NEW$ & VIEW$ (7 DECEMBER 2015): Oil? Earnings? Sentiment? Junk?

U.S. Employers Added 211,000 Jobs in November

• Payroll employment rose +211,000 in November and the two prior months were revised up some +35,000.   Aggregate hours worked edged down -0.1%, but for the last three months, it has surged at a 7.6% annual rate.
• The diffusion index climbed to 60.5%.
• Construction sector employment surged +46,000 and manufacturing employment slipped -1,000.  
• Private service employment rose +163000 in November.   
• Government employment posted +14,000. Federal employment was up +6,000. Government employment is no longer a large drag on overall employment.
• Average hourly earnings  rose +0.2% gain in November, +2.3% YoY. Last 3 months: +2.8% a.r.
• Household employment rose +244,000 after surging +320,000 in the prior month. The participation rate edged up to 62.5%. 

Two charts from the WSJ:

U.S. Trade Gap Widened 3.4% in October The U.S. trade deficit widened in October as exports resumed a steady decline, the latest sign a slumping global economy is draining foreigners’ appetite for American-made goods.

Exports fell 1.4% to a three-year low. Imports declined 0.6%. (…) Exports are down 4.3% this year compared with the first 10 months of 2014. (…)

Friday’s report showed exports fell due to a decline in industrial supplies—a category that includes oil—and capital goods, such as industrial engines. Imports, meantime, fell because of lower oil and food imports.

Exports to China were down 9.9% YoY while imports from China were down 1.7%. Exports to the EU were up 2.4% YoY while imports from the EU rose 3.3%.

• Strong Dollar Shreds Wheat Exports The strong dollar is stifling U.S. agricultural exports, worsening the strain on farmers already dealing with a collapse in prices and weaker demand.

REAL TIME ECONOMY

The Association of American Railroads publishes its Rail Time Indicators about one week after the end of the month with timely industry data that are never revised:

Total carloads were down 10.4% YoY in November, the biggest monthly decline since October 2009. In fact, rail carloads have not been this low since 2008.

It’s not just energy- and steel-related products that are seeing lower rail carloads, though. Paper, lumber, farm products excluding grain, grain mill products — the variety of commodities with carload declines in November (and recent prior months too, for that matter) makes one wonder if the economy might be less robust than most economists currently think it is.

Actually, this next chart gives one the impression that this is China. Remember that Services dominate the U.S. economy as the chart on the right illustrates (NMI = Non-Manufacturing PMI):

  

Intermodal traffic gives a better indication of final demand at the consumer level. Intermodal originations declined 1.0% YoY in November following –1.4% in October. This reflects the inventory correction underway across the economy given that most years, November is in the top half of months in terms of intermodal volume, but this year it is the third lowest.

The only clearly strong segment is Motor Vehicles and Parts:

If rail traffic were a Christmas tree, autos and auto parts would be the prettiest ornament on it right now. Combined U.S. and Canadian carloads were 7.1% higher in November 2015 than in November 2014, their fourth straight monthly increase and eighth in the past nine months.

Actually, carloads of autos and parts, which rose 2.5% in Q3, are accelerating sharply in Q4 with growth of 6.1% in October and 7.1% in November.

UAW Wins Vote at VW Chattanooga Plant

The United Auto Workers union won its first organizing vote at a foreign-owned auto assembly plant in the U.S. South on Friday, in a ground breaking victory after decades of failed attempts.

About 71 percent of skilled trades workers who cast ballots at Volkswagen AG’s (VOWG_p.DE) factory in Chattanooga, Tennessee voted to join the UAW, according to the company and the union.

The skilled trades workers account for about 11 percent of the 1,450 hourly employees at the plant.

If the UAW victory, as expected, survives an appeal by Volkswagen to the National Labor Relations Board, the 164 skilled trades workers will be the first foreign-owned auto assembly plant workers to gain collective bargaining rights in the southern United States.

While the unit of skilled trades workers who maintain the assembly machinery are a fraction of the hourly work force, observers said the victory was significant and could serve as a launching pad for the union’s efforts to organize other foreign-owned plants in the south. (…)

Casteel, and Chattanooga UAW Local 42 President Mike Cantrell, in a separate interview on Thursday, said the election was a result of the “frustration” of skilled trades workers not having collective bargaining rights for wages and benefits. (…) 

CHINA ECONOMY SUBDUED IN NOVEMBER

From CEBM Research surveys: housing and autos look up but rest remains weak:

This month’s survey results display that aggregate demand remained weak in November. In upstream sectors, a continued fall in steel prices placed further operating strain on producers, while adverse weather conditions weakened demand for cement during the month. Container freight shipment volumes failed to meet optimistic expectations set at the start of November. Most respondents had anticipated a rise in volumes tied to Christmas orders, but according to respondent feedback shipment volumes were flat on a monthly basis and fell yea-rover-year.

In this month’s property developer survey, respondents reported a healthy volume of sales activity during what is normally a month of seasonally sluggish sales. Speaking with developer and real estate agent respondents, the consensus forecast is that December sales volume will match November sales helped along by sales promotions and further sector policy easing.

For a second consecutive month, auto sales performance was the highlight of our monthly survey. In October, sales surged in response to the government’s decision to halve the purchase tax on small automobiles. Based on this month’s survey respondent feedback, the sales environment in November improved further from October due to the purchase tax cut as well as seasonal factors. A majority of respondents have further upgraded their 4Q15 sales forecasts from last month and have upgraded their full year 2016 forecasts.

CEBM’s banking survey showed very few signs of an improvement in the real economy. Based on survey feedback, the scale of loan issuance in November changed very little from the previous month. On the demand side, reduced profitability has lowered enterprises’ willingness to borrow to invest. On the supply side, a negative outlook for GDP growth and a month-over-month rise in overdue loans in November resulted in banks adopting an even more cautious lending stance than in the month prior.

Looking forward to December, the CEBM Composite Sales Expectations Index fell from 0% in November to -9.5% in December. The change in this month’s reading largely reflects a further deterioration in sales expectations for industrial-manufacturing areas of the economy.

• Iron Ore Plummets Below $40 a Ton as Global Glut Hurts Outlook

OIL

Divided OPEC Set to Keep Pumping OPEC ended a contentious meeting without any production cuts, leaving members to continue pumping crude at near-record levels.

(…) Members demanding output cuts, such as Iran and Venezuela, were unwilling or unable to offer production cuts themselves. Those most able to cut, Saudi Arabia and its neighboring Persian Gulf states, refused unless all members participate along with some producers from outside the organization. (…)

The 30 million-barrel figure wasn’t mentioned in OPEC’s news release after the meeting, an unusual omission. Asked about the ceiling at the news conference, Mr. Kachikwu and OPEC Secretary General Abdalla Salem el-Badri emphasized that the group would continue at the “current production level.” Leaving the meeting, one minister, Iran’s Bijan Zanganeh, said, “We have no ceiling now.”  (…)

One explained that they “did not consider it necessary to put numbers in the communiqué.” (…)

(…) the group has been discussing production cuts with non-OPEC producers but those discussions were inconclusive so far. (…)

“There is nothing at the moment that could be done from OPEC to correct the situation,” said an OPEC delegate from a Persian Gulf Country. “Shale is the new reality.” (…)

None of the member countries can balance their budgets at current oil prices, and many of them need prices double what they are now to ease growing fiscal strains. (…)

“OPEC is not a cartel,” the Saudi oil minister Ali al-Naimi said Friday before the gathering.

He really meant “is no longer a cartel”. In fact, what’s the point of an OPEC now?

• OPEC and the Oil Price: Who’s in Charge Now?

(…) the reality is that OPEC has gone from being fearsome to marginal to ineffectual. The keys to forecasting the price of oil today are on North Dakota’s plains, Iranian negotiating tables and Chinese factories, not in Viennese hotel suites. Without a member like Saudi Arabia with lots of spare capacity and the willingness to take some economic pain for the team, OPEC is toothless.

Readers know that one of the best indicators for U.S. shale oil production is carloads of petroleum and petroleum products provided by the AAR. Carloads dropped 14.4% in Q3 after –2.5% in Q2. They are declining even faster in Q4 with October down 18.5% and November down 20.1% YoY. These are big declines! Carloads are now lower than their lowest level of 2013.

The EIA tables show that the major tight oil plays in the U.S. produced 4.37 million b/d in October, down 3.3% YoY. These estimates have, so far, proven very conservative and they seem to be so again…

Meanwhile, the many forces at work:

• State funds pull $19bn from asset managers Oil-dependent economies forced to repatriate cash

• OPEC Unshackled From Quota Could Add Millions of Barrels in 2016

• SocGen Says Buy Oil Now as OPEC Must Cut Output to Stop Bleeding

  Brent crude will climb to $60 a barrel at the end of 2016 as production cuts by the Organization of Petroleum Exporting Countries will help balance supply and demand, the bank’s head of global asset allocation Alain Bokobza said on Monday. (…)

  “Saudi Arabia must gather OPEC members to stop producing that much — all the Gulf countries are just bleeding,” Bokobza told reporters in Singapore. “We’ll wake up one morning and OPEC members will say we’ll cut production. How much is the price rise on that announcement you think — $5, $10? We’re super bullish on the oil price.” (…)

• Saudi-Iran rivalry sets scene for OPEC showdown over output

It used to be said of OPEC that it was like a teabag – it only worked in hot water. If that is so, conditions on world oil markets could hardly be more difficult as prices languish at almost seven-year lows near $40 a barrel.

Yet, rather than closing ranks, OPEC is finding that an intensifying battle for market share, worsened by deep regional differences between Saudi Arabia and Iran, is driving it further apart. (…)

Halfway through last Friday’s six-hour meeting, an unexpected dispute erupted over the defining feature of the cartel. In a move sources say was masterminded by Saudi Arabia, ministers finally agreed for the first time in decades to drop any reference to the 13-member group’s output ceiling.

The pivot, which surprised not only markets but also some OPEC officials, appeared to be a direct response to Saudi Arabia’s arch-rival Iran, which has made clear it intends to make a rapid return to global oil markets next year as nuclear-related sanctions are lifted.

With Tehran looking to pump as much as 1 million barrels per day (bpd) more crude into a market already saturated with excess supply, an increase of about 1 percent in world supply, maintaining or legitimizing any pretence of OPEC limits – no matter how notional – was not an option for Riyadh.

“The ceiling issue was very controversial and they could not decide on it,” said an OPEC source briefed on the discussion inside the room. “Nobody was happy.”

Earlier, another source said there was a “huge disagreement among members, even bigger now, as oversupply is no longer mainly coming from Gulf delegates, but from Iran.”

In the near-term, the outcome of Friday’s meeting probably makes little difference in global markets. Ever since last year, most members have been pumping flat-out to defend their market from fast-growing upstart rivals like U.S. shale drillers.

And anyway the group’s 30 million bpd ceiling has largely been symbolic and, in practical terms, ignored.

Yet abandoning the pretence of production restraint threatens to intensify price wars between OPEC members, leaving them even less likely to agree on any market measures down the road, analysts said, and piling more pressure on prices.

In a note following the meeting, Goldman Sachs said it saw a rising probability that the markets may need to adjust through “operational stress” when the world runs out of storage capacity, reiterating its “lower for even longer” thesis. (…)

But the present Sunni-Shia conflicts setting Saudi Arabia and Iran at each other’s throats, particularly in Syria and Yemen, make the relationship between the two OPEC powers even more fraught.

“The fact that Iranian-backed Houthi militants are squaring off against Saudi-led troops in Yemen is not helpful, as increased Iranian oil revenues are likely to find their way to Iranian military interests in Yemen, Iraq and Syria,” said Aberdeen Asset Management’s investment strategist Robert Minter.

Hence OPEC is setting up for a showdown at the corral, he added, as Iran wants its pre-sanction market share back, and the Gulf states are not inclined to cede volume when they are already feeling the budgetary pain of reduced prices. (…)

What fully transpired during that afternoon remains unclear. But several OPEC sources said ultimately a decision was reached that having no ceiling at all would be less negative for oil prices than having a higher ceiling.

There appears to have been little if any debate about Iran’s production, although it has been clear for months that it will likely be the biggest challenge they face in 2016.

“We spent two minutes on that issue. You can’t stop a sovereign country from coming back to the market. So, debating it is irrelevant,” said Nigerian oil minister Emmanuel Ibe Kachikwu. “As a matter of fact, our position is that Iran would displace somebody who is not an OPEC member.” (…)

EARNINGS WATCH

Cuts to S&P 500 Earnings Estimates For Q4 To Date Within Average Levels

In terms of earnings estimate revisions for the S&P 500, analysts have lowered earnings estimates for Q4 2015 within average levels to date. On a per-share basis, estimated earnings for the fourth quarter have fallen by 3.4% since September 30. This percentage decline is larger than the trailing 5-year average (-2.7%), but smaller than the trailing 10-year average (-3.6%) for this same point in time in the quarter.

It is also smaller than the trailing 1-year average of 4.2%.

Of the 109 companies that have issued negative EPS guidance, 83 have issued negative EPS guidance and 26 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 76% (83 out of 109), which is above the 5-year average of 72%.

However, it is better than at the same time last year when there were 90 negatives and 19 positives.

As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings decline for Q4 2015 is -4.3% today, which is higher than the expected decline of -0.6% at the start of the quarter (June 30). If the Energy sector is excluded, the estimated earnings growth rate for the S&P 500 would jump to 1.0% from -4.3%.

As a result of downward revisions to sales estimates, the estimated sales decline for Q4 2015 is -3.0%, which is also higher than the estimated year-over-year sales decline of -1.2% at the start of the quarter. If the Energy sector is excluded, the estimated revenue growth rate for the S&P 500 would jump to 1.2% from -3.0%.

Among companies with negative guidance for Q4, 25 Consumer Discretionary companies have negatively guided so far (zero positives) compared with 21 at the same time last year (three positives). IT looks better however with 22 negatives and 10 positives compared with 22 negatives and 2 positives last year.

 

SENTIMENT WATCH

The Stock Market Is Missing the Warning From Junk Junk bonds are headed for their first annual loss since the credit crisis, reflecting concerns that a six-year U.S. economic expansion and stock-market boom are on borrowed time.

U.S. corporate high-yield bonds are down 2% this year, including interest payments, according to Barclays PLC data. Junk bonds have posted only four annual losses on a total-return basis since 1995.

The declines are worrying Wall Street because junk-market declines have a reputation for foreshadowing economic downturns. Junk bonds are lagging behind U.S. stocks following a debt selloff in the past month. The S&P 500 has returned 3.6% on the year, including dividends.

Adding to the worries are signs that the selling has spread beyond firms hit by the energy bust to encompass much of the lowest-rated debt across the market, potentially snarling some takeovers and making it difficult for all kinds of companies to borrow new funds. (…)

The junk-bond default rate rose to 2.6% from 2.1% this year and will likely jump to 4.6% in 2016, breaching the 30-year average of 3.8% for the first time since 2009, said New York University Finance Professor Edward Altman, inventor of the most commonly used default-prediction formula.

Mounting defaults signal an end to the six-year bull run in credit fueled by the Federal Reserve’s long commitment to low interest rates, said Mr. Altman. He said downturns in the junk-bond market often presage stock-price declines and economic slowdowns. Some investors fear just such a reversal as the Fedprepares to raise interest rates this month for the first time since 2006.

“In most high-default periods we’ve seen in the past, the rise in default rates precedes a recession,” said Mr. Altman, who has been studying the subject for more than 50 years. (…)

To be sure, the bottom hasn’t fallen out of the market. Higher-rated junk-bond issuers continue to find buyers for their bonds, and the retreat from risk so far is unfolding gradually. By contrast, junk bonds fell 26% in 2008. (…)

There are $1.3 trillion junk bonds outstanding as of Friday, up from $247 billion in 1998 and $709 billion in 2007, according to data from Bank of America.

Energy junk bonds are down 14% this year. Heavy-industry junk bonds have fallen 15% in 2015 and pharmaceuticals have fallen 8% since September, according to data from Barclays.

While investors are still buying some bonds in growth industries, such as restaurants and gambling, price drops for out-of-favor bonds have been fast and furious this year. That’s in part because new regulations have sharply curtailed trading by Wall Street banks, which cushioned past selloffs by buying bonds. (…)

S&P says that much of the decline in fundamentals has been linked to the significant slide in commodity prices, with failures in the energy and metals and mining industries making up a material part of the defaults recorded thus far.

Diane Vazza, head of global fixed income research at S&P, said: “By most measures, the rising number of defaults in the near future likely will be muted by historical standards, but the current crop of US speculative-grade issuers appears fragile and particularly susceptible to any sudden or unanticipated shocks.”

From the FT:

In the US, about three-fifths of defaults in 2015 have been among energy and natural resources businesses (…)

The sell-off has been concentrated in the energy and materials industries and the average yield for junk bonds in the two sectors shot above 12 per cent last week; no other sector has a yield above the overall average.

From Northern Trust:

Even though the Barclays 2% High Yield Index return is -0.5% through November 9, there’s been a wide dispersion in returns. There’s a 26% return differential between the best-performing sector (refining) and the worst-performing sector (independent energy). Of the 45 sectors in the Barclays index, 34 have positive returns and 16 have returns greater than 5%. In contrast, losses have been concentrated to just six sectors, with returns ranging from -5.5% to -15.9%. These sector returns show that high yield is no longer a beta-driven market fueled by accommodative Fed policy.

This is very much in line with sector profit trends as seen above.

Moody’s view:

(…) the annual growth rate for profits from current production has slowed considerably from the 11.8% advance of the year-ended September 2012 to the 0.9% of the year-ended September 2015, expectations of a continued rise by profits suggest the US should avoid a recession through 2016. Each of the previous three recessions was preceded by a yearlong average for profits that was less than its record high. In other words, the longer profits fall short of their zenith, the greater is the risk of recession. (…)

The credit cycle is closely linked to the profits cycle. For example, the median high-yield default rate jumps up from 2.8% when the yearlong average of profits from current production expands year-over-year to 6.8% when profits contract.

Moreover, the forward-looking average EDF (expected default frequency) metric of US/Canadian non-investment-grade companies generated medians of 3.3% amid profits growth and a much higher 8.0% when profits shrank. Because the high-yield EDF is a leading indicator of default risk, the high-yield EDF is more sensitive to swings in profitability than is the actual default rate.

In addition, according to a sample of quarterly observations that begin with 1986’s final quarter, the high-yield bond spread’s median year-to-year change shows a decline of -47 bp when profits grow annually and a +138 bp increase when profits contract.

However, spreads are more likely to widen when profits contract, than to narrow when profits grow. The high-yield spread widened from a year earlier in 83% of the 29 quarters showing a yearly decline by profits, while the spread narrowed year-to-year in only 61% of the 87 quarters posting an annual increase by profits. (…)

Despite a deceleration by the annual increase of profits from current production from the 1.7% of year-long 2014 to the 0.0% of the January-September 2015, early November’s Blue Chip consensus believes profits will accelerate to a 4.0% rise for yearlong 2016. However, the realization of 4% profits growth is very much in doubt.

Not only will US profitability be challenged by the loss of sales volumes and softening of product prices to a costlier dollar and the subpar expenditures of foreign economies, but margins will also be squeezed by the quickening of labor costs vis-a-vis revenues. Just when wage growth gathers momentum, the annual increase of core business sales will probably be halved from 2014’s 4.6% to 2015’s prospective 2.3%. (…)

Big trouble awaits US business activity if Q3- 2015’s slower rise by gross value added relative to unit labor costs persists. In terms of moving yearlong averages, recessions accompanied each of the three previous incidents showing a slower annual increase by gross value added relative to unit labor costs. For the year-ended September 2015, the good news is that the 4.3% annual increase by corporate gross value added still outpaced the accompanying 2.4% rise of unit labor costs.

DIAMONDS ARE NOT FOREVER:

De Beers Shuttering Canada Diamond Mine in Commodities Rout

Prices for just about everything that comes out of the ground have been falling, and diamonds are no exception.  Polished-diamond prices have declined about 30 percent since 2011, according to an index from PolishedPrices.com. Prices for rough, uncut diamonds have dropped 44 percent over the same period.