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$ (16 SEPTEMBER 2014)

Today: The 90% back in shape? How buybacks are boosting this market.
Industrial Production Falls in August U.S. industrial production fell in August for the first time since January, the latest sign of uneven improvement in the economy.

Industrial production, which measures the output of U.S. manufacturers, utilities and mines, fell 0.1% in August from the prior month, the Federal Reserve said Monday. Economists surveyed by The Wall Street Journal had forecast a 0.3% gain. July’s increase was revised down to 0.2% from 0.4% and August capacity utilization fell 0.3 percentage point to a 78.8% rate.

Manufacturing production, the biggest and most closely watched component of the overall figure, fell 0.4% last month after jumping 0.7% in July thanks to strong output from the automobile factories. Auto production can be volatile this time of year because of the shifting timing of summer shutdowns. Output for the smaller mining and utilities sectors expanded by 0.5% and by 1%, respectively.

Excluding autos, factory output rose by 0.1% in both July and August. It had expanded by 0.3% in the prior three months. (Chart from Haver Analytics)

large image

Empire Manufacturing Beats Expectations
Oil Prices Sink as Global Supplies Rise

Benchmark U.S. oil-futures prices approached a 16-month low for the second time in three trading sessions on Monday before recovering. Oil for October delivery ended at $92.92 a barrel, down more than 13% from highs for the year hit in June.

Both U.S. and world prices have tumbled over the past few months, as weak demand and robust global production left extra crude sloshing around the market. The glut is having ripple effects in the U.S. Stockpiles in one of the nation’s biggest storage hubs are rising, reinforcing the downward pressure on U.S. prices, analysts say.

Gasoline prices fell to a national average of $3.39 a gallon Monday, according to AAA, and are running nearly 4% below year-ago levels. (Charts from Ed Yardeni)

The Return of the Currency Wars

(…) when individual countries lean heavily on pushing their currencies down, that tends to shift demand from one place to another rather than increasing the total.  That is a “currency war.”  And we may be on the verge of one. Last time, the emerging markets were doing the complaining; this time, it may be the U.S.  (OK, I’m oversimplifying, but only a bit.)

Japan has already managed to depreciate its currency. The yen is at a six-year low against the dollar.  There is a fine line between pursuing expansionary monetary policy which works (in part) by reducing a country’s currency, and making currency depreciation a primary goal. The U.S. and Europe have tolerated the sinking yen largely because they saw it as part of Prime Minister Shinzo Abe’s broader effort to resuscitate the Japanese economy.

Now the spotlight is shifting to Europe.  Europe is growing painfully slowly, if at all.  Unemployment in the countries that share the euro is 11.5%. Among the under-25 crowd, nearly one in four is out of work. (…)

But what appears to be economically necessary is not politically possible. (…)

So what’s the ECB to do? Push down the euro to try to juice the eurozone’s exports.  That appears to be one of ECB President Mario Draghi’s current objectives, and it’s one he can achieve with words even if he can’t get his policy council to agree on printing a lot of euros.  It certainly is appealing to the French, who’ve long seen the currency as a useful economic instrument.

And the markets are getting the message. The euro, which was trading above $1.38 for most of the spring, has fallen below $1.30 – and Goldman Sachs economists predict it’ll fall to $1.15 by the end of 2015.

For now this isn’t a big threat to the U.S. economy.  The U.S. dollar has been strengthening for some time, initially because nervous investors were looking for safety and more recently because markets expect the Fed to begin raising interest rates from rock-bottom levels next year, well before the ECB does.

Although there are always manufacturers complaining that the dollar is hurting their exports and there are long-standing complaints about China’s manipulation of its currency to favor its exports, the dollar hasn’t really been a big political or economic issue in the U.S. lately.

Perhaps because there has been so much else to worry about; perhaps because the dollar’s attractiveness has helped the U.S. Treasury lure foreigners to lend billions of dollars at very low rates.   U.S. exports have been growing; they contributed 1.3 percentage points to the 4.2% annualized increase in gross domestic product in the second quarter. But that could change if Japan and Europe continue to nudge their currencies down as a substitute for economic policies more friendly to global economic growth.

CONSUMER SENTIMENT

I don’t care much for consumer sentiment surveys since they are coincident indicators at best. However, the breakdown in the recent U. of Michigan survey is interesting: Families with income under $75k reported a sharp rise in confidence to its best reading since May 2007! Same for the 35-54 age group!

Meaning: maybe the ten-percenters will no longer be alone in supporting the economy.

Now, look at this chart from Alexander Ineichen (via John Mauldin) and try to figure out (1) how bond yields can go much lower and (2) why bond yields should not go much higher as the Fed get his foot off the pedal.

image

WOW!

From ISI:image

CHEERLEADING!
Crying face Goldman: Here’s How Stocks Perform Before and After Fed Raises Rates With the focus shifting to when the Federal Reserve will start raising short-term interest rates, Goldman Sachs Group Inc. offers a road map for investors on how stocks perform before and after such a move.

“As in 1994 and 1999, the 2004 experience suggests the S&P 500 will rise during the next 12 months, cyclical sector leadership, and low valuation outperformance relative to high valuation stocks.”

In the three prior instances the Fed started raising rates, the S&P 500 has averaged a 3% gain in the three months prior to the first rate increase, according to Goldman. By comparison, it averaged a 4% drop in the three months following such a move. (…)

But as Goldman puts it, these historical comparisons offer a “relevant guide” to what could happen next. (…)

Sigh! Another very shallow analysis, this one looking at 3 periods, and self-qualified as a “relevant guide”. For a complete and unbiased analysis, see EQUITIES AFTER FIRST RATE HIKES: THE CHARTS SINCE 1954  

Alibaba Raises IPO Price Range
Pointing up Stock Buybacks Buoy Market U.S. corporations are buying their own shares at the briskest clip since the financial crisis, helping fuel a stock rally amid a broad trading slowdown.

Corporations bought back $338.3 billion of stock in the first half of the year, the most for any six-month period since 2007, according to research firm Birinyi Associates. Through August, 740 firms have authorized repurchase programs, the most since 2008.

 Ghost The growth in buybacks comes as overall stock-market volume has slumped, helping magnify the impact of repurchases. In mid-August, about 25% of nonelectronic trades executed at Goldman Sachs Group Inc., excluding the small, automated, rapid-fire trades that have come to dominate the market, involved companies buying back shares. That is more than twice the long-run trend, according to a person familiar with the matter.

Companies with the largest buyback programs by dollar value have outperformed the broader market by 20% since 2008, according to an analysis by BarclaysBARC.LN -0.61% PLC. (…)

According to Barclays, companies in the second quarter spent 31% of their cash flow on buybacks, the most since 2008 and up from 14% at the end of 2009. At the end of the second quarter, nonfinancial companies in the S&P 500 index held $1.35 trillion of cash, down from a record of $1.41 trillion at the end of last year, according to FactSet. (…)

Chip Gibbs, a managing director at Bank of America Merrill Lynch and head of the firm’s buyback business, said he gets more phone calls from corporate clients wanting to execute buybacks on days when shares pull back.

When stock prices dip, “companies get more aggressive,” said Mr. Gibbs.

Some companies have been buying large chunks of stock. International Business Machines Corp. IBM +0.28% , long one of the most active corporate share repurchasers, in the first quarter of 2014 spent $8.2 billion repurchasing 45.2 million shares. That means the company was the buyer of more than 13% of all IBM shares that changed hands in the first quarter.

IBM is the No. 2 buyer of its own stock over the past 12 months, scooping up $19.5 billion, according to Barclays. Apple Inc. AAPL +0.07% is first, buying $32.9 billion of its own shares. (…)

During the first quarter, when IBM accounted for one in eight open-market purchases of its stock, shares of the Armonk, N.Y., company rose 2.5%, beating the S&P 500’s 1.3% gain. (…)

Surprised smile  AB InBev Weighs SABMiller Bid Worth Up to $122 Billion AB InBev is talking to banks about financing a potential megadeal, perhaps reaching £75 billion ($122 billion), to buy global beer rival SABMiller, according to a person familiar with the matter.

NEW$ & VIEW$ (15 SEPTEMBER 2014)

Today: China slows down some more. U.S. energy production does not. Record S&P 500 Masks 47% of Nasdaq Mired in Bear Market. Earnings. Sentiment, sentiment!
China Industrial Production Growth Slumps to Six-Year Low

Value-added industrial output grew by 6.9% in August year-over-year, down from the 9.0% level in July, the National Bureau of Statistics said Saturday. It is the weakest growth seen since December 2008.

Fixed-asset investment in nonrural China rose 16.5% year-over-year in the January-August period, slower than the 17.0% increase recorded during January-July.

Retail sales expanded 11.9% year-over-year last month, down from the 12.2% year-over-year level in July.

And the real-estate industry continued to slump despite moves by more than 30 cities to relax purchase restrictions, with housing sales declining during the first eight months of 2014 by 10.9% to 3.43 trillion yuan ($559 billion) as developers fought bulging inventories, reluctant lenders and fickle buyers.

BTW, August Electricity output fell 2.2 percent, the first decline since May 2009 excluding January and February data.

Li’s Options Narrow as China Growth Slowdown Deepens

(…) The slowdown in August economic data that included a second straight decline in imports and a 40 percent drop in the broadest measure of new credit will test Li’s resolve to avoid stronger monetary stimulus to meet his 7.5 percent goal. (…)

A central bank report last week showed aggregate financing fell to 957.4 billion yuan ($156 billion) in August from 1.58 trillion yuan a year earlier. (…)

High five In a speech at the World Economic Forum in the northern Chinese city of Tianjin last week, Li said the government won’t be distracted by short-term fluctuations in individual economic indicators and will maintain its focus on structural adjustments and dealing with long-term issues.

Growth slightly higher or lower than the 2014 target of 7.5 percent is acceptable as long as employment, incomes and environmental protection improve, he said. (…)

Fracking Gives U.S. Energy Boom Plenty of Room to Run Current Top Gas Well Produces Five Times as Much as Record Setter a Decade Ago

Skeptics of the U.S. energy boom say it can’t last much longer because it requires drilling an ever-increasing number of wells.

But the boom already has lasted longer than anyone would have imagined just a decade ago and has more room to run. That’s because oil and natural-gas wells have become more productive—an unrecognized but potent trend that should keep the fuels flowing. (…)

The U.S. oil-and-gas industry no longer spends its time trying to find new shale formations to tap. Instead, it focuses on finding ways to get more out of the formations it has found. And it is succeeding. (…)

Of course, bigger and better wells come with bigger price tags, leaving drillers more vulnerable to falling energy prices.(…)

Lynn Westfall, the EIA’s director of energy markets and financial analysis, points out that the rig count in South Texas’ Eagle Ford Shale “has not changed since 2012, but the production per new well has doubled.”

Innovation makes the difference. The federal government recently predicted that oil production would rise through 2019 and then flatten off. But a second scenario in the report assumed that extraction technology would continue to improve, leading crude output to rise through 2040, if not longer.

The recent history of oil wells productivity is similar to that of gas wells. (…)

Europe Braces for Energy Shortages

Austria’s energy regulator E-Control and oil and gas company OMV AG OMV.VI -1.11%both said on Friday that gas shipments from Russia were down 15% from previously ordered volumes.

The decline in supplies to Austria began Thursday and was expected to continue through Friday, said Robert Lechner, of OMV’s press office.

“Until now we are not aware of the specific reasons for this,” Mr. Lechner said. (…)

Russia’s state-owned gas company Gazprom GAZP.RS -1.67% said on Wednesday it was supplying the amounts of gas that was available while pumping gas into storage facilities in Russia.

Russia supplies around 30% of the continent’s gas needs, half of which transits via Ukraine.

Several Eastern European countries depend heavily on Russian gas. Russia supplies 80% of Hungary’s gas needs, 89% of Bulgaria’s and 100% of requirements in Finland and Baltic states Lithuania, Latvia and Estonia, for example, according to gas industry group Eurogas. (…)

US targets Gazprom in new sanctions

(…) The latest measures targeting energy, financial services and defence industries also included Lukoil, the privately owned oil group, and Sberbank, Russia’s largest bank.

The new sanctions go much further than previous moves to punish Russia for its role in the eastern Ukraine insurgency by widening the number of companies targeted. In addition to blocking most major state-owned groups from western capital markets, the US has also tightened restrictions on some of Russia’s largest energy projects, a key engine of its future economic growth. (…)

Thumbs down OECD Cuts Growth Forecasts The Organization for Economic Cooperation and Development lowered its growth forecasts for the U.S. and other large developed economies, and said the continued weakness of the recovery demonstrated the need for significant changes in economic policy.
SENTIMENT WATCH
Resurgent U.S. Dollar Fuels Rally The dollar has logged its longest winning streak in 17 years, bolstering global demand for U.S. stocks and bonds.

The dollar has logged its longest winning streak in more than 17 years, rising against a broad basket of currencies for nine straight weeks, according to the ICE U.S. Dollar Index.

The gains reflect investor expectations that the Federal Reserve next year will raise its fed-funds rate for the first time since 2006, while central bankers in Europe and Japan will seek to spur stagnant economies by holding down interest rates and adopting other easy-money policies. (…)

A rising dollar often creates a virtuous circle for the U.S. economy. Dollar gains signal a perception of economic health. Also, by making imports including oil cheaper, they can boost U.S. growth by increasing consumer spending power. (…)

A stronger dollar isn’t a pana cea. It makes U.S. goods more expensive abroad, likely slowing the growth of U.S. exports such as automobiles, car parts and capital goods, and putting pressure on the trade deficit. A smaller trade deficit generally helps the economy over the long term because it means a growing share of money in the U.S. is being spent on goods and services domestically rather than abroad. (…)

What “bolstering global demand for U.S. stocks”? In fact, U.S. equities keep being swapped for global equities as these ISI charts show:

 image image

And these forecasts:

Stock-Market Bears Turn Docile

(…) For some investors, the disappearance of negative views is cause for concern. They worry that with bulls so dominant, whenever any shocks do hit, the damage could be much worse than if there were more skeptical investors around.

But a healthier U.S. economy, solid corporate profits and low interest rates have persuaded many bearish analysts that a major pullback for stocks isn’t in the cards at least well into next year. (…)

A Scary World, but Investors Trust the Fed The world is a scary place for investors amid global turmoil. But Investors widely believe the Federal Reserve and other central banks will do what it takes to keep economies and financial markets healthy.

(…) The most common explanation is that, five years into the economic recovery, money managers have come to rely on the Federal Reserve and other central banks to keep financial conditions favorable.

“Policy makers globally are still providing substantial support to financial markets,” noted Krishna Memani, chief investment officer at OppenheimerFunds Inc., which oversees $251 billion in New York. (…)

Still, Mr. Trennert, too, said he expects stocks to move higher, “simply because there is a paucity of other alternatives.” British Prime Minister Margaret Thatcher defended free markets by saying, “there is no alternative.” Mr. Trennert says the same “Tina” rule applies to the stock market today. (…)

The “TINA” rule? Beware! When Tina is the only reason you buy…

Surprised smile Record S&P 500 Masks 47% of Nasdaq Mired in Bear Market

About 47 percent of stocks in the Nasdaq Composite (CCMP) Index are down at least 20 percent from their peak in the last 12 months while more than 40 percent have fallen that much in the Russell 2000 Index and the Bloomberg IPO Index. That contrasts with the Standard & Poor’s 500 Index (SPX), which has closed at new highs 33 times in 2014 and where less than 6 percent of companies are in bear markets, data compiled by Bloomberg show. (…)

The proportion of technology companies, small-caps and newly listed stocks stuck in their own personal bear markets has risen from 30 percent in March 2013, when the overall equity market surpassed its 2007 record. S&P 500 stocks with at least 20 percent losses have fallen since then, the data show. (…)

Punch Please, read this:
Venture Capitalist Sounds Alarm on Startup Investing Silicon Valley Has Taken on Too Much Risk, Gurley Says

“I think that Silicon Valley as a whole, or that the venture-capital community or startup community, is taking on an excessive amount of risk right now—unprecedented since ’99,” said Bill Gurley, a partner at Benchmark, referring to the last tech bubble. (…)

Do people discount risk? Right now you’ve got private companies raising $200, $400, $500 million. If you’re in a competitive ecosystem and you raise that amount of money, the only way you use it—because these companies are all human-based, they’re not like building stores—is to take your burn up.

And I guarantee you two things: One, the average burn rate at the average venture-backed company in Silicon Valley is at an all-time high since ’99 and maybe in many industries higher than in ’99. And two, more humans in Silicon Valley are working for money-losing companies than have been in 15 years, and that’s a form of discounted risk.

In ’01 or ’09, you just wouldn’t go take a job at a company that’s burning $4 million a month. Today everyone does it without thinking.

(…) you just slowly forget, and half of the entrepreneurs today, or maybe more—60% or 70%—weren’t around in ’99, so they have no muscle memory whatsoever.

So risk just keeps going higher, higher and higher. The problem is that because you get there slowly the correcting is really hard and catastrophic. Right now, the cost of capital is super low here. If the environment were to change dramatically, the types of gymnastics that it would require companies to readjust their spend is massive. So I worry about it constantly. (…)

In the software-as-a-service world, where the risk is potentially among the highest, Wall Street has said it’s OK to lose tons of money as a public company. So what happens in the board rooms of all the private companies is they say, “Did you see that? Did you see they went out and they’re losing tons of money and they’re worth a billion. We should spend more money.” And there are people knocking on their door saying, “Do you want more money, do you want more money?” (…)

Scott Grannis tracks the decline in risk aversion

Risk aversion is still to be found (e.g., huge increases in bank savings deposits, zero yields on 3-mo. T-bills), but it is declining. Confidence, the flip side of risk aversion, is slowly rebuilding, but it is still relatively low.

The graph above speaks directly to the existence of declining risk aversion. It shows the price of gold and the inverse of the real yield on 5-yr TIPS (a proxy for the price of TIPS). Both gold and TIPS are refuges for those who worry about inflation and end-of-the-world scenarios, so their prices reflect the intensity of the world’s demand for safety. Gold prices maxed out at $1900/oz. a few years ago, which was roughly triple the average inflation-adjusted value of gold over the past century (now THAT’s what I call paying a premium). TIPS prices maxed out at a negative real yield of almost 2% early last year, which meant that investors were willing to give up almost 2% of their annual purchasing power in order to capture the U.S. government-guaranteed, inflation-hedging properties of TIPS. In short, people were paying ridiculous prices to minimize risk. But that’s changing.

It sure is changing. Here’s what is to be read in Barron’s web site front page this week:

You’ve got to give it to Barron’s. With these 5 stocks, you can almost end up with a reasonably well diversified portfolio: a financial, a consumer e-commerce with a China slant, a tech, a health-care REIT and a global consumer stock for timing (sorry). Pity however for all these other stocks likely to return a lousy 5-10%!

FYI, trailing 12-m EPS for the 500 S&P stocks are up only 12.7% Y/Y. One year ago, the gain was +0.7%.

EARNINGS WATCH

Oh yes! There’s this thing called profits:

S&P says earnings should reach $30.33 in Q3, up $0.20 from two weeks ago and +12.7% Y/Y and $32.34, up $0.05 and +14.4% Y/Y. If so, trailing 12-m EPS will rise 3% after Q3 and another 3.5% after Q4.

However, It seems that S&P is a little behind the ball on earnings revisions as Factset found that

The estimated earnings growth rate for Q3 2014 of 6.2% is below the estimate of 8.9% at the start of the quarter (June 30). Nine of the ten sectors have recorded a decline in expected earnings growth since the beginning of the quarter due to downward revisions to earnings estimates, led by the Energy and Consumer Discretionary sectors. The only sector that has recorded an increase in expected earnings growth since the start of the quarter is the Health Care sector.

The Energy sector has witnessed the largest dip in expected earnings growth (to 4.2% from 11.7%) since the start of the quarter.

image

The percentage decline in the Q3 bottom-up EPS estimate (which is an aggregation of the earnings estimates for all 500 companies in the index and can be used as a proxy for the earnings for the index) was 2.3% over the first two months of the quarter. This decline in the EPS estimate was equal to the trailing 1-year average (-2.3%), above the trailing 5-year average (-1.4%), but below the trailing 10- year (-3.1%) average for the first two months of a quarter.

At this point in time, 103 companies in the index have issued EPS guidance for the third quarter. Of these 103 companies, 77 have issued negative EPS guidance and 26 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the third quarter is 75%. This percentage is above than the 5-year average of 66%.

Note that this percentage is roughly in line with that of the previous quarter at the same time and substantially lower than that of the 2013-14 period.

(Tks for that Gary)

Words of wisdom from Howard Marks:

Today I feel it’s important to pay more attention to loss prevention than to the pursuit of gain. Although I have no idea what could make the day of reckoning come sooner rather than later, I don’t think it’s too early to take today’s carefree market conditions into consideration. What I do know is that those conditions are creating a degree of risk for which there is no commensurate risk premium