REFLATION
G-20 Ministers Vow to Promote Growth After Brexit Shock Global finance ministers redoubled their commitments to use all available policy tools to boost economic growth, wary that myriad headwinds risk pushing the world economy into a low-growth rut.
Cash-Strapped Governments Enjoy a Windfall in Low Borrowing Costs Plummeting bond yields are enabling some cash-strapped governments to reduce their deficits and potentially ease austerity measures.
(…) Spain is the trend’s latest beneficiary: It sold a three-year bond with a negative yield for the first time. That is a balm as the Spanish government is sparring with the European Union over missing its deficit targets.
Many yields have been pushed into negative territory. Earlier this month, investors paid Germany to borrow their money for 10 years. The Japanese and Swiss governments had already been able to get paid to borrow when issuing 10-year debt.
Société Générale estimates that about 40% of the reduction in budget deficits by eurozone governments between 2012 and 2015 was due to cheaper borrowing costs. (…)
Debate Over U.S. Debt Changes Tone A debate about whether the U.S.’s borrowing capacity has gone up—and how the nation might take advantage of it—has replaced the fights of yesteryear over the urgency of a “grand bargain” to slash the debt.
(…) The top candidates from both major parties have made scant mention of addressing rising long-term deficits and are calling instead for an increase in federal stimulus. (…)
The shift on both sides of the aisle is remarkable because it coincides with what economists consider full employment. (…)
So what accounts for the shifting political dynamic?
First, an expanding economy and the budget agreements of recent years have returned near-term deficits to their long-run averages. Second, health-care cost growth, a major driver of projected deficits, has slowed. Third, markets indicate borrowing costs may be lower for longer than anyone expected just a few years ago amid weaker global growth prospects.
The national debt as a share of gross domestic product has more than doubled since 2007, to around 75%, but net interest payments on the debt have actually declined. They fell to 1.25% of GDP last year, the lowest level since 1968.
Long-term deficits haven’t gone away, of course. The Congressional Budget Office this month said the national debt was on track to exceed the total output of the economy by 2033, six years earlier than last year’s forecast. The change was largely due to last year’s policy changes.
Also, a rising share of federal spending will be on autopilot as more retirees become eligible for Medicare and Social Security, whose spending isn’t appropriated annually by Congress. The current low-rate environment “offers a false sense of security,” said Michael Peterson, president of the Peter G. Peterson Foundation, a group that pushed for deficit reduction.
Still, the shifting political consensus echoes a similar rethink among some economists who say that stronger demand from abroad for U.S. Treasurys could keep interest rates lower for longer.
That would boost the case for tolerating higher debt levels, said economists Doug Elmendorf, who headed the CBO from 2009 until 2015, and Louise Sheiner of the Brookings Institution, in a paper in February. They argued any boost in spending should go toward policies that raise slumping labor productivity to lift economic growth.
When interest rates fall below economic growth rates, governments can borrow while still holding down the debt-to-GDP ratio. Low rates may present the U.S. with such an opportunity.
“Extraordinarily low interest rates makes the economics of public investment profoundly different than it appeared a decade ago,” said Larry Summers, an economist at Harvard University and former U.S. Treasury secretary.
Mr. Summers has warned of “secular stagnation,” a chronic deficiency of investment that leaves the world stuck in a low-growth rut. But even if he’s wrong, aging workforces in Europe and Japan and other global developments that boost foreign demand for Treasurys mean the U.S. could remain “in a low-interest-rate, high-saving, challenge-of-absorbing-savings world for at least years to come,” he said.
None of this means the U.S. will escape long-run, demographic-driven spending challenges. But it could buy the next president a little more breathing room. (…)
As China Lets Yuan Depreciate, Other Nations Take Note Beijing has managed to let the yuan slide against the U.S. dollar without sparking strong protests from its trading partners this year, but the Chinese currency’s bigger depreciation against a broader group of currencies is increasingly getting attention.
(…) Speaking to reporters on Saturday, Japanese Finance Minister Taro Aso said he had told the G-20 gathering to pay attention to the future direction of the yuan as well as the overall Chinese economy. Other Western officials said privately that they had cautioned China not to weaken the yuan broadly. (…)
At Sunday’s conclusion of the G-20 meeting, which was chaired by China, the group reaffirmed its pledge not to engage in beggar-thy-neighbor devaluations. In a statement, PBOC Gov. Zhou Xiaochuan said the yuan’s exchange rate against the currency basket is being kept “basically stable,” which he said has further strengthened “the market confidence” in the Chinese currency.
Meanwhile, a senior U.S. Treasury official noted that Beijing has intervened recently to prevent the yuan from falling further, actions the U.S. welcomes, describing them as not the kind of intervention “that we would see as being designed to gain an unfair advantage.”
But that isn’t to say Washington is done pushing Beijing to continue its exchange-rate reform. “The fact that they don’t have full transparency on their intervention makes it challenging to have 100% confidence,” the official said.
China enforces ban on original news reporting Clearest signal yet that President Xi Jinping is aiming at complete control of the media
China’s internet regulator has put a halt to original reporting by some of the country’s biggest online news portals, the latest step in President Xi Jinping’s bid to curb the nation’s media.
The move, which may force Sina and other internet companies to abandon their newsgathering operations, is the clearest signal yet that in Mr Xi’s China the state aims to have complete control over dissemination of news — just as it did under Mao Zedong in the founding days of the People’s Republic. (…)
While it has been illegal to hire reporters or publish content from autonomous sources as news since 2005, the rule has seldom been enforced. (…)
EARNINGS WATCH
Factset’s summary:
With 25% of the companies in the S&P 500 reporting actual results for Q2 to date, more companies are reporting actual EPS (68%) and actual sales (58%) above estimates compared to the 5-year averages. In aggregate, companies are reporting earnings that 6.7% above the estimates. This percentage is well above the 5-year average (+4.2%).
The blended (combines actual results for companies that have reported and estimated results for companies yet to report), year-over-year earnings decline for Q2 2016 is -3.7%, which is much smaller than the expected earnings decline of -5.5% at the end of the quarter (June 30). Five sectors are reporting or are expected to report year-over-year earnings growth, led by the Consumer Discretionary and Telecom Services sectors. Five sectors are reporting a year-over-year decline in earnings, led by the Energy and Materials sectors.
If the Energy sector is excluded, the blended earnings growth rate for the S&P 500 would improve to 0.0% from -3.7%.
The blended, year-over-year sales decline for Q2 2016 is -0.3%, which is smaller than the estimated sales decline of -0.8% at the end of the quarter (June 30). Six sectors are reporting or are projected to report year-over-year growth in revenues, led by the Telecom Services and Health Care sectors. Four sectors are reporting a year-over-year decline in revenues, led by the Energy and Materials sectors.
If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would improve to 2.6% from -0.3%.
At this point in time, 19 companies in the index have issued EPS guidance for Q3 2016. Of these 19 companies, 14 have issued negative EPS guidance and 5 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 74% (14 out of 19), which is equal to the 5-year average of 74%.
Industrial companies, in particular, have been scaling back their expectations, said John Butters, senior earnings analyst at Factset.
This past week marked a change in the aggregate expectations of analysts from slight growth in year-over-year earnings (0.3%) for Q3 2016 to a slight decline in year-over-year earnings for Q3 2016 (-0.1%). However, expectations for earnings growth for Q3 2016 have been falling not just over the past few weeks, but over
the past few months as well. On March 31, the estimated earnings growth rate for Q3 2016 was 3.3%. By June 30, the estimated growth rate had declined to 0.6%. Today, it stands at -0.1%.Eight sectors have lower expected earnings growth rates today compared to March 31 (due to downward revisions to earnings estimates), led by the Industrials sector. On March 31, the estimated earnings growth rate for the Industrials sector for Q3 2016 was 4.3%. Today, the estimated earnings decline is -5.2%.
US groups hoard cash as uncertainty grows Survey data could be harbinger of pullback in business investment
American companies are increasing their holdings of cash in response to a rise in economic and geopolitical uncertainty, according to a survey of corporate treasurers.
The data, which could be a harbinger of a pullback in business investment, come alongside cautious comments from US companies on the outlook for the third quarter. With the reporting season in full swing, Wall Street analysts no longer expect a rise in earnings.
The latest survey by the Association for Financial Professionals shows companies are taking their most cautious approach to cash management since mid-2011, when markets were roiled by the eurozone debt crisis and a showdown over the US debt ceiling. (…)
The survey, to be published on Monday, shows companies accumulated cash balances at a far quicker pace in the second quarter than in the first, and expect to do so at a still faster pace in the current quarter. An index of expectations for the current quarter jumped to plus-16 from plus-7 three months ago. The number represents the difference between the percentage of treasurers expecting to increase cash holdings and those who are expecting to decrease them. (…)
SENTIMENT WATCH
Mohamed El-Erian: Calm markets raise big risks for complacent investors
(…) The October referendum in Italy could complicate European politics already challenged by the legacy of the financial crisis, migration challenges and Brexit.
The US faces its own unusual election in November, with both presidential candidates navigating the pull of anti-establishment movements that oppose globalisation, trade agreements and elements of free markets. China’s ongoing political changes coincide with its leaders having to manage a tricky middle income development transition rendered more difficult by international economic headwinds and domestic financial bubbles.
Meanwhile, unease about policy effectiveness grows in a world that has been over-reliant on central banks and that will likely see three of these systemically important institutions (the Bank of Japan, the European Central Bank and the People’s Bank of China) pulled even-deeper into the uncharted waters of monetary policy experimentation.
Despite all this, measures of market sentiment have been remarkably calm. Just look at the VIX, the so-called “fear index” that captures the extent to which investors are unsettled by internal and external uncertainties. Spikes have been infrequent and quickly reversed. Indeed, rather than move up in a sustained manner to reflect the multi-faceted “unusual uncertainties”, its most distinguishing feature is that of overall stability at subdued levels.
There are good reasons for this. Liquidity injections — both actual and expected — remain ample on account of central bank stimulus and corporate cash being recycled back into markets via share buybacks, mergers and acquisitions. Investors have been conditioned by years in which “buy on dips” approaches have repeatedly proven profitable, especially in markets recently achieving new highs.
Few investors have rushed to reflect the reality of elevated prices and unstable asset class correlations back into their strategic asset allocation, particularly given unchanged investment objectives.
Lacking attractive alternatives, and with limits on how much cash traditional investment managers can hold, equities continue to attract a disproportionately large allocation.
It is understandable for markets to trade on the current reality of cash flow and put aside, at least for now, the possible consequences of the ever growing gap between investor behaviour and a growing list of unusual economic and political uncertainties. In the process, however, a cocktail is brewing that risks future financial volatility and jump conditions in various market segments.
Faced with this, investors would be well advised to reflect on the longer-term consequences of the significant divergence between liquidity-induced stability in markets and longer-term fundamentals in disequilibrium.
In addition to lowering the expected return from their strategic asset allocation and increasing the expected volatility of the return profile, investors should look at more of a bar-belled approach that combines higher cash allocations with greater exposure to alternatives; become more tactical; and, using scenario analyses, prepare stakeholders for unsettling volatility down the road.
The biggest mistake for investors — and it is an easy one to make — is to believe that this period of artificial market calm is destined, in itself, to lift the fundamentals that ultimately determine asset value. The opposite is, unfortunately, more likely.
Gavyn Davies: Regime change in the financial markets.
(…) The key question for investors in the forthcoming period is whether the deflation/monetary divergence duopoly is still dominating markets, or whether this regime is now ending. There are definitely some signs that things are beginning to change, though it is far too early to be confident about this. In recent weeks, global equities have recovered, especially in the US, where the S&P 500 index has reached new all time highs.
Three factors are leading to talk of global reflation among investors. These are:
- A distinct improvement in global activity data, with both the US and China having recovered from earlier weakness, and recessions abating in Brazil and Russia. According to Fulcrum’s nowcast models, global activity growth is now running at 3.5-4.0 per cent, compared to a low point of 2.0-2.5 per cent in February. There are, however, recession risks in the UK and Japan.
- A likely rise in global inflation rates from now on, as the impact of lower commodity prices on year-on-year inflation measures starts to disappear. Inflation in the developed economies should rise from 0.6 per cent now to almost 2 per cent by mid 2017.
- The end of global fiscal austerity, with a rising likelihood of fiscal easing in many economies, led by Japan. It seems that markets are shifting their focus from the central banks to the fiscal authorities in assessing the scope for policy easing, though this story is only in its infancy.
It is always difficult to identify major regime changes in the financial markets, but it is possible that the secular stagnation theme may now be abating, at least for a while.
Beyond the words, the facts are that equities are close to the twilight zone where downside risk gets substantially greater than upside, the latter being essentially driven by sentiment from now on.
