Euro-Zone Fault Lines Re-Emerge
The troubles at Banco Espírito Santo BES.LB -17.24% have hit Portuguese assets hard. The Lisbon stock market has fallen over 10% in July, and Portugal’s 10-year bond yields have risen to 3.91% from June’s low of 3.35%. But the pain hasn’t been limited to Portugal: Spain, Italy, Greece and even Ireland have seen their bonds and stock markets come under pressure, too.
That highlights two problems at the heart of the euro-zone crisis: one a cause and the other a consequence.
Regarding the cause, the fates of financial institutions and their sovereigns remain closely intertwined. The scale of the problem at Espírito Santo is unclear. And it is emerging at a time when Europe’s banking union is a work in progress. A pan-European regulatory framework is still being established, while a supranational deposit-insurance fund, akin to that in place in the U.S., is a way off.
Given this, Portuguese bonds are likely to remain volatile. But the country does still have €6.4 billion ($8.7 billion) earmarked for bank recapitalizations left from its bailout package.
As for the consequence, it is clear that investors still draw a dividing line between government bonds from crisis-hit countries, mostly in Southern Europe, and those from stronger countries in Northern Europe. The latter still behave like traditional government bonds, acting as a haven for investors in troubled times. Hence, Germany’s 10-year bond has rallied to yield just 1.18%, a whisker above the crisis low. Bonds from France, the Netherlands, Austria, Finland and Belgium have also gained.
But for Ireland, Spain, Italy, Greece and Portugal, it is a different story. Greece and Portugal, which are still rated firmly in the junk category, are clearly being evaluated on the basis of their higher credit risk. Ireland, Spain and Italy, however, are in a no-man’s-land from an investor perspective, their bonds sometimes behaving like haven government debt and sometimes like riskier corporate debt.
Take Spain: A year ago, its 10-year bonds offered a yield of 4.8% and a spread of over three percentage points over German bunds. That lured in funds seeking capital gains and relatively high yields. But by the start of July, the yield had fallen to 2.65% and the spread narrowed to 1.4 points. Yields are no longer high enough nor spreads wide enough to draw bargain hunters who are willing to take risk. But when trouble hits, the risks are too high to attract traditional government-bond buyers.
If Portugal can sort out the Espírito Santo mess, then Europe’s divisions could fade again. This may turn out to be a buying opportunity. But this is already the second bout of volatility to test nerves in the past two months, and the euro-zone growth outlook has darkened. Another reminder of Europe’s fragility is reason to stay cautious for now.
German Inflation Rises
In harmonized European terms, prices increased by 0.4% on the month in June and were up 1.0% on the year. This followed a rise of only 0.6% on the year in May.
In national terms, the statistics office said that prices increased by 0.3% on the month in June and grew by 1.0% on the year. Energy prices were down by 0.3% on an annual basis, while the index excluding energy prices grew by 1.2% on the year.
Europe risks ‘significant’ gas shortages
(…) Christophe de Margerie, chief executive of Total, the French oil major, told the Financial Times that Europe could struggle to find alternative sources of supply, even without Moscow retaliating against western sanctions by cutting energy supplies.
“Not only Total but the industry is saying: be careful. It has nothing to do with an embargo. But if for technical reasons, if for sabotage reasons there is a shortage, yes, we will have difficulties in providing gas from other sources,” he said. (…)
Still, Europe is in a stronger position now than in 2009. Five years ago, 80 per cent of Russian gas was piped across Ukraine, whereas now less than 50 per cent takes that route, thanks to the Nord Stream pipeline under the Baltic sea.
Central European nations have also greatly improved their storage facilities and emergency planning since 2009. Crucially, they have built more cross-border interconnector pipelines running between each other, north-to-south, to break dependence on Russian pipelines running from east-to-west.
Jonathan Stern, chairman of the Oxford Institute of Energy Studies, said that Europe had also taken steps in recent months to protect itself from any repercussions in the current crisis. Gas storage “is at a record high for this time of year,” he said. (…)
Slowing Store Traffic Worries U.S. Retailers American retailers may have more than a weather problem. For many stores, customer traffic has slowed and sales weakened in the spring, when warmer temperatures had been expected to help business.
Family Dollar Stores Inc. FDO -0.19% said fewer shoppers came into its stores in the three months through May 31, pushing sales down 1.8%, excluding newly opened or closed stores. (…)
“We’ve come to realize it’s more than just weather,” Container Store CEO Kip Tindell said. Falling traffic led to the first drop in quarterly sales at the company in more than three years. (…)
Kroger’s shoppers are “exhibiting less cautious spending behavior,” CEO Rodney McMullen told investors in June. “More customers perceive the economy to be in recovery” and are shelling out for things like premium pet food and organic products.
Uneven results but here are the facts through July 5″:
Indirect tax breaks, this time helping the 99%:
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Energy Prices Tumble Energy prices are tumbling, with natural-gas prices hitting a six-month low, in a setback for investors who were betting that supply shortfalls would drive markets higher.
Natural-gas futures hit a six-month low on Thursday. U.S. oil futures ended slightly higher, snapping a nine-session losing streak, the longest since December 2009.
It is a sharp turnaround for both markets, where investors until recently were overwhelmingly bullish, and a welcome relief for consumers, who had watched gasoline climb steadily for much of this year.
A frigid winter had depleted natural-gas inventories, raising questions about whether producers could replace those stockpiles before temperatures drop again. Escalating violence in Iraq had some money managers worried that fighting would disrupt the country’s oil exports.
The steady rise of North American oil-and-gas production has diminished those threats, calming energy markets to a degree that investors and analysts say would have been hard to imagine even five years ago. U.S. gas producers are refilling storage at a record pace, including a bigger-than-expected increase to inventories in government data released Thursday. Iraqi oil shipments have continued unimpeded.
Falling oil prices should help keep a lid on gasoline prices in coming weeks, while the declines in natural gas could mean lower heating bills this winter, a boon to U.S. consumers who still are struggling with sluggish wage growth.
A gallon of regular gasoline cost an average of $3.64 on Thursday, up from $3.50 a year ago but down from $3.67 in early July, the second-highest level ever for Independence Day weekend, according to AAA. (…)
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Corn price wilts on bumper crop forecast Grain below $4 per bushel on prospect of 1bn-tonne harvest
The prospect of a colossal 1bn-tonne global corn crop has sent the price of the grain below $4 per bushel for the first time in almost four years.
Reports of near-perfect conditions in the US corn belt and favourable weather from Ukraine to China have pounded bulls in agricultural markets in recent weeks. Farmers’ incomes, tractor sales and land prices could be hit. (…)
Falling corn and soyabean prices will be a main factor in driving down farm incomes to the lowest levels since at least 2005, Gary Schnitkey of the University of Illinois has estimated.
Cheaper corn may also spell the end of a boom in US farmland. Agricultural land values in the central US corn belt are up a modest 1 per cent annually, compared with double digit rises in recent years.
Bankers surveyed by the Federal Reserve Bank of Chicago expressed a “growing sentiment among them that agricultural land values would be headed downward”, the reserve bank said.
Grain shipper Keith Brandt in North Dakota is worried he’s about to run out of storage space just as rains in the U.S. improve the outlook for a soybean crop that’s already forecast to reach a record.
Rail delays of more than three months mean he’s still struggling to haul supplies from last season, while farmers across the nation have almost finished planting what the government estimates is an all-time high of 84.8 million acres. The supply boom sent prices to the longest slump in more than three decades and means that Brandt, the general manager of Plains Grain & Agronomy LLC in Enderlin, North Dakota, is facing the worst storage squeeze he’s seen in the 16 years he’s worked for the company. (…)
Futures in Chicago dropped for nine straight sessions through yesterday, the longest streak since 1981, and Goldman Sachs Group Inc. is predicting that prices will fall further. Climbing U.S. supplies will send global inventories to a record, according to a Bloomberg News survey.
Rising supplies will cut feed costs for producers of poultry, hogs and cattle, making it easier to increase meat production after wholesale-beef and pork prices reached records this month. (…)
A record payout to New Zealand dairy farmers last year is setting the stage for a global milk glut that Goldman Sachs Group Inc. predicts will last half a decade.
The world’s top exporter will expand production to an all-time high, the government predicts, after a 2013 surge in prices led to investment in more cows and nutritional supplements that boost milk flow, just as pastures recovered from a drought. Annual global dairy output will exceed demand by 2 billion liters through 2018, Goldman said in a report last month. That’s enough to fill 800 Olympic-size swimming pools.
A rebound in New Zealand supply is adding to gains in Europe and the U.S., overwhelming demand growth in China that helped send global dairy prices tracked by the United Nations to a record in February. Surpluses may further erode Chicago futures that have slumped 12 percent from a peak in April, cutting costs for buyers including Dallas-based Dean Foods Co. (…)
Class III milk, used to make cheese, closed yesterday at $21.39 per 100 pounds on the Chicago Mercantile Exchange, down from a record $24.32 on April 24. Prices may drop to $19.91 by December, according to broker INTL FCStone Inc. CME futures already anticipate a drop, with the contract for January delivery trading at $18.54. (…)
World food prices tracked by the UN’s Food & Agriculture Organization in Rome fell 1.8 percent in June, a third straight decline and 14 percent below the record set in February 2011. The gauge of dairy prices fell for a fourth straight month to the lowest since March 2013.
RAIL FREIGHT VERY STRONG
The Association of American Railroads (AAR) reported increased U.S. rail traffic for the week ending July 5, 2014 with 270,731 total carloads, up 9.4 percent compared with the same week last year. Total U.S. weekly intermodal volume was 227,097 units, up 10.5 percent compared with the same week last year. Total combined U.S. weekly rail traffic was 497,828 carloads and intermodal units, up 9.9 percent compared with the same week last year.
All 10 of the carload commodity groups posted increases compared with the same week in 2013, including motor vehicles and parts with 14,608 carloads, up 53.7 percent; grain with 18,121 carloads, up 21.7 percent; and metallic ores and metals with 26,749 carloads, up 14.5 percent.
For the first 27 weeks of 2014, U.S. railroads reported cumulative volume of 7,719,025 carloads, up 3.4 percent compared with the same point last year, and 6,869,537 intermodal units, up 6.1 percent from last year. Total combined U.S. traffic for the first 27 weeks of 2014 was 14,588,562 carloads and intermodal units, up 4.6 percent from last year.
Excluding coal and grain, carloads were up 13.6% Y/Y last week. (Chart via Business Insider)
Did China Just Crush The US Housing Market?
(…) Chinese oligarchs, scrambling to launder their “hot” domestic money abroad (as we predicted first two years ago) and now that Switzerland is no longer a safe offshore venue where one can park cash, they picked US luxury housing as the best money laundering alternative.
This means that far from indicating a recovery, as the recent surge in the high end of the US housing segment had long been touted, all the relentless move higher in ultraluxury properties prices was simply a recycling of China’s hot money, which unlike in the US, never made its way into the Chinese stock market (explaining why the Shanghai Composite has barely budged in years) and merely ended up in US real estate. If anything, this is simply another confirmation of the epic capital misallocation, and the complete lack of “trickle down” resulting from failed global central banking policies. (…)
The only net buyer of US stocks left…
Buybacks have continued, although as BofA Merrill notes, they’re off the highs we saw at the end of last year, beginning of this year. Merrill Lynch’s Equity and Quant Strategy team, led by Savita Subramanian, takes a look at the trends within their own customers’ accounts to get a sense of who’s buying and selling what.
On a rolling four-week average, everyone is selling stocks – hedge funds, private clients (high net worth) and institutions. This as equities have been making new all-time record highs. Except corporations, who continue to put stock away and shrink their floats – just as the Fed has incentivized them to do for years now.
The strategist notes that both institutions and private clients are actually slowing their net sales right now.
Glass half-full or half-empty?
First, where’s the market top euphoria? Remember Bob Farrell’s rules #5 and #9:
- 5. The public buys the most at the top and the least at the bottom
- 9. When all the experts and forecasts agree — something else is going to happen
Second, hedge funds have missed the recent rally being essentially neutral all along according to ISI’s surveys. Institutional equity managers have been raising cash since 2011, heavily diluting the S&P 500 Index advance from 1300! They are still high in cash. Their level of bullishness has been rising lately but they have yet to act on it…As to BoAML private clients, the chart above shows them as continuous net sellers. They must be near zero in equities by now! 
Let’s see how earnings performed in Q2.
Carl Icahn says ‘time to be cautious’ on U.S. stocks – Billionaire activist investor Carl Icahn said on Thursday that it is time for U.S. stock market investors to tread carefully after the run-up on Wall Street.
More High-Yield Downgrades than Upgrades Signals Wider Spreads
Moody’s illustrates the impact of easy money and low rates on risk taking:
The second quarter of 2014 extended a trend of more US high-yield downgrades than upgrades. Specifically, Q2-2014’s 84 high-yield downgrades exceeded the 66 high-yield upgrades.
The moving yearlong sum of net high-yield downgrades, or downgrades less upgrades, has topped the break-even mark of zero in each quarter beginning with 2012’s first quarter. Moreover, the net high-yield downgrades of the year-ended June 2014 approximated 3.2% of the number of US high-yield companies, which was a bit under the 3.3% of the year-ended June 2013. Though this metric still compares favorably with the 4.2% of the year-ended June 2007, the recent high-yield bond spread of 330 bp seems untenably thin, if high-yield downgrades continue to well outnumber upgrades.
The record indicates that unless net high-yield downgrades decline, the odds favor a widening by the high-yield bond spread during the next 12 months. For a sample that begins with 1987’s final quarter, the high-yield bond spread narrows year-to-year in 86% of the 42 quarters showing a yearly decline by net downgrades as a percent of the number of US high-yield issuers. On the other hand, the high-yield bond spread widens from a year earlier in 75% of the 65 quarters where the net high-yield downgrade ratio rises year-to-year.
Though the current trend of more high-yield downgrades than upgrades has yet to warn of a disruptive climb by the high-yield default rate, the unfavorable imbalance of credit rating revisions suggests that high-yield credit quality has not improved by enough to justify a narrowing by the high-yield bond spread to a recent 332 bp.
Ultra-Thin Spreads Fuel Upturn by Special Event Downgrades
Special-event downgrades stemming from mergers, acquisitions, divestitures, dividends and equity buybacks have been on the rise. Companies have been more willing to incur special-event downgrades because relatively low benchmark Treasury yields and exceptionally thin credit spreads have diminished the immediate cost of a credit rating downgrade.The now atypically narrow spreads of Caa-rated bonds offer an extreme example of this phenomenon. In terms of median yield spreads, June’s 483 bp Caa spread over Treasuries was only 115 bp above the overall high-yield spread of 368 bp. In stark contrast, the medians of the two previous business cycle upturns showed a much wider 832 bp Caa spread that was 436 bp above the overall high-yield spread.
Hmmm…Now, please go back to the top and read the first item, understanding that the fault lines are the Fed’s and the ECB’s making. Espirito Santo is one of these “special events” Moody’s is talking about although at the sovereign end. This can be a much bitter end…And there are likely more than one Espirito Santo around…trying to remain invisible…
Careful out there!