seasonality

Chicago Business Barometer Slumped in September

The Chicago Business Barometer plummeted to 48.7 in September from 54.4 in August. This is the lowest reading since May 2015 and was led by sharp declines in production and new orders. The drop in the index to below 50 points to a contraction in economic activity in the Chicago area in September. This was the fifth time this year that the index has fallen into contraction territory. Large monthly swings are not uncommon for this index. Over the year to August 2015, the average absolute monthly change was nearly four points. So, while a 5.7-point monthly drop is large, it is not extraordinary for this index. It had jumped up 5.3 points in July from June.

Nonetheless, the September reading points to weaker activity and is in line with other recently released regional economic surveys (notably the Philadelphia Fed’s index of business activity and the New York Fed’s Empire State Manufacturing Survey).

Haver Analytics calculates an alternative index that employs the methodology used by the Institute for Supply Management to construct its index of activity (to be released tomorrow). This figure was 50.1 in September. Though still in expansion territory, this ISM-adjusted measure also fell significantly from August.

Of the Barometer’s five components, three were below the 50 expansion threshold while two were above. The production index exhibited the most weakness, falling 15.4 points to 43.6, its lowest reading since July 2009 when the overall economy was just exiting the recession associated with the 2008-09 financial crisis. The new orders index also declined meaningfully in September. Both of these key activity indicators are currently running well below their historical averages.

The September survey contained a special question concerning what was impacting business. Just under 30% of the respondents said that China’s economic woes had a greater impact on them than had problems in Europe. A little under 20% cited the EU as a bigger influence, while nearly 30% said that neither of these had significantly affected business.

New orders declined from 58.5 to 56.7 to 49.5 in the last 3 months.

GAME CHANGER?

UAW Members Widely Reject Fiat Chrysler Deal United Auto Workers union members widely rejected a proposed contract with Fiat Chrysler, in a rebuke to union leaders who had praised the deal.

(…) a blow to the union’s president after he championed the deal as a fair bargain that addressed the inequities workers complained about. (…)

It is the first time a tentative national labor contract has been rejected by UAW members in 30 years, underscoring the level of discontent among factory workers and uncertainty about product commitments from the U.S.-Italian auto maker. UAW President Dennis Williams now needs to go back to the bargaining table to redraw an agreement that can be used as a pattern with General Motors Co. and Ford Motor Co. (…)

Hourly workers cited several problems with the proposed pact, including frustration with a lack of clarity when a two-tier pay structure would be eliminated. Concerns about health-care benefits and a lack of U.S. investment commitments also weighed on workers. (…)

“This is our time now. The UAW has given back and given back, making concessions after concessions. I think Sergio may have a hard lesson to learn here but we are ready for that.” (…)

“He is in a real bind. The younger workers are revolting.”

Mr. Williams had hoped to use Fiat Chrysler’s contract—which includes a $3,000 signing bonus and a modified version of its two-tier wage structure—to wring higher payouts from the financially stronger Ford and GM. Both auto makers were already balking at the Fiat Chrysler accord saying it was “too rich” and would erode its competitiveness with the foreign auto makers. (…)

Let’s face it, if you and I work on the line and you get $28 and I get $16 and we do the same job, there is nothing fair about that,” said Mr. Greenwood whose local represents workers at the Kokomo, Ind. transmission plant. “I wanted to see the second tier have a road map to get to traditional wages and I don’t mean over eight to 10 years, but in this contract.” (…)

• Deere Clinches Tentative New UAW Pact

(…) The union is expected to schedule a ratification vote for Sunday. The Moline, Ill.-based company and the union have been negotiating since August.

The UAW represents about 10,000 manufacturing workers at a dozen plants, mostly in Iowa and Illinois.

Deere is facing a significantly weaker business conditions than the last the time the company and the union negotiated a contract in 2009. (…)

China’s Official Factory Gauge Stabilizes Near 3-Year Low

The official purchasing managers index climbed to 49.8 in September, the National Bureau of Statistics said Thursday, compared with the median estimate of 49.7 in a Bloomberg survey, which was also the level in August. Readings below 50 indicate contraction. A separate PMI gauge from Caixin Media and Markit Economics also showed improvement from its initial reading, with the final September number climbing to 47.2. (…)

• Output climbed to 52.3 from 51.7
• New Orders strengthened to 50.2 versus 49.7
• Employment reading was unchanged at 47.9

The government’s non-manufacturing PMI reading for September was unchanged at53.4, reflecting the relatively stronger performance of services industries throughout the economic slowdown. New export orders for services jumped to 51.1 from 46.6.

Make sure to look at the independent Caixin PMI survey before getting too optimistic.

CEBM Research also sees continued slowdown in China:

This month’s reading shows that activity in the real economy continued to disappoint. Further deterioration in actual sales activity in the steel sector was observed. A majority of respondents are now convinced that a seasonal rise in sales is unlikely to occur this autumn. Feedback indicates that order levels were disappointing, yet the only countermeasures implemented to curb downward price pressure have been maintenance inspections. Cement sales were on par with survey respondents’ expectations, however demand for cement has continued to fade from strong levels observed in July. Cement inventory levels remain above normal, putting downward pressure on pricing.

On the external demand front, survey feedback indicates that export activity remained lackluster. Container freight shipping volume fell below respondents’ expectations for September. An anticipated boost in container freight volume tied to Christmas orders and a rush to make shipments before the start of China’s early October National Holiday failed to materialize.

CEBM’s property developer and agent surveys show that real estate sales fell below optimistic expectations set for September. Land sales activity showed continued signs of improvement in September, especially in 1st and 2nd tier cities. Local governments have boosted efforts to sell land. In addition, after many months of refraining from restocking land banks some developers have started to restock.

CEBM’s banking survey indicates the scale of loan issuance improved slightly in September in response to the PBOC lowering the benchmark interest rate in late August. Despite the recent improvement in corporate demand for credit, banks maintain a cautious outlook for 4Q15 given the weak economic backdrop and a lack of evidence indicating that infrastructure related demand for credit has materially increased. Survey respondents reported a slide in personal loan issuance in
September.

Looking forward to October, the CEBM composite expectations index increased from -23.6% in September to -6.48% in October. Upstream sectors such as steel and cement indicate a very weak rebound in activity (if any) during October. Expectations for property sales are cautious, with most respondents stating they expect sales volume in October to be on par with September sales volume.

Lastly, today’s Japan manufacturing PMI revealed weak demand from China as “a number of firms mentioned a fall in sales volumes to China as the main contributory factor behind the overall drop in export orders”.

Chinese Domino Effect Still Threatens World Markets

(…) In the third quarter, the MSCI Emerging Markets Index tumbled 20% through Tuesday, its worst quarterly performance since the third quarter of 2011.

The MSCI World Index, which tracks developed-country stocks, fell 9.3% in the period. The Dow Jones Industrial Average fell 7.6% in the quarter through Tuesday.

The J.P. Morgan GBI-EM Global Diversified Index, a benchmark for emerging-market bonds issued in local currencies, posted a return of negative 12% over the past three months, the worst quarter since the index was launched in 2003. (…)

While a weaker currency tends to boost the competitiveness of a country’s export sector, it has made it more expensive for borrowers in these countries to service and pay back dollar-denominated debt. It also stokes inflation, reducing consumers’ purchasing power in these countries.

Among the worst-performing currencies in the quarter were the Brazilian real, which fell 22% against the dollar; the South African rand, which weakened 12% and the Malaysian ringgit, which slid 14%.

These countries are the biggest commodity suppliers to China, and are suffering from a double whammy of a downbeat demand outlook and lower commodity prices. The S&P GSCI, an index that tracks a basket of 24 commodities, in late August hit its lowest in more than six years and remains near that level. (…)

In a September report, the Bank for International Settlements warned of a looming banking crisis as a result of rapid credit growth in some emerging markets. China boasts the highest ratio of private-sector credit to gross domestic product, standing at 25%, followed by 17% in Turkey and 16% in Brazil. Slowing growth could impair these companies’ ability to service their debt, driving up the bad loans at the banking sector in these countries.

Historically, a country with a ratio above 10% has a two-thirds chance of “serious banking strains” occurring within three years, said the BIS, noting “early warning indicators of banking stress pointed to risks arising from strong credit growth.”

The size of the emerging-market nonfinancial corporate bond market has doubled since 2009 to a record level of more than $2.4 trillion in 2014, according to the IIF.

In Brazil, 10 companies have defaulted on their debt this year, compared with six for all of 2014, according to Moody’s Investors Service. Brazil is struggling with a deep recession, high inflation and a widening scandal at its state-run oil company.

In Latin America, the corporate default rate hit 4.2% in the 12 months ended June, up from 3.1% a year ago, according to Moody’s. (…)

• IMF Flashes Warning Lights for $18 Trillion in Emerging-Market Corporate Debt

IMF Chief Predicts Only Modest Global Growth Next Year The head of the International Monetary Fund, Christine Lagarde, said the global economy will grow only modestly next year as emerging-market economies, particularly China, decelerate.

In July, the IMF reduced its outlook for global growth this year by 0.2 percentage point to 3.3%, already the weakest rate since the financial crisis. But the fund also forecast then that the world economy would rebound in 2016, expanding by 3.8% as wealthy economies picked up the pace.

Instead, a faster-than-expected slowdown in China is rippling around the globe, feeding a fall in commodity prices and exacerbating decelerations in a host of other developing countries. The IMF chief has said in recent days the fund will lower its forecasts for worldwide growth on Tuesday when it releases its latest outlook.

“Global growth will likely be weaker this year than last, with only a modest acceleration expected in 2016,” said IMF Managing Director Christine Lagarde at a Council of the Americas event. “Emerging economies are likely to see their fifth consecutive year of declining rates of growth.” (…)

Business sentiment dwindles in Japan

Business conditions in Japan stagnated during the third quarter as the quarterly Tankan survey of corporate sentiment confirmed a loss of economic momentum.

Corporate expectations for the next three months were down across the board, suggesting China’s slowdown has hurt sentiment badly, even though the headline Tankan index for current conditions was up slightly from a reading of 7 to 8. (…)

However, the Tankan shows no sign of a downward spiral in the economy so it is unlikely to cause panic at the Bank of Japan.

Big manufacturers, those worst affected by slower growth in China, downgraded their profit forecasts and predicted a gloomier outlook. (…)

The index for large manufacturers fell from 15 to 12. They lowered their profit growth forecasts by 3 percentage points to 3.8 per cent. In a sign of the continued improvement in the domestic economy, however, the index for large service companies rose from 23 to 25. (…)

The bigger move in the Tankan was the weak outlook. Companies forecast a reading of 5 on the next survey in December, down from 8. The production machinery industry, a leading indicator, forecast a reading of 17 down from 32.

The current reading for communications companies was 33. However, the sector expected a massive fall to 6 at the next survey, probably reflecting Prime Minister Shinzo Abe’s pledge to cut mobile phone bills, which helped drag down the index overall.

One development likely to give heart to the BoJ is a rise in forecasts for business investment — up by 2.9 percentage points to 6.4 per cent.

SENTIMENT WATCH

Why the Q3 earnings season is so important

(…) But the third-quarter US earnings season, beginning next Thursday with Alcoa, could be one of the most important in memory. The reason is that the US stock market is dangling on the cusp of a bear market.

As I write this, the low for the year, set in August, remains intact, but only just. More than any other single factor, we need to look to earnings to work out whether this turns into a bear market. And so far, the course of earnings gives better reason than almost anything else to suppose that the bear market is indeed under way. What US companies tell us next month could conceivably reverse that — or, more likely, tip the way into a bear market.

(…) According to Thomson Reuters, the consensus calls a 4.3 per cent fall, compared with 0.4 per cent when the quarter began. This is mostly because hopes for the materials sector have tanked as metals and energy prices have fallen.

Some of this is the tired game of earnings management by companies, talking down their prospects so that they can beat a lower bar. After drastic writedowns in forecasts ahead of time, both the first quarter (when a projected 2.8 per cent fall turned into a 2 per cent rise), and the second (when a projected 3 per cent fall turned into a 1.3 per cent rise), saw more than the customary beat.

But some facts need to be borne in mind. Earnings tend to be cyclical, and growth in earnings per share has flattened out almost completely. Margins tend to be even more mean-reverting, have stayed high for a while, and are also falling.

That, in turn, plays into the concept that Vadim Zlotnikov, chief market strategist at AllianceBernstein, suggests has driven the sell-off: pricing power. Deflation or slower inflation, of the kind that is feared as a result of the falls in metals prices and the evidence of slowing economic growth in China, attacks pricing power.

The latest US sell-off has been led by the one sector — pharmaceuticals — that has led the market for years by demonstrating dramatic pricing power. It is governmental intervention to combat what looks like an abuse of that pricing power that sparked the sell-off.

In this context, signs that pricing power remains intact, through sustained margins, could be a strong reassurance. Lack of it would have the opposite effect.

Also, a more detailed look at earnings momentum, or the way forecasts are changing sector by sector, is particularly troublesome. Forecasts are being written down not only for the month coming, but for 2016 as a whole. According to data tracked by Andrew Lapthorne of Société Générale, 2016 forecasts for the highly cyclical semiconductors sector in the US have been written down by 8.3 per cent over the past three months (while materials have been written down by 4.8 per cent).

This is dreadful earnings momentum, and suggests that the market is braced for negative forward guidance. This could counteract the likely success in exceeding earnings expectations for the third quarter.

Another important point concerns share purchases by companies. For several years, corporations have at the margin been the greatest buyers of their own stock. Data from David Kostin, US equity strategist at Goldman Sachs, shows that buybacks are seasonal, are lowest in the four “blackout” months when companies report earnings, and are highest in November and December, which between them account for almost a quarter of all money spent on buybacks.

(…) So announcements here are also important. According to Howard Silverblatt of S&P, there has been a run of six quarters in which at least 20 per cent of the S&P 500 companies have reduced their share count by at least 4 per cent — and thereby boosted their earnings per share by 4 per cent.

If companies are still producing enough cash to keep playing this trick, it would come as quite a relief.

It is hard to be optimistic about the forthcoming earnings season, although there is ample scope for it to produce further information that could turn the stock market back upwards. But it is also hard to overstate its importance. At the risk of overhyping it, the next earnings season really matters.

Some facts omitted by John Authers:

• Analysts have lowered earnings estimates for the S&P 500 for Q3 2015 by a smaller margin than average. On a per-share basis, estimated earnings for the third quarter have fallen by 3.0% since June 30. This percentage decline is smaller than the trailing 5-year and 10-year averages at this same point in time in the quarter.
• Fewer companies have lowered the bar for earnings for Q3 2015 as well. Of the 108 companies that have issued EPS guidance, 76 have issued negative EPS guidance and 32 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 70%, which is below the 5-year average of 72%.
• More companies have issued positive guidance for Q3 than normal according to data from both Factset and Thomson Reuters. In fact, with the same number of companies having pre-announced, 33 (31%) have guided positively compared to 27 (25%) at the same time last year. This is the highest number of positive pre-announcements since at last 3 years.
• If the Energy sector is excluded, the estimated earnings growth rate for the S&P 500 would jump to 2.9% from -4.5%.
• As to the “dreadful earnings momentum” by sectors, Authers only refers to the semis. Here’s TR’s tally for 2016. Apart from commodity-related sectors, nothing too dreadful in this table.

SEASONALITY: GOOD NEWS AND BAD NEWS FOR THE FOURTH QUARTER 

(…) The tables below show the quarterly returns for the S&P 500 over the past 50 and 20 years. The fourth quarter has been the strongest by far, averaging a gain of over 5% in the past 20 years. Weak third quarters are nothing new, averaging a loss over these time frames.

The table below shows fourth-quarter returns based on how the market has done heading into the fourth quarter. (…)  In fact, the fourth quarter tends to be relatively weak when stocks struggle through the first three quarters of the year. The S&P 500 averages a 2.5% gain in the fourth quarter, and is positive 60% of the time, after losing ground in the first three quarters. These figures are worse than the alternatives in the table below.

Also, volatility is higher in this scenario, as measured by the standard deviation of the returns. However, since the median return and the average positive are highest when the index is down at this point in the year, it tells me that volatility works to the upside, not just the downside. If I were looking for good news, that would be it. (Thanks Fred)

FYI: From SEASONALITY OF EQUITY RETURNS REVISITED: