Empire State Factory Sector Activity Remains Depressed

The Empire State Factory Index of General Business Conditions continues to indicate declines in manufacturing sector activity. The New York index nudged up to -16.64 during February, but remained near the lowest level since April 2009. Expectations had been for -10.0 in the Action Economics Forecast Survey. The data are reported by the Federal Reserve of New York and reflect business conditions in New York, northern New Jersey and southern Connecticut.

Based on these figures, Haver Analytics calculates a seasonally adjusted index that is compatible to the ISM series. The adjusted figure rebounded to 47.4 from a revised 43.0. It indicated m/m improvement, but remained below break-even for the eighth straight month. Since inception in 2001, the business conditions index has had a 65% correlation with the change in real GDP.

The degree of improvement in the component series varied. New orders and shipments gained slightly but remained near the recent lows. Unfilled orders, inventories & delivery times each increased sharply. Employment also increased sharply to the highest level in six months. During the last ten years, there has been a 69% correlation between the index level and the change in nonfarm payrolls, although the correlation has broken down during the last year.

The prices paid index declined sharply to a four-month low. Sixteen percent (NSA) of respondents reported paying higher prices while 13 percent paid less.

U.S. Home Builder Sentiment Falls to Lowest Level Since May A gauge of home-builder sentiment fell in February to its lowest level since May, a sign housing market growth could be moderating amid rising prices and shortages of labor and land.

An index of builder confidence in the market for new single-family homes fell three points to a seasonally adjusted level of 58 in February, the National Association of Home Builders said Tuesday. A reading over 50 means most builders generally see conditions as positive.

Home builders were less confident about present sales and buyer traffic, and sentiment fell in all four regions of the country. Confidence in sales for single-family homes over the next six months ticked up one point. (…)

The drop in the index was driven by a 5-point fall in buyer traffic, which economists noted could have been because of poor weather conditions in February. (…)

Home builder sentiment was strongest in the West, and weakest in the Northeast, where it remained in contractionary territory for the third straight month. (…)

The weather may have exacerbated the most recent decline but traffic has been weakening since last fall chart from Haver Analytics).

Redfin’s demand index has also weakened:

“The holiday season usually slows demand, however the downshift in December was sudden,” says Redfin chief economist Nela Richardson. “This was a steeper decline than we saw last year and it may feel jarring to sellers after so many months of strong buyer interest.

OPEC Presses Iran, Iraq to Cap Crude-Oil Production OPEC turned up the pressure on members Iran and Iraq to limit their oil production, a day after Saudi Arabia, Russia and other oil producers agreed to curbs on their output.

Qatar’s energy minister and current president of the Organization of the Petroleum Exporting Countries, Mohammed al-Sada, will discuss the production cap plan with ministers from Iran, Iraq and Venezuela at a meeting in Tehran Wednesday, people familiar with the matter said. (…)

Iranian oil minister Bijan Zanganeh told state media on Tuesday that Iran didn’t want to give up on its quest to claw back the customers it lost during sanctions imposed over its nuclear program. The agreement, he said, requires “discussion and examination.”

Iran has begun shipping oil to Europe again, and the country’s deputy oil minister, Rokneddin Javadi told state media on Wednesday that the country was on track to increase its exports by 500,000 barrels a day by March 20 above its level during sanctions, fulfilling a pledge to quickly ramp up output.

An OPEC official from a Persian Gulf Arab country said Tuesday’s meeting will shift the attention to Iran, which had been calling on other countries to cut production.

“If Iran rejects the proposal, we cannot be blamed for not trying. The ball is in their court now,” said the official.

Harold Hamm, chief executive of Continental Resources Inc., a North Dakota driller that plans to cut production by about 10% compared with last year, said the price of crude was dropping low enough for Saudi Arabia and its peers to eventually strike a deal. “It’s not if,” he said, “it’s when.” (…)

Iran could be offered special terms to increase production to a level above its January output, OPEC officials familiar with the matter said. (…)

From the Globe and Mail:

Olivier Jakob from Petromatrix consultancy said that if Saudi Arabia was to freeze output at January levels, the kingdom would need to cut exports by 0.5 million bpd in the summer months, when it burns more oil for power generation at home.

“The production freeze can therefore be seen as an un-official way for Saudi Arabia to make some room for the restart of the Iranian exports,” he said.

NIRP

David Kotok, Chairman and Chief Investment Officer of Cumberland Advisors. discusses negative interest rates:

(…)

5.   Fed Chair Janet Yellen has been asked about negative rates repeatedly and with growing intensity since they were first introduced in 2014. While she has admitted that the Fed must consider them, she has not committed herself to any serious contemplation of their imminent use. Yellen has raised a question about the legality of NIRP under American law. Picture that question debated in Congress or tested in our court system. And now we do not even know what the Supreme Court will look like, let alone how it would lean on this subject.

6.   Our view is that the Federal Reserve decision makers will do all they can to avoid the use of a negative interest rate policy tool. At Cumberland, we are using the no-NIRP path as an investment assumption when it comes to the United States.

7.   NIRP is, however, spreading in the rest of the world. Five currencies and 23 countries are now practicing some form of NIRP. In all cases the likely outlook is for NIRP to go lower in rate and for its usage to broaden. For perspective, keep in mind that 24% of the planet’s real output is housed in those 23 countries, ranging in size from Malta (the world’s smallest economy) to Japan (the world’s third-largest economy). At Cumberland, we expect this list to expand over the next two years. We expect the level of sovereign debt trading at negative rates (already measured at several trillion) to be expanding at the rate of 100 to 200 billion per month.

8.   The implications of lower and deepening NIRP policies are enormous. First, they ensure that interest rates will be at a zero or lower level for the rest of the decade in those jurisdictions. Imagine that we are seeing commitments now for the next two years, as publicly declared by the central banks. Think about how difficult it will be to “taper” back up to zero from a NIRP. Our best guess is that these countries and those who join them are locked in a NIRP policy regime for the rest of the decade. At Cumberland, we are using an expanding NIRP as a policy assumption for our investment decision making.

9.   The second implication of a spreading NIRP is that NIRP anywhere suppresses interest rates everywhere. The more NIRP we see, the more downward pressure on rates there will be in jurisdictions that are not under NIRP. We see that in the United States, where bond rates are positive numbers but are continually pressured to lower and lower levels. Those investors who do not understand NIRP have missed a huge rally in bonds. (…)

10.   The third implication of NIRP is that it changes a key characteristic of money. Money is still a unit of measure. Money is still a facilitator of commercial exchange. But NIRP alters behaviors when it comes to money’s being a “store of value.” When holding cash equivalents creates a cost, it alters behaviors by those who are paying this cost. Thus we see jurisdictions under NIRP where folks are pre-paying their taxes or obligations. And we see corporations buying back their stock with excess cash.

11.   The fourth implication of NIRP plays out in the borrowing arena. When a borrower can finance at near zero and when that borrower is assuming that NIRP will continue for a prolonged period, that borrower changes the way debt is viewed. Essentially the use of money becomes free or nearly free. We are seeing early signs of that now. Borrowing at very low or even negative rates for acquisitions is a growing activity because of NIRP. We expect that process to continue and accelerate as the use of NIRP spreads and as the interest rates in NIRP countries go even lower than the present levels.

12.   The fifth and a huge implication of NIRP is its impact on asset prices. Remember, NIRP assures that the riskless rate will be zero or lower for years to come. With that assumption in place, the prices of assets rise and rise. The longer the duration of those assets, the higher the prices can rise. Stocks, real estate, collectibles, and annuity streams of all types have an upward bias in price as NIRP spreads and deepens. As long as the creditworthiness of the asset is not impaired, the valuation of that asset will inevitably rise. We have seen that happening in very volatile terms. This volatility is expected, since the adjustment to NIRP is new and unfolding. But volatility does not mean only falling asset prices. VOL is bidirectional. High VOL only means the swings in asset prices are larger and more violent. But the swings happen in both directions.

In sum, NIRP is here to stay for a while. It is expanding. It means the zero or lower rate pressure is likely to be around for many years. It is bullish for asset prices. It is repressive for traditional savers. It is altering behavior as the store of value characteristic of money is distorted or replaced by NIRP. Whether we like or do not like NIRP is irrelevant. We have NIRP. The best outcome we see is to accept it and act accordingly.

NORMALIZATION

Some readers commented on yesterday’s post UPGRADING EQUITIES TO 3 STARS, particularly on the normalization of the Energy sector P/E. Paul wrote:

If you normalize for the energy sector today, logically, you probably should have normalized for the tech sector back in 1998-2003.

Furthermore, you could make an argument for normalizing those financial stocks that were not permitted to be shorted in fall 2008. I recall lots of companies wanting to be financial stocks in October 2008 when the SEC and Treasury put in their ill-conceived trial of not allowing financial stock short selling. When a group of stocks had their own special trading rules, they probably should have been “normalized” for that time period.

The only reason to normalize is when a particular stat makes no sense at its face value due to unusual and “one shot” events which materially distort a long-term relationship to such a point that it can mislead.

The Q1 earnings from S&P Energy companies collapsed 60% in 2015 and are seen down 90% in Q1’16. Part of the drop is due to asset impairment charges due to low energy prices as per accounting regulations. Valuations of energy companies will not decline to zero so their P/E will swell due to the short term charges. These high P/Es are not a reflection of a new, upward revaluation of these stocks but rather are due to the short term math and are therefore meaningless. Since Energy accounts for 7% of the S&P 500 Index, the artificial 40 P/E abnormally boosts the P/E of the whole Index, blurring the true P/E by some 2 full P/E points. Hence the need to normalize, assuming that Energy company stocks will eventually return to their historic “normal” P/Es.

Paul is right when he says that I could normalize other periods. Not the dot.com bubble, however, since P/Es then expanded because stocks soared, not because earnings collapsed on a short-term, “one shot” adjustment. I did, in fact, normalize the S&P 500 P/E in 2008, allowing for the humongous loses by many financial companies. A case in point was AIG as I explained in March 2009 (S&P 500 P/E Ratio at Troughs: A Detailed Analysis of the Past 80 Years)::

With the release of its Q4 2008 results, AIG subtracted $5.13 to S&P 500 Index operating earnings and $7.10 to reported earnings in the December quarter. These losses will negatively impact the S&P 500 Index earnings throughout 2009. Yet, AIG is 0.02% of the S&P 500 Index so its market value has literally no meaning to the overall Index. Were the US government to completely nationalize AIG tomorrow, its removal from the Index would make no difference to the Index value but the removal of its losses, operating and reported, would immediately boost Index earnings by 7.8% for operating and 17% for reported.

By the way, if you use the “Shiller P/E” in your assessment of equities, be aware that the 10-year trailing EPS used by the formula keeps including the humongous losses by many companies, several of which are no longer in the Index…

SENTIMENT WATCH

Goldman Sachs Survey: More Than Half Our Clients Expect Negative Returns for Global Equities This Year

“Fund managers are fearful that negative animal spirits have taken hold in the global economy and a recession is looming,” the note, sent out by Chief U.S. Equity Strategist David Kostin and his team, said. “More than one third of the clients attending our recent macro conference in Hong Kong expect cash will post the highest risk-adjusted return of any asset class in 2016. Nearly 60 percent of the participants forecast global equities will deliver a negative return this year.” (…)

“[Q]uantitative and qualitative measures of consumer activity suggest spending will continue and the current economic expansion will persist,” the team continued. “Our high-frequency GS/TRE weekly retail sales index accelerated in February from the average last month.”

The team said that the strength of the consumer should not be overlooked. “Many investors believe the economy is on the precipice of a recession. However, quantitative and qualitative measures of consumer activity suggest spending will continue and the economic expansion will persist.” (…)

Cash is king? From Morgan Stanley: