Real Estate Major Obstacle as China Engineers Stability for Now
China’s economy showed signs of stabilization in May. A contracting real estate sector and softening global demand mean it may be short lived. Industrial output, the main monthly measure of China’s growth, was up 8.8 percent year on year in May, edging up from 8.7 percent in April and in line with expectations. Fixed asset investment edged down and retail sales strengthened, reflecting higher prices.
Real activity indicators also pointed to stabilization. Output of electricity rose 5.9 percent on the previous year, up from 4.4 percent in April. Early signs in June are
positive, with prices for steel and other industrial commodities paring their falls from a year earlier.The latest monthly indicators suggest growth momentum has been sustained over the course of May. Bloomberg’s monthly Nowcast of GDP continues to register 7.4 percent year-on-year growth, unchanged from April. (…) (BloombergBriefs)
Total electricity consumption rose 5.3% Y/Y in May, after 4.6% in April. First 5 months: +5.2%. All of 2013: +7.3%.
But, just in case, China is making sure …:
China Reserve-Ratio Cut Extended to Merchants, Industrial China’s central bank extended a reserve-requirement cut to some national lenders including China Merchants Bank Co. and Industrial Bank Co. as officials try to support growth without unleashing broader stimulus.
BTW, ISI’s China survey keeps falling…
Outlook Improves for PCs
Last week, chip maker Intel Corp. INTC +6.83%, citing a surprising surge in commercial PC purchases, boosted its financial forecast for the first time in nearly five years. The Silicon Valley giant said revenue in the current quarter would be about $700 million greater than it expected, sending its stock up nearly 7% on Friday.
CENTRAL BANKS WATCH
(…) This seems unlikely, because the US economic recovery is still lagging that in the UK. Nevertheless, the parameters within which investors view forward guidance, including the Fed’s “dots” showing the future path for interest rates, may have been somewhat shaken.
The BoE will no doubt argue that they never gave the markets any cast iron reason to believe that the first rate rise would be delayed far into 2015 or 2016. “When conditions change, I change my mind”, was the gist of what Mr Carney said at the Mansion House. But the central banks do seem to want it both ways: the main point of forward guidance, according to many economists, was to pre-commit to policies that would not change when conditions changed.
Everyone knew all along that forward guidance suffered from a serious problem of time inconsistency. What was convenient for the BoE and the Fed to say when they were at their most dovish in 2012/13 may not be convenient to deliver when the situation has changed in 2015/16. The BoE has now reminded the markets that the fine print in forward guidance needs to be read very carefully indeed.
What are the similarities, and the differences, between the UK and US situations?
(…) In the UK, the BoE has said repeatedly that it expects labour productivity growth to bounce back as the economy recovers, thus allowing the productive capacity of the economy to expand alongside demand. This has not happened so far, and it is one of the key reasons why several members of the MPC are clearly getting jumpy.
In the US, the equivalent issue is the puzzle about labour force participation. Chair Yellen has been very clear that she believes that a significant proportion of the decline in participation will be reversed if the economic expansion is maintained, but recent data have shown no sign whatsoever that this is happening. If not Ms Yellen herself, then several other members of the FOMC are likely to start worrying about this before too long. In fact, James Bullard has already led the way on this.
(…) Even if the controlling members on the FOMC remain inclined towards dovishness, as they almost certainly do, there must be a risk that they will change their minds in response to incoming economic data, in the same way that the BoE has done.
There is no risk premium protecting against this possibility built into the path for US forward short rates. In fact, following the bond rally that has occurred this year, the market seems vulnerable to a sudden re-assessment of the Fed’s basic dovishness, just as it was before the taper tantrum last year.
I do not expect these similarities to become apparent at the FOMC meeting and the press conference this week. The committee is still in the phoney war phase (or perhaps it should be called the phoney peace), in which tapering is continuing along a pre-ordained path, almost regardless of economic events.
That will not change until tapering ends in October. After that, the hawkish surprise administered by the BoE last week might become a great deal more relevant for Fed watchers.
Meanwhile:
(…) What if we were to look not at what Ms Yellen says, but at what Ms Yellen has done? We might then conclude that the Fed’s first rate hikes could indeed happen sooner than expected.
This is the intriguing premise of a tool being used internally at BlackRock, the world’s largest fund manager, which it has nicknamed “the Yellen index”. It is a measure that suggests, on the economic indicators favoured by Ms Yellen, monetary tightening is already overdue and the Fed falls further behind the curve with every passing day. (…)
There is a lot of secret sauce in the Yellen index that BlackRock will not share, but it blends together economic indicators which the Fed chair has referenced as important considerations for policy makers, together with the unemployment and inflation targets already set out by the Fed.
The firm has been tracking whether those indicators are above or below the point at which monetary policy has been tightened in the past. On the premise that the Yellen Fed will behave consistently with the Ben Bernanke Fed, where she was a prominent voice and later vice-chairman, the index has been flashing that policy tightening is imminent since around the turn of the year. (…)
BlackRock’s innovative approach to monitoring and predicting monetary policy does not stop with the Yellen index; it has also created a “Stein index” based on the yields of corporate credit, junk bonds and commercial mortgage-backed securities, markets where Mr Stein has expressed concern.
(…) The Stein index, like the Yellen index, is flashing red for tightening soon. (…)
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Central banks shift into equities Trend ‘could contribute to overheated asset prices’
Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions.
“A cluster of central banking investors has become major players on world equity markets,” says a report to be published this week by the Official Monetary and Financial Institutions Forum (Omfif), a central bank research and advisory group. The trend “could potentially contribute to overheated asset prices”, it warns. (…)
China’s State Administration of Foreign Exchange has become “the world’s largest public sector holder of equities”, according to officials quoted by Omfif. Safe, which manages $3.9tn, is part of the People’s Bank of China. “In a new development, it appears that PBoC itself has been directly buying minority equity stakes in important European companies,” Omfif adds. (…)
In Europe, the Swiss and Danish central banks are among those investing in equities. The Swiss National Bank has an equity quota of about 15 per cent. Omfif quotes Thomas Jordan, SNB’s chairman, as saying: “We are now invested in large, mid- and small-cap stocks in developed markets worldwide.” The Danish central bank’s equity portfolio was worth about $500m at the end of last year. (…)
EARNINGS WATCH
Although the growth rate for the second quarter has dropped since March 31, analysts have cut earnings estimates over the first two and a half months of the quarter by the lowest amount since Q2 2011. The percentage decline in the Q2 bottom-up EPS estimate (which is an aggregation of the earnings estimates for all 500 companies in the index and can be used as a proxy for the earnings for the index) was 1.2% over the first two and a half months of the quarter. This decline in the EPS estimate was lower than the trailing 1-year (-3.1%), 5- year (-2.0%), and 10-year (-3.8%) averages for the first two and a half months of a quarter. In fact, this marked the lowest decline in the bottom-up EPS estimate during the first two and a half months of a quarter since Q2 2011, when the bottom-up EPS estimate actually increased by 1.0%. (Factset)
With only two weeks left to quarter end, so far, so good. No additional pre-announcement last week. Still 75% negative pre-announcements this quarter, the lowest in more than 2 years. Combined with low analysts revisions, it seems that companies feel no need to taper expectations any more.
The First Call earnings revision index has also been rising lately.
Much has been written in the past week on the Q1 decline in corporate profits from current production. Here’s Moody’s take on that:
The likelihood of a further upturn by the rate of industrial capacity utilization weighs against a yearlong contraction by 2014’s core profits. Capacity utilization offers a macro view of operating leverage, where profits tend to move in the direction taken by the capacity utilization rate.
Early June’s consensus calls for an upturn by the annual growth rate of industrial production from 2013’s 2.9% to 3.7% in 2014 and 3.6% in 2015. As inferred from the production projections and assuming annual increases of 2.3% for industrial capacity, the average annual rate of industrial capacity utilization should steadily rise from 2013’s 77.9% to 79.1% in 2014 and 80.1% in 2015.
Ordinarily, profits grow when capacity utilization rates rise. For a sample beginning with Q1-1968 and ending in Q1-2014, the yearly changes of (i) the moving yearlong average of core profits and (ii) the industrial capacity utilization rate moved in the same direction in nearly 79% of the 182 quarterly observations. Thus, Q1-2014’s percentage point yearly rise by the capacity utilization rate and its projected 1.1 point average annual increase over the next seven quarters very much disputes a continuation of Q1-2014’s -3.0% yearly decline by core profits, never mind a deeper decline of -3.5% for yearlong 2014.
SENTIMENT WATCH
In my Monday article (click for link) I highlighted how the market’s advance was strengthening and broadening out as the biggest sectors of the market that had lagged for the greater part of the year were beginning to gather momentum and become short-term leaders. Although this is a constructive development, I warned how the market was getting a little overheated as several of my intermediate-timing gauges had reached frothy levels, implying we either consolidate or experience a small pullback.
This was further confirmed this week as a number of major market indices received a Bloomberg TrendStall “sell signal” (see red triangles) as shown below.
(…) The five investment advisers with the best records over the past decade at calling market turns believe stocks are headed higher. They currently are recommending that 83% of their clients’ U.S. equity portfolios be invested in stocks, with the balance allocated to money-market funds. (By contrast, the average figure was 66% for the market timers among the more than 200 advisers tracked by the Hulbert Financial Digest.)
It’s worth considering their views, since each has exhibited a rare ability to capture rallies and sidestep declines in the portfolios they recommend to clients. (…)
But Mr. Schannep says that anxiety about a correction should not dictate investment decisions. “Far more money has been lost by investors trying to anticipate corrections than has been lost in all the corrections combined,” he says, quoting Peter Lynch, who for two decades through the mid-1990s managed Fidelity Magellan, then the top-performing U.S. stock-mutual fund.
How long will the current bull market last before it eventually succumbs to a correction—or worse? Mr. Schannep says it’s impossible to know. He says that indicators are more important than targets, and for now his indicators continue to point up.
Among the other market timers we track, there is concern about the widespread complacency—if not exuberance—currently prevailing on Wall Street. Mr. Sullivan says that optimism isn’t an automatic kiss of death, and that there have been many times in the past when a strongly bullish consensus turned out to be right.
He believes this will be one of those times, since his technical models—both for the shorter and longer terms—are in a bullish mode.
We chose the past decade as the time period over which to identify the best and worst timers, since it includes not only the strong bull market over the past five years but also the punishing 2007-09 bear market. Regardless, the top performers for any period, from as short as the past 12 months to as long as the past 20 years, are bullish.
What’s more, the 10% of market timers with the worst records—when measured over all time periods from short- to long-term—are quite bearish right now, both in their own right and relative to the top-performing timers. To be out of the stock market right now, you therefore have to bet that those timers who in the past have been most wrong are now uncharacteristically going to get it right.
The implication: Stay invested in stocks. Mr. Sullivan believes that this advice applies even to those who have missed out on the run-up in recent years by being in cash. It isn’t too late, in other words, to invest in this bull market, he says. (…)
(…) With a rather anaemic economy, the central bank is willing to trade higher financial instability down the road for greater economic healing in the present; and it believes (or more accurately hopes) that the recent strengthening in macroprudential regulation will prove sufficient to limit such financial instability should it materialise.
All this suggests that, rather than continuously increasing exposure to ever rising markets, it is time for highly exposed investors to gradually take some chips off the table.
They also need to monitor the liquidity of portfolios carefully, as it makes less and less sense to give up their flexibility to reposition for what is a low reward for assuming large liquidity risks. And, in taking long positions in markets, they should guard against falling hostage to a “relative” valuation mindset that overwhelms any assessments of the overall compensation for risk.
In their efforts to promote growth and jobs, central banks are trading the possibility of immediate economic gains for a growing risk of financial instability later. This does not necessarily mean investors should rush for the exits, immediately and in size. But it does call for the type of incremental prudence that today’s marketplace appears overly hesitant to adopt given the recent evolution of market prices.
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Investors Struggle to Digest Fresh Fears After a turbulent spell last week, investors are as uncertain as they have been in months. Financial advisers and portfolio managers are grappling with a raft of unsettling developments, including a potential oil-price shock driven by unrest in Iraq and an unexpected leadership shake-up in Congress.
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Macro Hedge Funds Throw In The Towel, Boost Their Equity Exposure To Highest In Three Years
(…) And with the 2014 calendar nearly half way done, and the macro hedge fund community not only underperforming the S&P 500 for the 6th year in a row, but generating a negative return YTD, what is a macro hedge fund universe to do? Why lose all pretense of being sophisticated fundamental trend pickers and do what Bernanke and Yellen have been forcing everyone to do from day one: go all in stocks of course! According to JPM as of this moment there is no difference in the positioning of both traditional long/short hedge funds and macro funds, both of which have increased their equity exposure to the highest since May 2011!
From JPM:
Our hedge fund beta monitor shows a proxy for Macro and Equity long/short hedge fund equity exposure. This proxy is constructed by the rolling 21-day beta of macro hedge fund returns with respect to returns on the S&P500 index. Macro hedge funds are a $500bn plus universe and account for around 19% of total hedge fund assets. This beta shows that both macro hedge funds and equity long/short hedge funds have increased their equity exposure recently to the highest since May 2011.
What does this mean? Well, unless corporate buybacks are about to have their greatest quarter in history, virtually all the “macro hedge fund” money on the sidelines, to use the most idiotic phrase in existence, was just allocated to stocks in the past three weeks. Which also means that there is nobody left to buy. However, with the global geopolitical situation getting worse by the day, there may suddenly be quite a few willing to sell.
- Growth is not particularly strong anywhere, but it’s positive everywhere. (ISI)
Meanwhile, some buyers keep seeing value out there…
Priceline Latest in High-Premium Buyers
Priceline Group Inc. has become the latest in a string of companies paying high premiums for acquisitions as the M&A market heats up.
The online travel service agreed to buy restaurant booking service OpenTable Inc. on Friday for $103 a share. That represents a 47% premium to OpenTable’s share price a week earlier.
The premium is higher than the average 34% one-week premium paid by acquirers in deals over $100 million this year, according to Dealogic. That’s up from the 29% average from this point last year. (…)
Priceline’s chief executive Darren Huston said the company’s management spent “a lot of time” evaluating OpenTable and decided the price was worth it.
However, he and finance chief Daniel Finnegan provided few details to analysts in a morning conference call. Mr. Finnegan, for example, said the transaction would be “slightly accretive” this year, but didn’t say by how much.
The $2.6 billion in cash Priceline is paying represents about 51 times forward earnings for the 16-year-old company, which provides online-reservation systems to restaurants.
Let’s hope they have spent enough time evaluating because they are paying $2.6B in cash! Hopefully, the fact that it is “slightly accretive” was not the clincher. Cash earns so little these days that just about any deal using cash is accretive (PCLN is full of cash). The key question to PCLN management is what does the deal do to return on capital.
PCLN sells at 5.5x assets which return 21%. It is buying OPEN at 7.7x assets returning 11%. Better have lots of synergies to offset the dilution…
Chart Of The Day: All The President’s Golf Games
For his defense, George W. was busy reading.