Durable Goods Orders Unexpectedly Rise in August

New orders for manufactured durable goods unexpectedly rose in August, coming in at $284.75B. This is a 0.2% increase from the previous month and is better than the expected 0.5% decline. The series is up 3.5% year-over-year (YoY). If we exclude transportation, “core” durable goods were up 0.4% from the previous month and up 1.1% from one year ago. (…)

Great chart by VettaFi showing the impact from Transportation and Defense while Capex have flattened over the past 12 months.

• More CFOs Pull Back Spending Plans Due to Higher Interest Rates Forty-one percent of finance chiefs said current rates have pushed them to scale back capital expenditures

In the survey [by Duke University’s Fuqua School of Business and the Federal Reserve Banks of Atlanta and Richmond], 41% of finance chiefs said current rates have forced them to pull back capital spending, while 42% said they have cut costs in other areas such as travel or advertising.

An additional 21% of respondents said they would curb capital spending, and 15% would pull back on other types of operational costs, if rates remain at current levels for another year or climb higher.

The remainder said their businesses aren’t sensitive to changes in rates, or that they weren’t sure at what rate they would pull back spending. The poll, conducted between Aug. 21 and Sept. 8, included CFOs from 320 companies.

The quarterly survey shows that CFOs are growing more concerned about higher borrowing costs. The last time the survey included the same question, in the fourth quarter of 2022, 32% of finance chiefs said they had pulled back on capital investments, while 29% said they had reduced other expenses.

Still, most finance chiefs have a positive outlook on the U.S. economy. When asked to rate their optimism about the economy on a scale of 0 to 100, CFOs on average provided a ranking of 56, up from 53 a year earlier. (…)

Government Nears Brink of Shutdown as Standoff Persists Speaker Kevin McCarthy rebuffed a bipartisan funding bill from the Senate in favor of a House plan driven by conservatives, as dim prospects for a deal raised the likelihood of a partial government shutdown.

• A Last-Minute Deal Averting Government Shutdown Is Unlikely Republican disarray weakens ability get concessions from Biden.

Canada Sees Fastest Population Growth Since 1957 on Influx of Immigrants Temporary residents grew by 46%, largest jump on record

The country’s population rose 2.9% in the 12-month period ending July 1, one of the world’s fastest growth rates, bringing the number of residents to 40.1 million. The jump was driven by the largest recorded increase in temporary residents in data going back to 1971. (…)

The number of non-permanent residents in Canada — a category that includes people on work or study permits as well as refugees — is now 2.2 million, or more than 5% of the total. (…)

The growth in the non-permanent population is “extraordinary” and was not planned by the government, Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, said by email. The increase can’t be sustained by the available supply of affordable housing, he said.

The last time Canada’s population grew faster was in 1957, nearly the height of the postwar baby boom and a period when the country was accepting Hungarian refugees who were fleeing Soviet repression. (…)

France looks at windfall levy to ‘take back control’ of energy prices

More to come…

John Authers: Rounding Up the Usual Suspects After a New Low Markets were supposed to have hit their bottom last October. Yet here we are again, with nowhere to hide. Now what?

Whose Fault Is This?

As ever, there’s a desire to apportion blame. Even more importantly, there’s a desire for a clear explanation, a narrative that is comprehensible. So it’s time to round up the usual suspects:

• Oil

(…) The latest numbers on inventories at Cushing, Oklahoma, published by the Department of Energy, showed a seventh successive weekly fall in the oil stockpile. The drawdown has been steady throughout the summer, and leaves the country vulnerable to further supply disruptions from sources beyond control, such as a cold winter or a hurricane in the Gulf of Mexico. (…)

• A Possible US Government Shutdown
• Derivatives

Colleague Lu Wang has a fascinating piece on a $16 billion JP Morgan fund that holds put options (conferring the right to sell for a given price, and used as protection against falling prices) that are on the verge of being triggered at the end of this week. If that happens, those on the other side of the options would be obliged to buy stocks, unwillingly. To guard against this, it makes sense for them to hedge by selling some stocks short, in a bet that they’ll fall. That will provide some profits to offset the losses they have to take.

When markets fall, there is always the risk that derivatives positions will mean that some individuals will take outsize losses. It’s difficult to blame an entire bear market on derivatives markets.

• The Federal Reserve

(…) the package of projections, in combination with the words of Chair Jerome Powell, sent the market into a funk. The 10-year bond yield has gained 50 basis points in the five trading days since that FOMC. Its three big jumps this month, marked on the chart below, were caused by the non-farm payroll data, the FOMC meeting, and Wednesday’s news on oil inventories.

(…) If the Fed wants some bang for its rate rises, it needs to leave them where they are for a while. It’s only recently that the notion has sunk in that the Fed really means it about keeping rates high for longer, and that is a problem. (…)

• The Yen

Foreign exchange, a series of zero-sum games in which someone has to win at someone else’s expense, offers the clearest fault lines. The greatest attention now focuses on Japan and China. The yen has dropped below 149/dollar. The level of 150, another bottom that appeared to have been reached last October, triggered intervention by the Japanese authorities last year. It’s difficult to see how much further the yen can be allowed to fall.

The greater issue for both Japan and China, however, might be the exchange rate between their own currencies. The yen has dropped to a level of 20 to the offshore yuan on two occasions in the last decade. The first time, in the summer of 2015, China responded with a poorly handled devaluation. The second time, in October 2022, Japan intervened to force its currency upward. Now, some move by Japan looks hard to avoid. As it’s still the world’s largest source of very cheap money, higher rates or bond yields there could be an issue elsewhere.

• Emerging Markets

The other typical victim of a strong dollar is the emerging markets complex. When the dollar exchange rate goes up, dollar-denominated debt gets more expensive to finance. (…) Now, the JPMorgan EM foreign exchange index, a popular benchmark, has dropped to fresh lows. There are inevitable risks in this.

• Banks

It was duration that precipitated the regional bank failures in March, as banks that had heavily invested in longer bonds were unable to access liquidity without taking losses. Judging by the share price of regional banks, which only made an unconvincing recovery and are sagging again, and even of the much larger Bank of America Corp., which is seen as vulnerable to further falls in bond prices, worries that duration will cause more financial accidents are still with us. (…)

At 4250:

• The S&P 500 is up 18.6% from its Sept. 30 2022 close when its trailing P/E was 16.2 and its Rule of 20 P/E was 22.5.
• Since then, trailing EPS have declined 2.5%, bringing the trailing P/E to 19.6 and the R20 P/E to 23.9.
• Ten year Ts were at 3.8%, now 4.6%.
• Core CPI was +6.3%, now 4.3%.
• Oil was $79/bbl, now $93/bbl.

China’s way to prevent a domino effect

Chain of events:

• Reuters on Sept. 7, 2022: China state firms takeover Evergrande’s $1.1 bln holding in Shengjing Bank

State-owned companies of the Chinese northestern city of Shenyang bought China Evergrande Group’s shareholding in Shengjing Bank in an auction for 7.3 billion yuan ($1.05 billion), Alibaba auction platform showed on Wednesday.

In July, Evergrande, the world’s most indebted property developer, said its unit, Evergrande Nanchang, had been ordered to pay an unamed guarantor 7.3 billion yuan for failing to honour debt obligations.

The unit has provided counter-guarantees in the form of a pledge of a total of 1.3 billion shares that it held in Shenyang-based Shengjing Bank, the firm said at the time. (…)

The 1.3 billion shares account for a 14.6% stake in Shenjiang Bank. Evergrande, which held 36.4% in the bank at the end of 2020, has been selling down its holdings in the bank since it slid into a debt crisis in the second half of last year.

• Reuters on Nov. 1, 2022: China Evergrande unit gets notice for $4.48 bln loan from Shengjing Bank

Debt-laden property developer China Evergrande Group said on Tuesday its unit received a notice of enforcement for unrecoverable funds from Shengjing Bank Co Ltd.

The bank said it failed to recover funds totalling 32.595 billion yuan ($4.48 billion), which was provided to the unit from 2020 to 2021, according to Evergrande. (…

• Buried within Reuters yesterday: China’s Shengjing Bank in $24 billion deal to sell assets to government-backed entity

Chinese regional lender Shengjing Bank (2066.HK) said on Wednesday it has agreed to sell a portfolio of assets, including certain loans and investments, among others, for 176 billion yuan ($24.07 billion) to Liaoning Asset Management.

Liaoning Asset will fund the purchase of assets by issuing special-purpose notes to the bank, the lender said.

Over 70% of the assets to be disposed are loans and the remainer include asset management plans, corporate bonds and deposits with banks, Shengjing bank said.

Liaoning Asset, which focuses on transactions of non-performing assets of financial institutions, is a unit of Liaoning Financial Holding owned by the finance authority in the Chinese province of Liaoning, where Shengjing Bank is based.

Last month, Shengjing Bank reported a 21.8% drop in its net profit attributable for half-year to 737.9 million yuan.

So, state-owned companies bought Evergrande’s stake in a bank that was a lender to Evergrande. Two months later, the bank called its $4.5B loan to Evergrande, which is unable to oblige.

The now distressed bank is “selling” a bunch of non-performing loans ($24B!!!) to another “government-backed entity”, getting paid, not with cash, but with “special-purpose notes” that will conveniently find their way to “performing loans”.

Voilà!

More to come.

• Finally, There’s More Money Than Fools in China Investors have become risk averse, shunning the markets in favor of bank deposits.

(…) For evidence of that changing sentiment, look no further than consumers’ savings data and the central bank’s quarterly urban survey. As of August, household deposits totaled a record 132 trillion yuan ($18 trillion), blowing past China’s entire gross domestic product last year. People keep on putting money into banks even as the People’s Bank of China cuts deposit rates.

It’s well-known the Chinese have been hoarding cash since the pandemic. But this behavior started as early as 2018. By then, households had already gone through a rollercoaster ride of excitements and disappointments. In fact, their preference for buying investment products, such as stocks, bonds and trusts, has been on a steady decline since the 2015 crash, according to the central bank survey.

This risk-off mentality creates a big headache for the government, in that it inevitably dampens new policies aimed at boosting market sentiment. (…)

The Shanghai Composite Index hovers at around 3,100, more than 40% below its record high in 2007. In the property market, existing home prices have fallen by at least 15% from their peak in more than half of China’s tier-2 and tier-3 cities. (…)

People have realized that taking risks doesn’t benefit them, at least not in the current political economy. They have money, but prefer sitting on the sidelines.

Bloomberg: BEST B-SCHOOLS 2023–24

WSJ: COLLEGE RANKINGS The Top U.S. Colleges for Partying

New Home Sales Tumble in August

The August release for new home sales from the Census Bureau came in at a seasonally adjusted annual rate of 675,000 units, below the forecast of 700,000. New home sales were down 8.7% month-over-month from a revised rate of 739,000 in July but up 5.8% from one year ago. The median home price is now at $430,300, down $6,300 from July on a nominal basis. (…)

• Builders Use Price Cuts to Spark Demand

In order reinvigorate buyer interest, builders may be furthering the use of price discounts. As of August, the median new home price has declined 2.3% on a year-over-year basis. The September NAHB homebuilder survey found 32% of builders reported offering price discounts, up from 25% in August and the highest share since December 2022.

Price discounting on the part of builders has narrowed the difference between new homes prices and existing home prices, which are now back on the rise following a brief slump in the second half of 2022. Separately reported, the S&P CoreLogic CS 20-City home price index rose 0.9% during July, the fifth consecutive monthly gain. Higher mortgage rates have led to a decline in existing home sales, but lean resale inventories are exerting upward pressure on home prices.

Compared to the existing market, there is a relative abundance of new homes available for sale. At the end of August, there were 436K units for sale, up 1.2% during the month and equivalent to 7.8 months supply. Since peaking at 9.7 months late 2022, months supply has trended lower over the past year, although the slower pace of sales yielded a slight increase during August.

Second quarter data from the Census’s Quarterly Starts and Completions report was released last month and revealed that newly built homes are getting smaller. The median square footage of a newly started single-family home fell to 2,191 feet, over 100 sq ft smaller than a year ago and the lowest level since late 2010. These smaller homes may provide a more affordable alternative for prospective buyers who have been priced out of larger properties.

  

While housing affordability is at an historical low, and still declining, there is a strong consensus that rental costs will drop. The supporting evidence are charts like this one showing how CPI-Shelter is about to follow private rent deflation.

But the reality is that rent on new leases are actually not declining, merely flattening at a level 25% above its 2021 low.

The above data is for new leases, less than 10% of all leases. Renewals are still inflating 4-5% according to public company statements, supported by the BLS data:

We all know that the BLS data is a slow moving average of actual rents but it still is not showing much of the slowdown everybody and the Fed have been expecting, is it?

People have to live somewhere, those who can’t buy must rent. Since the pandemic, homes have appreciated 45% on average while CPI-Rent is up 19%. And home prices have turned back up…

China Has Second Thoughts About Controlling Prices in Its Massive Housing Market China is starting to loosen pricing rules in its housing market—with unpredictable consequences.

(…) Under the rules, which were applied in dozens of cities, local governments typically blocked developers of new homes from offering discounts of 10% to 15% or more on unsold properties. In some cities, officials put a floor on sale prices for existing homes as well. 

In recent weeks, articles appearing in state media have argued that it may be time to ditch the policies and some cities are starting to loosen them. On Tuesday, the southwestern city of Chengdu removed price restrictions for projects on newly sold land in central areas and scrapped government-guidance prices for existing homes.

A broader retreat from price floors could help developers to clear inventories of unsold properties and raise revenues to pay down their sizable debts, setting the stage for a potential recovery.

But it could also expose Chinese homeowners to bigger drops in home prices, hurting consumer confidence when growth is weak—and potentially destabilizing the financial system.

About 96% of urban households in China owned an apartment as of 2019, according to the country’s central bank. And for many, their home is their largest financial asset. (…)

Private data shows home sales among China’s 100 largest developers plunged by 34% in August from a year earlier, extending a decline since April. Pain from the slowdown has rippled through the economy, depressing consumer spending and construction activity. (…)

Chinese developers had more than 313 million square meters of unsold residential development as of August, up 20% from a year earlier, according to official data. That is around 3.5 million homes, based on the average home size of around 90 square meters. (…)

If property values drop 30% in China—as much as they fell in Tokyo and Hong Kong during past downturns, ANZ said—about 12% of the country’s $5.3 trillion mortgage book, or around $640 billion in mortgages, would have negative equity, meaning the properties would be worth less than their mortgages.

If prices drop by half, about 51% of mortgages would be underwater.

In the U.S., nearly a third of all homeowners with a mortgage had negative equity in the aftermath of the financial crisis, according to Zillow. (…)

Rising Loan Costs Are Hurting Riskier Companies Investors fear unsustainably high interest rates will spark bank-loan defaults.

(…) Many companies borrowed at ultralow rates during the pandemic through so-called leveraged loans. Often used to fund private-equity buyouts—or by companies with low credit ratings—this debt has payments that adjust with the short-term rates recently lifted by the Federal Reserve. (…

Nearly $270 billion of leveraged loans carry weak credit profiles and are potentially at risk of default, according to ratings firm Fitch. (…) Excluding a 2020 spike, the default rate for the past 12 months is the highest since 2014. (…)

“The No. 1 risk to leveraged loans is if we get a big slowdown in the economy.” (…)

Fitch expects about $61 billion of those loans to default in the next two years, the “overwhelmingly majority of which” are anticipated by the end of 2023. (…)

Historically, creditors have recovered about two-thirds of their initial loans during defaults, according to Adatia, but he expects that will be much lower now.

“The overall quality of loan documents is atrocious right now,” he said. “This is 15 years in the making.”

• US small cap stocks wilt in the heat of higher interest rates Smaller companies’ weaker balance sheets exposed by ‘higher for longer’ environment

Goldman Sachs calculates that 30% of Russell 200 companies’ debt is floating-rate vs 6% for S&P 500 companies.

• Dimon Warns 7% Fed Rate Still Possible, Times of India Says Difference between 5% and 7% more painful than 3% to 5% was

(…) “We urge our clients to be prepared for that kind of stress,” the JPMorgan Chase & Co. CEO said in an interview with the Times of India, saying a hard landing remains a risk for the US economy. (…)

Here’s how interest rates are eating on S&P 500 companies’ profit margins, as of Q2:

By market cap:

LSEG IBES data show small and mid cap index forward earnings about flat. Note that while S&P 500 forward EPS are up 4.2% from their June 30 estimate, the S&P 400 and 500 estimates are up 0.5% and 1.5% resspectively. I would not bet my shirt on the Russell 2000 estimate which is up 7.3% from June and includes a bunch of unprofitable companies.

The World’s Biggest Crypto Firm Is Melting Down More than a dozen senior executives have left Binance, and the exchange has laid off at least 1,500 employees this year.

After FTX crashed, the world of crypto seemed to belong to the largest exchange, Binance. Less than a year later, Binance is the one in distress.

Under threat of enforcement actions by U.S. agencies, Binance’s empire is quaking. Over the past three months, more than a dozen senior executives have left, and the exchange has laid off at least 1,500 employees this year to cut costs and prepare for a decline in business. And while Binance still looms large in crypto, its dominance is dwindling.

Binance now handles about half of all trades where cryptocurrencies are directly bought and sold, down from about 70% at the start of the year, according to data provider Kaiko. (…)

The U.S. Justice Department has undergone a yearslong investigation that could result in criminal charges for Binance and Zhao as well as billions of dollars of fines, according to people familiar with the probe.

Binance also faces a Securities and Exchange Commission lawsuit that alleges it and Zhao operated illegally in the U.S. and misused customers’ funds. The firm has acknowledged past mistakes but says customer money is safe and it is committed to compliance. (…)

In the U.S., activity at its local exchange, Binance.US, has basically dissipated. Its chief executive officer, legal chief and risk head all left recently.

In a virtual Binance.US meeting days before his departure earlier this month, Binance.US CEO Brian Shroder said revenue at the exchange had fallen 70% year to date, according to a presentation viewed by the Journal. Executives looked on with dismay.

Shroder told employees Zhao would need to resolve “his regulatory matters, put his .US holdings in a blind trust, or sell his shares” in order for the U.S. platform to maintain its growth initiative. Those steps would allow the company to unblock banking relationships and get licenses, he said. Zhao is the majority owner of Binance.US and the global exchange. (…)

In Europe, more countries are shutting their doors to the exchange. (…)