COMING UNGLUED: Market Fragility and Credit Market risk indicators are now at post-Lehman levels.
Global Economic Risks have taken a noticeable and abrupt turn downward over the last 30 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggest the global economic condition is at a Tipping Point. Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses.
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MISGUIDED PUBLIC POLICY: Could Irresponsible Populist Policies be Steadily Destroying the System? - If you employ a decision making process that is based on an absurdly expensive electioneering hurdle, to decide on highly complex matters, debated through the beliefs in false economic theory, with highly polarized views - is it then any wonder we get either gridlock, kick-the-can-down-the road or pork barrel politics? We have a flawed and inoperable system that is doomed to waiting for crisis events to take actions that then have little probability of success. . MORE>>
The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern. - The "Peek Inside" shows the detailed coverage available this month.
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TIPPING POINT or 2012 THESIS THEME
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Theme Groupings
US ECONOMY: Service Sector Confirms Economic Slowing
Non-Manufacturing ISM Follows Its Manufacturing Cousin Lower, Misses Expectations
07/05/12 Zero Hedge
After the manufacturing ISM printed in contractionary territory a few days ago, there weren't many high expectations for today's Non-manufacturing ISM number. Which is good: printing at 52.1, it was a miss to expectations of 53.0, and down from 53.7. This was the 3rd month in a row of drops, and the 3rd downside miss in the last 4 data releases. Spin: at least it was above 50. And also the employment number rose. Which of course is the last thing the market needs, because if NFP comes much better than expected tomorrow, kiss more NEW QE goodbye for a while. ISM Services drops to its lowest since January 2010...
"General state of business this month is flat, with no changes." (Construction)
"Business is steady and an increase over last month, as we begin our peak season." (Arts, Entertainment & Recreation)
"We are starting to experience a slowdown from the modest, grinding improvements our market areas have been experiencing of late." (Finance & Insurance)
"Patient counts continue to be lower than budget." (Health Care & Social Assistance)
"Business is still growing, but there has been a definite slowing in growth." (Wholesale Trade)
"We have noticed a slowing of customer counts and sales over the last 30 to 60 days, compared to the same period last year." (Accommodation & Food Services)
"Stable business globally, but softening backlog as clients further tighten discretionary spend." (Professional, Scientific & Technical Services)
A few days ago we noted that the ECB may well be contemplating the monetary neutron bomb, which would see it lower rates to below zero, ushering in a Negative Interest Rate Policy. Today, Mario Draghi cut such speculation short promising the ECB has not discussed this. Yet one bank which certainly has is the Danish Central Bank, which just lowered its Discount Rate to 0%, joining China, England, the ECB, and, of course, Kenya in easing, but also went one step further and cut its deposit rate to negative 0.2%. Keep a note of this: NIRP is coming to a central bank, and shortly thereafter to a bank deposit branch, near you very soon.
From Bloomberg:
Denmark’s central bank cut its main borrowing costs to record lows and brought the rate it offers on certificates of deposit below zero, as policy makers test uncharted territory to fight a capital influx.
The benchmark lending rate was cut to 0.2 percent from 0.45 percent, while the deposit rate was reduced to minus 0.2 percent from 0.05 percent, Copenhagen-based Nationalbanken said in a statement today. The move followed a quarter of a percentage point cut in the European Central Bank’s main rate to 0.75 percent. Nationalbanken doesn’t hold scheduled meetings and only adjusts rates to defend the krone’s peg to the euro.
“There’s no experience of how negative deposit rates will affect the financial markets and the krone,” Jacob Graven, chief economist at Sydbank A/S, said in a phone interview today before the decision was announced. “It’s a sign of the strong Danish economy. This is good. The opposite situation would be far worse, if the central bank would have to hike rates to defend the krone. We have a luxury problem.”
Denmark has stepped up its battle to prevent the krone from strengthening beyond its currency band as the nation’s haven status attracts investors. Danske Bank A/S, the country’s biggest lender, said last week it now has a risk scenario that envisages Denmark abandoning the peg should the cost of fighting currency appreciation grow too high. The bank doesn’t view this as a likely outcome, it said.
The liquidity trap has been sprung. Soon everyone will be paying their banks for the privilege of holding their cash for them.
There are two reasons for this, and the dominant one will be incredibly important to markets moving forward:
First, looser monetary policy generally coincides with a weaker currency. (Expansionary policy increases the supply of money being used in the economy, lowering value of currency.)
Then again, a drop in the value of the euro could indicate that investors were unimpressed by the ECB's latest attempts to bolster the European economy, and that they were expecting more.
Either way, Europe benefits from a cheaper euro in the long-term because that encourages exports and diminishes the value of countries' debts in other currencies.
Here's a look at the euro versus the dollar in the few minutes after the announcements.
Before we walk through the specific datapoints, let's quickly present this chart (via FinViz) of the dollar vs. the Swiss Franc (a currency frequently seen as the safest of safe havens).
Yes, as you can see, the dollar is surging against the Franc, and in fact it's surging against just about every other major currency as well right now (the euro, the yen, etc.). So what conspired to cause this? Well, you've already had
So 3 of the world's biggest central banks are doing moves that are negative for their own currencies, and are therefore positive for the dollar. Then you have the data. All three labor-market datapoints for the US beat expectations.
So the US economy is showing a pulse (add those numbers into the latest positive data on construction, cars, and houses) and it's not clear that the Fed has any urgency to act. While the rest of the world is easing, the Fed is seeing a US economy that seems to be hanging on. Thus the story: A decent US economy, the Fed on hold, and the rest of the world easing aggressively. It all adds up to a perfect situation for the US dollar.
ANALYTICS
LIBOR MANIPULATION: Magnitude of Scandal Finally Being Understood
The Biggest Financial Scam In World History 07/05/12 Zero Hedge
Matt Taibbi explains
that this is the “mega scandal of all mega scandals”, because Libor is
the “sun at the center of the financial universe”, and manipulating
Libor means that “the whole Earth is built on quicksand.”
The only reason the real wage and salary growth has improved at all this year (a real growth rate of 1.1%) is because inflation has been declining since January as TrimTabs' Madeline Schnapp notes specifically "the price of gasoline has dropped sixty cents a gallon since April giving consumers about $60 billion in extra cash to save or spend". While good news, it is hardly sustainable and acts as a much weaker boost to the economy where balance sheets are still crammed with trillions of dollars of mal-investments left from the real estate bubble that have not been marked-to-market.
These non-performing assets are like a ball-and-chain around the neck of the economy and the quicker they are liquidated the quicker the economy can get back on its feet. Schnapp sees lower job growth than consensus for June and while her pre-July-4th ebullience is clear, her less-than-sanguine view on the economy and the "purging of mal-investments - destroying wealth and contracting credit" means wage-and-salary growth will be anemic at best.
07/06/12
Zero Hedge
STATISM
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - July 2nd - July 7th, 2012
CHINA PMI: 48.2. Fourth Stright Month of JOB Contraction
China HSBC PMI Falls To 48.2, Fourth Straight Month Of Job Contraction 07/01/12 Markit
"For the second quarter as a whole, the index averaged its lowest quarterly value since Q1 2009," according to the report.
Key points:
New orders fall to greatest extent in seven months, as export orders slump
Factory output declines marginally in comparison; stocks of finished goods rise
Input costs and output charges down
"It is all about growth and employment," said HSBC economist Hongbin Qu. "As external demand has weakened and domestic demand hasn't shown a meaningful improvement in response to earlier easing measures, growth is likely to be on track for further slowdown, hence weighing on the jobs market. But as inflation eases sharply, Beijing has plenty of room and policy ammunition to avoid a hard landing. We expect more decisive easing efforts to come through in the coming months.”
On jobs: "The size of China’s manufacturing workforce contracted for the fourth month running in June, albeit at only a modest rate that was the weakest in three months. Job shedding in part reflected spare capacity in the sector, which was highlighted by a slight decline in backlogs of work."
NOT GOOD: South Korean PMI Falls To 49.4, Orders Booked Fall For The First Time In 4 Months 07/01/12 Markit
South Korea's HSBC manufacturing PMI number for June fell to 49.4. This is a decline from 51.0 in May.
A reading below 50 signals contraction in the industry.
“Persistent global uncertainties continue to weigh on Korean manufacturing conditions," said HSBC economist Ronald Man. "Should the slowdown in demand for Korean goods be sustained, manufacturing employment may start to contract."
Key Points:
First sub 50.0 PMI reading for five months
Falling output prices recorded for eighth successive month
Order book volumes contract, ending a four-month period of expansion
From Markit:
Weaker domestic and international demand reportedly contributed to a lower output level in the manufacturing sector. Panellists also stated that a fragile economic climate affected South Korean manufacturers. Although the rate of decline was only moderate, the respective index was the lowest since December 2011.
Rush Limbaugh claimed Friday that the Affordable Care Act constitutes the biggest tax increase in history. We are confident that someone, somewhere is working out where the bill stands as far as world tax increases. In the meantime, we now have this graph, via Dr. Austin Frakt at The Incidental Economist and Boston University, showing the country's largest-ever tax increases as a percentage of GDP, using Treasury data compiled by Mother Jones' Kevin Drum. Obamacare is not even close. (Thanks to Dr. Frakt for giving us permission to run his chart.)
The long-term importance of the dependency ratio (which at its most base represents the ratio of economically inactive compared to economically active individuals) is at the heart of many of our fiscal problems (and policy decisions). Not only have they and will they become a larger and larger burden on the tax-paying public but as a voting block will be more and more likely to vote the more socialist wealth-transfer-friendly way in any election (just as we see extreme examples in Europe). The following chart provides some significant food for thought along these lines as by 2016, for the first time ever, developed world economies will have a higher dependency ratio than emerging economies and it rises dramatically. How this will affect budget deficits (food stamps) and/or civil unrest is anyone's guess but for sure, it seems given all the bluster, that we are far from prepared for this shift.
07/03/12
Zero Hedge
14
14 - Chronic Global Fiscal ImBalances
GLOBAL SLOWING: A Quickly Worsening Situation
OECD’s Composite Leading Indicator Suggests Economic Weakness Spreading to China and India 06/11/12 Reuters
OECD, the Paris-based economic think-tank, reported that its Composite Leading Indicator (CLI), which provides a measure of future economic activity, shows the following:
1. China: The CLI slipped to 99.1 from 99.4 in April, falling further below its long-term average of 100.
2. India: The CLI dropped to 98.0 from 98.2, again below the 100 average.
3. OECD: The overall CLI for the OECD area, covering 33 countries, inched up to 100.5 from 100.4 over the month, helped by fresh growth in activity in the United States, Japan and Russia.
4. U.S., Japan and Russia: The pace of improvement in the U.S., Japan and Russia has decelerated in recent months, giving a tentative sign their growth may be about to slow.
5. The euro area: remained stable at 99.6.
6. Italy: Their LCI inched down to 99.1 from 99.2.
7. Germany: Their LCI was unchanged at 99.4.
8. Britain: Their LCI inched up to 99.8 from 99.7.
07/02/12
Reuters
17
17 - Shrinking Revenue Growth Rate
LIBOR MANIPULATION: Barclay's Claims
Why it's important: More than $800 trillion in securities and loans are linked to the Libor, including $350 trillion in swaps and $10 trillion in loans, including auto and home loans, according to the CFTC. Even small movements – or inaccuracies – in the Libor affect investment returns and borrowing costs, for individuals, companies and professional investors
Rate Scandal Set to Spread Former Barclays CEO Lambasted in Parliament as Other Banks Brace for Fallout. 07/05/12 WSJ
"Either you were complicit, grossly negligent or incompetent," John Mann, a Labour lawmaker, told Mr. Diamond. After a pause, Mr. Diamond asked, "Is there a question?"
Barclays last week agreed to pay $453 million to settle U.S. and British authorities' allegations that the British bank tried to manipulate the London interbank offered rate, or Libor, which is the benchmark for interest rates on trillions of dollars of loans to individuals and businesses around the world. Investigations of more than a dozen banks—by authorities on three continents—are starting to unearth evidence that some banks improperly sought to manipulate Libor. Regulators say that some banks, including Barclays, submitted artificially low readings during the early days of the financial crisis as part of an effort to mask the financial problems they were encountering.
In its settlement with U.S. and British authorities, Barclays acknowledged that, starting in 2005, traders submitted erroneous data about its borrowing costs, in what was then an effort by some employees to boost profits on the positions they held. Regulators uncovered emails, instant messages and phone calls in which Barclays traders and other employees openly discussed their tactics. But by 2008, with the financial crisis intensifying, Barclays was routinely submitting some of the highest cost-of-borrowing readings of any bank. Executives at Barclays, which was financially healthier than some banks that were reporting lower borrowing costs, believed this was because rivals were reporting bogus data to conceal their financial problems. Mr. Diamond and other executives repeatedly complained to regulators.
Three weeks ago we noted that Goldman Sach's Global Leading Indicator (GLI) and its Swirlogram had entered a rather worrying contraction phase. Today's update to the June GLI data suggests things got worse and not better as momentum is now also dropping as well as the absolute level.
This continued deterioration in momentum suggests further softening in the global cyclical picture. Of particular concern is the broad-based deterioration in the GLI’s constituent components in June.
Nine of ten components weakened last month, only the second time this has occurred since the depths of the recession in 2008Q4. The June Final GLI confirms the pronounced weakening in global activity in recent months. Goldman has found elsewhere (as we noted here) that this stage of the cycle, when momentum is negative and decelerating, is typically accompanied by deteriorating data and market weakness.
Shrinking incomes, amid uncertainties surrounding employment, the financial markets, and the housing sector, have reduced consumer confidence, resulting in curtailed spending.
The softer economic data from the late spring was underscored by a weak performance in the personal income and outlays report.
Real disposable personal incomes increased 0.3 percent in May, a lowly 1.1 percent gain from year ago levels. This soft pace in incomes is insufficient to foster confidence and promote greater spending.
Real consumer spending increased 0.1 percent in May and was a mere 1.9 percent higher than year ago levels. Traditionally, sub-2.0 percent postings in the annual growth rate of real consumption expenditures portend recession – something to keep an eye on in coming months.
Late last week, in a conference call, Family Dollar Stores CEO Howard Levine noted consumers continue to face difficult economic headwinds. “While consumer expectations for inflation have moderated recently, unemployment rates have given up gains and consumer confidence is deteriorating,” he said.
The deterioration in attitudes may not be limited to Family Dollar store shoppers at the lower end of the income spectrum.
SENTIMENT & CONFIDENCE
The University of Michigan’s Consumer Sentiment Index took a turn for the worse falling 7.7 percent over the last month to 73.2 in June.
Similarly, the Index of Consumer Expectations plunged 8.7 percent to 67.8 in June.
According to Richard Curtin, the Surveys of Consumers chief economist, “Perhaps of greater importance was that the entire June decline was among households with incomes above $75,000. Higher income households were not only less optimistic about economic prospects but viewed their own financial prospects much less favorably.”
Confidence may get hit yet again now that the U.S. Supreme Court upheld the American Health Care Act, particularly within the small business sector. The Small Business Association reports that 99.7 percent of all employer firms in the U.S. are small businesses. Added healthcare costs could force employers to reduce staff.
The National Federation of Business Economists (NFIB) will be asking a special healthcare question in its next survey of small business conditions, which should be quite informative with respect to hiring prospects and subsequently future incomes and spending.
DISCRETIONARY SPENDING
The Fab Five indictors of discretionary spending softened in May,
the weakest being women’s and girls’ clothing, which contracted by 1.0 percent, far below the 9.0 percent gain registered in late 2010.
Casino gambling was up 0.4 percent yearover- year.
Jewelry and watches advanced 2.2 percent over the last year – likely due to trading down from “bling” to costume jewelry.
Meanwhile cosmetics are up 1.9 percent year-over-year.
The pace of dining out was the strongest of the Fab Five, advancing 3.5 percent over the last year. Darden Group’s CEO Clarence Otis last week noted the problems facing the restaurant sector. Fourth quarter same-store sales at Red Lobster declined 3.9 percent. Olive Garden fell 1.8 percent.
'Big miss at 49.7. The reading, which represents contraction, is well below the 52.0 that was expected. The Prices Paid Index (which measures the cost of goods for companies) went into total freefall, falling from 47.5 to 37.0.
07/03/12
ISM
US ECONOMY
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
CENTRAL BANK LIQUIDITY: UK Injects Yet Another £50
While everyone was expecting the BOE to return back to QEasing with a £50 Billion increase in its asset purchase program(me), to a total of £375 billion, which is what just happened, the bigger news came 1 second before the BOE announcement, with China declaring it has cut benchmark interest rates as once again the fate of the whole world is in the hands of small groups of academics, promising each other bottles of Bollinger if they can only get the S&P500 over 1,400. In other words, once again small groups of people around the world sat down and conspired (perfectly legally) to manipulate global interest rates. No hearings are scheduled.
From the BOE:
The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to increase the size of its asset purchase programme, financed by the issuance of central bank reserves, by £50 billion to a total of £375 billion.
UK output has barely grown for a year and a half and is estimated to have fallen in both of the past two quarters. The pace of expansion in most of the United Kingdom’s main export markets also appears to have slowed. Business indicators point to a continuation of that weakness in the near term, both at home and abroad. In spite of the progress made at the latest European Council, concerns remain about the indebtedness and competitiveness of several euro-area economies, and that is weighing on confidence here. The correspondingly weaker outlook for UK output growth means that the margin of economic slack is likely to be greater and more persistent.
CPI inflation fell to 2.8% in May and is likely to edge down further in the near term. Commodity prices have fallen, which should help to moderate external price pressures. And pay growth remains subdued. Given the continuing drag from economic slack, that should ensure inflation continues to ease into the medium term.
At its meeting today, the Committee agreed that the Funding for Lending Scheme, which would be launched shortly, was a welcome initiative. It also noted recent and prospective actions to ease liquidity constraints within the banking system. Taken together with reduced pressure on household real incomes, on the back of lower commodity prices, and the continued stimulus from past monetary policy actions, that should sustain a gradual strengthening of output growth.
But against the background of continuing tight credit conditions and fiscal consolidation, the increased drag from the heightened tensions within the euro area meant that, without additional monetary stimulus, it was more likely than not that inflation would undershoot the target in the medium term. The Committee therefore voted to increase the size of its programme of asset purchases, financed by the issuance of central bank reserves, by £50 billion to a total of £375 billion. The Committee also voted to maintain Bank Rate at 0.5%. The Committee expects the announced programme of asset purchases to take four months to complete. The scale of the programme will be kept under review.
The minutes of the meeting will be published at 9.30am on Wednesday 18 July.
The People's Bank of China decided to cut financial institutions RMB benchmark deposit and lending interest rates since July 6, 2012. One-year benchmark deposit rate cut of 0.25 percentage points, year benchmark lending interest rate cut by 0.31 percentage points; other deposit and lending interest rates and individual housing provident fund deposit and lending rates be adjusted accordingly.
Since the same day, the lower limit of the floating range of lending rates of financial institutions was adjusted to 0.7 times the benchmark interest rate. Individual housing loans interest rate floating range should not be adjusted, financial institutions should continue to strictly enforce the differentiation of the housing credit policy, to continue to curb speculative investment buyers. (End)
07/06/12
Zero Hedge
CENTRAL BANKS
Market Analytics
TECHNICALS & MARKET ANALYTICS
DIVIDEND YIELD PREMIUM: History Suggests Stocks Are Not YET Cheap.
The broad theme of buying stocks because they are cheap - as evidenced by the dividend yield's premium to US Treasury yields - seems to fall apart a little once one look at a long-run history of the behavior of these two apples-to-unicorns yield indications. Forget the risky vs risk-free comparisons, forget the huge mismatch in mark-to-market volatility, and forget the huge differences in max draw-downs that we have discussed in the past; prior to WWII, the average S&P 500 dividend yield was 136bps over the 10Y Treasury yield and while today's 'equity valuation' is its 'cheapest' since the 1950s relative to Bernanke's ZIRP-driven bond market; the 'old' normal suggests that this time is no different at all and merely a reversion to more conservative times - leaving stocks far from cheap.
$48.1 billion: The quarterly drop in U.S. corporate profits from abroad in the first three months of 2012.
It’s becoming increasingly clear that what happens overseas isn’t likely to stay overseas.
The final data for gross domestic product was released on Thursday, showing that the economy grew at an unrevised rate of 1.9% in the first quarter. Markets basically yawned as they went back to focusing on the euro zone summit and the release shortly after of the Supreme Court’s health-law decision.
But beneath the unchanged headline number were some worrying new details. For one, corporate profits were revised lower. The new data showed the first quarterly drop in the measure since the darkest days of the recession in the fourth quarter of 2008.
At first glance, the drop in profits was a bit hard to square with job numbers for the first quarter. Sure, employment has been weak for the past few months, but it was strong in the early part of the year. The answer came in where the profit drop originated. Profits from the U.S. were actually strong in first quarter, jumping 10% from a year earlier. But earnings coming from the rest of the world tumbled 12% from the first quarter of 2011.
Meanwhile, export growth was revised down to just a 4.2% gain from a previously reported 7.2% increase. Weaker corporate profits from abroad and slower export growth are telling a clearer story of a global slowdown. But the worrying part is that the story is already three months old.
The second quarter was even worse for the global economy than the first. That helps explain some of the weaker data in the U.S. in the past few months. For a while, it appeared that the problems overseas weren’t spreading too badly into the U.S., but the revised data make it clear that the spillover was already starting early in the year. The drag was likely exacerbated in the quarter that ends today.
Hopes are high that Europe has gotten its act together following a summit on Friday. But it’s worth noting that we’ve seen plans before that are long on statements of unity and promises for future action but short on specifics.
In the first quarter, the U.S. stayed mostly healthy while the rest of the world came down with the flu. In the second quarter, it looks like America caught the bug. As the third quarter begins, it still isn’t clear whether we spend the summer recuperating on the beach or in bed with pneumonia.
07/02/12
WSJ
ANALYTICS
DECISION POINT: BUY Signal Triggered
New BUY Signal for S&P 500 Index 06/29/12 Decision Point
Today our mechanical Thrust/Trend Model (T/TM) for the S&P 500 switched from NEUTRAL to BUY. For our purposes, the S&P 500 represents "the market."
The signal was generated by the Thrust Component of the T/TM, which consists of the PMO (Price Momentum Oscillator) and the PBI (Percent Buy Index). Once both of these indicators have moved above their EMAs, a BUY signal is generated. You can see that the PMO crossover occurred earlier this month. The PBI crossover occurred today, which was more delayed than we normally see.
While the T/TM is intended for intermediate-term timing, the Thrust Component of the model is really more short-term oriented and its intended effect is an earlier entry than we would normally get from the Trend Component alone. This makes it vulnerable to whipsaw.
At this point we will wait for the Trend Component to confirm the signal, which will happen when the 20-EMA crosses up through the 50-EMA. This will take a while because there is still a lot of separation between the two. (See arrows on the thumbnail chart above.)
The timing model is far from perfect, but it has proven to be a fairly reliable tool for identifying changes in trend. At this point we have to assume that a new up leg is in progress. Our intermediate-term market posture is now bullish.
A Stronger Dollar Sparks Second Quarter Earnings Worries for Corporate America 06/27/12 AlphaNOW
As the dollar rises against the euro, companies in the S&P 500 are cutting their forecasts for second-quarter earnings:
The greenback has gained about 15% against the euro over the course of the last year, perhaps because global investors, in light of the problems afflicting the eurozone, view owning dollar-denominated assets as preferable to exposing themselves to the uncertainty and risk that hovers overhead in Europe.
EXAMPLES
PHILIP MORRIS: Tobacco powerhouse Philip Morris International Inc. (PM.N) powerhouse is just one of a growing number of companies in the Standard & Poor’s 500 index to cut its earnings guidance to reflect the impact of the stronger U.S. dollar; it also warned that it is seeing sales of tobacco and cigarette products to drop in the European Union.“Growth in developed markets has dropped off significantly,” said Bob McDonald, the company’s chairman and CEO, at last week’s Deutsche Bank Global Consumer Conference. “These markets still account for 60% of sales and an even greater percentage of our profit.” (It doesn’t help, the company noted, that its commodity costs also have risen sharply.)
MERCK: Pharmaceutical heavyweight Merck & Co (MRK.N) sees the same trends buffeting its own earnings. “At today’s exchange rates, for example, sales in the second quarter would be adversely affected by about 3%,“ cautioned Peter Kellogg, chief financial officer of Merck, during the company’s first-quarter conference call with investors and analysts back in April.
PROCTOR & GAMBLE - PEPSI: In the final days of the second quarter, other big multinational companies like Procter and Gamble Co. (PG.N), and PepsiCo Inc. (PEP.N) also are giving negative guidance for their second-quarter results.
The strong dollar simply exacerbates the impact of economic weakness worldwide, particularly in Europe; the combination isn’t a good sign for the upcoming earnings season. The chart below provides a selection of companies in the S&P 500 (those that break out their sales by geography) that have the greatest exposure to Europe, as calculated as a percentage of their total revenue, with that revenue translated into British pounds.
From among these companies, Coca Cola Enterprises Inc. (CCE.N) generates the highest percentage of its sales (66%) from Europe, meaning that its second-quarter earnings are very likely to take a hit. Not surprisingly, all 11 analysts covering the stock who have changed their estimates have lowered their earnings per share estimates for the quarter. The dollar effect? Well, Bill Douglas, the company’s chief financial officer, told the Deutsche Bank Global Consumer Conference that he expects currency translation “to have a negative high single-digit impact on (earnings)” for 2012 as a whole.
EARLY INDICATIONS:
AlphaNow data on earnings preannouncements paints a less-than-rosy picture of what lies ahead. Companies In the S&P 500 have issued 26 positive EPS preannouncements, but that has been dwarfed by the 93 preannouncements cautioning that these companies might not live up to analysts’ expectations for second-quarter earnings.
To compute a ratio between these negative and positive preannouncements (an N/P ratio), you need only divide 93 by 26; the answer, 3.6, is the weakest showing in more than a decade, since the third quarter of 2001.
The Information Technology, Consumer Discretionary, and Health Care sectors have seen the largest number of negative earnings preannouncements.
In addition to the unfavorable exchange rates, companies are citing slower economic growth in emerging markets and Europe as one of many problems that corporate America must grapple with.
Analysts’ downward revisions, coupled with negative guidance from the companies themselves, makes corporate earnings look bearish in the second quarter.
As a result, the estimated growth rate for earnings by companies in the S&P 500 has fallen from 9.2% to 6.1%, since the second quarter began in April.
If the expected earnings growth rate comes in at 6.1%, it will be the third quarter in a row in which earnings growth has remained stuck in the single digits, after eight consecutive quarters of double-digit growth.
Excluding Bank of America (BOA), the estimated growth rate for the S&P 500 drops to a 1.1%. (See Exhibit 3, below.)
It doesn’t help that those companies that are generating growth in sales are still having difficulty converting that into growth on the bottom line.
According to Thomson Reuters I/B/E/S data, nine of the ten sectors in the S&P 500 will record higher revenues for the second quarter, but only five sectors will see earnings grow by more than 1%.
Analysts expect that three of the ten sectors in the S&P 500 will see earnings decline: Utilities (-16.2%), Energy (-13.5%) and Materials (-11.1%).
This trend highlights the clear discrepancy between earnings and revenue growth that we discussed previously, and most companies are still facing higher commodity costs, which are eating up profits.
Troy Alstead, chief financial officer of Starbucks (SBUX.O) reminded his listeners at a recent conference that his company, like many of its peers, has suffered from “extreme commodity cost pressures.”
Today, with the end of the second quarter only days away, the company, along with those same peers, now must also battle the “macro challenges that we face in Europe”.
A Stronger Dollar Sparks Second Quarter Earnings Worries for Corporate America 06/27/12 AlphaNOW
DISTORTIONS: HEDGING OPERATIONS
Hedging their exposure to foreign currencies is a tried and tested way for multinational companies to reduce the likelihood that their earnings will be dealt a blow by a sudden unfavorable move in the dollar exchange rate.
While most companies don’t disclose these hedging activities on their balance sheets, it is logical to assume that many are embarking on some kind of hedging strategy.
PRICELINE.COM Inc. (PCLN.OQ) the online travel company is more reliant on international gross bookings than it is on its U.S. revenues, and, like many of its peers, reduced earnings guidance during its most recent conference call with investors and analysts in light of the challenging economic conditions in Europe.
Dan Finnegan, the chief financial officer of Priceline.com, warned that expected volatility in the euro/dollar exchange rate “can materially impact our results expressed in U.S. dollars.”
In order to protect its sales, the company explained that is has contracts in place to shield a substantial portion of its second quarter EBITDA and net earnings from any fluctuation in the euro or pound against the dollar during the second quarter, Finnegan explained.
ADOBE: Recently, Adobe Systems Inc. (ADBE.OQ) posted results that were slightly better than analysts had predicted (it announced earnings of 60 cents a share, compared to the Thomson Reuters consensus forecast of 59 cents a share) for its fiscal second quarter, which ended May 31.
However, the company saw a $14.5 million decrease in revenue due to unfavorable currency rates over year-earlier levels.
Mark Garrett, the chief financial officer at Adobe Systems told conference call attendees that the company had a $10.7 million gain from hedging activities in the second quarter, compared to a $200,000 gain form hedging during the second quarter of 2011.
“Thus the net year-over-year currency decrease to revenue, considering hedging gains, was $4 million,” Garrett said.
07/02/12
AlphaNOW
ANALYTICS
BANK PROFITS: As go Bank Stocks, So Goes the Equity Markets
Risk-Taking by Banks Still Not Paying Off in Higher Returns on Equity 06/29/12 AlphaNOW
Bank investors prize ROE as a measure of how well a financial institution uses its capital to generate profits – but industry-wide, ROE now is at levels once thought unimaginable. Is the right approach taking on more risk, or going back to basics?
Large global financial institutions could routinely earn returns on equity (ROE) for their shareholders north of 10%, and often even above 20%.
The financial crisis of 2008 brought about a host of new regulations and restrictions on their activities (such as the provisions of the Dodd-Frank Act barring much proprietary trading and many investments in hedge funds and private equity vehicles).
The more capital they need to keep on their balance sheets and the more higher-risk but potentially profitable businesses they can no longer pursue as actively, the greater the potential for their ROE to dip.
The common worry became that if their ROE fell below 10%, investors would be less willing to purchase their stock, since at that level the returns were less attractive relative to the risk and the degree of volatility in the share prices.
An ROE of around 20% enabled a bank’s stock to trade at around three times book value, a smaller ROE would weigh on that book value ratio and thus the share price.
As ROE levels have declined since the financial crisis, so, too has the book value of banking stocks in both the United States and Europe.
European banks, in particular, appear to have a lot to worry about, with a price/book ratio, on average, of around 0.5.
Whenever a company trade at a level below its book value, it signals that it is generating on return on shareholders’ equity that is below its costs of capital – thus, instead of creating value for shareholders, it is destroying it.
In theory – although it’s rarely practical in the real world – it would be better for the directors of such a company to liquidate it if they aren’t able to turn that ROE around and boost book value above 1.
There is a perverse macro-level outcome from over-zealous central-planning. We have talked in the past about the greater risk of huge tail events in a controlled/normalized/planned/smoothed world, but as SocGen's Dylan Grice in an analogy to driving: "traffic lights and road signs are well intentioned, but by subtly encouraging us to lower our guard they subtly alter the fundamental algorithm dictating micro-level driving behavior." In other words, we drop our guard. With the plethora of financial market traffic light and road signs (Basel III, Solvency II, Bernanke Put) the fear is that this illusion of capital or safety has made markets more lethal (think AAA-rated bonds for a simple example). "We should be able to understand that the world isn’t risk free, can never be made risk free and that regulations which trick people into thinking it is risk free serve only to make it more dangerous." But instead, following the rule-of-Iksil (baffling with bullshit), regulators have gone the traditional route - but this time to an exponential place of craziness with Dodd-Frank - layering complexity upon complexity to give an out to those who abuse it most. Perhaps, as Grice notes, instead of focusing on 'fixing' the "crisis of capitalism", it would be more pragmatic to focus on the "crisis of dumb counterproductive intervention"?
07/03/12
Dylan Grice
SocGen
CRONY CAPITALISM
GLOBAL FINANCIAL IMBALANCE
SOCIAL UNREST
STATISM
CURRENCY WARS
STANDARD OF LIVING
GENERAL INTEREST
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JULY 2012: GLOBAL MACRO TIPPING POINT
