Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

NEW$ & VIEW$ (3 MARCH 2016)

Fed Beige Book: Economic Activity Slowed in Some Districts Economic activity downshifted in parts of the U.S. in recent months, the Federal Reserve said, with a few areas reporting a hit to consumer spending tied to recent market turmoil.

Just half of the Fed’s 12 districts reported modest or moderate growth since early January, according to the central bank’s “beige book” summary of regional economic conditions released Wednesday. The prior report showed nine districts expanding at that pace.

Three Fed districts cited the financial-market turmoil that kicked off 2016 as one factor behind consumers’ reluctance to spend, along with economic uncertainty and a reluctance to add to existing debt. (…)

Eight districts reported “significant headwinds” for manufacturing due to weak demand from the energy sector, and many districts said “the strengthening dollar and weakening global outlook” reduced demand for exports. (…)

Most Fed districts reported modest improvement in labor-market conditions. Seven districts said employers reported difficulty finding skilled workers.

Wage growth varied from flat to strong across all districts. St. Louis noted that 56% of contacts reported wages were above year-ago levels, the highest share in two years. Most districts reported prices remained steady. (…)

Gary sent me this Reuters piece: Unemployment is rising in former U.S. oil boom states

  • U.S. Oil production drops to new cyclical low

According to the U.S. Energy Information Administration (EIA), crude oil production was down for the sixth consecutive week through the week of February 26. As today’s Hot Charts show, U.S. production was down to 9.08 million barrels per day during that week, a new cyclical low.  With companies still slashing their capital spending budgets against a backdrop of hostile credit markets, we believe that the downtrend in U.S. crude oil production is for real this time around. We remain comfortable with our current forecast calling for WTI in excess of $40/barrel in the coming quarters. (NBF)

image

Earnings Downgrades Turning Into Deluge as First Quarter Craters

Bearnobull’s readers have been aware of this for weeks…

While bulls cling to predictions that profit growth will resume for Standard & Poor’s 500 Index companies in 2016, analysts just reduced income estimates for the first quarter at a rate that more than doubled the average pace of deterioration in the last five years. Forecasts plunged by 9.6 percentage points in the last three months, with profits now seen dropping the most since the global financial crisis, data compiled by Bloomberg show. (…)

Forecasters see the stretch of profit contractions now lasting 15 months. In the seven times earnings have fallen at least that long since 1970, stocks slipped into a bear market in all but one instance, data compiled by Bloomberg and S&P Dow Jones Indices show. (…)

Reversing from a growth forecast of 1.6 percent three months ago, income among S&P 500 companies is now estimated to fall 8.0 percent this quarter. Projections for profit gains have turned to declines for technology firms and companies that make consumer necessities, expanding the number of industries with no growth to seven out of 10.

While it’s not unusual for analysts to trim estimates for any current quarter, the recent pace of downgrades is alarming. The reduction of 9.6 percentage points in the past three months is worse than all quarters since the start of 2011 and compares with an average rate of decrease of 4.1 percentage points.
Analysts see another 1.9 percent decline in S&P 500 profit next quarter, after predicting growth of 3.7 percent at the start of the year. Should the forecasts come true, that would make five consecutive quarters of negative growth. (…)

As I explained in PICK YOUR FACTS, earnings data are currently all over the map depending on which aggregator you use. I am currently using Thomson Reuters’ data because they are “middle of the road” and updated daily. Here’s their Q1’16 tally which shows –6.1% in Q1, down from –5.7% one week ago:

image

Interestingly, the revisions are not due to poor pre-announcements. There have been 18 positive pre-announcements so far for Q1, same as last year at the same time. There have been 89 negatives, down from 90 last year. Either corporations are whispering analysts lower or analysts are more conservative given the financial turmoil.

Why Big U.S. Banks Can Ride Out the Oil Bust

(…) Consider that energy-sector exposures at the big four U.S. banks— J.P. Morgan Chase,Bank of America, Wells Fargo and Citigroup—range from roughly 1.5% to 3.5% of their total loan books, according to the banks’ recent annual filings and other disclosures. That doesn’t sound huge. But it doesn’t include so-called “unfunded” exposure.

This mainly refers to lines of credit extended to clients that haven’t been tapped. Including these, total exposure is more than 2.5 times as large, or $186 billion in aggregate, for the big four.

Fortunately for bank investors, this doesn’t have to be such a big problem, especially considering the big banks’ strengthened capital positions.

(…) Credit-line agreements typically come with covenants that allow banks to cut off a client in some kind of distress. What’s more, credit lines to the energy sector are regularly reappraised against collateral, which mainly consists of oil reserves in the ground.

Not that banks are immune to drawdowns: At J.P. Morgan’s investor day last week, finance chief Marianne Lake said the bank’s downside scenario for energy—oil prices of around $25 a barrel for 18 months, resulting in an extra $1.5 billion of provisions—assumes a “quite dramatic draw down” of credit lines.

Even then, though, investors shouldn’t be quick to panic. During the oil-price bust of the 1980s, bank write-offs peaked at about 10% to 15% of loans to companies in exploration and production as well as oil-field services. Integrated majors, which make up a sizable part of big banks’ loans books, have better staying power.

Assume then, that today’s energy bust is just as bad as in the 1980s, but across the entire lending portfolio—an overly harsh scenario. Assume also that outstanding credit lines are fully tapped—also unlikely. Still, potential losses look painful but manageable. As a percentage of Tier 1 common equity, they would range from 3.6% at J.P. Morgan to 5.9% at Citigroup.

And that would be in a worst-case scenario. The reality is likely to be far less onerous. (…)

EUROZONE SERVICES PMI AT 53.3

February saw a broad-based slowdown of the eurozone private sector economy. Rates of output expansion eased across Germany, Italy, Spain and Ireland, while France fell back into contraction for the first time in 13 months. Price pressures also remained on the downside, with modest reductions registered for both output charges and input costs.

The final Markit Eurozone PMI® Composite Output Index fell to 53.0 in February, its lowest reading since January of last year but above the earlier flash
estimate of 52.7. Rates of output growth slowed in both the manufacturing (12-month low) and service (13-month low) sectors.

image

The level of incoming new business also rose at a weaker pace in February, its least marked in a year. Spain and Ireland reported slower increases, and France saw a contraction, but demand growth ticked higher in Germany and Italy. There were also signs that pressure on capacity eased at eurozone companies, as backlogs of work rose only negligibly.

imageEmployment increased for the sixteenth month in February, with job creation signalled at both manufacturers and service providers. However, the combined rate of increase eased to a five-month low, reflecting the slower growth trends in output and new business.

Staffing levels were raised across the ‘big-four’ euro area economies in February. Modest increases were signalled by Germany and Italy, and Spain saw a faster rate of growth. The pace of increase also ticked higher in France, but remained marginal and the weakest among the ‘big four’.

Deflationary pressures intensified in February. Average prices charged for goods and services both declined at faster rates, as companies competed to win new business. Selling price reductions were seen in France, Spain and Italy, with the decrease especially sharp in France. Germany and Ireland both registered higher output prices, as increases at service providers offset reductions at manufacturers.

Meanwhile, average input costs fell for the second month running and to a slightly greater extent than in January. Manufacturers reported the steepest drop in their purchase prices in over six-and-a-half years. In contrast, service providers continued to see costs increase.

Services:
At 53.3 in February, down from 53.6 in January, the final Eurozone Services Business Activity Index fell to its lowest level since January 2015. Three out of the ‘big-four’ national service economies – Germany, Italy and Spain – saw growth of business activity, while France fell back into contraction. The slowdown mainly reflected a weaker rate of improvement in new business received. Slower growth of new work meanwhile filtered through to the labour market and business confidence.

Job creation at euro area service providers slowed to a four-month low, but remained stronger than the average for the current 16-month sequence of growth. All of the nations covered by the surveys reported higher employment.

France reported the weakest increase in payroll numbers and Ireland the fastest, although both saw jobs growth accelerate since January. Germany, Italy and Spain all saw slower expansions in staffing levels than one month earlier.

Business optimism dipped to a three-month low in February. Confidence levels were lower in each of the ‘big-four’ euro area nations and also in Ireland. However, the overall degree of positive sentiment was broadly in line with the long-run survey average.

Input price inflation faced by euro area services firms was little-changed from the moderate rate seen in January, and well below the long-run series average. Falling fuel prices helped to keep cost pressures low. Meanwhile, average output charges declined for the fifth month in a row. Only Germany and Ireland reported increases in selling prices.