Greece strikes an ‘a-Greek-ment’ with creditors as full details of deal emerge after 17 hours of talks Greece has until Wednesday to pass proposals into law including hike in VAT, cut in pensions and a €50bn privatisation fund

• Tsipras Completely Capitulates to Creditor Demands

(…) Party insiders did not hide their disgust, though Mr Tsipras managed to quell a full-scale mutiny. “It is a total capitulation. We never had a ‘Plan B’ for what to do if the European Central Banks cuts off liquidity and the creditors simply destroyed our country, which is what they are doing,” said one Syriza veteran.

“We thought that when the time comes, Europe would blink, but that is not what happened. It should have been clear since April that the markets were not going to react to Grexit.” (…)

Yellen Says Fed Remains on Track to Raise Rates in 2015 Fed Chairwoman Janet Yellen reaffirmed the central bank’s plan to start raising short-term U.S. interest rates later this year and pointed to tentative signs that wages are on the rise as slack gets reduced in the labor market.

“I expect that it will be appropriate at some point later this year to take the first step to raise the federal-funds rate and thus begin normalizing monetary policy,” she said in remarks to the City Club of Cleveland. “But I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step.” (…)

She offered a restrained assessment of the economy’s progress, pointing to persistent slack in the labor market even as she acknowledged it might be getting closer to full health. She said lower oil prices have hurt the domestic energy sector and a strong dollar has restrained exports, but added that those drags should fade “as the value of the dollar and crude oil prices stabilize.” She predicted moderate economic growth over the course of this year.

In all, she gave no indication the Fed was veering from its broader plan on rates and dedicated little attention in her speech to global threats, making no mention of China and only a single passing reference to Greece. (…)

Is It Time to Stop Worrying About Inflation?

The Bank for International Settlements has forcefully made the case for a change in established priorities, and some policy makers seem inclined to follow that advice,including Federal Reserve Bank of St. Louis President James Bullard.

OIL

• Oil tumbles as Iran nuclear deal looms Oil prices tumbled on Monday as Iran and six world powers closed in on a nuclear deal that would end sanctions on the Islamic Republic and let more Iranian oil on to world markets.

Iran and six world powers are reportedly on the brink of finding a nuclear deal that would bring sanctions relief in exchange for curbs on Tehran’s nuclear program.

A senior Iranian negotiator said a nuclear deal would be completed but cautioned that there was work to be done and he could not promise the talks would finish on Monday or Tuesday.

• Oil Production Shows Signs of Flagging As the U.S. and OPEC have flooded the world with oil, producers elsewhere have cut back. That casts a shadow over long-term supply growth.

(…) Across the world, just six major oil projects received the green light in 2014, compared with an average of more than 20 a year from 2002 to 2013, according to Deutsche Bank.

The International Energy Agency said Friday that non-OPEC supply growth would “grind to a halt” in 2016, with output due to fall in Russia, Mexico, Europe and elsewhere.

Oil companies need to replace between 5% and 8% of crude output each year just to offset shrinking production from old wells, analysts estimate. Currently, that amounts to at least five million barrels of daily output. Falling production in areas that have been outside the spotlight in recent months could send prices shooting up in the coming years, hurting consumers and damping economic growth, once the market works through the current overhang, investors and industry officials say. (…)

The Canadian Association of Petroleum Producers in early June cut its forecast for the country’s 2030 oil production by 17%, or 1.1 million barrels a day. (…)

The IEA said in its Friday report that it expects non-OPEC production outside the U.S. to decline by about 300,000 daily barrels next year. The global market is likely to remain oversupplied in 2016 due to robust OPEC production, the agency said. (…)

• Saudis Pump Record Crude as OPEC Sees Stronger Demand in 2016

The world’s biggest oil exporter pumped 10.564 million barrels a day in June, exceeding a previous record set in 1980, according to data the kingdom submitted to the Organization of Petroleum Exporting Countries. (…)Demand for OPEC’s crude will climb next year by 900,000 barrels a day to average 30.1 million a day, according to the report. That’s still about 1.2 million less than the group estimated it pumped in June. Global markets remain “massively oversupplied,” the International Energy Agency said on July 13.

OPEC’s 12 members raised production by 283,200 barrels a day to a three-year high of 31.378 million a day last month, according to external estimates of output cited by the report. This data included a lower estimate for Saudi production of 10.235 million barrels a day. (…)

Global oil demand will accelerate next year, to 1.34 million barrels a day, compared with 1.28 million in 2015, led by rising consumption in emerging economies, according to the report. Supply growth outside OPEC will slow to 300,000 barrels a day in 2016 from 860,000 a day this year with the gain concentrated in the U.S.

The IEA estimated demand would grow more slowly next year, with consumption expanding by 1.2 million barrels a day compared with 1.4 million in 2015, according to its monthly report July 10. The Paris-based adviser forecast no growth in non-OPEC supply next year.

World oil demand will average 93.9 million barrels a day in 2016, while non-OPEC supply will total 57.7 million barrels a day, according to the OPEC report.

• Saudi Arabia raises $4bn amid oil slump Riyadh to use bonds and reserves to maintain spending

Fahad al-Mubarak, the governor of the Saudi Arabian Monetary Agency, said the government would use a combination of bonds and reserves to maintain spending and cover a deficit that would be larger than expected. (…)

Analysts have estimated a deficit of about $130bn this year. The government, which had not tapped bond markets since 2007, has been dipping into its large foreign reserves, which peaked at $737bn last August, to sustain spending on wages, special projects and the Saudi-led air war on Yemen. It has drawn down $65bn since oil prices fell. (…)

Saudi Arabia needs an oil price of $105 a barrel to meet planned spending requirements, but the average price for the year is estimated at $58 a barrel, he said. “If the government continues business as usual and draws down like this it will deplete reserves faster than expected, by the end of 2018 or early 2019,” added Mr Sfakianakis. (…)

China Exports Grow, but Remain Weak

Exports in June were up 2.8% in dollar terms from a year earlier, data from the General Administration of Customs showed Monday. This exceeded the median 0.5% forecast of 14 economists surveyed by The Wall Street Journal, and marked a reversal from the 2.5% decline seen in May.

EARNINGS WATCH

From Factset:

The estimated earnings decline for Q2 2015 is -4.4% (-4.5% last week). If this is the final earnings decline for the quarter, it will mark the first year-over-year decrease in earnings since Q3 2012 (-1.0%), and the largest year-over-year decline in earnings since Q3 2009 (-15.5%). Seven sectors are projected to report year-over-year growth in earnings, led by the Health Care sector. Three sectors are predicted to report a year-over-year decline in earnings, led by the Energy sector.

If the Energy sector is excluded, the estimated earnings growth rate for the S&P 500 would jump to 2.0% (2.2% last week) from -4.4%.

The estimated revenue decline for Q2 2015 is -4.2%. If this is the final revenue decline for the quarter, it will mark the first time the index has seen two consecutive quarters of year-over-year revenue declines since Q2 2009 and Q3 2009. It will also mark the largest year over-year decline in revenue since Q3 2009 (-11.5%). Seven sectors are projected to report year-over-year growth in revenue, led by the Health Care sector. Three sectors are predicted to report a year-over-year decline in revenue, led by the Energy sector.

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

At this point in time, 107 companies in the index have issued EPS guidance for Q2 2015. Of these 107 companies, 80 have issued negative EPS guidance and 27 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the second quarter is 75%. This percentage is above the 5-year average of 69%, but is below the percentage recorded at the same point in time in the previous quarter (84%).

S&P’s calculations show that Q2 EPS are expected at $28.29, down $0.13 from last week. If so, trailing EPS would be $110.45 after Q2.

SENTIMENT WATCH

A new era of “rational exuberance”?

It was inevitable. Even with its current flaws, the Shiller P/E has pundits finding justifications for its lofty level (my emphasis):

(…) To his credit, legendary investor Jeremy Grantham has not succumbed to attacking Shiller. Rather, he recently made an elegant observation with regard to the good professor’s full historic data set: The Shiller P/E averaged 14.0 times earnings from 1900 to July 1987; in the period that followed Greenspan’s taking the helm to present day, the Shiller P/E has averaged 24.4.

In other words, some element appears to have entered investors’ calculus that justifies paying prices that are markedly higher than they were before Black Monday, before Greenspan committed to provide liquidity to support the financial system. Years ago, investors even came up with a nickname to describe the effective floor placed under all risky asset prices since the Fed began making policy with an aim to mitigate losses: the “Greenspan Put.”

To be sure, investors have changed with the times when it comes to the identity of the put’s benefactor. The current put is ever so originally called the “Yellen Put,” which replaced, of course, the “Bernanke Put.”

So which history should investors reference to judge the current value of the stock market — the pre-Greenspan era or that which followed? The former casts the current Shiller P/E of 27 as frothy, if not rich; the latter suggests investors are perfectly rational in their exuberance. After all, stocks are not nearly as overvalued today as they were in 1999. And more to the point, policymakers remain loathe to end an era, regardless of the damage it has wrought on the notion of price discovery. (Evergreen Gavekal)

In other words, let’s forget the first 105 years of data. The last 30 years, which include 2 bubbly periods, provide the only relevant data set…

(www.multpl.com)

While Grantham tries to justify high equity valuations, his colleague moves to the sidelines:

GMO’s Montier Shifts To 50% Cash, Sees 3 “Hellish” Scenarios For Markets

“This is definitely the most difficult time to be an asset allocator. It’s very hard to find value,” Montier told Citywire at the Value Intelligence Conference in Munich, an event hosted by Value Intelligence Advisors (VIA).

The fund manager recently cut his equity exposure to US ‘quality’ names and, as such, has upped cash in his Global Real Return fund. He currently holds 20% in liquid assets, i.e. cash and derivatives, while a further 30% is invested in fixed income.

“2007 and 2008 we had about 80% of the fund in non-risky assets. This has been the first time since that we have had over 50% in very liquid assets,” he said.

(…) at the moment, I think it’s best to stand a bit and hold onto some dry powder.”

Greek, Chinese and Puerto Rican Crises All Fall Short of Going Global After economic turmoil erupted on three continents in recent weeks, a familiar consequence of past crises is notably absent: panic.

(…) Financial contagion appears to have been contained for several reasons. The rest of the world’s banks have limited exposure to debt in Greece, Puerto Rico and China; global investors had already fled Greece and were always limited in how much they could invest in China. European authorities have set up firewalls to insulate the rest of Europe from the fallout of a Greek exit from the eurozone. And few economies seem similar enough to trigger selling by investors based on guilt by association. (…)

Yet while financial contagion looks limited, other kinds of contagion—political and economic—still threaten.

Greece’s acrimonious negotiations have heightened both antiausterity sentiment in peripheral economies like Spain and Italy and opposition to bailouts in Germany, corroding the single currency’s unity. Meanwhile, even if the damage of China’s burst stock bubble is limited to China, the knock-on effects on growth could drag down its trading partners, which have already suffered from slumping Chinese demand for commodities and manufactured goods.

The good news is that the global financial system, for now at least, has been a less potent amplifier of economic disruptions than it was in 2008. From 2004 through 2007, banks’ loans to other countries’ banks and companies grew 17% a year, according to the Bank for International Settlements. Since then, they’ve grown just 0.5% annually. That means a default in one country is less likely to be transmitted via banks to another.

One exception: Foreign currency loans to Chinese companies have nearly quadrupled since 2008, to more than $800 billion. But the Chinese government’s ample financial resources could buffer its financial system from a shock. Moreover, China’s stock market is still relatively closed. China’s irrationally exuberant stock investors have been borrowing from local brokers, not foreign banks.

Susan Lund of the McKinsey Global Institute says each of the current episodes looks more like the U.S. savings-and-loan debacle of the early 1990s than the 2008 mortgage meltdown: “a localized national crisis without big international spillovers.”

While cross-border lending by banks has shrunk, lending via the bond market has grown. A wave of defaults could send investors in bond funds rushing for the exit. But that would still be less disruptive than the collapse of a global bank.

Since mid-2012, foreigners’ holdings of Greek government and bank debt have shrunk 86%, from €247 billion ($275 billion) to just €34 billion, according to Cornerstone Macro, an investment research firm. That limits the contagion should Greece leave the euro, and the European Central Bank has pledged to backstop the bond market of any country that suffers collateral damage should that occur.

Puerto Rico’s troubles have yet to ripple more broadly because, unlike Greece, it has no peer in remotely similar straits. Illinois, the financially weakest state, owes tax-supported debt equal to just 6% of personal income, compared with 65% for Puerto Rico, according to Standard & Poor’s. Last week, S&P upgraded the credit rating of California, once the poster child of fiscal dysfunction, to its highest in over 20 years.

Yet one shouldn’t take too much comfort from the absence of obvious spillovers. Recent years have shown that channels of contagion can remain hidden until even a well-telegraphed event such as a Greek euro exit or a Puerto Rican default becomes reality. If nothing else, they create uncertainty that undermines businesses’ willingness to invest and hire.

Moreover, outside the financial realm, the direct economic threat of China’s troubles could be far larger than in the past. Its contribution to global economic output has nearly tripled to 14% today from 5% a decade ago, and J.P. Morgan estimates it has contributed in the past 12 months fully a third of global growth this year, double its contribution in the run-up to the 2008 crisis.

The apparent desperation with which the Chinese authorities have sought, not altogether successfully, to stop the Chinese bubble from deflating suggests they are more concerned about the country’s outlook than outsiders are.

China remains a small market for the U.S., but is among the biggest for many other countries and they have been hard hit, especially through the slump in the prices of oil and other commodities for which China is one of the largest buyers, if not the largest. Iron ore miners in Australia, rubber plantation farmers in Thailand and milk producers in New Zealand have already been hit by oversupply and falling prices associated with China. Brazil is in recession, and Canada may be as well.

J.P. Morgan estimates that a shock that drains one percentage point of growth out of China’s domestic economy drains a half percentage point off global growth and 0.7 percentage point from emerging markets.

After tracking disappointing global industrial output figures in emerging markets, economists at J.P. Morgan are considering trimming their estimates of global growth. China’s slowdown appears to be spreading to other emerging markets, particularly in Asia. (…)

Société Générale’s uber bear Albert Edwards has a different view (via FT Alphaville)

The same loss of confidence in the omnipotence of the Chinese authorities will surely ultimately swirl westward. The Fed and the ECB have created similarly grotesque stock market bubbles in an effort to shore up their anaemic economic expansions. Do not be surprised when the S&P collapses in exactly the same way as the Shanghai stock exchange, and don’t expect the panic monetary measures that will be enacted (more QE) to prevent the ultimate denouement of this global equity Ponzi scheme.

Clients who accept that we have been in yet another global financial bubble are always looking for a trigger – a sign of the top where they can get out. Like Chuck Prince of Citigroup, competitive pressures mean they need to keep dancing while the music is playing. When asked to identify the trigger for the coming debacle we usually offer a few plausible ideas but we might as well shrug our shoulders. Nobody rings the bell at the top and my erstwhile colleague, James Montier, was firmly of the view that bubbles can burst simply because of a loss of price momentum and nothing else. The collapse in the Chinese equity market is a good example. I have yet to see any convincing explanation for the timing of the collapse of the market other than a loss of investor confidence. Neither will we hear a bell rung in the west.

CEBM Research questions the wisdom of the Chinese leadership:

The PBoC’s decision in November 2014 to begin lowering the benchmark lending rate—leading to a noticeable improvement in residential property sales in 1H15—likely has instilled a false sense of confidence among policy makers that the broader economy will respond to current easing measures in similar fashion to that of past periods monetary easing. However, the environment in which easing is currently being conducted is different from past periods.

One important difference is that the strong link between real estate sales and real estate investment that existed in the past has become more tenuous. Another key difference is that the use of leverage accompanying current easing has been much lower than in the past: Monetary policy has been eased, but total social financing
growth continues to fall. Where as past recoveries were accompanied by a strong surge in leveraging, the current attempt at stabilizing growth lacks strong support from leveraging. Lower use of leverage likely means that it will take longer for the economy to stabilize and recover.

(…) Based on the PBOC’s 2Q15 survey of Chinese enterprises, sectors that historically were key growth drivers are now experiencing business conditions worse than experienced during the Global Financial Crisis. Looking at the current recovery in real estate sales, one noticeable difference between
past recoveries in 2009 and 2012 and the present is the lack of support from credit issuance. In 2009 and 2012 sales recoveries were accompanied by surges in long-term mortgage loan growth. The current recovery in sales has lacked the support of a surge in mortgage loan issuance. Instead, the primary factor driving the sales recovery has been upgrade demand. If the recovery in property sales continues to lack strong mortgage lending support, the strength of the sales recovery will be relatively weak and the length of the recovery will be relatively short.

Looking at monetary data, a lack of support from leverage is also evident. During past easing a noticeable increase in TSF growth followed easing measures. However, this time around, total social financing growth continues to slide. The change in dynamic is a result of the government’s objective to strike a balance between stabilizing short term growth and controlling medium-term debt accumulation. This objective has weakened the transmission mechanism between monetary policy, leveraging, and output growth, resulting in a protracted slowdown.

As monetary policy has become less effective, a greater reliance must be placed on fiscal policy to stabilize growth. Infrastructure investment has commonly been used as counter-cyclical tool to offset slowing growth in other areas of the economy. However, compared to project investment in 2009 and 2012, the rise in current infrastructure project investment in response to slowing growth has been relatively weak and has not brought with it an exceptional boost to the economy.

(…) Currently there is plenty of room for more fiscal spending. This judgment is based on the current 200bn RMB gap between the 12-month rolling deficit spending
and the annual deficit target for 2015. Based on this indicator, fiscal spending is still not as proactive as it could be. There are two possible factors that help explain why government spending is less aggressive than it likely should be: 1) the anti-corruption campaign has muted the willingness of local governments to spend, and or 2) the central government remains confident that more fiscal spending is not needed to achieve this year’s GDP growth target. Government spending will be an important variable to watch in the upcoming half.

Greece and Puerto Rico are small fish. China is the whale. We have grown accustomed to wise decision-making by Chinese leaders but this is a new team facing new and significant challenges. If CEBM is right, their monetary and fiscal reactions so far are not adequate to the present environment. Add the way they are handling the equity bear and one must reassess whatever level of confidence there was in Beijing’s ability to manage the economy. Chinese leadership is showing signs of panicking.

Why is this important and significant for investors?

Because China is now accounting for more than  30% of world growth. Check out China’s impact on emerging economies…

…and world economy:

Recall that the OECD LEIs suggest weaker global growth ahead. The China LEI is particularly weak.

• Gavyn Davies: Whatever happened to the Brics?

(…) The graphs below show that the Brics were negligible contributors to global growth in the 1990s, but by 2010 they were contributing between one third and one half of all global growth, depending on whether the data are measured in market exchange rates or PPP rates. Since 2010, although the absolute growth rate of the Brics has declined considerably, so too has growth in the advanced economies. Consequently, the Brics share in global growth has actually remained roughly unchanged. Furthermore, the IMF expects the Brics share to remain fairly constant as the global economy recovers in the next five years:

If the IMF forecasts are correct, the Brics will remain central to global growth prospects for many years to come. But IMF and other GDP forecasts have consistently been far too optimistic for the past five years, with persistent downward forecast revisions failing to keep pace with the repeated disappointments in reported data.

Recently, the situation has deteriorated markedly, with a big decline in Brics growth rates being detected by our “nowcast” models early this year. Growth in China fell to about 5 per cent before recovering in recent weeks; Brazil and Russia have collapsed deep into negative territory; and even India, the markets’ favourite since the arrival of the Modi government in May last year, has been growing at only half its trend rate.

There has been an unmistakable cyclical contraction throughout the Brics, and it is very debatable whether this has now hit bottom:

There are several reasons for this simultaneous slowdown in what are four very different economies.

The first reason is that the Brics story has always been dominated by China, which alone represents 56 per cent of Brics GDP. When China sneezes, most other emerging economies catch a cold. Brazil and Russia (and many smaller Asian economies) are essentially supplier economies to China in commodities and manufactured products. Chinese underlying GDP growth has slowed from 11 per cent in 2007 to 7 per cent now, and other economies have suffered accordingly. The resulting reversal in the secular commodities super-cycle is probably not over yet, and commodity-producing emerging economies will continue to suffer accordingly.

But many emerging economies, including China and India (as well as Korea, Taiwan, Hong Kong etc), are commodity importers, and these should be gaining from lower energy and metals prices. Surprisingly, most of these economies have failed to benefit from the recent commodity shock, and instead GDP growth has slowed down sharply. Something else must be going wrong in these countries.

One common factor is a decline in credit growth, often from stratospheric levels, leading to a sharp tightening in domestic monetary conditions. China is, of course, the prime example of this phenomenon, but it is far from the only one. Brazil, India, Russia, Hong Kong, Singapore, Indonesia, Philippines and Thailand have all seen bubble-like increases in credit/GDP ratios since 2010, and they now face prolonged workouts from the excesses caused by earlier lax policies.

In 2015, declining headline inflation has generally not been matched by reductions in policy rates, so real interest rates have risen, causing increases in non performing loans. India, for example, is battling against this latter phenomenon, with the central bank struggling to bring down real lending rates in the banking sector.

A further disappointment on the policy front has been a failure to maintain market-friendly and business-friendly advances in domestic regulatory and taxation policy. The original catch-up in growth rates owed much to closing productivity gaps with western nations as trade expanded, the population shifted to cities and public investment surged (especially, again, in China). It was always assumed that the later phases of catch-up would be more difficult, relying on economic reforms that would prove politically difficult to implement.

The World Bank ranks 189 countries each year on the “ease of doing business”. The Brics are ranked as follows: Russia 60th, China 90th, Brazil 120th, and India 142nd. With even Greece being ranked ahead of each of the Brics, there is clearly much more work needed if the Brics growth miracle is to resume.

Even now, in their troubled state, the Brics are expected by the IMF to provide up to half of global growth in the rest of this decade. But the control of excessive credit can be a prolonged and difficult job. There could be more disappointments ahead.

BTW:

54% All EM Stocks Are In A Bear Market Even As The MSCI EM Index Is Off Only 7%

Currently, 82% of all emerging market stocks are in a correction and the majority of stocks, 54%, are in a bear market. 

 Airbus Completes Channel Crossing With Electric Plane Airbus Group completed its first-ever flight of an electric plane across the English Channel as the European plane maker seeks to spark interest in less polluting aircraft.

The two-seat E-Fan demonstrator plane powered exclusively by lithium batteries took 36 minutes to fly from Lydd in southern England to Calais, France. The flight mirrored the July 1909 flight by Louis Blériot in his fragile wood and fabric model XI—the first aviator to cross the Channel.