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

U.S. SERVICES PMIs WEAKEN

Markit’s:

February data pointed to a fractional reduction in U.S. service sector business activity, which ended a 27-month period of sustained growth. At the same time, new business volumes expanded at the slowest rate since January 2015 and service providers were the least optimistic about their growth prospects for five-and-a-half years.

Survey respondents noted that heightened uncertainty about wider economic outlook, and reluctance among clients to commit to new projects, were factors that had weighed on their business sentiment.

Adjusted for seasonal influences, the final Markit U.S. Services Business Activity Index registered 49.7 in February, down from 53.2 in January and below the neutral 50.0 value for the first time in almost two-and-a-half years. As a result, the latest reading indicated the weakest service sector performance the government shutdown disrupted business activity in October 2013.

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The seasonally adjusted final Markit U.S. Composite PMI™ Output Index posted 50.0 in February, thereby signalled that private sector output was unchanged over the month. Moreover, the index was down from 53.2 in January and the weakest recorded since October 2013.

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While temporary disruptions related to heavy snowfall on the east coast was a factor weighing on the services index, anecdotal evidence from survey respondents also suggested that softer new business growth and concerns about the underlying economic outlook had placed downward pressure on business activity during February.

Growth of incoming new work has now eased for three consecutive months, with the latest upturn the weakest since the start of 2015. Although service providers pointed to generally supportive economic conditions, some reported more cautious spending patterns among clients and intense competition to secure new work. February data meanwhile indicated a further drop in unfinished work, with the rate of backlog depletion the fastest for almost two years.

Despite a slight drop in business activity and a softer expansion of incoming new work, the latest survey highlighted that job creation was sustained at a solid pace across the service economy. The rate of employment growth eased since January but was still slightly faster than the long-run survey average.

Overall input cost inflation remained moderate in February, which survey respondents widely linked to the influence of lower fuel prices. Meanwhile, prices charged by service providers decreased for the first time in five months, but at only a fractional pace.

Looking ahead, service providers’ optimism about the year-ahead business outlook dropped to its weakest since August 2010. Moreover, the latest reading was the joint-lowest since the survey began in October 2009.

The ISM’s:

The Composite Index of Nonmanufacturing Sector Business from the Institute for Supply Management (ISM) was little-changed at 53.4 during February versus an unrevised 53.5 in January. It was the lowest reading since February 2014. Consensus expectations had been for 53.1 in the Action Economics Forecast Survey.

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Haver Analytics constructs a Composite Index using the nonmanufacturing ISM index and the ISM factory sector measure released Tuesday. It held steady m/m at 52.9, also the lowest level since February 2014. During the last ten years, there has been a 72% correlation between the index and the q/q change in real GDP.

Amongst the component series, the employment index declined sharply to 49.7, indicating a decline in jobs for the first time since February 2014. During the last ten years, there has been a 96% correlation between the employment index and the m/m change in service plus construction payrolls. The new orders index also fell to 55.5, its lowest point since March 2014. The supplier delivery index declined to 50.5, indicating a modest pick-up in delivery speeds. The rise in the business activity reading to 57.8 reversed much of the prior month’s decline, but left it well below the July 2015 high of 63.4.

The prices paid series remained below break-even for a second month as it fell to 45.5 from 46.4. Ten percent (NSA) of respondents paid higher prices while 17 percent paid less.

The export order series (NSA) reversed the prior month’s decline and jumped to 53.5. The imports series surged m/m to 55.5, the highest level since March 2015. The order backlog figure remained at 52.0, down from a high of 56.5 six months ago.

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)

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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:

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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. (…)