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$ (25 SEPTEMBER 2015): Lift-off On! Capitulation On?

Yellen Sees Rate Rise This Year

Ms. Yellen, setting out to build a case like a prosecutor giving a closing argument, presented a 40-page speech in a cavernous auditorium at the University of Massachusetts in Amherst. (…)

Central to the argument she set out to establish is a belief that slack in the economy has diminished to a point where inflation pressures should start to gradually build in the coming years. Ms. Yellen argued those pressures aren’t asserting themselves yet, because a strong dollar and falling oil and import prices are placing temporary downward pressure on consumer prices. As those headwinds diminish, she predicted, inflation will gradually rise.

The Fed needs to get in front of this, she said, and also prevent speculative forces in financial markets that could lead to “inappropriate risk-taking that might undermine financial stability,” she said in the prepared text of her comments.

“It will likely be appropriate to raise the target range of the federal-funds rate sometime later this year and to continue boosting short-term rates at a gradual pace thereafter as the labor market improves further and inflation moves back to our 2% objective,” Ms. Yellen said. (…)

“She made the case for why rates should start moving up soon. She hadn’t done that yet, and I believe investors will welcome the additional clarity,” said Roberto Perli, an analyst at the research firm Cornerstone Macro. (…)

In her comments Thursday, Ms. Yellen emphasized the domestic economy and sought to look past headwinds from abroad.

“Some slack remains in labor markets, and the effects of this slack and the influence of lower energy prices and past dollar appreciation have been significant factors keeping inflation below our goal,” she said. “But I expect that inflation will return to 2% over the next few years as the temporary factors weighing on inflation wane.”

Ms. Yellen underscored the risks of waiting too long to raise rates, something she touched on in congressional testimony earlier this year but hasn’t drawn out in a speech. (…)

“The more prudent strategy is to begin tightening in a timely fashion and at a gradual pace, adjusting policy as needed in light of incoming data,” she said. (…)

Questions:

  1. Why the wait?
  2. Why bother with a vote next time?
  3. How about these fellows speaking today? Bullard, George to Hint at 2016 U.S. Rate Outlook

She must have read my piece IS THE FED IN LEFT FIELD, AGAIN? Winking smile 

Yellen’s complete speech in pdf.

U.S. New-Home Sales Up 5.7% in August

Sales of new, single-family homes rose by 5.7% to a seasonally adjusted annual rate of 552,000, the Commerce Department said Thursday.

The reading was well above economists’ forecast for a rate of 515,000 and comes after July’s reading was revised up to 522,000 from an initially estimated 507,000. (…)

From a year earlier, sales were up 21.6% in August.

Many home builders are reporting steady, year-over-year sales gains in the low double-digit percentages. KB Home on Thursday reported a 19% increase in orders in its fiscal quarter ended Aug. 31 from a year ago. On Monday, Lennar Corp. posted a 10% gain in orders for its quarter ended Aug. 31.

MoM sales increased in three of the four regions of the country. Sales in the Northeast rose 24% MoM but are unchanged YoY. In the West, sales posted a 5.4% rise (10.0% YoY). Sales in the South gained 7.4% and were up 32% YoY. In the Midwest, sales declined 9.1%, down for the third month in the last four and unchanged YoY.

Businesses Curb Spending on Durable Goods Orders for long-lasting manufactured goods fell in August, in a sign that a strong dollar and economic turmoil overseas may be restraining demand for American-made goods.

New orders for durable goods fell a seasonally adjusted 2% in August from a month earlier, the Commerce Department said Thursday.

August’s decline reflects a slight pullback in business investment in new machinery, electronics and other goods, after two months in which spending rose. New orders for nondefense capital goods excluding aircraft, considered a proxy for business spending on equipment and software, fell by 0.2% in August after posting increases in June and July. That figure has fallen month over month in five out of the past eight months. On a year-over-year basis, it has fallen for seven straight months.

Fingers crossed The positive bias here is that non-def ex-aircraft is up at a 14.3% annualized rate in the last 3 months (chart from Doug Short)

Core CAPEX Growth

Chicago Fed National Activity Index Reverses Earlier Improvement

The Chicago Federal Reserve reported that its National Activity Index (CFNAI) during August collapsed to -0.41 after jumping to 0.51 in July, revised from 0.34. Ironing out this volatility was the three-month moving average which remained fairly stable near break-even, its best level since January. During the last ten years, there has been a 77% correlation between the Chicago Fed Index and the q/q change in real GDP.

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CHINA FACTS

From CEBM Research surveys:

  • Steel sales in August fell below expectations. Roughly half of respondents reported sales below expectations, while the other half reported that sales volume met expectations. All respondents reported that the overall demand situation remains very weak. Steel producers normally experience a period of strong sales activity September and October. However, respondent feedback indicates the 3-month sales outlook is relatively pessimistic.
  • In July, cement sales saw a meaningful rebound boosted by infrastructure projects. August survey feedback, however, indicates that cement sales lost momentum. Respondents suggested, however, that projects are limited in number and investment for the unforeseen future. They do not expect to see good sales in September.
  • Housing sales in August dropped as expected, but decreased more than agents’ originally forecasted. Most agents regarded the sales decrease in July as a seasonal decline, with another factor being that there were fewer listings. These factors persisted in August, and combined with greater financial market instability, willingness to invest in real estate weakened. Another emerging factor affecting the industry environment is changing credit conditions. Bank credit may have been tightened for some potential homebuyers. Some respondents reported tightened bank credit for their customers. Two main reasons are: 1) Strong 1H15 issuance has reduced the available quota for 2H15; 2) rate cuts have reduced banks’ NIM, especially NIMs on mortgage issuance.
Emerging Markets Go From Bad to Worse

The MSCI Emerging Market Currency Index, a broad gauge of emerging-market currencies, has fallen to its lowest level in six years. Mexico’s peso fell to a record low Thursday as Turkey’s lira and South Africa’s rand continued to tread close to their weakest levels on record. (…)

On Tuesday, the Asian Development Bank cut growth forecasts for emerging Asia for this year and next year while the Organization for Economic Cooperation and Development last week said the outlook for emerging market economies had worsened, further casting doubt on global growth prospects. (…)

Brazil Braces for More Pain The country’s battered currency touches a new low as unemployment surges and the central bank forecasts a far deeper recession.

(…) Brazil’s central bank lowered its 2015 forecast for a second time Thursday and now predicts the economy will shrink 2.7% this year—the worst contraction in 25 years.

Almost all of the gauges on Brazil’s economic dashboard are heading toward the red. Unemployment rose to 7.6% in August, the eighth consecutive monthly increase. and double the rate from a year ago.The inflation rate is rising toward 10%, cutting into the budgets of the country’s poor. And Brazil’s budget shortfall stands at about 8% of annual economic output—a big reason why Standard & Poor’s cut Brazil’s hard-won investment grade credit rating to junk. (…)

Already, Brazil’s central bank has raised interest rates by 2 percentage points to 14.25% to stem inflation and stabilize the currency. (…)

Japan falls back into deflation Figures are blow to Shinzo Abe’s economic stimulus package

Headline prices, excluding fresh food, were down by 0.1 per cent compared with a year ago in August, as slumping global energy prices outweighed stronger domestic inflation in Japan. (…)

However, core prices excluding food and energy were up by 0.8 per cent on a year ago, a level seldom seen since the 1990s. That suggests the domestic economy is running out of spare capacity, creating pressure for higher prices. (…)

Haruhiko Kuroda, the governor of the BoJ, has taken to highlighting the spread of domestic price rises as a sign his policy is working. “If you look at goods used every day or week like food and household products, the proportion with rising prices was higher after April in particular,” said Mr Kuroda at a recent press conference.

He has continued to insist Japan can reach 2 per cent inflation by the middle of fiscal year 2016 even though most analysts think that goal is now out of reach.

SENTIMENT WATCH
Punch U.S. Equities: KKR gets more positive

(…) We are adding two percent to our U.S. Equity position, lifting our weighting to 22% from 20% and a benchmark of 20%. This increase now takes our overall Global Equity allocation to above benchmark for the first time this year, with a notable overweight to developed markets relative to an underweight in emerging markets. See the following pages for specific details, but we fund this increase in U.S. Equities by reducing the cash balance we elected to build up in January 2015.

From a cyclical perspective, we see negative sentiment, decent – albeit unspectacular – EPS growth, and reasonable valuations as signals to “Lean In” to certain parts of the U.S. market. Probably more important, though, is the positive secular case we now see unfolding for the United States. Indeed, the long-term outlook for the U.S. consumer has improved materially in recent quarters, and we now see more gains ahead, particularly around household formation. Meanwhile, Corporate America is increasingly leveraging its “Made in America” innovation across a variety of sectors, including Healthcare, Technology, and Energy Services, to distance itself from its global peers. Against this constructive macro backdrop, our allocation framework now argues for an increased weighting on both a short-term and long-term basis to the United States. (…)

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While we expect there to be plenty of debate around whether to add to U.S. Equities at current valuations, at this point in the cycle, we think that the long-term outlook for the United States has become much less controversial, particularly relative to its global comps. Indeed, at a time when the China Growth Miracle that defined the 2000-2010 period is waning, we see the U.S. gaining increasing stature as an investment destination of choice. (Full KKR report pdf in Bearnobull’s Library)

NEW$ & VIEW$ (24 SEPTEMBER 2015): Fed Open Mouth Committee; Lower Inflation; Lower Sentiment

Fed Chair Janet Yellen’s speech at 5 p.m. may help investors understand what circumstances the Fed needs to see if it is to move ahead with a rate increase this year — and whether continued market volatility, including the selloff in global equities in the past week, is an obstacle to a 2015 liftoff.

The Fed’s stately building seems to have been replaced by a modern Tower of Babel with various speakers’ dissonant voices causing great uncertainty in the financial markets.

Gavyn Davies: A catch-22 for the Fed

(…) Mainly because of the rising dollar, the FCI [Financial Conditions Index] has identified a tightening of 200 basis points since last year, and 90 basis points since June 2015. It has actually tightened slightly since last week’s FOMC meeting. Although forward short-term interest rates have dropped by about 10-15 basis points, this has been more than offset by a stronger dollar and weaker equities.

According to Goldman Sachs, the tightening seen in the FCI has already resulted in a reduction in US GDP growth of 0.5 per cent (year on year); and this drag will increase to 0.8 per cent by 2015 Q4. This could explain why the US activity growth rate has fallen recently, according to the Fulcrum “nowcast” models, from 2.5 per cent in July to 1.7 per cent now.

Furthermore, Goldman Sachs calculates that the very recent tightening in the FCI would have the same effect as three quarter-point increases in the federal funds rate. As a result, they conclude that the current stance of the FCI is tighter than optimal, given the normal relationship with the Fed’s objectives for inflation and unemployment. That seems to be Mr Dudley’s view as well.

There is, however, a catch-22 with any attempt to use the FCI as a guide to setting monetary policy. Eventually, if the Fed really does want to tighten policy, it will have to follow through with its threat, or else the markets will undo the rise in the FCI as they realise that the Fed is bluffing. This is a game of chicken, a game with no unique equilibrium.

So how will this infuriating game end? If we are to believe their interest rate projections, a majority on the FOMC wants to press ahead with gradual rates rises, starting this year, regardless of the FCI. In the medium term, this might turn out to be the appropriate path for short-term interest rates. But, for now, given recent events in China, that seems optimistic to the markets. A collision is therefore developing between the Fed’s reluctance to recognise downside economic risks and what the markets want to hear.

Until the majority on the FOMC starts paying more attention to the large tightening in the FCI, the economy may weaken further. That is what the markets are worried about.

FYI, the Atlanta Fed GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2015 is 1.5% on September 17, having been inching up since mid-August.Evolution of Atlanta Fed GDPNow real GDP forecast

U.S. Core Inflation Not Immune to Falling Gas Prices

Economists tend to view core inflation metrics as more valuable gauges of price pressures, as the exclusion of food and energy prices make them less volatile than their headline counterparts. Still, those components can influence the core trend through indirect channels. This is particularly true for energy prices, with energy-sensitive production and transportation costs often factored into the final prices paid by consumers. The continuing drop in prices at the pump could steal momentum from an otherwise improving core inflation trend — and at a critical juncture for monetary policy makers no less.

(…) Gas prices have a distinct seasonality, and based on the average over the past 10 years, prices typically decline an additional 13 percent from September through year-end. That means there is a strong possibility that prices could head further toward $2.00 per gallon around year-end.

The correlation between rates of change in retail gasoline prices and core inflation illustrate the substantial second-order effects from the former to the latter. This is demonstrated in the accompanying figure. (Note that moving averages are used to reduce noise.)  As it takes time for these effects to percolate through to final prices, the gas price trend leads core inflation by several months.

The correlation between the adjusted moving averages for gas and core CPI is an impressive 70 percent. For the core PCE deflator, it is a lesser, albeit still significant, 45 percent. That suggests there is a distinct possibility that low and falling gasoline prices could nudge core inflation lower through year-end and into early 2016. A simple linear regression of the series suggests that core CPI could drift from 1.8 percent in July and August down toward 1.6 percent in the first quarter of next year. The implication is less compelling for the core PCE deflator given the lower correlation coefficient.

Nonetheless, a similar regression suggests this series will remain near the current level of 1.3 percent into the new year.

While there are many other factors at play with core inflation — including rental pressures, currency effects and a tightening labor market — knock-on effects from cheap energy prices appear poised to at least partly offset an emerging upward bias in the coming months. Policy makers have repeatedly indicated that they would be willing to look beyond transitory factors as they assess the appropriate timing for policy normalization. But if core inflation appears to have stalled, the case for liftoff will be more difficult.

The latest Markit manufacturing PMI survey shows that prices of manufactured goods are now deflating in the U.S.

From the same survey, I find this chart intriguing. U.S. new export orders have climbed back above 50 in the face of a strengthening dollar.

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Volkswagen could pose bigger threat to German economy than Greek crisis The Volkswagen emissions scandal has rocked Germany’s business and political establishment and analysts warn the crisis at the car maker could develop into the biggest threat to Europe’s largest economy.

Volkswagen is the biggest of Germany’s car makers and one of the country’s largest employers, with more than 270,000 jobs in its home country and even more working for suppliers. (…)

“If Volkswagen’s sales were to plunge in North America in the coming months, this would not only have an impact on the company, but on the German economy as a whole,” he added.

Volkswagen sold nearly 600,000 cars in the United States last year, around 6 percent of its 9.5 million global sales. (…)

In 2014, roughly 775,000 people worked in the German automobile sector. This is nearly two percent of the whole workforce. (…)

In addition, automobiles and car parts are Germany’s most successful export — the sector sold goods worth more than 200 billion euros ($225 billion) to customers abroad in 2014, accounting for nearly a fifth of total German exports. (…)

Disinflation washes up in Vietnam Nation once known for hyperinflation joins the 0% brigade

(…) Consumer price inflation in Vietnam, whose multi-zero banknotes are testament to years of hyperinflation, fell short of market forecasts for a rise of 0.8 per cent in September. The zero reading was the lowest in almost 10 years of data. (…)

After China devalued the renminbi on August 11, Vietnam responded by widening the trading band for the dong, twice, from 1 per cent to 3 per cent, to allow the currency to fall and support exports. The currency has since lost 3 per cent to 22,486 per dollar.

Nguyen Bich Lam, head of the General Statistics Office, said those moves should lift CPI by 0.7 per cent by year-end. He said Vietnam should aim for 5-8 per cent inflation to support growth.

The fall in inflation is mostly a result of the drop in oil prices. Prices in the transport category were down 13.1 per cent over 12 months. But food prices were also down 1.8 per cent and housing and construction material prices were down 1.7 per cent.

Debt Relief Snarls Market for Student Loans Federal programs designed to ease the burden of college loans are causing snarls in the bond market and raising concerns that banks may soon ratchet back lending.

The programs, which let struggling borrowers scale back their repayments, have made student loans more affordable at a time when millions of Americans are falling behind on their student debts. (…)

Credit rating firms Moody’s Investors Service Inc. and Fitch Ratings Inc. have collectively placed more than $36 billion worth of bonds backed by student loans on watch for a possible downgrade, warning it is increasingly likely that borrowers won’t pay their loans off in full by their original due dates and that bonds backed by those loans could end up in default.

The result is that investors are demanding better prices in the esoteric but crucial market where banks raise capital by selling or repackaging their loans. (…)

Moody’s is expected to make a decision on whether to downgrade the bonds as early as November. (…)

As of June, there were $371 billion of FFELP loans outstanding, according to the Education Department. Overall, there are $1.27 trillion of outstanding student loans, 93% of which are federally backed, according to MeasureOne, a San Francisco-based firm that tracks the student loan market. (…)

Moody’s has put $34 billion of these bonds on watch for a downgrade this year through June. Since then, Navient’s shares have tumbled about 35%.

Navient was the largest buyer of FFELP student loans last year, purchasing $11.3 billion of these loans from banks and other institutions, according to the company. Wells Fargo& Co., the second-largest private student loan originator by volume, sold $8.5 billion of FFELP loans to Navient late last year. (…)

J.P. Morgan Chase & Co. had more than $4.5 billion of the federal student loans on its books as of June, according to bank filings, with some $500 million in delinquency or default. A bank spokeswoman said it has no plans to sell these loans at this time. SunTrust Banks held $4.4 billion of these loans as of June. A bank spokesman declined to comment on future plans for its loan holdings.

Fracking Firms That Drove Oil Boom Struggle to Survive A wave of bankruptcies and closures is sweeping across the oil patch, and dozens of the mostly small, privately owned hydraulic-fracturing companies that help oil-and-gas explorers drill and frack wells are at risk.

Most of the companies that help oil-and-gas explorers drill and frack wells are small, privately owned and just a few years old. They are part of a flood of new entrants in the energy business—one that is drying up as oil prices languish below $50 a barrel. (…)

At least five frackers have filed for bankruptcy, stopped fracking, or shut their doors altogether, according to consulting firm IHS Energy. Other analysts say that number may be higher, and they expect many more companies to follow suit or consolidate in a merger frenzy.

Energy analysts at Wells Fargo & Co. say as much as half of the available fracking capacity in the U.S. is sitting idle. (…)

So far this year, the amount of fracking work has fallen about 40% from a year earlier, and the price of a frack job has fallen 35%, according to Spears & Associates, a consulting firm for oil-service companies. (…)

Gasoline Volume Sales

Because the sales data are highly volatile with some obvious seasonality, we’ve added a 12-month moving average (MA) to give a clearer indication of the long-term trends. The latest 12-month MA is 6.1% below the all-time high set in August 2005 but off the -8.9% interim low set in August 2014.

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The 6.1% drop highlighted is from the 2005 peak. I am more interested in the more recent trend which is clearly up. The recent monthly data circled in red are well above anything seen since 2010.

SENTIMENT WATCH
Ghost Louise Yamada: Major Sell Signals on All Indices

“We’ve been progressively more cautious and this month we became even more cautious…because we have major monthly sell signals in place for all of the indices… [H]istorically if we look back we got one of these monthly sell signals in January of 2008 and in June of 2000 so we tend to take them rather seriously. The next thing we are waiting for is a crossover of the monthly moving averages and we use a 10-month and a 20-month moving average, which would be a monthly death cross if you will. Everybody is talking about that…and the New York Stock Exchange just this week has been the first one to register that cross under of the 10-month moving average under the 20-month so that death cross is in place for one of the indices. I think that things are becoming much more fragile.”

“There’s a good possibility that we see a 20% decline, which is defined as a bear market or slightly more than that. Whether it’s cyclical or structural has yet to be determined but for instance if the S&P, which is already down around 10%, were to come down another 10% you’d take it right back to 1600, which, ironically, is the breakout point through the 2000 and 2008 peaks, which was broken through on the upside in 2013. So a pullback to that breakout level would be a perfectly normal cyclical bear market in what presumably would be an ongoing bull market, just as we saw cyclical bear markets in the course of the 1982-2000 bull market.”

“[T]his is the first time that a continuation of easing, so to speak, was greeted by disappointment in the market… Whenever the Fed offers liquidity the markets tend to go up and interestingly here they’ve maintained some sort of liquidity by not tightening…and that’s been greeted negatively for the first time I think.”

“We have some monthly sell signals on a variety of the international markets and we’re watching carefully to see whether that begins to spread to the rest of the ones that have been looking good. Japan had been looking good. Germany had been looking good. India had been looking good. But if we start to see that we’re losing that leadership and getting sell signals for those major markets joining a lot of the other emerging nations, we would be raising our antenna a little bit more. I think that’s definitely part of what was on Yellen’s mind the other day.” (…)

“I have no problem staying in cash. Preservation of capital…this is not a good environment in which to initiate positions. I think you really need to wait and see where the dust settles. We have an enormous number of stocks that are down already 20-80%. The larger declines are obviously in the energy area and once you’ve had that kind of decline you’re not going to go to new highs anytime soon. And that’s a fair amount of S&P capitalization weight that’s damaged and when you have that kind of damage it’s going to take time before one is going to benefit on a sustainable basis by being involved.”

“I would wait until we have evidence that all of these sell signals are false, which I don’t think we are going to get. But the point is, time will tell. We would need to see the advance-decline line move to a new high; we’d need to see these monthly sell signals reverse, which could happen in a period of 3-4 months as it did in 2011 even though you had almost a 20% decline there for the S&P and the Dow but these signals are not only in place but the momentum is declining which did not happen in 2011…so I think we are looking at something a little bit more serious in this environment.”

Goldman Says Copper Bear Market to Last Years as Gluts Build

Copper will slump as the U.S. Federal Reserve starts to raise interest rates, demand growth stalls in China and stockpiles surge, according to Goldman Sachs Group Inc., which stood by a year-end forecast that signals the biggest annual drop since the globalfinancial crisis.

Prices will probably drop to $4,800 a metric ton by the end of December and $4,500 at the end of next year, analysts including Max Layton and Jeffery Currie wrote in a report. The metal traded at $5,080 at 7:44 a.m. in London. A drop to Goldman’s end-2015 target implies a full-year retreat of 24 percent, the most since the 54 percent plunge in 2008.

“We see a long list of potential catalysts for copper’s next major move lower,” Layton, Currie and Yubin Fu wrote in the note received on Thursday. Of particular importance for copper has been the weakness in China, which points to a hard landing for commodities demand during 2015, they said. (…)

There will be about 530,000 tons more global supply than demand in 2016, Goldman said, paring its estimate from about 670,000 tons. The worldwide surplus was seen at 566,000 tons in 2017, 626,000 tons in 2018 and 657,000 tons in 2019, it said. (…)

Global stockpiles were seen increasing by as much as 1 million tons between November and March, Goldman said in the report, which was titled ‘Copper’s bear cycle still has years to run.’ Holdings in LME-tracked warehouses stood 327,175 tons as of Wednesday, according to bourse data. (…)

Confused smile Oh Canada! Four in 10 Americans Want Wall on Northern Border