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$ (20 JUNE 2014)

Conference Board Leading Economic Index Increased Again in May

The Conference Board LEI for the U.S. increased for the fourth consecutive month in May. Positive contributions from all the financial and labor components of the leading economic index more than offset the large negative contribution from building permits. In the six-month period ending May 2014, the LEI increased 2.3 percent (about a 4.7 percent annual rate), slower than the growth of 3.5 percent (about a 7.2 percent annual rate) during the previous six months. In addition, the strengths among the leading indicators remained widespread.

Recent data suggest the economy is finally moving up from a 2 percent growth trend to a more robust expansion,” said Ken Goldstein, Economist at The Conference Board. “The CEI shows the pace of economic activity continued to gain traction in May, while the trend in the LEI remains positive. Going forward, the biggest challenge is to sustain the rise in income growth which will drive consumption.

Smile The no-recession indicator, courtesy of Doug Short:

Click to View

Click to View

Philly Fed Beats Forecasts

Philly Fed report for the month of June came in better than expected (17.8 vs 14.0), hitting its highest level since last September.  It was also the fourth straight month of improvement in the index and the fourth straight month it came in better than expected.  Recent improvement in this indicator certainly supports the notion that harsh winter weather was behind the sluggish data earlier this year.

The table to the right provides a breakdown of each of the components in the Philly Fed report.  Of those nine components, just two declined this month while seven increased.  Unfortunately, one of the largest increases in this month’s report was in Prices Paid which spiked to 35.0 from last month’s reading of 23.0.  This is the highest monthly reading since July 2011, and the first time the Prices Paid index has seen double digit increases for two straight months since June 2009.  In fact, it is only the third time in the history of the index going back to 1980 that we have seen two straight double-digit increases in the Prices Paid component.  This is probably not the type of news the Fed wanted to hear after this week’s CPI data.

http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html#tabs-2
Housing Falters as Forecasters See U.S. Sales Dropping

The Mortgage Bankers Association yesterday lowered its new and existing home sales forecast for 2014 to 5.28 million — a decrease of 4.1 percent that would be the first annual drop in four years. The industry group also cut its prediction on mortgage lending volume for purchases to $751 billion, an 8.7 percent decline and the first retreat in three years.

Bullish forecasts in early 2014 from MBA,Fannie Mae and Freddie Mac have been sideswiped by rising home prices and an economy that isn’t producing higher paying jobs. The share of Americans who said they planned to buy a home in the next six months plunged to 4.9 percent last month from 7.4 percent at the end of 2013, the highest in records going back to 1964, according to the Conference Board, a research firm in New York. (…)

The pullback by the largest investors, who raised about $20 billion to purchase as many as 200,000 properties in the past two years, has also cooled the market.

With home prices up 31 percent since a post-bubble low in January 2012 and bargains harder to find, Blackstone Group LP has reduced its pace of buying by 70 percent since last year. The firm is focusing its acquisitions for rentals on five markets — Seattle, Atlanta and the Florida cities of Tampa, Orlando and Miami, Jonathan Gray, the firm’s global head of real estate, said in March. (…)

The Federal Housing Finance Agency, which oversees Freddie Mac and Fannie Mae, in May announced new rules to encourage lenders to relax credit standards. The rules are designed to reduce the risk that lenders will have to buy back soured mortgages due to underwriting errors — an issue that has kept standards tight.

The average credit score for borrowers in May who bought homes was 755 on a scale of 300 to 850, according to a report this week from Ellie Mae, a loan processor in Pleasanton, California. That compared with 756 in December, the last time it was higher.

A decade ago before the housing bubble, the average score was about 715, said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.

St. Louis Fed Financial Stress Gauge Hits a Record Low Fear is not a factor for financial markets right now. According to a weekly index produced by the Federal Reserve Bank of St. Louis, market stress hit a record low reading in the week ending on June 13.

According to a weekly index produced by the Federal Reserve Bank of St. Louis, market stress hit a record low reading in the week ending on June 13. The bank said its Financial Stress Index came in at -1.303 for the week, after standing at -1.264 the prior week.

The latest decline was driven by a broad array of forces, led by very low bond market volatility and a decline in inflation expectations over the next decade. During the height of the financial crisis over 2008 and 2009, the bank’s index surged and was above a 6 reading for a time. The St. Louis Fed says a zero reading indicates “normal” financial conditions: negative numbers denote below-average stress, and positive numbers indicate more stress than normal.

image

For the same price, here’s the Cleveland Fed Financial Stress Index:

image

So, no need to stress on equity valuations:
Irrational exuberance, Janet Yellen and the stock market

Janet Yellen says share valuations remain within “historical norms”.

Two words: “irrational exuberance”.

This chart shows the level of the forward price/earnings ratio on the S&P 500, with the current level marked by the blue line, and Alan Greenspan’s famous comment in 1996 highlighted.

S&P 500 forward PE ratio

(BTW, interesting post on CAPE, returns etc.:Andrew Smithers Valuing non-US markets)

Ghost But there are reasons to stress in credit markets:

Thin Spreads Mask Signs of Credit Cycle Stress

Reflecting above-average confidence, the high yield bond spread recently narrowed to 322 bp for its thinnest band since mid-July 2007. Nevertheless, history clearly doubts the durability of such very thin spreads. For example, the high yield bond spread’s month-long average has been greater than 322 bp nearly 91% of the time since January 1983. Thus, it’s hardly surprising that the high yield spread tends to widen by more than 100 bp in the 12 months following a 322 bp gap.

Furthermore, in view of how June’s composite speculative grade bond yield is on track to set a record low month-long average, the credit market’s confidence in the benign outlook for high yield seems all the more excessive. Not only have high yield spreads been wider 90.7% of the time, but the average speculative grade bond yield has been greater than June’s likely average for 99.7% of the sample’s 378 monthly observations. The latter underscores how important the avoidance of substantially higher Treasury bond yields is to the corporate bond market.

The record shows that credit cycle downturns tend to be preceded by extraordinarily narrow high yield bond spreads. Just several months prior to August 2007’s start to the latest credit cycle downturn, the high yield bond spread averaged merely 281 bp during 2007’s second quarter. Back then, few, if any, dared to predict that the spread would swell to 513 by 2007’s final quarter.

Similarly, a credit cycle downturn emerged in August 1998 notwithstanding how the high yield bond spread’s three-month average had dropped to a speciously upbeat 330 bp during as of April 1998. (Figure 1.) (…)

image

Careful out there! You now know the odds are against you.

The Asset-Rich, Income-Poor Economy

Kevin Warsh and Stanley Druckenmiller in the WSJ:

(…) The aggregate wealth of U.S. households, including stocks and real-estate holdings, just hit a new high of $81.8 trillion. That’s more than $26 trillion in wealth added since 2009. No wonder most on Wall Street applaud the Fed’s unrelenting balance-sheet recovery strategy. It’s great news for those households and businesses with large asset holdings, high risk tolerances and easy access to credit.

Yet it provides little solace for families and small businesses that must rely on their income statements to pay the bills. About half of American households do not own any stocks and more than one-third don’t own a residence. Never mind the retirees who are straining to make the most of their golden years on bond returns.

The Fed’s extraordinary tools are far more potent in goosing balance-sheet wealth than spurring real income growth. The most recent employment report reveals the troubling story for Main Street. While 217,000 jobs were created in May, incomes for most Americans remain under stress, with only modest improvements in hours worked and average hourly earnings. (…)

Balance-sheet wealth is sustainable only when it comes from earned success, not government fiat. Wealth creation comes from strong, sustainable growth that turns a proper mix of labor, capital and know-how into productivity, productivity into labor income, income into savings, savings into capital, capital into investment, and investment into asset appreciation.

The country needs an exit from the 2% growth trap. There are no short-cuts through Fed-engineered balance-sheet wealth creation. The sooner and more predictably the Fed exits its extraordinary monetary accommodation, the sooner businesses can get back to business and labor can get back to work.

What is the difference between 2% growth and 3% growth in the U.S. economy? As the late economist Herb Stein recounted, the answer is 50%. And the real difference is one between a balance-sheet recovery that helps the well-to-do and an income-statement recovery that advances the interests of all Americans.

Thumbs up Harley Unveils an Electric Motorcycle Harley-Davidson, known for gasoline-powered motorcycles thundering with machismo, is testing a battery-powered model that it hopes will appeal to younger people concerned about the environment.

NEW$ & VIEW$ (19 JUNE 2014)

LOWER FOR LONGER
Fed Keeps Rates Low, Sees Rise in ’15, ’16 With its bond-buying program winding down, officials are turning their attention to the question of when to start raising the federal funds rate from near zero—where it is likely to remain through the year.

(…) With the job market gradually improving, the Fed is taking away that support and slowly turning its attention to the timing and pace of short-term interest rate increases. It has kept short-term rates near zero since December 2008 and isn’t planning to start raising them until next year.

Investors appeared cheered by that timing. The Dow Jones Industrial Average rose 98.13 points, or 0.58%, to 16906.62 after earlier being down 26 points, while the 10-year U.S. Treasury note rose 12/32 in price to push the yield down to 2.611%.

On average, Fed officials projected the benchmark federal funds rate would hit 1.2% by the end of 2015 and 2.5% by the end of 2016, up slightly from averages of 1.125% in 2015 and 2.4% in 2016 when the Fed last projected rates in March. Over the longer run, officials on average said the target interest rate could settle in at a lower-than-normal 3.75%, down from earlier forecasts of 4%.

Officials also projected the jobless rate falling more than previously thought. They see it receding to 6% or 6.1% by year-end and then to the mid-5% range in 2015 and low-5% range in 2016.

The revisions from March suggest the Fed sees less slack in the economy than previously thought, which could lead to higher inflation and helps explain the slightly higher near-run interest rate projections. Ms. Yellen dismissed as “noisy” recent increases in inflation, though some market analysts said the Fed risks allowing inflation pressures to build as unemployment falls. (…)

“There is uncertainty about what the path of interest rates, short-term rates, will be, and that’s necessary because there’s uncertainty about what the path of the economy will be,” she said.

Underscoring that point, she noted there is a wide range of views even among Fed officials about where rates will be by 2016. Fed forecasts range between 0.5% and 4.25%.

Mohamed A. El-Erian: Fed Dishes Out Continuity

(…) For 2014, the Fed no longer believes that the U.S. economy will recover fully from its first-quarter, weather-induced disappointments. Beyond that, it has joined those worried about the growth potential of the economy. As such, Fed officials have started to concede that the long-term Fed funds rate is likely to settle below its historical level, though they don’t think by much (at least so far). Finally, to the extent that Fed officials worry about inflation, it is limited primarily to movements in prices of goods and services, and the concerns have more to do with “persistently low” rates rather than excessively high ones.

For those of us following closely the evolution of Fed policy, this seemingly steady Fed is one that also has to deal with some pretty large unanswered questions. Consider the following four as an illustration of a broader phenomenon:

  • The balance between cyclical considerations, which validate a “highly accommodative stance of monetary policy,” and secular and structural ones that would limit the beneficial impact of such an approach while increasing the costs and risks;
  • The extent to which asset-price inflation will serve as a conduit for higher growth and employment, rather than financial instability down the road;
  • The ability of macro-prudential measures to counter the risks of bubble-ish markets, overexuberant investors and deteriorating technical market conditions; and
  • How U.S. policies will impact the rest of the world in the context of “multi-speed central banking.”

Each of these issues is complex and consequential as a standalone. The whole is materially more so. And all will require a tremendous amount of intellectual and operational agility on the part of the Fed. Fortunately, this was also the first Fed meeting at which the number of governors participating in the policy deliberations is almost complete.

Ms. Yellen says that “the decline in headline unemployment to 6.3% overstates the improvement in the labor market” explaining why the Fed plans on holding rates low even after the rate falls to 5.5%.

The U-rate is now a moving target, no longer THE benchmark as Yellen said that the Fed will now be preoccupied by a large number of indicators. Recall that the U-rate goal post was 6.5% in Dec. 2012 and 7% in June 2013.

Let’s hope that the recent rise in inflation is just noise, as she says, even though the increase was fairly broad based.

As to the overstatement by the lower U-rate, let’s remember two facts:

  • The recent drop in the U-rate was not because of a decline in the participation rate.
  • The JOLT report indicates that for each job offering, and job openings have spike up in recent months, there are currently 2.2 job seekers, down from 6.8 in 2009 and close to the 2000-2007 range. Workers on the sideline should eventually take notice of the renewed balance in the job market and re-enter. Otherwise, wages could well keep rising, especially given the inflation “noise”.

image

image(http://stateofworkingamerica.org/)

Weak GDP numbers apparently did not dampen labor demand a whole lot, with net gains in jobs posting an 8 month run. Job openings (not able to fill currently)
remained at the highest level in the expansion and plans to create new jobs gained more strength. Although the percent of owners reporting job openings is ten points below the record high, it is holding at the highest level seen since mid- 2007, suggesting that labor markets might be tighter than the unemployment rate
suggests. (NFIB)image

Talks that the Fed is behind the curve will reappear in a media near you…

China Housing Slump Hits More Than Homes

China’s housing slump is affecting other parts of the world’s No. 2 economy, hitting everything from construction-worker wages to furniture demand to sales at Yang Limin’s steelyard in this dusty northern Chinese town.

This is typically the time of year when construction companies are at their busiest, said Mr. Yang, manager at Ningxia Yanbao Steel Market Co. But the firm sold only 100,000 tons of steel this year, he said, down 30% from the same period a year ago. In several steel trading offices down the street, several employees appeared to be dozing at their desks.

“It’s already June, and things haven’t improved,” Mr. Yang said. “And next year doesn’t look so good either.” (…)

The latest negative news came Wednesday, when government data showed average new home prices in 70 cities fell 0.15% month-on-month in May, according to Wall Street Journal calculations. That marked the first monthly drop in the measure since May 2012. Housing prices also declined slightly in Shanghai and Shenzhen, suggesting the slump is spreading to China’s most-developed cities, although they rose slightly in Beijing. (…)

PBOC Keeps Pumping Cash

China’s central bank will pump cash into the country’s financial system for a sixth straight week, as Beijing grapples with a still-nascent economic recovery, a sharp slowdown in capital inflows and a decline in foreign investment.

The move to ease funding conditions for banks, the longest of its kind since an 11-week streak last summer, is part of a broader effort by policy makers to lower borrowing costs for businesses and debt-laden local governments.

The People’s Bank of China will inject a net 15 billion yuan ($2.4 billion) into the money market this week via short-term loans to commercial lenders, said traders participating in the bank’s open-market operations that fall on each Tuesday and Thursday. It follows a net injection of 104 billion yuan last week and 73 billion yuan in the previous week. (…)

Vietnam Devalues Dong First Time in a Year to Spur Exports
Brent Rises to Nine-Month High on Iraq Conflict Brent crude traded at a nine-month high as Iraqi forces battled insurgents north of Baghdad. West Texas Intermediate rose for the first time in four days after a government report showed U.S. crude supplies shrank.
Punch WHY IRAK MATTERS

Via ValueWalk:

On Tuesday, IEA’s report forecast that 60 percent of expected growth in OPEC’s crude production capacity in 2019 would come from Iraq.incremental opec crude production capacityWatch the south:iraqi oil production by region

SENTIMENT WATCH

(Bespoke Investment)

Buyback Binge Surges to New High

(…) Stock buybacks and cash dividends reached $241.2 billion during the first three months of the year, exceeding the previous record of $233.2 billion set in the fourth quarter of 2007, according to S&P Dow Jones Indices. The new high is more than three times the $71.8 billion total in the second quarter of 2009, when the economy was in the early stages of recovering from the financial crisis. (…)

Companies particularly splurged on buybacks during the first quarter. They bought back $159.3 billion worth of stock during the first three months of 2014, up 59% from a year ago and a 23% increase from the fourth quarter. (…)

FedEx Sets Ambitious Targets

FedEx Corp. FDX +6.16% posted impressive fourth-quarter earnings gains and set ambitious targets for the new year despite the challenges at its express business caused by lackluster global trade.

Chief Financial Officer Alan B. Graf Jr. called fiscal 2014 “a good year” despite a third quarter plagued by rough weather. He said FedEx expects 2015 “to be even better.”

He and other executives said FedEx’s restructuring plan is still on track but told analysts on an earnings call that the company had to take different steps than initially planned to achieve the goal of $1.6 billion in profit improvements by the end of 2016. Global trade isn’t improving as quickly as expected, he said.

“It used to be that international trade was a multiple of GDP, and those days have passed,” Mr. Graf said. “We do expect global trade will pick up, but I don’t think it’ll be a multiple of GDP.” (…)

Overall, FedEx posted a profit for the fourth quarter ended May 31 of $730 million, or $2.46 a share, more than doubling from $303 million, or 95 cents a share, in the year-earlier period, which included $1.18 a share in charges tied to a business realignment program and an aircraft write-down. The company had projected per-share earnings of $2.25 to $2.50.

Revenue rose 3.5% to $11.8 billion, above the $11.66 billion projected by analysts polled by Thomson Reuters.

For the new fiscal year, the company said it expects earnings of $8.50 to $9 a share, with the outlook reflecting no expected year-over-year fuel impact along with moderate growth in the economy. Analysts polled by Thomson Reuters projected $8.76 a share. (…)