Services Sector Expands in July

The Institute for Supply Management’s nonmanufacturing index increased to 58.7 in July from 56.0 in June, reaching its highest level since the recalibrated gauge began in January 2008.

The ISM subindexes generally strengthened in July with some hitting multiyear highs.

The new orders index increased to 64.9 from 61.2 in June. July’s is the highest reading since August 2005. The ISM business activity/production category jumped to 62.4 from 57.5. It was the highest reading since February 2011.

The ISM employment index edged up to 56.0 from 54.4 in June.

(Bespoke Investment)

America’s Young CEOs See More Hiring

In a survey conducted by the Young Presidents’ Organization, a global network of young chief executives, 45% of the American respondents said they expect to boost hiring by at least 10% over the next twelve months, an uptick from the 41% who said that three months ago. Nearly 12% foresee boosting headcounts over 20%.

Behind the new jobs are improved sales. Nearly three-quarters of the U.S. CEOs said they expect sales to go up at least 10% over the next 12 months. Small businesses were the most upbeat: 77% said they expected the increase. But even most big companies—62%–were expecting the same.

Youth optimism?

Wells Fargo loosens standards for jumbo mortgages

(…) In late July, the San Francisco-based bank lowered the minimum credit score on these fixed-rate jumbo mortgages to 700 from 720, Goyda said. Credit scores range from 300 to 850, and levels below 640 are often considered subprime.

The lower requirements for jumbo loans are the latest effort by Wells and other banks to loosen mortgage criteria that are still tight by historical standards. Of the large banks surveyed by the Federal Reserve in July, thirty-nine percent said they were somewhat relaxing requirements on prime residential mortgages, and all banks reported that demand for prime mortgages was at its highest level in a year. (…)

In addition to lowering minimum credit scores, Wells Fargo is now willing to buy jumbo loans from other lenders that go toward the purchase of a second home, Goyda said. For a refinancing, the bank is now willing to buy mortgages whose balance exceeds the size of the borrower’s previous loan, known as “cash-out refinancing.”

Wells Fargo’s standards for mortgages it buys from other lenders remained more conservative than those it offers directly to consumers via its branches and online, Goyda said. The minimum credit score on those jumbo mortgages is 680.

The latest expansion of Wells Fargo’s mortgage lending comes six months after the bank began to offer home loans directly to borrowers with credit scores as low as 600 that were eligible for insurance with the Federal Housing Administration. Its previous minimum credit score for FHA-insured loans was 640. (…)

(CalculatedRisk)

MEANWHILE, IN DRAGHI’S LAND:

Italy Leads Markets Sharply Lower A cocktail of renewed concerns over the conflict in Ukraine and a return to recession in Italy rattled investors’ nerves hitting European stocks and sending the region’s emerging-market currencies sliding.

Italy’s FTSE MIB dived 3.1%, deepening a heavy decline for what until recently was the euro zone’s best-performing stock market. The selling accelerated after data showing an unexpected decline in second-quarter gross domestic product.

German bonds surged to a fresh all-time high as investors clamored for safe assets.

Second-quarter preliminary GDP fell 0.2% on the quarter and fell 0.3% on the year against expectations of a 0.2% rise and a 0.1% rise respectively. First-quarter GDP was revised to a fall of 0.4% on the year from a previous estimate of a 0.5% fall.

Italy Recession, German Orders Signal Euro-Area Struggle Italy unexpectedly returned to recession and German factory orders dropped the most since 2011 as political tensions and slowing global growth threaten the euro area’s recovery.

German orders slid 3.2 percent in June from May.

We all though that France was the only very weak spot in Europe. Will Germany hold?

German factory orders can be volatile but Q2 data shows a 1.5% decline on the heels of -1.8% in Q1. Not good to say the least. Markit’s German Manufacturing PMI was positive but subdued at 52.4 in July. However,

The main upward contributions to the headline PMI came from stronger rates of growth in output and new orders, with intermediate goods producers reporting the steepest increases. The latest rise in new work was the quickest in three months and frequently linked by panellists to the securing of new clients and stronger export demand.

Indeed, new export orders placed at German manufacturers increased at an accelerated pace in July, with Austria, Switzerland, the US and Asian markets specifically mentioned by panel members as sources of export growth.

Domestically,

Germany’s Retail PMI – which measures month-on-month sales on a like-for-like basis – registered at 52.1 in July, thereby extending the current period of continuous growth to 15 months. This was down on June’s 41-month high of 56.2 and below the average for this sequence. Higher sales were generally linked by
survey participants to the football world cup, promotional offers and good weather.

Sales also rose on an annual basis in July, but the rate of growth slowed to the weakest in 2014 so far. While 39% of the survey panel reported an increase
in sales, nearly 32% signalled a decline.

July data indicated that German retailers missed initial sales targets for a third straight month. The degree of underperformance was the most marked in ten
months. Concurrently, companies signalled negative expectations for the month-ahead outlook, with one in-five retailers predicting sales to fall short of initial
plans in August.

So, we have Italy in recession, France tilting seriously in the same direction and Germany showing clear signs of wavering just as the Russian-Ukraine situation is getting pretty bad.

Add that inventories in Europe are too high and that deflation is almost a reality (charts from Markit).

  

If you really want to be in Europe, get there physically, not through equity investments.

SENTIMENT WATCH

Markets Are Coming to Terms With Some Harsh Truths It’s as if markets can finally see the elephant in the room. Actually, there are three elephants, and it’s now impossible to ignore them.

The first is the cold reality that no matter how benign the data, we have crossed a threshold of economic recovery where the Fed is going to have to, sooner or later, signal that it’s preparing to raise rates in the New Year. After six years of ZIRP (zero interest rate policy), that will be a major downer for risk asset markets, which, in the absence of that liquidity, would be hamstrung by both internal and regulatory constraints on lending at financial institutions. Remove the crutch of Fed liquidity and a lot of risky assets will get hit – stocks, high-yield bonds, emerging-market sovereign debt. As we enter into the home stretch of the Fed’s program for tapering its bond buying, that reality seems to have finally sunk into the mindset of investors.

The second elephant is the harsh truth that the more China finds ways to disguise or artificially postpone the slowdown that its economy must undergo while it shifts from over-leveraged investment-led growth to consumer-led growth, the more painful the eventual correction is going to be. That’s why Tuesday’s private-sector HSBC estimate of the nonmanufacturing PMI, which hit its lowest level ever, was alarming to investors. HSBC’s private-sector-compiled numbers are given more credibility than the government’s and they capture more of what’s happening in the real China away from the state-run enterprises.

The third elephant is geopolitical risk: Israel, Iraq and the big one, Ukraine, which burst back into investors’ consciousness on Tuesday when a Polish official warned of the potential for Russia to invade Ukraine and about which investors have been reminded Wednesday with reports that Vladimir Putin is preparing retaliation for sanctions. Together, these elephants cannot be ignored. The only way to deal with them is to get them out of the room. And that’s not easy. After all, they are elephants.

Goldman Sachs: Here’s What Will Happen When Fed Raises Rates Goldman Sachs says it knows what’s going to happen when the Federal Reserve starts raising interest rates. The quick takeaway: Stocks look much more attractive than bonds at least through 2018.

“We forecast a dramatic divergence between stock and bond returns during the next several years,” a Goldman team led by stock strategist David Kostin wrote to clients this week. Goldman predicts the S&P 500 will generate a 6% annualized total return between now and 2018, compared to a 1% annualized gain for the benchmark 10-year Treasury note, assuming the Fed starts raising rates in the middle of next year.

Goldman predicts the federal funds rate, which has been pinned near zero since the financial crisis, will reach 4% by 2018. The last time the Fed raised rates was in June 2006.

“The prospect of higher short-term interest rates is now within the investment horizon of many portfolio managers for the first time since the financial crisis,” Goldman said.

Stocks typically perform well in the months leading up to an initial rate increase, Goldman says. For instance, when the Fed first raised interest rates in 1994, 1999 and 2004, the S&P 500 rallied 11%, 21% and 18%, respectively in the 12 months prior to those moves. The market then declined in each of those subsequent one- and three-month periods following a rate increase.

“These price responses are largely consistent with an initially improving economic backdrop benefiting equity returns, followed by a corresponding decline in equity valuations as the Fed constrains further upside with tighter financial conditions,” Goldman said.

Now, Goldman predicts the S&P 500 will rise by about 8% over the next 12 months, which would take the stock index close to 2100. It closed Monday at 1939.

The firm estimates the S&P 500 will reach 2300 by the year 2018, with the 10-year yield climbing to 4.5% from its current 2.5% level. Bond yields and prices move inversely of one another.

And as the Fed gradually raises rates over the next several years, Goldman expects the U.S. economy will keep growing at about a 2.0%-to-2.5% rate.

EARNINGS WATCH

With 410 companies (88% of S&P 500 market cap) having reported, RBC Capital says that EPS are on track to rise 9.2% Y/Y, up from +8.7% last week. Earnings ex-Financials have surprised by 4.0% so far. Revenues are seen growing 4.3%, up from +2.7% in Q1 and the best growth rate since Q4’12.

Domestically oriented companies’ revenues are up 6.5%, a 2.3% beat. Profits are up 10.5% a 5.2% beat.

Globally oriented companies’ revenues are up 3.1%, a low 0.4% beat. Their profits are up 7.8%, a 3.4% beat.