RECESSION WATCH
Today, we get both the best and the worst recession indicators, courtesy of Doug Short. First, the best:
Conference Board Leading Economic Index: Fifth Monthly Increase
The index rose 0.3 percent in June to 102.2 percent. May was revised upward from 101.4 to 1.07 percent (2004 = 100). The positive contributions from the financial and new orders components more than offset declines in building permits and the labor market indicators. In the first half of this year, the leading economic index increased 2.7 percent (about a 5.5 percent annual rate), slower than the growth of 3.5 percent (about a 7.2 percent annual rate) during the second half of 2013. In addition, the strengths among the leading indicators continue to be more widespread than the weaknesses.
The worst:
The ECRI Indicator
Doug Short is one of the few bloggers to keep following the ECRI:
Here is a chart of ECRI’s data that illustrates why the company’s published proprietary indicator has lost credibility as a recession indicator. It’s the smoothed year-over-year percent change since 2000 of their weekly leading index. I’ve highlighted the 2011 date of ECRI’s original recession call and the hypothetical July 2012 business cycle peak, which the company previously claimed was the start of a recession. I’ve update the chart to include the “epicenter” (Achuthan’s terminology) of the hypothetical recession.
As for the disconnect between the stock market and the mid-2012 recession start date, Achuthan has repeatedly pointed out that the market can rise during recessions. (…) The next chart gives us a visualization of the S&P 500 during the nine recessions since the S&P 500 was initiated in 1957. I’ve included a dotted line to show how the index has performed since ERIC’s original July 2012 recession start date (now adjusted forward by three months).
Yes, the market can rise during recessions. It just generally doesn’t.
INFLATION WATCH: TRANSPORTATION COSTS
Truckload linehaul rates paid by North American shippers in June were 5.2% higher than in June of last year. As demand continues to increase while capacity exits the marketplace, this year’s procurement events and contract negotiations have not, in general, been ending favorably for shippers.
Although intermodal costs seem to have peaked for this year and have been falling over the last couple of months, they remain considerably high compared to the last several years. On average for 2014, intermodal costs have been up 2.1% year-over-year, with the difference greater in the last three months, partially due to rising diesel costs. For the most part though, it’s supply and demand. The AAR has reported that U.S. intermodal volumes are up significantly over last year: 9% in April, 8% in May, and 7% in June. (Cass)
In all, intermodal rates are up 3.8% Y/Y in June.
More Firms Are Handing Out Pay Raises, NABE Survey Finds The share of U.S. firms that report giving pay raises has nearly tripled since last fall, though official data haven’t shown any broad acceleration in wage growth.
Some 43% of the NABE members who responded to the survey said wages and salaries at their firms have risen in the past three months. No respondents said wages had fallen, and 57% said wages were unchanged in the second quarter.
In the October 2013 survey, just 16% of economists said their companies had given raises in the prior quarter. That number has risen steadily since to 23% in January, 35% in April and 43% now.
Raises were spotty by sector, with just 11% of goods-producing firms and 35% of service firms reporting wage hikes. Some 59% of finance, insurance and real estate firms reported a rise in wages, as did 50% of transportation, utility, information and communications companies. (…)
In the NABE survey, 35% of respondents said they expected wages at their firms to rise in the third quarter versus 65% who expected no change.
Some 25% of economists said their firm has raised prices in the last three months, up from 20% in April and January. Fewer, 21%, said they expect prices to rise in the next three months.
Yellen Wage Gauges Blurred by Boomer-Millennial Workforce Shift
As today’s middle-aged Americans grow older, they are leaving their prime working years behind, trading big salaries for part-time gigs or retirement, just as an even larger group of young people come into thelabor force at entry-level salaries. The seismic shift may be one reason behind the sub-par wage growth that Yellen says still shows “significant slack†in the job market. (…)
China’s First Mortgage Debt Since Crisis Shows Li Concern China will revive mortgage-backed debt sales this week after a six-year hiatus, as the government extends help to homebuyers in a flagging property market.
Postal Savings Bank of China Co., which has 39,000 branches in the country, plans to sell 6.8 billion yuan ($1.1 billion) of the notes backed by residential mortgages tomorrow, according to a July 15 statement on the website of Chinabond. The last such security in the nation was sold by China Construction Bank Co. in 2007, Bloomberg-compiled data show.
Premier Li Keqiang is seeking to avert a collapse of the real-estate market after data last week showed new home prices dropped in a record number of cities in the world’s second-largest economy. The central bank in May called on the nation’s biggest lenders to accelerate the granting of mortgages to first-home buyers, and cities including Nanning, Hohhot and Jinan eased property restrictions. (…)
EARNINGS WATCH
Earnings and Revenue Beat Rates
- Bespoke Investment tallies all NYSE companies:
Last earnings season, the earnings beat rate hit its lowest level of the current bull market with a reading below 60%. So far this season, 64.2% of companies have beaten estimates. Keep in mind that only 10% of companies have reported so far this season, so it’s still very early.
The top-line revenue beat rate is a bit weaker than the earnings beat rate, coming in at 57% so far this season. This is slightly better than the final reading of 56% that was registered last season.
- Factset focuses on S&P 500 companies as of last Friday:
As of today, 74 companies in the S&P 500 have reported actual earnings and sales numbers for the second quarter. Of these 74 companies, 73.0% have reported sales above estimates and 30.0% have reported sales below estimates. Thus, the percentage of companies reporting sales above estimates to date for Q2 2014 is running well above both the trailing 1-year trailing (55.3%) and 4- year averages (57.2%). The current record for the highest percentage for a quarter is 71.5%, set in Q2 2011.
Companies are also beating revenue estimates by wider margins than average. In aggregate, companies are reporting actual sales that are 1.43% above expectations. This percentage is well above the trailing 1-year average (+0.58%) and 4-year average (+0.57%).
Of these 74 companies, 72% have reported actual EPS above the mean EPS estimate and 28% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate isequal to both the 1-year (72%) average and the 4-year (72%) average. At the sector level, the Materials (100%), Health Care (83%), and Financials (79%) sectors have the highest percentages of companies reporting earnings above estimates, while the Consumer Discretionary (55%) and Consumer Staples (57%) and sectors have the lowest percentages of companies reporting earnings above estimates.
In aggregate, companies are reporting earnings that are 4.5% above expectations. This surprise percentage is above the 1-year (+3.2%) average but slightly below the 4-year (+5.1%) average.
Companies in the Materials (+7.5%), Financials (+7.5%), and Health Care (+7.0%) sectors are reporting the largest upside aggregate differences between actual earnings and estimated earnings. On the other hand, companies in the Energy (-0.6%) sector are reporting the largest downside aggregate differences between actual earnings and estimated earnings.
The blended earnings growth rate for the second quarter is 5.5% this week, above the growth rate of 4.5% last week. During the past week, upside earnings surprises reported by companies in the Financials and Health Care sectors were the largest contributors to the increase in the growth rate for the index.
At this point in time, 14 companies in the index have issued EPS guidance for the third quarter. Of these 14 companies, 9 have issued negative EPS guidance and 5 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the second quarter is 64% (9 out of 14). This percentage is slightly below the 5-year average of 64%.
- S&P has 84 reports in and the beat rate is 66.7%. Importantly, S&P now sees Q2 EPS at $29.64, 1.8% higher than the $29.12 estimate one week ago. This would bring trailing 12-month EPS to $112.13, up 0.5% from last week. Q3 and Q4 estimates are also being ratcheted up. Operating margins are now estimated at 10.05%, a big jump from Q2’13’s 9.51%.
Melt-up conditions are clearly accumulating. Geopolitics are the only major impediment. Here’s the Rule of 20 Barometer using trailing earnings of $112.13 and 2.0% inflation (June CPI is out tomorrow):
Lance Roberts rightly noted Saturday that all of the S&P 500 gains for the year have occurred since April 1st, a period that has historically been some of the weakest return months of the year.
But then he wrongly writes that
These gains have also come at a time when corporate profits are slowing; economic growth is weak and geopolitical tensions have been on the rise.
Profits are showing signs of accelerating: Q1’14 +6.0%, Q2e +12.4%, Q3e +14.1%, Q4e +14.7%.
Economic growth is strengthening after a strangely feeble Q1. The domestic economy is indeed accelerating looking at PMI production and new orders data, transportation stats, bank loans, employment and consumer income and core retail sales. Only a weak housing market and lagging capex prevent a real economic take off.
As to valuations, we are indeed a little stretched. Unless inflation really takes off, the economic and financial background seems supportive as is the lack of general enthusiasm towards equities. The Yellen and Draghi show is underway. The apparent central banks put should hold until investors begin to worry that these modern day Atlas are well behind the curve and are about to drop the ball.
SENTIMENT WATCH
Russ Koesterich is global chief investment strategist at BlackRock
(…) Financial market volatility is mostly driven by the credit cycle. When monetary conditions are loose – meaning credit is both available and cheap – market volatility tends to be lower. (…)
Of course, other factors have been at work as well. Since investors have been comforted in recent years by the warm blanket of central bank accommodation, they are essentially conditioned to “buy the dipâ€.
(…) Stocks have also been supported by a steady stream of mergers and acquisitions. (…)
Recent levels of volatility have been in the bottom 1 per cent of volatility levels going back to 1990. In other words, it looks too low even after accounting for a benign credit environment. This is particularly so given that up until last week investors were ignoring rising geopolitical risk.
Indeed, the recent escalation of violence in Iraq and Ukraine has raised the stakes. Turmoil in both regions has the potential to cause a spike in oil prices, which would be a real headwind for the global economy at a time when economic growth is fragile. (…)
To the extent a rate rise occurs earlier than investors expect, this could affect volatility. A marginal tightening in monetary policy means a less accommodative credit regime, which in the past has generally been associated with an uptick in volatility.
Still, all else being equal, stocks can continue to climb this year. Stocks are fully valued after a strong rally, but the lack of attractive alternatives (bonds are expensive and cash pays zero), and a slow, but steady, recovery, can support further modest gains. That said, further gains are likely to come with more volatility.
Complacency is still the biggest risk, with little bad news priced into the markets. Investors might want to consider taking steps that can help insulate them against an increase of volatility if – or when – it spikes up again.
As every student of US film clichés knows, when the hero in the movie says “It’s quiet, too quietâ€, bad things are about to happen. It is impossible to predict when the next bad thing will happen, but it is unlikely our good fortune can last. Investors should consider preparing now.
(…) (The negative January Rule this year has, for that matter, also been ineffective so far.) So, all is apparently well, as we have arrived within three months of the dreaded (by bears) presidential third year. Accordingly, my recent forecast of a fully-fledged bubble, our definition of which requires at least 2250 on the S&P, remains in effect.
What is worse for us value-driven bears, a further bullish argument has struck me recently concerning the probabilities of a large increase in financial deals. Don’t tell me there are already a lot of deals. I am talking about a veritable explosion, to levels never seen before. These are my reasons. First, when compared to other deal frenzies, the real cost of debt this cycle is lower. Second, profit margins are, despite the first quarter, still at very high levels and are widely expected to stay there. Not a bad combination for a deal maker, but it is the third reason that influences my thinking most: the economy, despite its being in year six of an economic recovery, still looks in many ways like quite a young economy.
There are massive reserves of labor in the official unemployment plus room for perhaps a 2% increase in labor participation rates as discouraged workers potentially get drawn into the workforce by steady growth in the economy. There is also lots of room for a pick-up in capital spending that has been uniquely low in this recovery, and I use the word “uniquely” in its old-fashioned sense, for such a slow recovery in capital spending has never, ever occurred before. The very disappointment in the rate of recovery thus becomes a virtue for deal making. (…)
(…) Also, individuals and institutions did feel chastened by the crash of 2009 and many are just now picking up their courage. And as they look around they see dismayingly little in the way of attractive investments or yields. So, the returns promised from deal making are likely to appear, relatively at least, exceptional. I think it is likely (better than 50/50) that all previous deal records will be broken in the next year or two. This of course will help push the market up to true bubble levels, where it will once again become very dangerous indeed. (…)
In early July, Janet Yellen made an admirably clear statement that she is sticking faithfully to the Greenspan-Bernanke policy of extreme moral hazard. She will not use interest rates to head off or curtail any asset bubbles encouraged by the extremely low rates that might appear. And history is clear: very low rates absolutely will encourage extreme speculation. (…)
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$100B down, $200B to go!
(…) according to data compiled by Bloomberg and the Investment Company Institute, nearly $100 billion has been added to various equity funds in the past year. That is ten times more than in the previous twelve months. In the five years through 2012, as much as $300 billion was withdrawn. There is no doubt that individual investors have developed a considerable degree of confidence about the Fed’s intention plowing “plenty of plenty†back into risky assets. (Palos Management)
Investors have grappled with many obstacles this year, ranging from the withdrawal of the Federal Reserve’s postcrisis stimulus to patchy economic growth and military flare-ups in Ukraine and Israel.
Their response? Buy the dips.
The latest proof that fund managers are heeding this stock-market adage came on Friday, when the Dow Jones Industrial Average jumped 123.37 points, recovering almost all the ground it lost a day earlier after the downing of a Malaysia Airlines 3786.KU 0.00%jetliner over Ukraine and Israel’s incursion into Gaza.
The gain left the Dow just 0.2% below its most recent all-time high set Wednesday. The Dow has set 15 records this year after notching 50 last year. (…)
“Investors are learning that it’s a loser’s game to sell on the news,” said Jim Paulsen, chief investment strategist at Wells Capital Management, which oversees $350 billion. Recent events “don’t give you a sense that they’re going to turn into some wider conflict,” Mr. Paulsen said. (…)
“The dips have been relatively small and short-lived, so you have to move in pretty quickly,” he said. (…)
When you sit on the sidelines, clients demand an explanation, Mr. Armiger added.
The pressure to buy shares is strong in part because more portfolio managers are lagging behind their benchmarks than in years past, and conservative managers who hoard cash risk falling further behind, analysts said. (…)
There you go! But wait, there’s more in the same WSJ:
Little can take down U.S. stocks these days. Call it the “honey badger†market.
That’s what Andrew Wilkinson, chief market analyst at Interactive Brokers, labeled Wall Street on Friday, a play off of a YouTube video showing the fearlessness of the honey badger and how the animal will do whatever it takes to survive.
“If financial market participants acted more like that famous honey badger, fewer investors might be suffering from seller’s remorse on Friday,†Mr. Wilkinson wrote to clients on Friday. “The cobra-scoffing, honeycomb-raiding honey badger, famous for snacking no matter whether its prey bites, injects venom or stings the heck out of its attacker, just eats what it wants, when it wants, and pays little attention to the risk.â€
Friday’s stock rally “appears to be a victory for couldn’t-give-a damn-what-you throw-at-me risk managers,†Mr. Wilkinson said.
Honey, I shrunk the retirement account!
There is also this new twist on “fundamentals†from JPMorgan (via Business Insider)
We accept such correction risks, but see only modest near-term downside that may anyway be quite difficult to trade, as the fundamentals behind the rally in stocks are to us largely intact. Low implied volatilities make it relatively cheap to hedge such downside, though. The fundamentals we focus on remain the lack of any return on cash and generally low market and economic volatility. Incoming economic data and surveys are raising our confidence that global and US growth is set to rebound to a 3% handle in H2, after a dismal and unexplained weak H1. The major first GDP report for Q2, China, came in just above our expectations, reducing fear on the downside. Forward looking PMIs suggest a strong Q3, even as we accept that this signal has not functioned well so far this year. Q2 earnings reports are also coming in well above expectations (see equity section below).
BTW, from FT Alphaville:
Roughly a quarter of all hedge funds tracked by Preqin have posted negative returns year to date, though the industry is up 3.2 per cent overall.
One in four is pretty bad for an industry with aspirations to asset class status, when the world has largely been calm and markets positive. Indeed, hedge fund managers are braced for their worst year since 2008.
Nearly two-thirds of hedge fund managers are anticipating full year returns of 6 per cent or less, according to Preqin, the data provider, which surveyed 150 hedge funds collectively managing $380bn of assets. Of these, 44 per cent expect a full-year return of 5 per cent or less.
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Inflation is needed to calm asset bubbles Only a genuine inflation scare can alter investors’ mindsets
(…) Michael Kastner, principal at Halyard Asset Management, says the common refrain from retail and professional investors is the complaint that they need to do something with their cash.
The amount of cash sitting on the sidelines, known as money market fund balances, stands at about $2.575tn, where it stood in 2007 before the financial crisis erupted.
In March 2009, money markets were holding nearly $4tn as investors were firmly in bunker mode. Since then that cash kitty, earning essentially nothing, has normalised, driven by the search for yield. That is an activity that flashes red on the radar screen of central bankers. (…)
Beyond valuations, there is also the issue of how investor behaviour in terms of risk taking has been altered by an extended period of low interest rates that a central bank is in no rush to change. (…)
Mr Kastner says Fed policy has driven investors into areas of the market and exuberance that typified the end of the last boom in 2007. But he worries that changes since then have exposed retail investors to greater excesses with credit derivative securities being packaged into exchange traded funds and how small investors are now able to invest in illiquid hedge fund strategies. He also contends that junk bonds and the bank debt market “is approaching bubble territoryâ€.
The greatest reason to worry about all these developments is that when investors seek an exit, any crowding of the gate will send markets into a tailspin, as we saw in 2008 and also for tech stocks in 2000.
Having told investors that the Fed wants a stronger economy and higher inflation before policy tightens, Ms Yellen faces the prospect that asset prices will rise further and ignore her powers of persuasion to deter the reach for yield.
Only a genuine inflation scare can alter investors’ mindsets, but by then any major market reversal could well damage the economy and central bank credibility.
That assumes that investors understand how inflation can hurt the economy and investment returns. It has been nearly 20 years since core CPI has exceeded 3.0% and nearly 25 years since it reached 5.0%.
CHART FOR THOUGHT
from BoAML via Zerohedge:
Finally,
Michael Dell announced via Twitter that his eponymous company will start accepting bitcoin on the company’s website. For Dell, it’s a chance to reach out to a hip, tech-savvy customer base. For bitcoin, it’s one of the clearest signs yet of mainstream acceptance.
I beg your pardon, I have been accepting bitcoins for a while now!