FLASH PMIs

USA: Fastest uptick in US private sector business activity for almost a year, as new orders return to growth, but selling price inflation accelerates

The S&P Global Flash US Services Business Activity Index posted 53.8 in March, up from 50.6 in February to signal a solid expansion in service sector business activity. The rise in output was the fastest since April 2022, with firms linking the upturn to stronger demand conditions and a renewed increase in new business.

New orders at service providers increased for the first time since last September, as greater client activity sparked a modest upturn in new sales. The expansion in new business was the fastest since May 2022 with domestic and foreign client demand both improving.

Input prices rose markedly again in March, despite the rate of cost inflation softening to the second-slowest since October 2020. Firms’ pricing power was buoyed by stronger demand conditions, as they raised their selling prices at the sharpest rate for five months.

A renewed upturn in new business led to the fastest increase in backlogs of work since May 2022. Pressure on capacity subsequently drove job creation, as service sector employment rose at the steepest rate since last September.

Service sector business expectations regarding the outlook for the coming year remained upbeat during March. Concerns relating to inflation and higher interest rates nonetheless weighed on confidence, as the degree of optimism dipped from that seen in February to below the series average.

At 49.3, the S&P Global Flash US Manufacturing PMI was up from 47.3 in February, and signalled a slight deterioration in operating conditions across the manufacturing sector during March. The rate of decline in the health of the sector was the slowest in the current five-month sequence of deterioration amid a renewed rise in production and a softer fall in new orders.

Output across the goods-producing sector increased for the first time since last October, and at the steepest rate for ten months. Companies noted that greater production stemmed from a less marked contraction in new sales. The decline in new orders was the slowest in the current six-month sequence of decrease amid signs of improvements in demand conditions. New export orders fell at a sharper pace, however.

Inflationary pressures across the manufacturing sector softened in March. Rates of increase in input costs and output charges slowed as firms noted less marked supplier price hikes and moderations in some raw material costs. The rise in cost burdens was the second-slowest since July 2020, as companies increased their selling prices at the softest rate since October 2020 in a bid to remain competitive.

Increased output and an unprecedented improvement in supplier delivery times led to a slower fall in input buying and a softer depletion of pre-production inventories. Lead times were reduced to the greatest extent on record (since May 2007), allowing firms to start replenishing stocks and process backlogs of work, which fell solidly. At the same time, post-production inventories expanded for the first time in four months.

Employment continued to rise at a modest pace in March, with the rate of job creation broadly in line with the series average. Firms noted further difficulties finding skilled candidates.

Finally, output expectations regarding the next 12 months were buoyed by hopes of greater investment, increased marketing spending and boosts to client demand. The degree of confidence was below the series trend, however, and the lowest for three months, amid inflationary concerns and uncertainty about the outlook for demand.

The [Composite] PMI is broadly consistent with annualized GDP growth approaching 2%, painting a far more positive picture of economic resilience than the declines seen throughout the second half of last year and at the start of 2023. (…)

There is also some concern regarding inflation, with the survey’s gauge of selling prices increasing at a faster rate in March despite lower costs feeding through the manufacturing sector. The inflationary upturn is now being led by stronger service sector price increases, linked largely to faster wage growth.

My take is that the U.S. economy is hanging in thanks to services but the “modest upturn in new sales” makes this fragile. Services employment, wages and pricing power remain solid while the goods sector is in recession. Not stagflation, slowflation rather.

EUROZONE: Service sector revival powers eurozone growth higher in March

• Flash Eurozone PMI Composite Output Index at 54.1 (Feb: 52.0). 10-month high.
• Flash Eurozone Services PMI Activity Index at 55.6 (Feb: 52.7). 10-month high.
• Flash Eurozone Manufacturing Output Index at 49.9 (Feb: 50.1). 2-month low.
• Flash Eurozone Manufacturing PMI at 47.1 (Feb: 48.5). 4-month low.

(…) A key development was the further revival of growth in financial services, with a notable turnaround in real estate activity compared to late last year, despite recent concerns regarding banking sector stability and higher interest rates. Consumer services activity also continued to revive from the downturn seen late last year, notably in respect to travel and tourism. Growth was also recorded in industrial services, IT and healthcare.

Measured across both sectors, new orders rose for a second month in a row and at the steepest rate since last May. However, an increased rate of growth of new business in the service sector contrasted with a steeper rate of loss of new orders in manufacturing, which has now seen order inflows fall for 11 successive months.

The backlogs data therefore suggest that rising levels of outstanding work will help support further service sector growth in coming months, but in manufacturing existing output is only being sustained by eating into previously-placed orders, posing downside risks to future output.

Average prices charged for goods and services meanwhile continued to rise sharply, the rate of increase falling further from the peak seen last year to the lowest since May 2021, though remaining higher than any time in the survey’s history prior to the pandemic.

Especially elevated output price inflation was seen in services, albeit down to a 13-month low, while prices charged for goods leaving the factory gate rose at the slowest rate since January 2021.

Employment growth meanwhile picked up to reach a nine-month high in March, accelerating notably in services to a ten-month high as firms sought to keep pace with rising demand, but holding steady in manufacturing at a relatively slower pace that was among the lowest seen over the past two years.

China’s economic rebound weaker than expected, warns Maersk 70 per cent of Chinese savings are in real estate, which has been hit hard by a government crackdown on leverage, while Chinese stocks were also underperforming.

Buy-or-Rent Premium Is Highest Since 2006 Housing Bubble

With mortgage rates high and home prices still elevated, the monthly payment for a newly purchased home — assuming a 10% down payment and a 30-year fixed rate mortgage — was $1,176 more than renting an apartment at the end 2022, according to an analysis from the National Multifamily Housing Council, a trade group that represents owners of professionally managed rental buildings.

The cost of homeownership has surged 71% over the past three years, or an average of about 20% per year, compared to average annual rent growth of 6.3% over the same period. As a result, the premium owners pay over renters is now wider than it’s been since third quarter of 2006, the report said. (…)

Relief from covid money is more than over. Delinquencies on credit cards are rising sharply and are now at 2010 levels for all age groups on their way to 2008 levels:

Delinquency rates on CC loans are particularly high at smaller banks. While smaller banks are only a fraction of the CC business, their recent poor credit experience likely reflects loose lending standards overall…

…potentially also applied to their CRE loans which totally dominate that segment.

A severe recession could wipe out $140B of small bank equity. MS data show banks hold 38% of the $4.5B CRE debt outstanding. Smaller banks own 80% of that debt, $1.4B.

• Banks Step Up to Serve Crypto Firms After Signature, Silvergate Blowups As crypto companies have scrambled to establish new bank relationships, industry executives say they have received a positive reception from some regional banks.
• Small U.S. banks imperiled by big office loans

Small U.S. lenders that have outsized exposure to office loans could become the next group to face strains after bank failures roiled financial markets this month, according to analysts.

Rising interest rates, a slowdown in the commercial real estate (CRE) market and the proliferation of remote work pose challenges for smaller firms that made risky loans to finance office buildings, the analysts said.

For banks with assets between $1 billion to $10 billion, CRE loans comprised about 33% of the total held on their books, according to estimates by ratings agency Fitch. At the end of last year, CRE only made up about 6% of loans held by larger banks that had total assets of more than $250 billion, it said.

Goldman Sachs economists estimate the combined share of small and mid-sized banks, including lenders with less than $250 billion in assets, is 80% of the overall stock of commercial mortgage loans, it said in a note. (…)

The total exposure of the U.S. banking system to CRE loans was $2.5 trillion at the end of December, Fitch said. (…)

Dror Poleg

FT

• Financial bankruptcy filings on the rise in 2023 SVB Financial Group’s Chapter 11 bankruptcy filing March 17 marked the ninth corporate bankruptcy filing in the financial sector in 2023, the highest level since 2010 for the first two-and-a-half months of the year, according to S&P Global Market Intelligence data.

Monetary Tightening and U.S. Bank Fragility in 2023

This is from the NBER last week

A case study of the recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower capitalization than SVB. On the other hand, SVB had a disproportional share of uninsured funding: only 1 percent of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run. We compute similar incentives for the sample of all U.S. banks.

Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs.

Now that banks can sell their underwater bonds at par to the Fed, the risk to their equity capital is substantially reduced. But uninsured deposits will continue to flee, severely limiting these banks’ ability to lend.

Money market inflows accelerated further this week, suggesting bank deposit flight continued. Last week $116 billion flowed into US money market mutual funds. This week $136 billion flowed into US money market funds (the 4th largest weekly inflow since 2007) suggesting deposit flight continued this week. (GS)

Larger banks are also seeing cash going out toward higher return instruments like mutual funds which are not in the lending business.

(FT)

SVB Collapse Could Mean a $500 Billion Venture Capital ‘Haircut’

The $2 trillion venture capital industry could see portfolio markdowns of 25% to 30% — a “haircut” of possibly $500 billion — following the Silicon Valley Bank debacle, according to Bloomberg Intelligence.

“After the failure of SVB, we expect greater valuation scrutiny and disclosure, especially as a large chunk of ‘fiduciary’ capital from pension funds has flowed into these markets — and unlike endowments and family offices, there are no avenues to extend and pretend,” Bloomberg Intelligence analyst Gaurav Patankar writes in a note Friday.

Some VC and private equity firms are turning toward strategies to “extend” and “pretend,” meaning they would hold on to assets or prop up capital to avoid true price discovery, Patankar added in a Friday interview. Examples of this include net asset value loans that let general partners borrow against a pool of portfolio companies within a fund, GP-led secondary structures where a fund sponsor sells one or more assets from a fund it already manages to a new fund, and alternative financing via private credit. (…)

The Information informs us:

Tonal, a fitness startup with a cadre of celebrity backers, is crunched for cash after failing to find a buyer. The company now may take a drastic step: raising money at a valuation nearly 90% lower than its last one, in a deal that would effectively wipe out the stakes of many existing investors, people familiar with the matter said.

Private equity firm L Catterton, a current Tonal shareholder, is in talks to lead the funding round, which is expected to total $125 million at a valuation of between $200 million and $300 million, the people said. That would compare to the valuation of $1.6 billion at which Tonal last raised money, in 2021. The potential financing would be one of the harshest down rounds for a once high-flying startup that last raised money during the era of low interest rates.

Likely not the only one…

Central Banks Shed Most US Debt Since 2014 as Dollar Needs Jump

Fed data show foreign official holdings of Treasury securities fell by $76 billion in the week through March 22 to $2.86 trillion. That’s the largest weekly decline since March 2014.

At the same time, the US central bank’s recently-established Foreign and International Monetary Authorities, or FIMA, repurchase agreement facility was tapped for a record $60 billion, data show, dwarfing the $1.4 billion peak reached during the height of the pandemic. (…)

The dash for dollars all happened before the focus pivoted to Deutsche Bank AG Friday. (…)

“Our sense, given dollar funding rates, is that the borrowing was precautionary,” Barclays Plc strategist Joseph Abate said of the surge in use of the Fed’s FIMA program.

The facility was established in March 2020 and is designed to help ease any pressures in global dollar funding markets. It allows foreign central banks to post their US Treasury holdings as collateral in exchange for dollar liquidity, which is often in high demand during times of stress. The rate was 4.75% at the time of the operations, before the Fed raised borrowing costs by another quarter-point this week.

The weekly average level of usage as of Wednesday was $33 billion, which suggests an institution made multiple trips to the FIMA facility, according to Barclays.

“The central bank wanted to build a war chest of available dollars in case the banking crisis deteriorated but did not want to fire sell its Treasuries,” Abate wrote in a note to clients. (…)

“Someone, somewhere, needs dollar funding,” said Antoine Bouvet, senior rates strategist at ING Bank NV. It’s “not a huge worry at this stage given the cross-currency bases and also low take-up in dollar FX lines.” (…)

Note that the FIMA program was designed “primarily [to] be used only in times of unusual market stress” according to the Fed. It requires that counterparties post U.S. Treasury collateral at an approximate 5% annual rate.

• @Jkylebass: so it appears that the secret borrower of USD from the FED could be China.

Meanwhile, across the pond

Deutsche Bank Drops in Selloff Citi Describes as Irrational

(…) Analysts struggled to explain the selloff, which prompted German Chancellor Olaf Scholz to publicly back the lender. (…)

“Deutsche Bank has fundamentally modernized and reorganized its business model and is a very profitable bank,” Chancellor Scholz said Friday at a news conference in Brussels when asked about the lender’s situation. “There is no need to worry about anything.” (…)

@biancoresearch: This is not the stock chart of a company that is “fundamentally modernized and reorganized its business model and is a very profitable” as Scholz contends.

All of the above screams some sort of a credit crunch is coming. If the Fed saved banks from deposit runs, will it want to have to save them from a CRE crisis potentially engulfing many small and medium-size banks.

A bit of inflation for a while may be more desirable.

COLLATERAL DAMAGE?

Buyback warning (The Market Ear)

“The 20% year/year decline in buybacks during 4Q 2022 is likely one early signal of a broader slowdown in corporate spending. Buybacks typically lead stickier investment spending in capex and R&D. Despite a record $360 bn in YTD authorizations, GS Buyback Desk flows suggest actual YTD executions are running well below 2022 levels. Economic data that have historically been leading indicators of capex have also turned lower in recent months.”

Goldman

Corporations will buy a net $350 billion in equities in 2023, a 47% slowdown vs. 2022. According the GS Buyback desk, a record high $360 billion of stock buybacks have been authorized so far this year. However, authorized buybacks are concentrated among a handful of companies and executions are down significantly vs. 2022. We expect just 1% EPS growth this year and forecast S&P 500 buybacks will decline 10% from a record high of $949 billion in 2022. M&A activity has also slowed materially YTD.

  JPM Asset Management:

While the odds of a U.S. recession have increased in light of all this, the risk outlook for the markets is becoming more balanced. Monetary policy should pose less of a headwind for stocks going forward. Economic data is moving in the right direction and the slowdown in inflation, wages and activity should become more pronounced in the coming months.

Moreover, if the outlook worsens, the Fed could ease monetary policy, which could provide significant support to financial markets.

Meanwhile, the investment landscape still presents opportunities. Bonds can provide portfolios with attractive income and some capital appreciation when the Fed eventually cuts rates. An emphasis on quality is important, but broadly speaking, equity markets tend to perform well in the 12months following an end of a tightening cycle. By no means are we looking at clear skies yet, but calmer waters after a tumultuous March could provide support for balanced portfolios in the remainder of the year.

Hmmm…my own analysis (Jan. 10 2023) showed that “buy-the-pivot” ain’t so simple.

The black circles in these next charts (log left scale) point out periods when equities fell during Fed easing periods:

While it is true that equities eventually tend to do well after Fed easing episodes, “eventually” is the key word here: most times, the Fed eases for “good” reasons. Equity markets are not always in sync with the FOMC and some lags have been very costly.

I found 15 “Fed changes of posture” since 1957.

• From the first pause to the market low, the S&P 500 troughed 9 months after, on average. But the range is -3 months to +31 months.
• From the first cut to the market low, the S&P 500 troughed 6 months after, on average. But the range is -3 months to +21 months.

Actually, the S&P 500 declined after every Fed cut but five (1966, 1980, 1984, 1989, and 1995). Equities dropped between -4.0% to -47.7% (month end data) with an average of -16.1%. If we exclude 1974 (inflation) and 2001 and 2007 (bubbles), the average is -5.9% (range: 0.0% to -19.9%).

And I found no stable correlation with valuations, inflation and profit trends that could help decide when it might be safe to jump in.

A dovish turning Fed then only tells us to reduce our underweight and get ready to buy more aggressively.

Also illustrated by elliottwave international:

• Despite banking concerns, insiders have been buying

Talk of a “banking/financial crisis” has dominated the business news in recent weeks. Even so, Jay noted that financial corporate insiders have been voting with their wallets.

The chart below displays Corporate Insider Buys among component companies of the Financial Select Sector SPDR Fund ETF (XLF) and denotes those times when the indicator crossed above 39.9. Note the sharp uptick in buying over the past two weeks. Under similar buying conditions, XLF rallied 88% of the time between 2-12 months later and outperformed the S&P over the next year after 6 of 8 signals.

Insiders would presumably be more inclined to sell shares if they anticipated a collapse in their sector. While insider selling has picked up somewhat, it remains subdued relative to other periods. The indicator below combines buying and selling activity into the Corporate Insider Buy/Sell Ratio – XLF indicator. The red dots note those times when the ratio has crossed above 0.139. Again, mostly gains over the medium-term.

• Outside of banks, insiders give the US market the cold shoulder (INK Research)

Insider buying has picked up over the past week, but the response outside of the Financials sector has been underwhelming. That may be explained by the behaviour of the broad market compared to the Financials group. The S&P 500 has not changed much over the past month, but as of Monday, the Dow Jones U.S. Banks Index was down about 20% during the period. Potential bargains are simply easier to find in the Financials than in the broad market.

We see the INK US Financials Indicator has moved over 100%, led by the banks. In light of this meaningful insider buying, we have put the Financials sector on watch for a possible upgrade to undervalued. We are also watching the Energy sector for
a possible upgrade as insider sentiment continues to climb.

(…) the INK US Indicator, which tracks insider sentiment across listed companies on the major US exchanges, sits at an unimpressive 33%. That means there have been three stocks with key insider selling for every one stock with key insider buying over the past 60 days. Moreover, insider selling measured in dollars has picked up and is now above average as we near the end of Q1.

The broad American market remains unattractive from an insider sentiment perspective. Based on our signals, passive investors betting on a buy-and-hold strategy via market-cap-weighted ETFs are likely to remain frustrated for months to come.

Ink’s list of companies with net insider buying and selling can be accessed in the Inside Insiders section of my SPECIAL FRIENDS PLACE.

Ed Yardeni:

Eight of the 11 S&P 500 sectors are down ytd, led by an 11.1% drop in Energy and a 9.4% decline in Financials, while only three are up ytd, namely Communication Services (18.4%), Information Technology (17.5), and Consumer Discretionary (9.6). The three outperforming sectors are doing well because they include the MegaCap-8 stocks, which as a group are up 26.5% ytd based on their collective market cap.

FYI, these 8 MegaCap stocks average a 43.3 trailing P/E, 37.6x on forward.

  REALLY COOL!!

Zipline, the logistics company: https://www.youtube.com/watch?v=DOWDNBu9DkU

Steady Jobless Claims Show Labor Market Remains Strong New applications for unemployment benefits fell by 1,000 last week

The four-week average of weekly claims, which smooths out volatility in the weekly numbers, edged lower last week to 196,250.

Claims have remained at or below the 2019 prepandemic average of about 220,000 for several months. The trend held even as large employers in interest-rate sensitive industries such as technology, finance and real estate cut jobs. (…)

But even with the job-cut announcements, there hasn’t been an uptick in filings for unemployment benefits. (…) Some workers may be forgoing applying for jobless assistance because they are quickly finding new work or are receiving generous severance packages. (…)

The level of insured unemployment is somewhat elevated from a low point of about 1.3 million last spring. Modestly elevated continuing claims could be a sign some beneficiaries are taking longer to find new jobs.

Claims always rise prior to recessions. Not happening yet. Continuing claims also always rise prior to recessions. There was a 23% jump last fall but flat since.

Gundlach Joins Powell-Is-Wrong Chorus Predicting Rate Cuts

(…) Swap markets are suggesting the Fed is probably done with its current cycle of rate increases, with the chances of a quarter-point hike in May falling to just one-in-three. The market is also pricing for at least three quarters of a point of easing by year-end, despite Fed Chair Jerome Powell’s insistence Wednesday that officials don’t anticipate cutting rates.

Gundlach, DoubleLine Capital LP’s chief investment officer, sees the Fed cutting rates “substantially” soon, according to posts on Twitter. He also warned of “red alert recession signals” emanating from the US yield curve. (…)

Traders have regularly underestimated the size of the Fed’s hikes. They first started anticipating a policy pivot in the middle of last year — betting the central bank’s rate would be lower in a year’s time than they expected it to be in six months — but so far all those wagers have proved fruitless.

“Investors are seeking safe-haven yields over fears of banking stresses and tighter financial conditions, worries about the commercial real estate industry and a general view that the Fed — and BOE today — have taken policy rates too deep into restrictive territory, for now,” said William O’Donnell, US rates strategist at Citigroup Global Markets. (…)

Banks Are Still Drawing on the Fed for $164 Billion of Emergency Cash Borrowing from the Fed’s new lending program rose to $53.7 billion.

US institutions had a combined $163.9 billion in outstanding borrowings in the week through March 22, compared with $164.8 billion the previous week, according to Fed data Thursday.

Data showed $110.2 billion in borrowing from the Fed’s traditional backstop lending program known as the discount window compared with a record $152.9 billion in outstanding credit the previous week. The loans can be extended for up to 90 days and the window accepts a broad range of collateral.

Outstanding borrowings from the Bank Term Funding Program stood at $53.7 billion, compared with $11.9 billion the previous week. The BTFP was opened March 12 after the Fed declared emergency conditions following the collapse of California’s Silicon Valley Bank and New York’s Signature Bank.

Fed loans to bridge banks established by the Federal Deposit Insurance Corp. to resolve SVB and Signature Bank rose to $179.8 billion from $142.8 billion the previous week.

“There’s nothing here, which suggests things aren’t spreading,” said Blake Gwin, head of US interest rates strategy at RBC Capital Markets. (…)

• Deutsche Bank Shares Slump as Credit-Default Swaps Surge The stock dropped 10%. The cost of insuring DB’s debt against default jumped as five-year credit default swaps widened by 24 basis points to 193 basis points on Friday morning, after jumping by the highest amount on record the day before.
• John Authers:

(…) That dive for the banks is one for the history books. Falls like this don’t happen at all often, and when they do tend to mean bad things for everyone else. The following chart, from the terminal, shows banks’ performance on one axis, and the S&P 500 on the other, both on a log scale. When banks fall badly relative to everyone else, the broader market tends to decline, as I’ve tried to mark with the colored rectangles. That’s because banks matter to the economy. When they’re in trouble, it’s much harder for anyone else to make a profit:

The implicit bet being made in markets at present is that the banks really are in trouble. That will lead to lower rates, and quickly. Those reduced rates will in turn buoy the stock market. The part missing from this equation is that troubled banks would damage economic activity, and it would only be because of this that rates fell. Absent confidence of a serious economic slowdown driven by the banking sector, the current bet on stronger stocks and lower bond yields involves fighting the Fed, which insists it won’t be cutting this year.

So how to justify the continued strength of the market while bank investors are so obviously worried? Maybe there’s hope for a bailout in some form that will hurt banks’ shareholders but rescue everyone else. That’s not outlandish. Or possibly, everyone else thinks that the investors are unnecessarily panicking — in which case we should expect a banking rebound pretty quickly. Or it’s just a Pavlovian reaction that any fall in rates is a reason to go out and buy tech stocks. Whichever alternative holds, the combination of deeply troubled banks and strong performance for the rest of the stock market cannot persist much longer. (…)

Bloomberg Economics has estimated that the stress on financials should translate to the equivalent of an extra 50 basis points on the fed funds rate in the US.

So, Wednesday’s 25bps rise was actually +75bps!

The FOMC sees tepid GDP growth ahead (my red bar is at the last 10 year average ex-pandemic):

But we know that the Fed’s forecasts can miss wildly. Prior to the last 7 recessions, the FOMC’s GDP growth estimates overshot by 2.9% on average per Rosenberg Research which adds

But worse is the Fed funds rate calls — the one thing they actually control they get wrong nearly two-thirds of the time. Just remember — at the end of 2019, the dot-plots were at 1-5/8% on the funds rate for the end of 2020 and we ended up at 0% (with everlasting QE). At the end of 2021, the call was for a 0.9% median dot-plot and we ended up north of 4%. What more do you need to know?

David’s math:

The one thing that was very interesting is the +0.4% real GDP growth forecast for 2023 (on a Q4/Q4 basis), and I say that because the Atlanta Fed Nowcast is +3.2% annualized growth for Q1 (front-loaded by the weather in January) — stringing out what this means for the balance of the year is a steady diet of -0.5% GDP prints (sequential) for Q2, Q3, and Q4.

So even as Powell suggested that this banking sector situation won’t spin out of control, the Fed is implicitly calling for a three-quarter recession starting two weeks from now!

And we know that the S&P 500 never ever bottoms when the recession is just getting started — looking over the valley means seeing the whites of the eyes of the economic recovery, which will be a 2024 story best saved to be having priced in by the fourth quarter of this year and not earlier.

Evergrande Strikes Deal for Bond Restructuring The restructuring has been agreed to by a group that holds more than a fifth of the property developer’s international bonds. Other bondholders have until March 31 to approve the restructuring.

(…) Evergrande had contracted sales of the equivalent of $4.6 billion in 2022, down from $64 billion in annual sales in 2021 and more than $100 billion before its financial problems mounted.

The company said its main objective over the next three years is finishing properties it is currently developing. It needs $36 billion to $44 billion of new funding to do that. Evergrande plans to use any money generated by its existing projects to pay back this new financing, rather than to settle old debt.

• Evergrande Restructuring Is a Warning to China’s Other Creditors Offshore creditors who lent property developer billions are discovering they have little recourse

(…) Many investors piled into those bonds on the assumption that Beijing would never allow a truly widespread property bust because of the fraught politics of homeownership in China. That assumption proved wrong, and now they are likely to pay a steep price. (…)

The fundamental problem is that most of Evergrande’s assets reside in the onshore operating company, which also has its own debts. Offshore creditors were lending to the holding company and would rank lower than those onshore creditors. Evergrande had about 613 billion yuan, the equivalent of $90 billion, of onshore liabilities at the end of 2021 and about 141 billion yuan of offshore liabilities. (…)

Evergrande’s restructuring plan may end up as a template for other beleaguered Chinese developers with lots of offshore debt such as Sunac and Kaisa. As in the case of Evergrande, offshore investors lent to an offshore holding company rather than the onshore entities directly holding assets.

That means that they, too, could end up last in line for repayment. The long-term damage to Chinese companies’ ability to borrow offshore may be substantial—but in the meantime foreign creditors are left holding the bag.

U.S. New Home Sales Edge Up from Downward-Revised Level Sales of new single-family homes increased by 1.1% in February to 640k units (saar). January sales were revised down sharply to 633k from 670k.

Inflation Has More U.S. Companies Ditching ‘Last-In, First-Out’ Accounting Roughly 30 U.S. companies switched their method for recording inventory in 2021 and 2022, compared with 13 the prior two years, data show

(…) One lever finance executives have to combat the impact of inflation on earnings is to make an accounting-policy change: moving to “first-in, first-out” accounting, or FIFO, instead of LIFO. Switching to FIFO can boost a company’s profitability because older inventory acquired at a lower cost is used to value the cost of goods sold on the income statement. Through FIFO, businesses can also better align their inventory accounting across global operations, as the method is allowed under International Financial Reporting Standards while LIFO isn’t. (…)

Businesses have been heading toward FIFO over LIFO for years—particularly with the rise of tech companies, whose costs tend to fall over time—but such activity appears to have accelerated amid a turbulent economy. About 30 U.S. companies total in 2021 and 2022 switched their inventory accounting method to FIFO from LIFO, according to a review of public filings from investment research firm Bedrock AI. That is up from a combined 13 companies in 2019 and 2020, when inflation was less of a concern. No companies have switched to LIFO from FIFO since 2019, Bedrock AI found.

On average, an estimated 55% of companies in the S&P 500 used FIFO as their primary inventory method and 15% used LIFO, according to Credit Suisse Group AG, citing annual reports from 2021 and 2022. The rest of the companies used other options such as the average-cost method or a combination of methods, Credit Suisse said.

LIFO allows companies to use additional cash up front from their lower tax bills to invest in their businesses, but it also increases reported costs of goods sold and hit earnings. The method is a cost assumption companies make on financial statements but generally doesn’t reflect the actual flow of inventory in their operations.

Some companies could view it as less costly to switch off LIFO since a 2017 law lowered the corporate tax rate to 21% from 35%, said Michelle Hanlon, an accounting professor at the Massachusetts Institute of Technology’s Sloan School of Management. (…)

Companies in other industries such as consumer goods, oil and gas, chemicals and medical technology also have made the move over the past year. (…)

EM: ANOTHER TYPE OF RISK

Political risk has become an increasingly important underwriting variable for investors in this asset class, as EM countries face the socioeconomic fallout from the pandemic. Preserving governability and social peace may be challenging moving forward, due to (a) the slow progress made in improving socioeconomic conditions in EM countries over the last decade, (b) citizens’ deep distrust of the political establishment, and (c) the increasing perception that economic and political systems are broken. (Oaktree)

Note where South American countries stand.