SMALL BUSINESS SENTIMENT: IMPROVES A BIT

…but seems to be breaking out, finally!

NFIB owners increased employment by an average of 0.11 workers per firm in May (seasonally adjusted), the eighth positive month in a row and the best string of gains since 2006. Fifty-five (55) percent of the owners hired or tried to hire in the last three months and 46 percent reported few or no qualified applicants for open positions. Twenty-four (24) percent of all owners reported job openings they could not fill in the current period (unchanged), providing some downward pressure on the unemployment rate. Fourteen (14) percent reported using temporary workers, unchanged for several months. Job creation plans continued to strengthen and rose 2 percentage points to a seasonally adjusted net 10 percent, approaching “normal” levels for a growing economy, even with no growth last quarter.

Actually, job openings are at a cyclical high:

Wages are accelerating, along with prices:

Three percent reported reduced worker compensation and 24 percent reported raising compensation, yielding a seasonally adjusted net 20 percent reporting higher worker compensation, unchanged and among the best readings since 2008. A net seasonally adjusted 15 percent plan to raise compensation in the coming months (up 1 point), the strongest reading since 2008.

Seasonally adjusted, the net percent of owners raising selling prices was a net 12 percent, unchanged from April after an 8 point rise in March. Overall, there is more upward pressure on prices. Twenty-two (22) percent plan on raising average prices in the next few months (down 3 points) and only 2 percent plan reductions (down 1 point). Seasonally adjusted, a net 21 percent plan price hikes (down 1 point). If successful, the economy will see a bit more “inflation” as the price indices
seem to be suggesting.

I have been writing on this for a while (e.g. FACTS AND TRENDS: THE BIG WAGER in April) but more people are now writing about this:

Martin Feldstein: Warning: Inflation Is Running Above 2%

Inflation is rising in the United States and could become a serious problem sooner than the Federal Reserve and many others now recognize. There are three basic reasons why the Fed is too optimistic in its current forecast that inflation will remain below its 2% target until after 2016.

First, data indicate that prices are already rising faster than 2% and have accelerated in recent months. Second, the low rate of short-term unemployment may be creating pressure for faster inflation despite the large total number of unemployed and underemployed individuals. And third, the rhetoric of Fed officials indicates that the central bank may not react quickly and aggressively enough if inflation continues to rise above 2%. (…)

The key to the future is how the Fed will respond when prices steadily rise above its 2% target rate while the overall unemployment rate is still relatively high. A misinterpretation of labor-market slack, and a failure to create a positive real federal-funds rate, could put the economy on a path of rapidly rising inflation.

Crude Tops $111 on Iraq Unrest

(…) Iraq has been ramping up production in recent months, and has a target of 4 million barrels a day by the end of 2014. Most of the country’s oil production is in the south, far from the current violence. (…)

OPEC Dismisses Oil-Supply Concerns Rising non-OPEC oil production will be sufficient to meet growing demand in the second half of the year, the oil-producers’ group said, dismissing concerns over supply in the coming months.

In its monthly report on the oil market, OPEC—which produces one in every three barrels of oil consumed globally—forecast non-OPEC oil supply would rise by 1.2 million barrels a day in the next six months.

The rate of growth is slightly slower than in previous months but should still be sufficient to meet growing demand when combined with OPEC output and healthy stock levels, the oil-producers’ group said.

In a reflection of its view that the market is balanced, OPEC decided to maintain its official output quota at 30 million barrels a day at its semiannual meeting in Vienna on Wednesday.

Last month, however, the International Energy Agency warned that OPEC could struggle to keep up with rising oil demand as many of its member countries contend with significant supply disruptions. Output from Libya has dwindled to less than 200,000 barrels a day this year amid strikes, protests and conflicts between rival factions in the country. Iran’s oil production is still hobbled by Western sanctions, while a growing insurgency in Iraq has cut off exports from its northern oil fields.

According to the IEA, OPEC will still need to boost its output by 800,000 barrels a day in the second half of the year to meet demand.

OPEC’s output has hovered below 30 million barrels a day for most of the year, falling to 29.4 million barrels a day in March. It has since rebounded, rising to 29.8 million barrels a day last month, but remains below the 30.3 million barrels a day the group predicts it will need to produce to meet demand in the second half of the year.

Investors Face Tough Walk on Easy Street A Chicago Fed index shows financial conditions are at their easiest since 1994. That might not worry the Federal Reserve, but it should give investors pause.

The Federal Reserve Bank of Chicago on Wednesday reported that its financial conditions index, with over 100 measures ranging from debt issuance to consumer surveys on credit conditions, showed America last week faced its easiest financial conditions in 20 years. Indeed, the last time the measure was so loose was in early February 1994, the point at which the Federal Reserve began a series of rate increases that would give stock and bond investors fits for the remainder of that year.

(…) a separate index from the Chicago Fed suggests financial conditions aren’t especially easy after factoring in the recent performance of the economy. There will need to be more labor-market improvement, and probably higher inflation readings, before the central bank begins the process of raising its target for overnight rates.

Moreover, the easy readings on financial conditions aren’t translating into wide credit availability. Mortgage rates are extremely low, for example, but the bar that first-time home buyers must clear to secure a loan remains very high. So, although some Fed policy makers worry the financial environment could lead to credit excesses, there are scant signs that is actually happening. (…)

China’s New Loans Top Estimates in Boost for Economic Growth China’s new yuan loans and money supply topped estimates in May as the government supports economic growth while reining in shadow banking.

Local-currency loans were 870.8 billion yuan ($140 billion), the People’s Bank of China said on its website today, higher than 42 out of 43 analyst estimates in a Bloomberg News survey. M2, the broadest measure of money supply, rose 13.4 percent, compared with a median projection for 13.1 percent.

ECB Says Deflation Risk Remote

(…) But the ECB argued Thursday that weak demand weighing on prices in some countries doesn’t equal a broad-based, generalized and prolonged fall in prices across the entire currency bloc. In fact, the share of items in the euro zone with negative annual inflation growth rates isn’t “exceptionally high,” when compared with earlier episodes of deflation, the ECB said.

The central bank also cited its latest staff projections, which see inflation increasing gradually to 1.5% in the final quarter of 2016. Economic growth is projected to pick up gradually, with gains in competitiveness supporting euro-zone exports. At the same time, unemployment is falling slowly from high levels, which should help boost prices.

“While significant relative price adjustments are taking place in some euro area countries, it is highly unlikely that those processes will result in a downward deflationary spiral,” the ECB said in the report. “The risk of deflation in the euro area appears remote at the current juncture,” it added.

The Lose-Lose Tax Policy Driving Away U.S. Business There’s a good reason why American companies are sitting on $2 trillion in unremitted foreign earnings.

(Michelle Hanlon is an accounting professor at MIT’s Sloan School of Management)

The U.S. corporate statutory tax rate is one of the highest in the world at 35%. In addition, the U.S. has a world-wide tax system under which profits earned abroad face U.S. taxation when brought back to America. The other G-7 countries, however, all have some form of a territorial tax system that imposes little or no tax on repatriated earnings.

To compete with foreign-based companies that have lower tax burdens, U.S. corporations have developed do-it-yourself territorial tax strategies. They accumulate foreign earnings rather than repatriate the earnings and pay the U.S. taxes. This lowers a company’s tax burden, but it imposes other costs. (…)

In short, our international tax policy encourages U.S. multinational corporations to keep cash abroad, borrow more in the U.S. and invest more in foreign locations than they otherwise would. Everyone loses: The U.S. government gets little if any tax revenue from the foreign earnings, and shareholders and the U.S. economy are deprived of valuable resources.

(…) Threatening corporations with stricter rules and retroactive tax punishments will not attract business and investment to the U.S. (…)

The real solution is a tax system that attracts businesses to our shores, and keeps them here. Members of both parties have acknowledged concerns about the competitiveness of U.S. corporations. Consensus on what to do, however, has been elusive.

The U.K. may be a good example: In 2010, after realizing that too many companies were leaving for the greener tax pastures of Ireland, the government’s economic and finance ministry wrote in a report that it wanted to “send out the signal loud and clear, Britain is open for business.” The country made substantive tax-policy changes such as reducing the corporate tax rate and implementing a territorial tax system.

Congress and President Obama should make tax reform a priority. That could end the death spiral and send out a signal, loud and clear, that the U.S. is also still open for business.

That said, large U.S. corporations are finding ways to remain competitive. Note that this Goldman Sachs chart (via Zerohedge) uses the median S&P 500 tax rate. In effect, the S&P 500 can almost be split in two between those companies with international tax planning capabilities and the others which suffer from the higher U.S. rate.

US companies keep buying and keep borrowing 

Highly respected Andrew Smithers looks at the recent drop in U.S. profit margins but sees no immediate danger to it.

I wrote in an earlier blog that I would become more cautious about US equities if profit margins came down. We have just had the figures for the first quarter of 2014 and profit margins have narrowed. I should therefore keep readers up to date and explain why I do not think the latest data are signalling the top of the market. (…)

The new data, published on May 29, show that profit margins fell in Q1 2014 (see chart one). Nonetheless, I think it would be premature to treat this as a clear bear signal, because it was a quarter in which corporate output fell, even when seasonally adjusted, and the severe weather can reasonably be held to blame for the decline.

The decline in profit margins means that corporate cash flow has fallen, but the message on profits is more complicated. National income and product accounts profits fell on one measure and rose on another and, importantly, the measure on which they rose is nearer than the other to the way that companies report their profits to shareholders.

The main difference between the two measures lies in the capital consumption, or CC, adjustment. The national accountants include this in their preferred profit figure. It aims to show the rate of capital consumption (aka depreciation) that allows for the impact of inflation. But companies report their profits at book values, so the capital consumption without the CC adjustment is a better guide to the profits that US companies show in their accounts.

Corporate cash flow fell, whichever way profits are defined. New data on US financial accounts, the “Z.1” published earlier this month, show that this did not affect corporate share buying. Buy-backs continued unabated at an annual rate of $400bn, which is 2.5 per cent of gross domestic product. Despite slightly lower investment and a slight fall in dividend payments, non-financial corporate debt grew even faster than before and has expanded by 9.2 per cent over the past 12 months, with the result that US non-financial companies’ leverage is now at an all-time high relative to output (see chart three).

There are therefore three reasons for not worrying too much about the fall in profit margins. First, this may well prove to be a one-off event resulting from exceptional bad weather. Second, profits in the way companies look at them rose, even as measured in the national accounts. Third, there was no diminution in company buying.

There are still, of course, some good reasons for caution. The new Z.1 data allow the value of the US stock market to be updated and, as shown on my website, as at June 6 2014 with the S&P 500 index at 1,949 points the overvaluation shown by q was 88 per cent for non-financials and 87 per cent as shown by the cyclically adjusted price/earnings ratio, or Cape, for quoted shares. (…)

The Fed is tapering, but that only slows the growth of liquidity, it does not reverse it and the more liquidity there is, the less pressure there is on other, non-corporate investors to sell.

The next lot of data on profit margins, corporate balance sheets and equity buying are due in September. There seems to me to be a good chance that profit margins will have recovered or at least stopped falling, and that companies will have continued to buy shares and raised their leverage to even greater heights.

Maybe there is immediate danger to this:

Investors lap up ultra-long bonds Sales of corporate bonds maturing in 50 years reach record levels

Issuance of the so-called ultra-long bonds has been rising in recent years, but has picked up in 2014 to reach a record $33.5bn as of Wednesday, according to Dealogic. Total issuance of ultra-long corporate debt jumped to $56.5bn in 2013, a rise of 84 per cent from 2012. (…)

On Tuesday, building-supply maker Johnson Controls sold $450m in 50-year bonds as part of a $1.7bn offering. Demand for the 50-year tranche surpassed the $3bn mark, according to people familiar with the sale. The 50-year bonds offered yields 30 basis points higher than those offered by the company’s 30-year debt.

If You Only Look at One Picture Today, Make it This One

(…) To see just how many advisors have turned bullish on stocks, I really want you to look at the below chart of the Investors Intelligence Bull Index. Under the chart, you will see a black line, indicating the S&P 500.

Chart courtesy of StockCharts.com

(…) Whenever this index has gone over 60, the stock market has come down hard. (…)

Dear reader; the odds of a very deep stock market sell-off are high. Investors have become too complacent; the past has been forgotten. The economy isn’t improving; we even had negative GDP growth in the first quarter of this year. The Fed has supported this entire stock market rebound with years of artificially low interest rates and a money printing program so aggressive that mankind has never seen anything like it before. (…)

Mike Lombardi is quick to conclude along his own bias. In reality, this particular indicator is useless (see INVESTOR SENTIMENT SURVEYS: DON’T BE TOO SENTIMENTAL!).