NEW$ & VIEW$ (19 JULY 2016)

   Fed Officials Gain Confidence They Can Raise Rates This Year Federal Reserve officials are looking more confidently toward a rate increase before year-end, possibly as early as September, now that financial markets have stabilized after the Brexit vote and the economy shows signs of picking up.

Officials are almost certain to leave rates unchanged when they meet July 26-27, according to their public comments and interviews with officials. But the message in their postmeeting policy statement could be that the economy is on a more solid footing than appeared to be the case when they last gathered in June, setting the stage for raising rates if the data hold up in the months ahead. (…)

U.S. Home Builders Index Dips

The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo eased to 59 in July from an unrevised 60 in June. The NAHB figures are seasonally adjusted. During the last ten years there has been an 72% correlation between the y/y change in the home builders index and the y/y change in housing starts.

The index of present conditions in the housing market fell to 63 from 64 while the index for the next six months declined to 66 from 69. Both readings have been falling since their Q4’15 peaks.

Home builders reported that the traffic index also eased to 45 from 46, and remained below the Q4’15 high.

• The Hamptons Housing Market Has Crashed: Luxury Home Sales Drop By Half As Prices Plunge

China GDP data show services growth flagging

China’s gross domestic product growth may have come in on-target in the second quarter at 6.7 per cent, but its composition deserves a second look now that more detailed figures are out on each sector’s contribution. (…)

Yet services GDP did grow on a quarter-to-quarter basis, rising by 25 per cent from the first quarter in constant-price terms while secondary sector GDP fell by nearly 22 per cent.

The catch is that much of that likely came from state-owned firms at the expense of private-sector expansion, as NBS figures from May show private companies’ fixed-asset investment contracting for a fifth straight month compared to continued investment growth from state-owned firms. (…)

China’s government spending continues to rise in order to cushion the slowdown in the private sector activity. (Via The Daily Shot)

EARNINGS WATCH

• 44 companies (12.3% of the S&P 500’s market cap) have reported. Earnings are beating by 4.6% while revenues are surprising by 0.6%.
• Expectations are for a decline in revenue, earnings, and EPS of -1.3%, -6.2%, and -3.8%.
• EPS is on pace for 0.3% (-0.6% yesterday), assuming the current beat rate for the remainder of the season. This would be +4.5% (+3.8%) excluding Energy and the Big-5 Banks.

CETERIS NON PARIBUS

Fed actions having unintended consequences:

BofA Targets Lower Costs Bank of America said it would deliver another $5 billion in annual cost cuts by 2018 as part of its strategy to deal with persistently low interest rates that are eating away at lenders’ profitability.

(…) Much of the cost-cutting burden is falling on the bank’s staff. Bank of America has shed about 25% of its jobs since Mr. Moynihan became CEO in 2010, with employment falling to about 210,000 from nearly 284,000. The bank slashed about 6,000 jobs over the past 12 months, or 3% of its work force, and in January it let retention packages for some of its longtime Merrill Lynch brokers expire.

“We’re down 2,600 people quarter over quarter,” Mr. Moynihan said. “It’s a constant reduction in personnel through hard work and automation.”

(…) the firm has invested in automated trading platforms that cut down on the need for well-paid traders. Mr. Moynihan said last month that he planned to keep cutting jobs at the trading unit, which already lost 10% of its workforce over the previous year and increased its revenue this quarter by 12%. (…)

More unintended consequences of low interest rates:

One group of electronics suppliers could get squeezed to help pay for the largest proposed technology takeover by market value. Suppliers to EMC Corp. are in the line of fire as Dell Inc. completes its acquisition of the data storage company, the WSJ’s Samuel Goldfarb and Rachael King report. EMC shareholders were to vote today on the $60 billion sale, which comes as Dell seeks to overcome persistent declines in world-wide computer sales by creating a one-stop shop for corporate information technology. Dell is highly aggressive at delaying payments to help finance operations, and the scale of the acquisition presents an inviting target for Dell’s leverage. One expert says companies Increasingly are using their supply chains not just to obtain goods but to “fund the organization and to fund the growth opportunities.” Worries over ongoing payment terms is a common one for suppliers caught up in acquisitions, and the size of the Dell-EMC deal will only make those concerns bigger. (WSJ)

BTW, Dell’s 107 average days in accounts payable in its most recent quarter compare to 87 days three years ago and EMC’s average of 42 days.

And this ballooning problem:

U.S. Pension Funding Levels to Deteriorate, Moody’s Says

U.S. multiemployer pension plans, already short on cash, are likely to see funding levels deteriorate due to aging constituents, low interest rates and a sluggish global equity market, Moody’s Investors Service said in a report on Wednesday.

The credit rating company examined 124 multiemployer pension plans, finding the group was short by $337 billion at the end of 2014. While strong investment returns helped boost plan assets 4.5% to $302 billion in 2014, obligations rose 5% to $639 billion.

Moody’s said the situation may have deteriorated even further last year, as interest rates remained low. Those figures have yet to be released. (…)

More trouble is on the horizon. The Pension Benefit Guaranty Corporation needs $15 billion over the next decade to protect multiemployer pension plans against default, CFO Journal reported in June. The pension insurer projected that its multiemployer pension insurance program will have a deficit of $53.4 billion in today’s dollars by 2025, if it cannot raise the money needed. (…)

• Drop in Rates Swells Pension Burdens in U.S. Companies struggle to close funding gap, avoid big rise in payments to government insurer

(…) Under accounting rules, the declining rates triggered an increase in pension obligations for companies with defined-benefit plans, which offer retirees a set payout.

Now, those companies are pursuing a variety of tactics as they struggle to close the resulting gap in pension funding and to avoid steep increases in premium payments to the nation’s pension insurer.

The combined pension deficit for S&P 1500 companies ballooned to $568 billion at the end of June, a $164 billion increase from the end of 2015, according to Mercer, a benefits consulting firm.

And companies could have large holes to plug by the end of year, when they typically complete their funding calculations.

“It’s brutal,” said Alan Glickstein, senior retirement consultant at Willis Towers Watson.

But the market’s turmoil could help fatten the coffers of the U.S. Pension Benefit Guaranty Corp., which backstops the private-sector pensions that cover about 40 million Americans.

The federal agency collects a fixed fee for each person enrolled in private-sector pension plans and a separate fee, or variable premium, for every dollar that pension plans are in deficit.

So, there could be a fee windfall heading its way in coming months and years as pension deficits balloon.

Those fees were already on the rise. Congress passed increases in the Bipartisan Budget Act of 2015, mandating a 25% increase in the fixed fee between 2016 and 2019 for plans sponsored by single employers. Variable rates will rise roughly 37% over that period.

Last year, the agency received some $4.1 billion in premium revenue from those plans, up 8.5% from 2014, reflecting prior premium increases.

Many consultants and plan managers say the PBGC’s premium revenue, all of which comes out of corporate pockets, will jump again this year.

As they scramble to close their pension funding gaps, some companies are exploiting low interest rates to borrow cheaply in bond markets.

Others could step up plans to transfer pensions off their books entirely by paying insurance companies to take over those obligations, said Caitlin Long, a pension expert.

Newspaper publisher McClatchy Co. said in February it would contribute $47 million of real-estate assets to its pension plan to boost funding and reduce fees.

In February, General Motors Co. sold $2 billion of bonds, and pumped the money into its pension plan. One investment banker at a major bank said he expects similar deals to come to market as the year progresses.

Chemical maker Chemtura Corp. shifted part of its pension plan to an insurer earlier this year, citing rising PBGC fees as a reason.

Pittsburgh-based specialty-material manufacturer Allegheny Technologies Inc. is considering doing the same with some of its pension, said Patrick DeCourcy, the chief financial officer, in an earnings call in April.

The potential pension deal would “help to lower the burden of significantly escalating premium charges from the PBGC,” said Mr. DeCourcy, according to a transcript of the call.

Such deals are expensive, however, and take a lot of time to put together, said Ms. Long.

In the interim, many companies could simply tap bond markets for a loan.

Not only are interest rates low, but interest payments on bonds are tax deductible, and companies don’t have to pay additional fees to the PBGC. “I would think this is an environment that companies would find compelling,” one banker said.

But companies are continuing to offload their pension burdens. Paint manufacturer PPG Corp. decided to transfer some of its pension plan to Massachusetts Mutual Life Insurance and Metropolitan Life Insurance Co. partly to avoid the rise in PBGC premiums, according to finance chief Frank Sklarsky.

Congress approved an increase in PBGC fees as part of an accounting maneuver that allowed it to fund the 2015 federal budget. Any fees that go to the PBGC count as revenue for the federal government, helping to offset total spending.

One PBGC official said the agency would rather see companies fully fund their pensions than pay big fees.

“We prefer if people fund up their plans,” the official said. “It’s in the participants’ interests for the plans to be fully funded.”