affordability

Fed Bets It Won’t Fall Behind Curve on Rates Many economists fear the Fed will wait too long before raising interest rates, but officials believe markets and economic indicators aren’t signaling an economy near overheating.

(…) “The idea that the Fed might get behind the curve is a powerful one, and that’s certainly been the history of the institution. People are right to worry about that,” James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview with the Journal last week. (…)

Top Fed officials believe they can be patient before starting to raise short-term rates. Among the reasons why: Whether they look at financial markets or the broader economy, the actual prices people pay for Treasury bonds, workers’ wages or the costs of day-to-day consumer goods aren’t signaling an economy near overheating. (…)

Fed officials have made some subtle shifts. Ms. Yellen in July testimony to Congress said that if the economy continues to improve more quickly than expected, the central bank will raise rates sooner than expected. That means earlier than mid-2015 is possible.

Still, she and other top Fed officials believe they have been served well keeping the money spigots open in an economy that keeps disappointing. They will need some more proof before they heed the warnings of those who say they’re falling behind the curve.

U.S. Factory Output Up in July, Gaining Momentum

The combined output of factories, mines and utilities rose 0.4% from June, maintaining the prior month’s pace, the Federal Reserve said Friday. A boost in vehicle production drove the increase.

Capacity utilization, a measure of slack across industries, rose a tenth of a point last month to a 79.2% rate. Higher capacity use often leads businesses to step up investment, while stoking inflation. Capacity use has climbed more than half a percentage point since February and was up 2.7 points over the past year.

Manufacturing output climbed at a healthy pace, driven by a 10% rise in auto production, the sharpest increase in five years. Production of other goods also rose steadily, indicating broad-based demand among households and companies.

Strong report overall. Note how Bus. Equip. is accelerating and the strength in Construction Supplies, two weaker areas so far in this recovery. (Chart and table from Haver Analytics)

• Deere to Lay Off 600 Factory Workers

Deere DE -0.11% & Co. said it will lay off more than 600 factory employees indefinitely as part of its plan to scale back agricultural equipment production amid weaker demand.

Housing Affordability Hits Six-Year Low Housing affordability hit its lowest level in nearly six years in June as home prices continued to climb..

 

U.S. Producer Prices Rise 0.1%

The producer-price index for final demand, which measures changes in the prices firms receive when they sell goods and services, increased a seasonally adjusted 0.1% last month from June, the Labor Department said Friday. Excluding the often-volatile categories of food and energy, producer prices rose 0.2%.

Producer prices rose 1.7% in July from a year earlier, slipping from annual gains of 1.9% in June, 2% in May and 2.1% in April.

Prices for goods were flat last month after rising 0.5% in June. Food prices rose 0.4% in July and energy prices fell 0.6%, including a 2.1% decline in gasoline prices. Prices for services rose 0.1% last month after climbing 0.3% in June.

The personal consumption category, which is the report’s closest equivalent to the closely watched CPI, rose 0.2% from June and 2.1% from July 2013.

U.S. Farmers Are Up to Their Ears in Corn Months of wet weather have fueled expectations for a U.S. corn crop so large that mounds of the grain will be a common sight across the Midwest after the harvest, which starts next month.

GAS PRICES TO FUEL SPENDING DURING BACK-TO-SCHOOL SEASON

Retail gas prices are only 1.5% lower than at this time last year. However, they rose in late August and early September 2013 before dropping 12% by mid-November. This year, crude prices are 10% lower and weak, in spite of the geopolitics. Gasoline futures keep falling and currently suggest retail prices in the $3.35 range over the next several weeks.

Natural Gas Slides in Cool Weather Prices have lost 20% since mid-June, ending Friday at $3.776 a million British thermal units on the New York Mercantile Exchange, a nearly three-week low.

Canada Adds 41,700 Jobs in July in Restated Report

Revised July employment data from Canada’s statistics agency Friday showed a much stronger-than-expected gain in jobs and lower unemployment rate, though economists maintain the results don’t alter the bigger picture of a lackluster Canadian labor market.

Bundesbank Warns on German Growth

Germany’s central bank said on Monday that sanctions enacted by western countries against Russia, along with counter measures that Russia has put in place, hurt firms dependent on exports as well as parts of the domestic economy such as construction.

“A flurry of unfavorable news reports relating to the international environment have dampened Germany’s economic outlook in the second half of the year,” the Bundesbank said in its monthly bulletin.

“Current indicators cast doubt on the assumption on which the spring forecasts were based, namely that the underlying cyclical trend would strengthen further in the second half of 2014,” the bank said.

“The fact that the order flow declined perceptibly over the course of the second quarter and export expectations have dropped suggests that the industrial economy will be especially hard hit by the disruptive external factors,” the bank said.

Chinese banks step up property lending Rise comes even as house prices fall for third straight month

New home prices in China fell 0.9 per cent in July from June, government data showed on Monday, the third straight monthly drop. Sales volume and construction activity have also slowed as potential buyers adopt a cautious approach ahead of expected further price declines.

Despite this weakness banks, under pressure from the government to prop up the property market, lifted lending to residential real estate developers by 26.9 per cent year on year in the first six months of 2014 to Rmb3.1tn ($504bn). That is a marked increase over the 19.3 per cent year-on-year pace of growth in the first quarter, according to the central bank’s latest monetary policy report.

Nearly half of the increase went to affordable housing. That leaves banks exposed to highly indebted local governments, which finance such projects largely through off-budget financing vehicles. (…)

Over the weekend, rumours circulated in local media that China Construction Bank, the country’s second-largest lender, may relax mortgage-lending restrictions at its Shanghai branches, presumably with the approval of local authorities. That would make Shanghai the first of China’s top-tier cities to relax purchase restrictions.

UKRAINE

• Putin’s Big Miscalculation

Stratfor’s George Friedman in Barron’s:

(…) Putin has exhausted most, if not all, of his options, says Friedman. He can’t risk invading Ukraine unless he moves very quickly. In six weeks or so, autumn rains will make much of the country’s eastern marshes a muddy quagmire that will bog down any tanks he sends in. And, according to Friedman, Putin can’t be assured of military success given the sad state of his military forces. “Look how badly the Russians have bungled the planning and execution of the humanitarian aid relief convoy, and it gives you some idea of the actual disarray in Moscow,” Friedman asserts.

Besides, any invasion or other overt support for the Ukrainian rebels is likely to induce more sanctions from the U.S. and EU. This would only exacerbate Russia’s economic despond. And for this very reason, Russia this winter isn’t likely to cut off its natural-gas flows to Europe, which account for about 30% of the Continent’s supplies. Russia is too dependent on the cash from energy exports, contends Friedman.

So about all that Putin can do is bet that the government in Kiev will eventually collapse or be pushed back into the Russian orbit. It was the preternatural venality of Ukrainian politicians that allowed Putin to eventually subvert the 2004 Orange Revolution. But this time around, Western governments and the IMF are keeping a closer eye on Kiev. As long as they don’t lose interest, Putin’s latest ploy will prove no strategy at all, but merely a figment of hope, adds Friedman.

So if the geopolitics of the Ukrainian situation teaches us nothing else, at this point, one should go long the U.S. economy and stock market and short Russia.

• War for ‘New Russia’ drives Ukraine separatists

The resignation of Igor Girkin, the Russian military mastermind behind the takeover of large parts of eastern Ukraine by rebel fighters, this week was the latest crack to appear at the top of the months-long rebellion that has become increasingly strained.

His departure is the third high-profile change in the rebel hierarchy in the past week. Alexander Borodai, also a Muscovite, stepped down last week as prime minister of the self-declared Donetsk People’s Republic. With Mr Girkin, he was part of Russian-backed separatist forces in Moldova’s breakaway region of Transnistria in the early 1990s.

The replacement of both with Ukrainians marks a transition in the leadership from highly trained Russian military officers to locally recruited warlords in an increasingly tense stand-off with Ukrainian forces.

“It will be like Stalingrad,” an armed rebel nicknamed Taipan recently told the Financial Times, referring to the battle between the separatists and government forces that is expected in coming days and weeks. (…)

To evade the increasingly frequent shelling by Ukraine’s government forces, the rebels have concealed their tanks and are finding more cover in Donetsk. They have also become more suspicious of the western media, fearing that their location could be revealed to Ukrainian artillery squads.

“If I see you here again, I will shoot you,” one separatist commander said when approached by western journalists this week. (…) 

• Rebel leader in Ukraine says forces bolstered by ‘1,200 troops trained in Russia’

Pro-Russian rebels in eastern Ukraine are being bolstered by 1,200 troops who “trained for four months in Russia”, according to the separatists’ leader.

A video recording of Alexander Zakharchenko speaking to delegates in the rebel-held city of Donetsk appeared to confirm reports of Moscow’s military support to the separatists, who have been fighting Ukrainian government troops since April. (…)

Russia denies any incursion into Ukraine by its troops. It also denies lending any military or logistical support to the rebel militias. (…)

It was not possible to verify Mr Zakharchenko’s claims of massing troops independently, but a heavy Russian military presence has been noted in the border zone in the past three days.

On Thursday evening, correspondents from The Telegraph and The Guardian saw at least 23 armoured vehicles and military trucks crossing from Russia into Ukraine close to the Donetsk checkpoint, north of Rostov-on-Don. It was the first time that international media had reported such a crossing.

Russia’s ministry of defence rubbished accusations of an incursion and Ukraine’s claim that it destroyed part of a Russian column on its territory.

“No such Russian military column exists that supposedly crossed the Russian-Ukrainian border, neither at night nor during the day,” said Igor Konashenkov, a ministry spokesman. “Such claims, based on some kind of fantasies, or, to be more accurate, the suppositions of journalists, should not be the subject of serious discussion for high-ranking figures of any state.” (…)

Who do you want to believe? If you are interested in knowing more about Russia and understanding Putin’s intentions, the New Yorker has a longish but interesting article. It starts slowly but gets better: Watching the Eclipse

OTHER POSSIBLE MISCALCULATIONS

• Investors Rethink Bets on European Shares

Cheap enough? Not for me given the geopolitics, the unresolved economics and a potential recession…

• RATE YOUR RISK: From Jack Rivkin, CIO at Altegris Advisors via John Mauldin’s Thoughts from the Frontline:

(…) Historically, in a rising rate environment, different yield vehicles carry different degrees of risk. The table below provides a comparison of risk relative to a one percent increase in rates. Our suggestion is at this stage in the fixed income markets one should be moving holdings to the left, lowering duration. (…)

1% Rise in Interest Rates Could Materially Impact Bond Prices
Bond Price % Change after 1% Interest Rate Increase   |  As of June 30, 2014

• India’s sharp central bank governor, Raghuram Rajan, had lunch with the FT:

“Central bankers have had enormous responsibilities thrust on them to compensate, essentially, for the failings of the political system. And my worry is we don’t have sufficient tools to do that, but we’re not willing to say it. And, as a result, we push as hard as we can on the existing tools, and they may create more risk in the system.” An early critic of quantitative easing, Rajan picked a very public fight this January, accusing the US Fed of reining in QE without considering the effect on emerging economies, not least the period of capital flight and investor panic in India, prior to his arrival at the RBI.

“Six years since the financial crisis, central banks still have their foot fully on the accelerator . . . [pushing] credit into emerging markets,” he says. “We don’t know how this will end . . .  It may end smoothly, if we let the air out of these inflated markets slowly, or by a series of mini-crises. But it may be more dramatic if, one fine day, suddenly the world realises the US is going to raise interest rates quite quickly . . . then the air will go out much faster.”

Even worse, he says, is a broader pattern of globalisation beset by repeated crises, as developed and developing worlds fail to co-ordinate, sending capital washing back and forth between them, violently destabilising their financial systems.

“Leverage moved to the emerging markets, emerging markets spent too much, crisis, then leverage moved to the industrial countries, and now it is moving back to emerging markets,” he says. This time, however, the blame lies with richer countries that have failed to reform their economies, and the inability of institutions such as the G20 to formulate a resp­onse. “I’m worried that it’s everyone . . . doing what they can do, given we have a vacuum in the multilateral space,” he says. “The vacuum is harmful.” (…)

SENTIMENT WATCH

• Why Jackson Hole Has Been Good for Stock Bulls With the world’s central bankers set to descend upon Jackson Hole, Wyo. later this week, stock-market bulls are hoping the annual gathering will generate yet another positive response on Wall Street.

Ms. Yellen, 68, is delivering a speech titled “Labor Markets” at the Jackson Hole symposium Aug. 22 at 10 a.m. New York time. The three-day meeting of central bankers and economists begins Aug. 21 with a topic of “Re-evaluating Labor Market Dynamics.”

Over the past seven years, the conclave has prompted a stock-market rally each time.

From 2007 through 2011, the Dow Jones Industrial Average notched triple-digit-point gains each time former Fed Chairman Ben Bernanke spoke at the gathering. The Dow gained 90 points in 2012 and rose again following last year’s event, one that drew less attention than usual because Mr. Bernanke wasn’t at the conference.

In previous years, Mr. Bernanke used the venue as a staging ground for the Fed’s past three bond-purchase programs. This time Ms. Yellen is expected to focus on labor markets, which are improving rapidly even though U.S. economic growth has been sluggish and erratic. (…)

Several themes are expected to be addressed at the conference: How low can the unemployment rate go before officials need to worry about wage pressure and inflation? Can the long-term unemployed be drawn back into the workforce in a more vibrant economy? Is workforce productivity waning?

The Fed has already made it known that it intends to conclude its bond-buying program in October. But Ms. Yellen has never been one to get aggressive about tightening monetary policy.

That point will likely be reinforced at this week’s conference, one that may yet again generate a bullish response in the markets.

Here’s a good wrap-up article: Yellen Dashboard Warning Light Glows as Millions Work Part Time

• Wall Street bulls climb wall of worry Positive signs that S&P 500 revenue growth is coming

(…) The broad market has not endured a significant correction for nearly three years, a performance many bears think cannot last much longer.

The counter, however, is that while the bull run is mature, some factors suggest the rally is not totally out of steam and that July’s negative performance may well have been the buying opportunity for the next major move upwards.

Better than expected earnings for the second quarter and an economy that is chugging along appear to have been enough to outweigh global troubles, including continuing tension in the Ukraine, conflict in Gaza, US involvement in Iraq and an Ebola outbreak that is the most serious since the disease was first recognised nearly 40 years ago.

Then there is the question of where investors who do decide to dump equities would direct their money instead.

Cash pays next to nothing and while fixed income yields are a little higher, bond investments are exposed to the risk of rising rates.

Junk bonds face some of the same concerns as stocks – a mature rally and an asset class that is certainly no longer cheap. (…)

With nearly all of the S&P 500 companies having reported, earnings per share for the group is up by 12 per cent, beating expectations for 11 per cent growth and representing the sixth consecutive quarter of record earnings per share, says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. (…)

One caveat is that companies have achieved such high earnings by cutting costs and reducing their share counts rather than through pure sales volume growth.

Operating margins for the companies that have reported so far have reached a record high of just over 10 per cent, while more than 20 per cent of the companies in the index received at least a 4 per cent tailwind to earnings per share by buying back more shares than they issued, thereby reducing the total share count. (…)

Aggregate sales growth for the S&P 500 in the quarter came in at about 4 per cent, which is slightly below expectations.

While that pales in comparison to earnings growth, the good news is that the 4 per cent represented the largest gain since the first quarter of 2012 when sales rose 6.6 per cent.

For equity bulls, that represents a positive sign that the sorely needed revenue growth pick-up may be in the offing. (…)

• A Bull’s Advice: Get Ready for S&P 2500 Federated Investors’ Stephen Auth sees the bears underestimating the power of the economy and the market.

(…) Market valuations depend on growth, bond rates, and perceptions of risk, and all three of those are going in the direction that actually expands the price/earnings multiple. At the same time, earnings are expanding, and that’s a recipe for another leg up in the market.

(…) the reason that corporate profit margins are so high isn’t that sales are that great, which is typically why they peak, but because corporate managers, believing the world is going to end, have really hunkered down to make their companies more efficient. Our view on earnings, based on 120 analysts who talk to companies, is that as we get some top-line growth from economic acceleration, money will pour through to the bottom line. Companies have a lot of operating leverage. I’m looking at this and saying, “I’ve got a top-line surprise from the economic activity that flows through to earnings, and I get a pop in earnings.” That’s why we have a target of $120 for the S&P 500’s earnings this year.

We have the S&P at 2100 at the end of this year. We’ve had that target out there since last fall. Our view is that $120 in earnings is very likely. And the market multiple, considering the level of long-term inflation we see and where long-term bond yields ought to be, should be 17½ times.

(…) Longer-term, say 18 months to two years out, we see the S&P 500 getting to 2500—about 30% higher than where it is now. We’ve been telling people to position themselves for a secular run in equities, because the economy has several years of expansion ahead of it. (…)

Three things could end my story. One is that China could blow up, but our read is that China is steady as she goes, with a soft landing. (…) The second thing would be a meltdown in Europe. We don’t really need Europe to grow for the U.S. economy to do quite well. People forget that back in the 1990s, the U.S. economy was the sole engine of global growth. It pulled the emerging markets with it, and we can have that again. But we can’t have Europe dragging us down, so I’m watching that carefully. European Central Bank President Mario Draghi is pretty supportive of that economy. And the third concern I have is the outbreak of a major shooting war in Ukraine, but I don’t see that happening. (…)

• Bull Market Waning as Barclays Sees 1% Gain for S&P 500

• ISI’s recent survey of N.Y. institutional investors reveals much skepticism: they see the S&P unchanged through December 2015. Moreover, 80% were bearish on homebuilders and 90% bearish on China. Hmmm…maybe its time to look at these again, particularly home builders. Stay tuned.

GOOD VIDEO

Take 15 minutes off and watch this video. Help Wanted: Humans Need Not Apply

In 2012, there were 6.2 million scientists and engineers (as defined in this report) employed in the United States, accounting for 4.8% of total U.S. employment. Science and engineering employment was concentrated in two S&E occupational groups, computer occupations (56%) and engineers (25%), with the rest accounted for by S&E managers (9%), physical scientists (4%), life scientists (4%), and those in mathematical occupations (2%). From 2008 to 2012, S&E
employment increased by 352,370, a compound annual growth rate (CAGR) of 1.5%, while overall U.S. employment contracted at 0.9% CAGR.

In 2012, the mean wage for all scientists and engineers was $87,330, while the mean wage for all other occupations was $45,790. Between 2008 and 2012, the nominal mean wages of the S&E occupational groups grew between 1.4% CAGR (life scientists) and 2.2% CAGR (physical scientists, S&E managers, mathematicians). Inflation-adjusted wage growth for each of the S&E occupational groups was less than 0.6% CAGR, and in the case of life scientists was negative. Nominal wage growth for all occupations in the economy was 1.1%; real wages declined 0.5%.

The U.S. Science and Engineering Workforce:
Recent, Current, and Projected Employment,
Wages, and Unemployment (pdf)