at the industry level, he advises against using aggregate GO as a substitute for aggregate GDP.

He does, however, obligingly provide estimates for aggregate GO in the newly released tables. As of 2013’s fourth quarter, the nominal value of U.S. GO came to $30.1 trillion. In contrast, nominal GDP ran at $17.1 trillion, with consumer spending accounting for 68.2% of it. But if we think of gross output as “the economy,” consumer spending accounted for just 38.7%, seemingly a better approximation of reality.

Landefeld’s main objection to aggregate GO is that it commits the sin of double- and even triple-counting.

To see why, imagine a simple economy in which the only output is bread. The GDP of the bread economy would simply tally the final sales value, in dollars, of all the loaves produced, adding whatever investment there might be in plants and equipment to support production. But on a GO basis, we’d also tally the various stages of B-to-B transactions needed to get the bread to consumers. First, farmers grow the wheat and sell it to millers, who grind it into flour. Then they sell the flour to bakers, who turn it into bread that they sell to retail outlets. Finally, the retailers sell the bread to consumers. And, of course, other transactions also take place, since the bread must be wrapped in something.

GO includes the value of final sales, plus the dollar value of all intermediate transactions. Hence, the double- and triple-counting, compared with GDP. Regarding that point, Landefeld raises another objection. Let’s say the bread industry suddenly undergoes a spate of vertical integration, with bakers buying the farms that grow the wheat and the mills that produce the flour. In that case, many intermediate cash transactions would disappear, and GO would decline. In fact, as Landefeld points out, the opposite has been happening. A move to greater outsourcing has increased the number of intermediate transactions, artificially boosting gross output.

No such declines or gains could happen to gross domestic product. But Landefeld feels that as long as GO is confined to the industry level, the advantages of viewing an industry up close outweigh the disadvantages of double-counting.

WHILE ALL OF THESE OBJECTIONS are valid, there is still value to GO on both the aggregate and industry level. Economist Mark Skousen can be credited with pioneering the concept of gross output in his 1990 book, The Structure of Production (see his op-ed article on this topic in the April 22 Wall Street Journal).

Among other things, Skousen notes that GO acts as a more sensitive seismograph in registering the shock of business cycles. During a downturn, intermediate-goods industries are struck especially hard, with consumer spending satisfied from the drawdown in inventories. So, for example, the fall in real GO during the recession of 2007-09 was 8.7%, compared with a 4.3% decline in real GDP over the same period. 

French Government Won’t Oppose GE’s $13 Billion Bid For Alstom

Siemens Said to Offer Alstom Asset Swap to Beat GE BidDid GE Win France’s Blessing for Alstom Deal?

France says could block Alstom deal as president meets GE Confused smile

NEW$ & VIEW$ (21 APRIL 2014)

U.S. Gasoline Prices Rise to 13-Month High in Lundberg Survey

The average price for regular gasoline at U.S. pumps jumped 8.5 cents in the past two weeks to a 13-month high of $3.6918 a gallon, according to Lundberg Survey Inc.

The survey covers the period ended April 18 and is based on information obtained at about 2,500 filling stations by the Camarillo, California-based company.

Prices are the highest since March 22, 2013. The average is 15.55 cents higher than a year ago, Lundberg said. Gasoline has risen 39.74 cents a gallon since bottoming out in February and is up 43 cents this year.

“The most important factor right now in this rise is crude oil, which rose by a very similar amount to the street-price move,” Trilby Lundberg, the president of Lundberg Survey, said in a telephone interview yesterday. “From here, we will probably see very little increase, if any, with the big caveat of course being crude. If crude prices climb even higher, then this may not be the peak.”

Pointing up An “extremely robust” rise in U.S. gasoline demand may have also helped increase retail prices, according to Lundberg. Demand for the motor-fuel in the last four weeks is up 4.6 percent from the same period a year ago, Energy Information Administration data show.

Here’s the chart, courtesy of gasbuddy.com. Gas prices have jumped 11% since the end of January.image

Data, Anecdotes Indicate ACA Damping Hiring, Wages

Bloomberg economist Richard Yamarone:

(…) Several business people have cited the Affordable Care Act (ACA ) as the primary obstacle to hiring and capital spending. Essentially the ACA forces any business with more than 50 employees working more than 30 hours a week to offer some form of healthcare to its staff. Since reducing staff below 50 is not an option for some restaurant chains, such as Darden Group which employs more than 200,000 people, cutting hours worked is the only viable move. The data support this: hours worked in the retail and leisure and hospitality sectors are below 30 hours a week and hiring has increased in these two industries.

During March, the leisure and hospitality group added 29,000 positions, while retailers increased payrolls by 21,300. Combined, these two industries account for 25 percent of all private workers, so it is a significant percent of the labor market. The data support this trend of increased low-wage hiring in avoidance of the ACA mandate. (…)image

Pretty clear, isn’t it?

Mortgage Lenders Ease Rules for Buyers Mortgage lenders are beginning to ease the restrictive lending standards enacted after the housing boom turned to bust, a sign of their rising confidence in the housing market

Or a sign of weak demand.

(…) One such lender is TD Bank, Toronto-Dominion Bank‘s U.S. unit, which on Friday began accepting down payments as low as 3% through an initiative called “Right Step,” geared toward first-time buyers and low- and moderate-income buyers. TD initially launched the program last year with a 5% down payment. It keeps the product on its books and doesn’t charge for insurance. Borrowers also don’t need to put down any of their own cash if a family, state or nonprofit group provides a down-payment gift.(…)

Valley National Bank, a community bank based in Wayne, N.J., lowered down-payment requirements to 5% from 25% this month on mortgages for certain buyers in New York, New Jersey and Pennsylvania. Next month, Arlington Community Federal Credit Union, based in Arlington, Va., will begin accepting 3% down payments on mortgages up to $417,000, down from 5%.

Low-down-payment mortgages never went away after the housing bust. Instead, they shifted from private lenders to the Federal Housing Administration, which insures loans with down payments of just 3.5%.

Over the past year, however, more than one in six loans made outside of the FHA included down payments of less than 10%, the highest share since 2008, according to figures from data firm Black Knight Financial Services. That still is lower than the nearly 44% of the market they accounted for at the peak of the housing bubble in early 2007. (…

Another sign that banks could get less picky: Credit scores for borrowers seeking conventional mortgages also are easing. Scores on purchase mortgages stood at 755 in March, down from 761 a year earlier, according to data from Ellie Mae, a mortgage-software provider. Those on purchase loans backed by the FHA dropped to 684, compared with 696 one year earlier. (Under a system devised by Fair Isaac Corp., credit scores run on a scale from 300 to 850.)

Smaller lenders are accepting even lower scores. Average credit scores on purchase loans closed through a consortium called LendingTree fell to 679 in March, down from the year-earlier 715.(…)

While smaller lenders are trying to appeal to first-time buyers, larger lenders are gradually reducing down payments for jumbo loans—those too large for government backing—to woo wealthy customers. EverBank began accepting down payments of 10.1% for jumbo borrowers with strong credit this year, down from 20%, and Wells Fargo reduced to 15% from 20% its minimum down payment for jumbos last year. Bank of America made the same change for mortgages of up to $1 million. (…)

Japan posts largest-ever trade deficit Deficit has ballooned wider under Abenomics

(…) The gap between the value of Japan’s exports and that of its imports grew by more than two-thirds in the 12 months through March, to Y13.7tn ($134bn), according to government data released on Monday. It was the third consecutive fiscal year of deficits, the longest streak since comparable records began in the 1970s. (…)

Japanese export volumes have barely risen and the yen value of goods shipped to foreign markets has increased much more slowly than the value of imports.

Exports actually declined slightly by volume in January-March compared with the previous quarter, by 0.2 per cent on a seasonally adjusted basis, according to calculations by Credit Suisse, even as imports grew 4.5 per cent. (…)

Japan’s energy import bill has risen sharply in the wake of the Fukushima nuclear accident in 2011. All of the country’s operable atomic reactors are offline pending safety reviews, robbing Japan of a power source that provided 30 per cent of its electricity before the disaster.

Utilities have been forced to buy more foreign oil and gas to make up the difference, and a weaker yen has made each barrel that much pricier. National fuel imports jumped 18 per cent by value last year, according to Monday’s trade data. (…)

Overall Japanese exports increased 0.6 per cent by volume last fiscal year, Monday’s data showed, leading to a 10.8 per cent rise by value in light of the weaker yen. Imports rose 2.4 per cent by volume and 17.3 per cent by value.

Taiwan Export Orders Grow in March

Taiwan’s March export orders grew at the fastest pace in three months, adding to signs that the island is benefiting from recoveries in developed economies. Export orders, an early indicator of actual exports, rose 5.9% in March from a year earlier to US$37.9 billion, after a 5.7% February on-year rise, the Ministry of Economic Affairs said Monday.

Export orders placed with Taiwan are closely watched as a bellwether for the global economy and particularly the tech industry. (…) In the nine months since July, export orders from Europe and the U.S. rose nearly 4% on year, while those from China, Taiwan’s biggest export market, grew only 1.4%. (…)

In March, orders from Europe rose 8.9% from a year earlier, picking up from 1.3% on-year growth in February. Orders from Japan rose 18%, which was an improvement from February.

Sad smile Orders from the U.S. were up 1.0%, following February’s 2.3% rise. Orders from China and Hong Kong rose 3.1% in March, slowing from February. Demand from China tapered off in March as China’s recent economic data pointed to weaker growth.

Orders for electronic products including semiconductors—roughly a quarter of total orders—rose 10.1%, following a 15.4% increase in February.

Orders for information and communication products like smartphones and components—also about a quarter of orders—gained 8.6% from a year earlier, after rising 3.2% in February.

New Tax Bug Bites Tech Firms First-quarter corporate earnings are getting clipped after Congress allowed a key tax credit to expire at year-end. Google is among the latest to cite the expired research-and-development tax credit for affecting its financial results.

The Internet search company Wednesday reported a first-quarter tax rate of 18%, up from 16% for all of 2013. Chief Financial Officer Patrick Pichette called out the expired credit on a conference call as one of the reasons for the higher rate.

If Google’s tax rate had remained 16%, its first-quarter earnings per share would have been $5.50, instead of the $5.33 Google reported.

Google isn’t the only one warning investors about a higher tax rate as a result of the expired credit. A spokeswoman for software maker Citrix Systems Inc. CTXS +0.16% said the expired credit is one reason the company projects its tax rate this year will increase to 19% from 13%. Set-top box maker Arris Group Inc.ARRS +1.92% said its per-share earnings will be 12 cents lower over the course of 2014. Analysts have projected 65 cents per share for the company, according to Capital IQ.

Others companies that have cited the tax impact of the expired credit include tool maker National Instruments Corp. NATI +0.88% , chip maker Atmel Corp. ATML +1.66% and spice maker McCormick MKC -0.21% & Co.

In most cases, the effect of the expired credit will be small. Semiconductor company Intel Corp. INTC +0.41% is one of the nation’s biggest spenders on research and development. A spokeswoman says the credit is typically worth more than $150 million a year to the company. Intel in 2013 reported net income of $9.6 billion.

The R&D tax credit, first enacted in 1981, has lapsed nine times since then. But it has always been renewed, with the credit typically made available retroactively.

Most recently, Congress renewed the credit in January 2013 and allowed companies to claim it retroactively for 2012. The credit had previously expired at the end of 2011.

That led to an accounting quirk early last year where many companies could claim five quarters of the credit in the first quarter of 2013.

Earlier this month, the Senate Finance Committee proposed renewing and expanding the credit through Dec. 31, 2015. The Senate proposal would expand the credit to let small companies—many of whom aren’t profitable and don’t pay income taxes—apply the credit to payroll taxes. (…)

Banks warn as low rates squeeze returns Average net interest margin falls to 2.64% at biggest US banks

(…) For the biggest four US banks with major consumer lending businesses, Wells Fargo, Bank of America, JPMorgan Chase and Citi, the average net interest margin fell to 2.64 per cent in the first quarter, the lowest level in at least a decade, according to data compiled by Keefe, Bruyette & Woods and SNL Financial.

The continued decline is surprising analysts who expected the Federal Reserve’s withdrawal of economic stimulus to lead to higher rates and better profit margins at the biggest US banks.

“There’s no sign that there’s a bottoming out in the Nims yet,” said Frederick Cannon, a bank analyst at Keefe, Bruyette & Woods. “What we’ve seen is tapering not having the effect that was expected.”

The yield on US 10-year Treasury bonds has fallen from 3 per cent in January to 2.7 per cent, even as the Federal Reserve has reduced its bond purchases. (…)

Rates on US Treasuries fell in the first quarter as there was higher demand from large pension funds and political turmoil in Ukraine spurred a shift to safer assets.

Banks’ other lever to improve margins – paying less to customers for deposits – has proved difficult because they are already so close to zero given the prolonged period of low rates since the financial crisis.

John Gerspach, Citi’s chief financial officer, told analysts last week: “We expect our net interest margin to decline by several basis points, likely followed by a modest increase in the back half of the year.”

Bruce Thompson, finance chief at BofA, said: “You would expect to see the Nim in the second quarter moderate a little bit.” (…)

At Wells Fargo, the total average loan yield fell 7 basis points in the first quarter from the previous quarter while the Nim fell to a low of 3.18 per cent.

The net interest margins of 33 US banks that have already reported their earnings fell by a median 3 basis points in the first quarter to 3.38 per cent, according to KBW Research and SNL Financial, showing that Nims have not quite ended their downward slide. (…)

Italy Cuts Taxes to Boost Economy

Italy’s government on Friday approved the country’s first extensive income-tax cuts in more than a decade, a move expected to give up to €80 a month in extra cash to three-quarters of the workforce.

The cuts are worth €10 billion ($13.8 billion) over a year and will go into effect next month. Prime Minister Matteo Renzi has said the measure is aimed at voters heading to the polls for the European Parliament elections in May. It is also meant to boost domestic demand and ease Italy’s dependence on export-led growth as foreign demand shows signs of slowing.

Mr. Renzi, whose center-left Democratic Party is currently enjoying record-high support in opinion polls, is making a high-stakes bet with the move, given his administration hasn’t identified all the budgetary savings required to fund the tax cuts on a permanent basis.

“These aren’t one-off tax cuts, they’re structural,” Mr. Renzi said.

He outlined €6.9 billion in targeted measures that would help lessen the impact on the state’s finances. Among them are plans to implement a maximum salary cap of €240,000 for public servants and €2 billion in savings on government purchases.

The government will also oblige local administrations to cut spending and make all their expenditures public. Otherwise, they face reduced transfers from the central government. (…)

The income-tax cuts will result in up to €1,000 in additional annual take-home pay for workers with salaries of up to €28,000 a year. Italian employees typically face tax rates of 50% and higher when the country’s stiff payroll contributions are included. The government hopes that by targeting the tax cuts at the medium and lower end of the wage spectrum they will boost consumption, which the Bank of Italy said remains 7% below its level in 2007. (…)

Sleepy smile Obama Extends Review of Keystone

The Obama administration is indefinitely extending its review of the Keystone XL pipeline, likely delaying a decision on the project until after November’s U.S. midterm elections. (…)

SENTIMENT WATCH
  • Why This Bull Market Feels Familiar It Has Lots in Common With the ’90s Rally, but With Stronger Headwinds

(…) The middle of the 1990s in particular was especially good for investors, with stocks posting big gains despite a slow-growth economy dubbed the “jobless recovery.”

“While hoping the finale doesn’t also repeat, we are seeing a lot of similarities between today’s environment and the mid-1990s,” says Liz Ann Sonders, chief investment strategist at Charles Schwab.(…)

From 1990 through 1999—when the Internet stock bubble began to dominate the market—the S&P 500 more than tripled.

Much of those gains came in the years from 1995 through the end of 1998, when the S&P 500 rose an average of 28% a year. The stock market became dominated by a “buy the dip” mentality. Optimistic investors saw every downturn as an opportunity to buy more stocks—until the spring of 2000, when the dip turned into a crash.

“One similarity, which is also a lesson for today, is that there weren’t many pullbacks,” says Robert Doll, chief equity strategist at Nuveen Asset Management. Another dynamic, Mr. Doll recalls, is that before the tech bubble, leadership of the rally would rotate among sectors. That’s something that has been the case of late, he says. A concern among some investors is that it will be difficult for the rally to continue, with valuations having risen sharply over the past year.

In the mid-1990s, however, valuations were only slightly higher. From 1995 through the end of 1997, stocks in the S&P 500 traded at an average of 17.9 times the previous 12 months’ earnings, according to Standard & Poor’s. Today, the S&P 500 is at 17.4 times trailing earnings.

Ms. Sonders says the economic backdrop of the mid-1990s echoes today’s. “Like then, we are in a post-financial-crisis period accompanied by a ‘jobless,’ disinflationary recovery,” she says.

Of course, today’s economy is facing more significant headwinds than those that followed the savings-and-loan crisis of late 1980s. The July 1990-March 1991 recession was relatively shallow and short.

But like today, in the mid-1990s investors worried about the slow pace of employment growth and the prevalence of low-paying jobs among those positions being created.(…)

Aside from the 1997-98 Asian financial crisis, which sent a scare through global financial markets, the main hiccup for stocks came in 1994.

The cause was a jump in bond yields as the Federal Reserve began to raise interest rates faster than had been expected. From the end of January 1994 through the end of June, the S&P 500 lost 7.8%.

But that didn’t end the bull market. “If rates go up in line with improvement in the economy, that’s a good market environment for stocks,” says Ms. Sonders.

The lesson for investors today is that rising rates may pose a hurdle, but don’t have to mean the end of a bull market, says Mr. Piantedosi. “Once the Fed did what they needed to do with rates, we took off from there,” he says.

Still, Fed policy in the 1990s looked nothing like today’s stance at the Fed.

And there are other headwinds today that didn’t exist in the 1990s, Ms. Sonders notes. Profit margins are higher today, making it harder to generate profit gains. And economically, income inequality is greater now than two decades ago.

Another difference from the 1990s is that many stock investors are still wary after the bear markets of the early 2000s and the financial crisis.

Ultimately, whether stocks continue their bull market will depend on the fundamentals, not just similar charts, says Mr. Doll. “In order to get continued decent markets, I do think we need to see some more improvement in the economy and earnings growth,” he says. “But I think we’ll get it.”

Punch In reality, as the chart below clearly illustrates, the end of the 1990s was actually a once-in-a-lifetime event. After the mild 1990 U.S. recession, valuations rose above the “20 Fair Value” line early in 1991 and equities returned some 5% annually until mid-1994 when the Rule of 20 P/E dropped below 18. Earnings jumped 40% during the following 30 months under stable 2.5% inflation, bringing the Rule of 20 P/E back to 20 by December 1996. Equities then roared ahead 25% during the next 9 months, crossing the yellow/red border into what Greenspan called “irrational exuberance” which brought the Rule of 20 P/E to 31.5.

image.

Two major events characterized the 1995-2000 period:

  • profits rose 65% over 5 years while inflation declined from 3% to 1.5% (Oct. ‘98)
  • the growth of the internet mesmerized investors to the point where everything that was even remotely internet-related got valued into the stratosphere.

I can’t say whether the current social media craze will develop like the internet craze but I doubt that S&P 500 profits can jump 65% over the next five years without a meaningful acceleration in inflation. Recall that the rise in profit margins from their trough in 1991 to their peak in early 1998 accounted for 55% of the earnings advance during that period. The margin effect has been played out this cycle as EBIT margins troughed at 9.5% in 2009 and peaked at 15% in 2011, edging down to their normal cyclical high of 14% since. Profit growth is thus more likely to grown in line with nominal GDP growth until the next cyclical downturn.

It is also doubtful that inflation will decline much from current levels. In fact, it is much more likely to rise, if only because that is what the world’s major central banks are openly targeting. Similarly, we should also expect that long-term interest rates will rise over the next few years as tapering continues and inflation accelerates. That would be contrary to the drop in Treasury yields from nearly 9% in mid-1990 to 4.5% at the end of 1998.

In all, if this bull market feels familiar, it is only because of the growing cheerleading from the media and because of what follows. Please read on:

(…) More than 85% of investors are feeling optimistic about the investment landscape, and 74% think stocks have the greatest potential of any major asset class, according to a survey of 500 affluent investors released Monday by Legg Mason Global Asset Management. The survey was conducted in December and January. (…)

Lance Roberts comments:

However, the idea that individual investors are still “out of the market” should be taken with a bit of caution. The chart below is data compiled by the American Association of Individual Investors (AAII) which surveys it membership on portfolio allocation.  The data is compiled and released monthly.

With cash hovering at the lowest levels since the “Tech Wreck,” and equity exposure at the highest, investors are more than just “warming up” to equities. They are effectively“all in” with respect to the financial markets. An analysis of investor sentiment (both professional and individual) and rising leverage confirm the same. 

What is clear in all of this analysis is that investor behavior tends to be exactly the opposite of what it should be. (…)

  • Mutual Funds Moonlight as Venture Capitalists BlackRock, T. Rowe Price Group and Fidelity Investments are among the mutual-fund firms pushing into Silicon Valley at a record pace, snapping up stakes in high-profile startup companies.

Last year, BlackRock, T. Rowe, Fidelity and Janus Capital Group Inc. together were involved in 16 private funding deals—up from nine in 2012 and six in 2011, according to CB Insights, a venture-capital tracking firm.

This year, the four firms already have participated in 13 closed deals, putting 2014 on track to be a banner year for participation by mutual funds in startup funding. On Friday, T. Rowe was part of an investor group that finished a deal to pour $450 million into Airbnb, said people familiar with the matter.

Last week, peer-to-peer financing company LendingClub Corp. raised $115 million in equity and debt, the bulk of which came from fund firms including T. Rowe, BlackRock and Wellington Management Co.

Investors put money into venture-capital funds knowing it is a bet that a few untested companies will become big winners, making up for many losers. But mutual funds, the mainstay of the U.S. retirement market with $15 trillion in assets, aren’t typically supposed to swing for the fences. Instead, they put most of their money into established companies with the aim of making steady, not spectacular gains. (…)

But these deals are more opaque than most fund investments: Fund firms aren’t required to immediately disclose such investment decisions to investors, and privately held companies are also more challenging to value, making it more difficult to gauge how a stake is performing. (…)

Hmmm….