U.S. Industrial Production Fell in March U.S. industrial output slowed in March, a sign that weakness persists for manufacturers and the energy industry.

Industrial production—a broad gauge of output across U.S. factories, mines and power plants—decreased a seasonally adjusted 0.6% in March from the prior month, the Federal Reserve said Friday. Output has fallen for six of the past seven months. From a year earlier, industrial production decreased 2% in March. Manufacturing output, the largest component of the index, fell 0.3% in March. (…)

The Fed’s national report showed March’s manufacturing decline was led by weaker production of motor vehicles and parts and of electrical equipment, appliances and components. Production of computers increased last month. Compared with a year earlier, manufacturing output was up 0.4% in March.

Overall capacity utilization, a measure of industrial slack, slipped by 0.5 percentage point to 74.8% in March. The reading is more than 5 percentage points below the average since 1972.

The mining sector, which is heavily tied to energy firms, has been the largest and most consistent drag out industrial output over the past year. Mining output is down 12.9% over the past 12 months.

The sector’s output decreased by 2.9% in March, the largest monthly drop for the category since September 2008 when production was curtailed due to hurricanes. The latest decline “reflected substantial cutbacks in coal mining and in oil and gas well drilling and serving,” the Fed said. (…)

Utilities production dropped 1.2% last month, and declined 7.7% on the year. The March decline was due to a drop in output from natural gas utilities. Demand for heating and cooling, which is closely related to weather, strongly influences utility production.

Haver Analytics’ table shows how moribund U.S. manufacturing is, flat in total during Q1 with March being the worst month.

This is with light vehicle production up 5.2% YoY in Q1. Remember Ward’s comments after March disappointing vehicle sales:

March volume of 1.585 million units averaged 58,720 over the month’s 27 selling days, 4.7% below year-ago’s 61,593 and 25 selling days.

Perhaps more significant, the seasonally adjusted annual rate fell to 16.5 million units, lowest since February 2015’s 16.3 million and below 17 million for the first time since last April.

Back on March 31, Ward’s was forecasting NA vehicle production up 2.5% in Q2, down from +5.2% in Q1. Spring sales better be strong…although car sales seem to be at their cyclical peak…

CalculatedRisk’s chart on capacity utilization shows how U.S. industries have become less and less efficient over the years, adding to the labour productivity problem.

This is 7 years into the recovery and U.S. manufacturers are only operating at 75%. No wonder capex are on low gear. Meanwhile, EU manufacturers are operating at 81.3%, up 3 points in the last 3 years. Germany’s is at 85.1% (chart from Trading Economics)

Citi’s surprise index failing…again…

…to boost sentiment: (charts from Ed Yardeni)

Speaking of transportation:

Freight Shipment Volumes Remain Below 2015 Levels

The March freight shipments index rose 1.4 percent, but still remains 1.5 percent below the same month a year ago. March shipments have grown at a slower pace than each February for the last couple of years, so this is not unexpected. The March 2016 index is still 6.2 percent lower than the December 2015 index, indicating that the plummet in January is going to take quite some time to dig out of. On an average basis, the first quarter of 2016 was 3.0 percent lower than the same period in 2015. (Cass)

No Oil-Freeze Deal at Doha Meeting Oil producers that supply almost half the world’s crude failed Sunday to negotiate a production freeze intended to strengthen prices.

The talks collapsed after Saudi Arabia surprised the group by reasserting a demand that Iran also agree to cap its oil production. (…)

U.S. crude plunged 6.7% to $37.70 a barrel and Brent was down 6.9% to $40.14 a barrel in early Asian trading. (…)

The outcome Sunday seemed to underscore the pre-eminence of the deputy crown prince over the kingdom’s oil policy, and raised questions about the motivations driving oil policies long directed by Mr. al-Naimi. (…)

Iran had already declined to participate in the negotiations. It had ruled out any freeze until its production recovered the nearly one million barrels a day lost after international sanctions were imposed over its nuclear program.

The country was recently released from the sanctions and has said it planned to increase production to 4 million barrels a day, from 3.1 million barrels. Market observers said such an increase would take years. (…)

• Grand Oil Bargain Is Victim of Saudi Arabia’s Iran Fixation

• Oil’s Anti-Freeze: The Saving Grace of a Stalemate The worst may be over but there is no quick fix

No doubt, the near-term picture is a mess. The oil market can look forward to rising output from Iran, the return of temporarily disrupted production in places such as Iraq and Nigeria, as well as a potential boost to supply from wild cards like Libya.

Yet the unpredictability of exporters’ output is also working in oil bulls’ favor. A workers’ strike in Kuwait has cut output by 60%, according to officials, with refinery utilization also down. With exports unaffected and orders met from stocks, this is only likely to have a lasting impact if the strike lasts more than a week, argues Barclays.

But the question mark over 1.6 million barrels a day of production, about the size of the first-quarter market surplus, is a reminder that the strain low prices put on exporters operationally and socially could spell further disruptions.

Meanwhile, the global market is slowly creaking into alignment. Slightly stronger-than-expected demand, and the odd bright spot like India, must be set against a go-slow global economy.

But non-OPEC supply is falling: the International Energy Agency now expects 57 million barrels a day of production in 2016, compared with its forecast of 57.8 million six months ago. Exporter discord keeps up the pressure on struggling U.S. shale operators and cash-strapped oil and gas majors, who are chopping investment. It delays the question of how onshore U.S. producers will behave as oil prices rise and potentially exacerbates labor and equipment shortages when they do.

The demise of a freeze with little fundamental impact hits sentiment but leaves a market undergoing slow, self-repair effectively unchanged. It reinforces one, key message: The worst may be over but there is no quick fix.

• Major sell-off averted by rebalancing hopes

(…) “As crude balances are set to tighten both seasonally and structurally in the coming months, we would — for the time being — think that the Doha failure would not expose the markets to much downside, unless the post-meeting rhetoric does throw oil on the fire,” said JBC Energy, a Vienna-based consultancy. (…)

But over the period major forecasting agencies such as the International Energy Agency and Energy Information Administration have grown more confident that there will be a significant rebalancing of the oil market later this year.

While oil stocks are expected to grow by 1.5m barrels a day in the first six months of 2016, the IEA now expects them to slow to 200,000 b/d in the second half of the year because of the drop in high-cost production in places like the US.

“Beyond these weekend headlines, our outlook for oil prices remains that gradually improving fundamentals, driven by non-Opec production declines . . . will bring the market into a sustainable deficit in the third quarter,” said Jeff Currie, analyst at Goldman Sachs. (…)

• Oil bulls will be the losers as technology upends demand

(…) The end of Opec’s oligopoly, the collapse of crude oil prices, the natural gas glut, the collapse in liquefied natural gas prices, the emergence of “the energy broadband” (a global network of land and “floating pipelines” in the form of LNG infrastructure), or the end of crude oil’s monopoly in transportation demand were among the many concepts and contrarian conclusions that Daniel Lacalle and I proposed almost two years ago in our book, The Energy World is Flat.

We outlined a comprehensive framework of flattening forces that would transform the energy world via two major dynamics — 1) flattening across energies (inter-energy convergence) where the main losers were coal and crude oil, and 2) flattening across regions (intra-energy convergence) where the main loser was LNG.

The battle for demand is central to the framework of a flat energy world, and among many implications argues that Opec’s dominance was not just about oligopoly of oil supply, but more importantly about monopoly of transportation demand which, combined with structural overcapacity in refining, allowed Opec to capture large economic rents from both consumers and refiners for decades.

This common error — to focus on supply and take for granted oil demand and oil market share in transportation demand, ignoring the threat of displacement and substitution — can be a dangerous one.

Because “without demand, crude oil is worthless — regardless of the marginal cost”, and why in stark contrast to “peak oil theory” supporters, we argued that “the last barrel of oil won’t be worth millions, it will be worth zero”, a demand-driven view of the world and eulogy to my fellow engineers and the relentless power of technology, the most powerful flattener of all.

Because consumers don’t need oil per se: they need transportation. And if they find cheaper, cleaner and more reliable means to meet their transportation needs, they will change.

Look, for example, at the remarkable success of Tesla as it pushes the boundaries of electric cars and batteries. Or the super cycle in LNG and natural gas supply, the “energy broadband” are for the first time supplying the world with global, abundant, reliable and cheap natural gas — possibly below $20/boe for the foreseeable future — which will continue to displace crude oil transportation demand and keep oil prices in check.

Or the relentless flattening power of renewable energies, with solar power displacing crude oil demand for electricity in the Middle East. Many still disregard these threats as “they are negligible and/or will take a long time”, but remember that commodity prices are driven by marginal economics. Look, for example, how a mere 2 per cent excess in supply has led to a 70 per cent collapse in oil prices. Ceteris paribus, a 2 per cent demand displacement would have had the same impact.

So watch closely not only transportation demand, but also refined oil product’s market share. Because, despite being often used interchangeably, oil demand and transportation demand are no longer the same.

These flattening forces are relentless and present the cartel with the dilemma and difficult trade-offs between “short-term gain and long-term pain”, as higher short-term prices at the expense of lower volumes can be self-defeating and reinforce “even lower for even longer” oil prices. A new reality where crude oil producers compete between themselves and crude oil competes for transportation demand. The implications and opportunities within and beyond energy markets are enormous.

China house prices defy cooling measures Market rises up to 63% in major cities despite lending clampdown

House prices in China’s leading cities surged as much as 63 per cent in the year to March while lower-tier cities saw prices tumble, highlighting the country’s increasingly bifurcated market. (…)

Year-on-year price rises in March were as much as 63 per cent in Shenzhen and 30 per cent in Shanghai, according to the National Bureau of Statistics’ monthly 70-city property price survey.

“The [nationwide] rate of increase in prices of new and existing residential buildings has significantly accelerated from the previous month, by 0.6 and 1.2 percentage points respectively,” wrote Liu Jianwei, an NBS statistician.

New mortgage borrowing increased 60 per cent in the first quarter year-on-year, according to Faye Gao, analyst at Bernstein Research. The research house estimates new lending reached Rmb313bn ($48bn) in March, second only to this January over the past five years. (…)

Among other tier one cities, prices in Beijing were up 28 per cent year-on-year for existing homes and 18 per cent for new builds.

By contrast, prices in less desirable “tier-three” cities such as Dandong and Jinzhou, down 3-4 per cent, were depressed by build-up of unsold stock. (…)

• China’s Home-Price Gains Spread as Easing Measures Spur Demand

Global corporate defaults reach $50bn Number of delinquent companies rises at fastest pace since 2009

Corporate borrowers across the world have defaulted on $50bn of debt so far this year as the number of delinquent companies accelerates at its fastest pace since the US emerged from the financial crisis in 2009.

The number of defaults rose by five in the past week, including the first European company of the year, according to Standard & Poor’s. Forty-six companies have defaulted since the year began.

The sharp decline in commodity prices, spurred by slowing global growth and lacklustre demand for base metals and crude, has weighed on oil and gas producers and miners. Nearly half of the defaults have occurred in these two industries, with companies such as Peabody Energy, Energy XXI and Midstates Petroleum all missing interest payments. (…)

S&P forecasts about 4 per cent of subinvestment-grade US companies will default by the end of the year, more than double the number in 2014. (…)

Junk issuance has more than halved from levels a year ago, falling to $56bn in the US, Dealogic data showed. (…)

Lists maintained by both S&P and Moody’s of the companies at greatest risk of default have lengthened. S&P counted 242 so-called weakest links at the end of March, the highest level since 2009. The list included satellite operator Intelsat and luxury goods department chain Neiman Marcus. (…)

Corporate Credit Is in Late-Cycle Mode

(…) After reaching Q3-2014’s 5.3%, the yearly increase of core business revenues (which exclude sales of identifiable energy products) slowed in each of the five subsequent quarters to the 1.4% of 2015’s final quarter. Recent data suggest that this metric may have improved to a still mediocre 1.9% annual increase for 2016’s first quarter. Nevertheless, the projected yearly increase by Q1-2016’s core business revenues falls noticeably short of the expected 4.8% yearly increase by private-sector wage and salary income and thus warns of a further narrowing by profit margins. (…)

Narrower margins will probably reinforce the now rising trend of high yield defaults. The number of US-company credit rating downgrades to the very low high yield rungs of Caa3 or lower jumped up from Q1-2015’s 12 and Q4-2015’s 33 to 66 in Q1-2016, wherein 35 of Q1-2016’s 66 downgrades stemmed from oil & gas related difficulties. First quarter 2016’s number of downgrades to Caa3 or lower was the most since the 87 of Q2-2009. The number of downgrades to Caa3 or lower previously jumped up to at least 66 in Q1-2009.

The latest surge by downgrades to 66 strongly supports the realization of a roughly 6.0% high yield default rate six to 12 months hence. The correlation between the default rate and the yearlong number of downgrades to “Caa3-or-lower” lagged one quarter is a very strong 0.96. According to the latter relationship, the midpoint for Q3-2016’s expected default rate is now 6.5%. (Figure 1.) (…)

The credit cycle may be in its final stage according to how the moving yearlong sum of the number of downgrades ascribed to mergers, acquisitions, or divestitures (M&A) has exceeded the number of M&A-linked upgrades since the end of September 2013. Since the end of Q3-2013, M&A’s influence on US credit rating changes figured in 31 upgrades and 78 downgrades for investment grade issuers and in 136 upgrades and 174 downgrades for high yield.

For the year-ended March 2016, the 70 M&A-linked upgrades were unchanged from the year-ended March 2015, while the 122 M&A-linked downgrades advanced by 36% annually. The 122 M&A-linked downgrades of the year-ended March 2016 were the most since the 141 of the year-ended December 2007. However, the year-ended December 2007 also was home to a comparatively numerous 100 M&A-linked upgrades. (Figure 3.)

The 52 net M&A-linked downgrades of the year-ended March 2016 was the highest such count since the 75 of the year-ended December 2002. Regarding the span immediately preceding and including the financial crisis, net downgrades linked to M&A peaked at the 41 of the year-ended December 2007.

The last two cycle peaks for the dollar value of M&A involving US businesses suggest that the moving yearlong sum of net downgrades linked to M&A will move higher until the dollar value of M&A’s yearlong sum crests. (Figure 4.)

Elevated readings for net downgrades linked to M&A tend to be late in the business cycle. Thus, the latest steep upturns by both the dollar-value of M&A and net downgrades stemming from M&A strongly suggest that the current recovery has aged.

 Wait, there’s more scary stuff:

The moving yearlong sum of US credit rating downgrades at least partly attributed to shareholder compensation rose from March 2015’s 32 and December 2015’s 48 to 61 for the span-ended March 2016. The yearlong sum of downgrades ascribed to either equity buybacks or dividends last climbed to 61 in early 2007.

Meanwhile, the yearlong sum of upgrades stemming from infusions of common equity capital (including IPOs) sank from the current cycle’s peak of 48 for the span-ended September 2010 to the 14 of the span ended March 2016, where the latter matched its current cycle low from the 12-months-ended September 2012 and December 2012. Regarding the previous upturn, the moving yearlong sum of equity-infusion upgrades sank from a June 2005 high of 57 to the 31 of December 2007. (Figure 5.)

The climb by shareholder compensation downgrades suggests corporations are increasingly compelled to take extraordinary measures in order to support equity prices. When companies are willing to return capital to shareholders even at the cost of a credit rating downgrade, managements implicitly admit to the difficulty of achieving a satisfactory return from business assets. Similarly, the much diminished incidence of upgrades from infusions of common equity capital reflects the now high cost of equity capital that stems from the more uncertain outlook for profits at this late stage of the business cycle.

Cries of agony: energy’s bad debts

One of the biggest risks to the world’s financial system is the $2.5 trillion of debt owed by oil and gas firms. After a year from hell, prices of commodities, and the shares and bonds of the firms that produce them, have bounced in the past month. But the evidence of financial pain is all around. Last week Energy XXI, an explorer with $4 billion of debt, filed for bankruptcy in Houston. And JPMorgan Chase, Wells Fargo and Bank of America complained of rising energy-sector bad debts in their first-quarter results. Only 5% of global energy debt sits on the balance-sheets of America’s biggest three banks. A further 34% of global energy debt comes in the form of US-listed bonds. The majority of global exposure is hidden in smaller banks or beyond America’s borders. With a Saudi-led attempt to curb oil output ending in failure yesterday, expect more yelps. (The Economist)

EARNINGS WATCH

Factset’s weekly summary:

Overall, 7% of the companies in the S&P 500 have reported earnings to date for the first quarter. Of these companies, 71% have reported actual EPS above the mean EPS estimate, 17% have reported actual EPS equal to the mean EPS estimate, and 11% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above both the 1-year (69%) average and the 5-year (67%) average.

At the sector level, the Consumer Discretionary (100%) sector has the highest percentage of companies reporting earnings above estimates, while the Financials (44%) and Materials (50%) sectors have the lowest percentages of companies reporting earnings above estimates.

In aggregate, companies are reporting earnings that are 5.1% above expectations. This surprise percentage is above both the 1-year (+4.2%) average and the 5-year (+4.2%) average.

In terms of revenues, 60% of companies have reported actual sales above estimated sales and 40% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is above both the 1-year (50%) average and the 5-year average (56%).

In aggregate, companies are reporting sales that are 0.1% below expectations. This surprise percentage is below both the 1-year (+0.6%) average and above the 5-year (+0.7%) average.

The blended earnings decline for the first quarter is -9.3% this week, which is slightly smaller than the blended earnings decline of -9.4% last week. Upside earnings surprises reported by companies in the Financials sector were mainly responsible for the small decrease in the overall earnings decline for the index during the past week.

If the Energy sector is excluded, the estimated earnings decline for the S&P 500 would improve to -4.2% from -9.3% and the estimated revenue growth rate for the S&P 500 would jump to 1.6% from -1.3%.

  

VALUATION TRENDS

I strongly prefer valuing equities using actual trailing data but it is also interesting to try to anticipate. The Rule of 20 is based on trailing EPS and inflation. Trailing EPS are currently forecast to decline 8-9% YoY in Q1. Allowing for a 5% beat, Q1 EPs could end up down 3.5% or about $1.00 on the S&P 500 Index, bringing trailing EPS down to about $116.50. With core CPI at +2.2% (from 2.3% in February), the Rule of 20 P/E is 20.1 and the S&P 500 Index sits 0.4% above its fair value level of 2074, down from 2081 at the end of March.