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As we reported last month, Global Economic Risks have taken a noticeable and abrupt turn downward over the last 60 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggested the global economic condition is at a Tipping Point. Though we stated "Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses" nothing has occurred even after the 19th disappointing EU Summit to address the EU Crisis. Some event is soon going to push the global economy over the present Tipping Point unless major globally coordianted policy initiatives are undertaken. The IMF recently warned and reduced Global growth to 3.5%. This is just marginally above the 3% threshold that marks a Global recession. This would be the first global recession ever recorded. The World Bank is "unpolitically'projecting 2.5%. The situation is now deteriorating so rapidly, as to be impossible to hide anylonger.

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CURRENCY WARS: The Fighting Resumes - The "Race to the Bottom" Monetary Policy Programs Accelerates

THE "UNLIMITED" & "UNCAPPED" SALVO - The macroprudential policy strategy of Financial Repression reached a seminal point last month with the announcement of the Federal Reserve's "Unlimited" QEIII/Operation Twist and the ECB's "Uncapped" OMT. We have moved into the outer limits of Monetary Policy which now forces the accelerated currency debasement of the developed economies against its Asian & BRIC competitors. The 'race to the bottom' has entered another phase which now sets the battle lines for the next set of conflicts.

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MARKET ANALYTICS & TECHNO-FUNDAMENTAL ANALYSIS

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	PART I - Understanding FINANCIAL REPRESSION
	PART II - FINANCIAL REPRESSION in Europe
	PART III - FINANCIAL REPRESSION in the US & ASIA
	PART IV - Preparations for FINANCIAL REPRESSION

Password: macro

US FINANCIAL STATEMENTS - As A Corporation it is Both Insolvent & Exhibits Fraudulent GAAP Accounting Practicing

USA, Inc. - Part 2: If America Were A Corporation, It Would Be Broke-er 11-01-12 Mary Meeker KPCB via ZH

When Mary Meeker, formerly of pre-IPO bubble analyst fame, released her "USA, Inc." presentation last year, which assayed the US government as if it were a corporation, her conclusion was simple: the country is broke, and can not continue along the path it is on now. Fast forward to today, when the US debt balance is over $1 trillion higher, and the next edition of Mary Meeker's presentation which she released at last week's Ira Sohn conference. Her conclusion: the US is now broke-er than ever.

The summary bullets of the must read cover to cover 50 page presentation.

1. America is losing its edge - some of this is inevitable as other countries improve their competitiveness, some of this is self inflicted.
2. Financial strength is vital to competitiveness – it’s core to a healthy economy, job creation, vibrant education / culture and military leadership.
3. Positive cash flow and a strong balance sheet are key to financial strength – bottom line, it’s bad to spend more than one brings in, as America is doing. In effect, as each day passes – with our rising losses and debt load – we rob just a little bit more from the future.
4. America does not need to lose its edge, it needs conviction and leadership to move its ‘business model’ in the right direction – we are all in this together, we need to understand and acknowledge our problems and agree to move forward with collective inspiration and sacrifice.
5. American tax dollars fund our government – we all need to understand where our taxes go and decide if we believe our hard-earned dollars are put to their highest-and-best use. The politicians we elect decide where our money goes.

As everyone who has worked in finance knows, the first page of every presentation is the Sources and Uses table. USA, Inc., has one two. We fail to see, however, who in their right mind would consider this a sane investment.

To be sure, the full name of the corporation should be Welfare USA, Inc. as can be seen below from the consolidated Healthcare spending for the US in context...

And the percent of households paying taxes vs those receiving government benefits. Houston: we have inversion!

Full hair-raising presentation below:

Meeker USA Inc  

JAPAN - Easy Money Has Hurt Corporate Profitability in the Longer Term

No, Soaring Deficits Do Not Mean Record Corporate Profits: In Fact Just The Opposite 10-22-12 Zero Hedge

Like the US, Japan has seen its share of soaring budget deficits in both absolute terms and as a % of GDP. In fact, since the 1960s, the deficit as a % of GDP number has gone up, up, up.

So how have corporate profits performed in Japan during this period of "deficit spending into oblivion" utopia starting in 1960 and ending, well, never? After all recall that Japan will surpass one quadrillion in sovereign debt this year, and well over 200% in debt/GDP. Well, as a paper by Jim Montier (which we dissected previously) showed early this year, corporate profits in Japan have done poorly to say the least. Below is the Bloomberg data for the ratio for Japanese profits to sales for all industries.

In fact when plotting the two on the same chart and inverting the corporate profits axis, we get...

It should be clear to everyone, except for the most confused journalism majors, that if the correlation of soaring deficits did result in rising profits, than the trendline of the second chart above would be up. Not down. Alas, it is down.

And as the third chart shows, in Japan, over the past 40 years, soaring deficits have actually resulted in collapsing profit margins. Which incidentally, is how one refutes amateurish correlation=causation CPM click magnets.

But wait, there is more.

Because the question still stands: why did Japanese profits decline for over 40 years during a time when the Japanese government was spending like a drunken sailor. We explained it previously in detail, but here it is again in a nutshell:

• In an environment of soaring liquidity and free money, the hurdle rate on new investments collapses, as does the requirement to invest in CapEx, both growth and maintenance. In fact, as we have shown over the past year, the age of the global asset base has hit a record high across the world, both in the developed and developing countries, leading to record low return on assets! (and record debt encumbrance, but that's a different story). On record old assets. And since companies are forced to dividend cash to shareholders at a record pace (in lieu of fixed income in a ZIRP environment), there is less and less cash left to support CapEx spending.

So why did cyclical (not secular) profitability in the US spike in the past several years? Two simple reasons:

i) debt refinancings into an ever cheaper cost of capital, which however has now hit a floor as very little incremental balance sheet benefit is left for companies, both investment grade and high yield, and

ii) SG&A reductions, as more and more companies lay off thousands, or merely replace their fixed cost structure with a cheaper employee base (converting from full-time to part-time workers is one example, and one we have documented extensively).

Finally, as we showed last quarter, corporate profitability has already peaked, and at in Q3 will post its second consecutive quarter of Y/Y declines. In the meantime, we believe it is unnecessary to demonstrate that US deficit spending did not decline at all in recent months, and in fact has at worst kept up at the same pace.

The key point is that it has been the Fed's easy money policies that have resulted in cyclical bouts of corporate profitability, whose end has usually coincided with the period of easy money. Now, however, the Fed has no choice but to keep ZIRP for ever, even as corporate profits have once again started declining, and there is no lever the Fed, or anyone, certainly not the US Treasury, can pull to push them higher.

In other words, an absolute dead end, and not to mention record deficits do not drive record profits, which was the original idiotic contention.

So instead corporates get a 2-3 year profit boost benefiting shareholders who get to cash out, while in return America has a record debt load to show for it. Sounds like a grand exchange... if only one lives in a socialist utopia, as taught by the Columbia school of journalism or comparable, and has no idea how every single instance of socialism ends when the other people's money runs out.

MONTHLY PMI/ISM - G7 in Contraction

Q3 EARNINGS SEASON - Europe Impacting Demand

U.S. Firms Get Dinged in Europe 10-24-12 WSJ

Europe's economic woes are washing over U.S. multinational companies, contributing to a season of weak corporate earnings. Domestic sales are growing, as the U.S. housing market and consumer confidence recover. But China's economy has slowed, robbing U.S. companies of their most reliable growth engine of recent years. Almost uniformly, however, U.S. companies reporting third-quarter results identify Europe as the weakest link in the global economic chain.

• 20-25% of REVENUE: On average, Europe accounts for about 20% to 25% of sales for big U.S. companies.
• AUSTERITY: European economies are struggling with debt accumulated during the boom years of the prior decade, compounded by austerity measures aimed at reducing government deficits.
• CONTRACTION: The euro-zone economy shrank in the second quarter, and is projected to shrink for the rest of the year.
• US DOLLAR: U.S. firms face another hurdle: the dollar has gained 7.4% in value against the euro in the past three months. That makes American goods more expensive and reduces the dollar value of European sales.

WHIRLPOOL: Take it from Michael A. Todman, president of international operations for Whirlpool Corp. The appliance maker reported stronger-than-expected financial results and boosted its forecast for the rest of the year. But sales to Europe and the Middle East fell 19.5%, and Whirlpool reported a $35 million operating loss in the region. Speaking to investors Tuesday, Mr. Todman cited a long list of European ills, including

1. Weak consumer
2. Demand, lower efficiency from reduced production,
3. A strong dollar and
4. High raw materials costs.

KIMBERLY-CLARK: Other companies report similar challenges. Wednesday, consumer-products maker Kimberly-Clark Corp., the maker of Huggies, said it would stop selling diapers in Western and Central Europe, with the exception of Italy. Chief Executive Tom Falk said the European diaper business was breaking even, and "we expect the European market to remain challenging going forward."

CATERPILLAR: Earlier, construction-machinery giant Caterpillar Inc. reported a 5% increase in quarterly sales and a 49% increase in profit. But sales in its European region fell 1%. Caterpillar predicted "modest improvement" in economic conditions in most of the world next year, but "continuing difficulty in Europe."

3M: U.S. sales at 3M Co. rose 2.8% from a year earlier. But sales to the Asian-Pacific region dipped 1.4%, and sales to Europe fell 6%.

IBM: International Business Machines Corp.reported flat profit on a 5% decline in revenue, weighed down by a 9% revenue drop in Europe.

FORD & GENERAL MOTORS: More bad news is likely next week, when Detroit auto giants Ford Motor Co. and General Motors Co. are expected to report big losses in their respective European operations. "We are seeing companies talk about weakness in Europe and finally slower growth in emerging markets and China," said John Butters, an analyst at FactSet.

DUPONT: At chemical maker DuPont Co., third-quarter European sales fell 6% by volume. The stronger dollar compounded the problem, sending European revenue down 15% compared with last year. DuPont's sales fell to every region of the globe, contributing to a 9% drop in revenue and a 98% decline in profit, including restructuring charges.

MOLEX: In the fiscal year ended June 30, 2008, sales to Europe accounted for 20% of revenue at electronic-connector maker Molex Inc. In the year ended June 30, 2012, European sales accounted for 14% of revenue. On Tuesday, Molex said third-quarter sales to Europe fell 16% from a year earlier, contributing to a 2% decline in global revenue; net income fell less than 1%. "Europe is clearly the most challenged region in the world today, and we don't see the economic prospects in Europe improving in the near term," chief executive Martin P. Slark told investors.

CELANESE: "Europe's still sliding," Mark Rohr, chief executive of Celanese Corp., CE +4.05%a Dallas chemical maker. Celanese Monday reported a 30% drop in third-quarter net income, on an 11% decline in sales. Celanese executives told investors Tuesday they expect sales to rebound in the second half of next year in most of the world—but perhaps not Europe. "We are not comfortable that Europe is at the bottom and is starting to rebound," its chief financial officer, Steven Sterin, said.

• Third-quarter earnings have fallen 3.9% at the 186 members of the Standard & Poor's 500-stock index that have reported results, according to Thomson Reuters.
• An unusually high share of companies—62%—have reported lower revenue than predicted by analysts.
• Greg Harrison, a Thomson Reuters analyst, says firms have offset sluggish sales by cutting costs, keeping average profit margins steady around 9% to 10%.
• There is one perverse benefit for U.S. firms as the euro crisis drags on. The region accounts for a smaller share of revenue, so future declines will have a smaller impact on the bottom line.
• Executives of U.S. multinationals say the economic outlook is particularly cloudy, with an election in the U.S. and a leadership transition in China. But many say Europe is the biggest question mark.

Q3 EARNINGS SEASON - European Corporations Report Negative Production Surprises

Deciphering The Dismal Reality In Europe From The Hopeful Green Shoots 10-31-12 Morgan Stanley via Zero Hedge

European corporates continue to report considerably more negative surprises in production than expectations a mere three months ago - with the divide now at extreme levels. As Morgan Stanley notes though, there remains a 'hope' for green shoots in the euro area on the back of the ECB's OMT announcement and an apparently more robust China. Unfortunately, as these ywo simple charts indicate, the reality is that business surveys are pointing to a continued slide and that recent resilience is unlikely to last. In fact, in Morgan Stanley's view, incoming data and anecdotal evidence would suggest Q4 could be even worse than had been expected and the recessionary envionment will drag well into next year.

Via Morgan Stanley:

Investors on a mission to spot green shoots: Recently, we have started to receive more and more questions from investors on whether we are seeing any tentative green shoots in the euro area on the back of the ECB’s OMT announcement and an improving global outlook. These questions often reflected encouraging dynamics in Asian exports – typically a good early indicator for a turnaround in the global trade cycle – as well as better-than-expected outcomes for 3Q GDP (and an especially strong one) in the UK and the US just this past week.

Coupled with the ECB’s announcement on unlimited OMT bond purchases and a tightening in peripheral government bond spreads, this has caused avid euro area data watchers to ask whether 3Q activity could also have been firmer than expected in the euro area, especially after this week’s first 3Q GDP flash estimates released in Spain and Belgium. According to these data, the Spanish economy would have contracted at a slower pace of ‘only’ 0.3%Q, despite another austerity package being implemented over the summer. After the Belgian economy printed a stable GDP number in 3Q today, this could suggest that euro area 3Q GDP could have been firmer than we were forecasting (we are looking for -0.3%Q in non-annualised terms).

Alas, we have to conclude that the resilience is unlikely to last: In our view, the October business surveys already sent a clear warning sign not to get too comfortable in the deceptive sunshine of an Indian summer. Like the weather currently, where sunshine will likely soon give way to the first autumn storms, we would urge investors to prepare themselves for the coming winter chills.

In our view, incoming data and anecdotal evidence would suggest that 4Q could be even worse than we had expected so far, and that the outright contraction in headline GDP could also drag into the early part of next year. Relative to our baseline forecasts, it is actually the core countries, notably Germany and France, which recently gave rise to fresh concerns on the back of a marked slowdown in global capex (Germany) and an ambitious austerity programme (France). Meanwhile, peripheral economies such as Spain and Italy seem to have been more resilient than we feared initially – and the recession there appears to be unfolding somewhat more mildly than anticipated.

The deteriorating cyclical outlook for the euro area as whole as we head into the winter supports our out-of-consensus call for December rate cut: We continue to expect a reduction in all three key policy rates by 25bp when the ECB staff are forced to revise down their growth estimates once again and when they roll out 2014 inflation forecasts. Such a step would bring the deposit rate into negative territory for the first time in the ECB’s history. While the deposit rate cut could be more controversial on the Governing Council than a refi rate reduction, we believe that without a cut in the deposit rate – which is the binding lower limit for short rates – a refi rate reduction would not have much of an impact.

FRANCE - Socialism is Expensive

France's Fiasco In One Fine Chart 10-31-12 Zero Hedge

France ranks at or near the top in

1. Government transfers to households,
2. Vacation times and
3. Labor market rigidity,

and at or near the bottom in

1. Hours worked per week,
2. Labor force participation rates and
3. Retirement age as a % of life expectancy.

As JPMorgan's Michael Cembalest notes, France is a workers's utopia - which is expensive to maintain - and sure enough four out of four of its main economic indicators are accelerating lower since Hollande's 'Deluge' began.

JPMorgan's Michael Cembalest's full Eye-On-The-Market PDF Here.

"Google Law" Yet Another Warped Policy by Hollande; Government Motors French Style 10-31-12 Mish

French president François Hollande took two more swan dives into the pool of ludicrous actions in the past few days, first with car-maker Peugeot, quickly followed up with a guaranteed-to-fail proposal regarding search engine giant Google

GOVERNMENT MOTORS FRENCH STYLE

Bloomberg reports France Guarantees Peugeot Debt in Exchange for Influence

EU CREDIT DOWNGRADES - France and UK On Tap

The Complete 'Advanced' Economy Sovereign Ratings Cheat-Sheet 10-29-12 Zero Hedge

S&P recently acted to markedly downgrade Spain, and Moody’s has ended its recent ratings review, leaving Spain at Baa3; and while ratings could remain largely stable in the short-term (supported by OMT's promise and the possible delay of GRExit), there are a few exceptions such as France and and the UK that Citi's Rates group expect to see downgrades on in the short-term. The following table provides the full breakdown of Moody's and S&P's ratings for the advanced economies along with Citi's model views - which imply weak outlooks for most of Europe in the medium-term as Greek reality hits home.

and in cased you were wondering just what Spain is doing with its bank bailout plan:

Via Citi:

Although we expect most sovereigns will have stable ratings in the near-term, there are a few notable exceptions. We expect that Moody’s will place France on a ratings review for a possible downgrade (ie Negative Watch) in the next 2-3 quarters, largely because of the fiscal program and weak economy. Moreover, we also expect that S&P will likely place the UK on Negative Outlook in the next 2-3 quarters (in line with Moody’s Aaa Negative Outlook). We also expect that Portugal will be downgraded over the next 2-3 quarters due to continued recession plus the probable need to extend its Troika programme.

Over the long-term, we still believe that ultimately, it will become evident that the Greek programme remains off track and that Greece’s debt is still unsustainable. We think the likely stalemate between Greece and its international creditors will eventually lead to a withdrawal of international support leaving Grexit as potentially the only available solution for Greece.

Due to our longer-term view on Grexti and various sovereign-specific factors, we continue to expect a wide series of downgrades over the next 2-3 years

GLOBAL -Credit Feuled Globalization in Retreat

Charting The Undoing Of Credit-Fueled Globalization 10-28-12 Zero Hedge

For two decades the rate of growth of world trade volumes considerably outstripped that of industrial production as credit-fueled globalization created huge imbalances in the world.

As Diapason Commodities' Sean Corrigan indicates in these three simple charts, all that vendor-financed circular exuberance has come to an end.

The Bottom-line: Forced deleveraging (not least of which in Europe) is crushing the credit-fueled (and unsustainable) dream of endless growth as debt saturation has been reached (on private and now public balance sheets). To wit: Global Trade Volume growth is deep in the danger zone and about to turn negative; as the hopes of so many Sinomaniacs and Pollyannas is slowly peeled back to a righteous recognition of reality.

The ratio of Global Trade Volumes to Industrial Production remained in a relatively stable uptrend as imbalances fueled by credit averaged 3.4% annually more trade than production. All that ended when whatever Keynesian Endpoint or Debt Saturation barrier we hit in 2008 and the impossible was proclaimed entirely possible.

What this means - simply - is that without credit expansion, world trade volumes are decelerating rapidly.

With Europe on a path to considerable deleveraging (as is clear below)...

...things do not look set to get better any time soon - and expectations for world trade to enter contraction any minute now is highly likely.

DREAMS OF CHINA SAVING THE DAY

And as Sean Corrigan notes - on the dreams of China saving the day once again:

The minor uptick in China’s ‘flash’ PMI estimate for October – from 47.9 to 49.1 ? has sparked the usual explosion of uncritical hopefulness (on the part of those who, by and large, thought there never could be a slowdown under the aegis of the all?powerful CCP to begin with,) that this finally marks a bottom in that country’s economic cycle.

In giving vent to such optimism, the Sinomaniacs conveniently overlooked the fact that much of the improvement was down to the fact that it was the price indices, rather than those relating to output or employment, which struggled back above the expansion/contraction threshold of 50 – a circumstance which might just temper their extend?and?pretend expectations of an ever imminent monetary relaxation, were they to reflect on it for a moment between jubilations.

Worse still, the Pollyannas appear to have forgotten that the PMI simply gauges whether things are generally better or worse than they were last month – and that in a non?quantitative manner, to boot. The unequivocal answer is worse (if marginally so, this time) for the twelfth consecutive month and for the fifteenth out of the last sixteen occasions. Thus, it may be true that the rate of decline seems to have slowed – how enduringly, only time will tell ? but the fact of that ongoing decline itself remains, even after so many uninterrupted months of economic deterioration.

China bulls and the other assorted, ?next quarter? blue?skyers may have either venal or psychological reasons to puff this one reading , but the test of an analyst who knows his stuff – and who is not afraid to be honest with you ? is whether he makes this simple, but crucial, distinction in his commentary.

and on extrapolating this recent China growth, Michael Pettis has a few words:

If you want to make economic predictions, in other words, whereas a long historical view will be very useful because it allows you to consider the dislocations created by a reversal of unsustainable imbalances, recent economic data are largely useless, as are predictions based on linear adjustments of recent economic data. Instead of projecting from past data you must model the various paths by which rebalancing can occur, and your prediction must be limited to those paths.

CHINA - PMI Improvement

China's Bullish PMI Report 10-31-12 Societe Generale via BI

GREEN SHOOT: China's Manufacturing Industry Is Growing Again 10-31-12 BI

JAPAN - The Biggest Debtor with the Biggest Problem!

Meanwhile In Japan... 10-27-12 Sean Corrigan of Diapason via ZH

Two of the saving features that allowed Japan to internalize 30-some years of failed fiscal and monetary policy (and yes, not one, not two, but now 8 failed iterations of quantitative easing) and to offset one relentless deflationary vortex was

i) Its DEMOGRAPHICS coupled with an investing culture that favors deposits and bonds over equities, which incentivized its aging population to invest its savings into government bonds, and

ii) Its TRADE SURPLUS which led to foreign capital flows to enter the country.

Well, as far as i) is concerned, Japan may have reached its demographic limit, since as reported several months ago, Japan's pension funds are now not only selling JGBs to meet redemption and cash needs, but forced to do truly stupid things like investing in the riskiest of assets to generate a return at any cost. In other words, demographics will no longer be a natural source of demand for deficit funds. As for ii), well... here is what has happened with Japan's trade surplus status in recent weeks following the collapse in the country's foreign relationship with China.

In other words, so much for net exports also being a source of capital. Some more thoughts on this from Sean Corrigan of Diapason:

Far across the Senkaku Islands, Japanese money supply has been decelerating from its recent impressive lick, while small business confidence has plummeted below even the post?Fukushima trough. Meanwhile, the nation’s exports languish at levels first seen in 2004, thanks to the toxic mix of the fallout from the territorial spat with the Chinese and the general Asian weakness ? also evident this week in Singapore (IP ?2.5% YOY), Thailand (manufacturing output off 13.7% YOY to rest where it was in 2007), and the Philippines (exports off 9% YOY to stand no higher than in2005).

All this sufficed to bring about a record trade deficit of close to Y1 trillion in Japan itself last month, at which point it was threatening to swallow the large monthly investment income component whole and, hence, to restrict the growth of the capital pool on which the country so heavily relies.

Nothing daunted, after two decades of blue bottle?against?a?windowpane policy?making, the country is again to be dosed with the same old, ineffective, patent medicine as the BoJ prepares to increase its version of QE by a cool Y10 trillion ($125 billion), some of which will help fund the already over?indebted government’s imminent Y700 billion fiscal injection.

You would think they would long since have have learned the futility of what they are about; the fact that this has eluded them for all these years them should worry us greatly about our own masters’ willingness to draw the correct lessons on that grim tomorrow when their own programmes are undeniably seen to have failed. Can we not admit it is folly always to resort to the crude economics of a Krugman – the macroeconomic equivalent of the château generalship of the Somme – and to whine that we have only failed because we have not thrown enough money or lives into the fray.

And that's two birds with one stone. The only source of "capital" left - BOJ monetization. The only problem, of course, is that Japan already has well over 200% of national debt to GDP. And that's the smaller problem. The bigger problem: even the smallest increase in prevailing interest rates, and the entire Japanese house of cards topples. Recall these charts:

As well as this chart of sovereign interest to revenue, in which Japan is also an outlier:

And certainly this chart showing Japan's straight diagonal line of debt/GDP:

But how many have seen this chart showing global sovereign debt as a percentage of total government revenues? 

So - is Europe still the biggest unresolved issue as conventional wisdom would have everyone believe? Or is Japan finally preparing to reclaim its rightful place as the straw that broke the Keynesian camel's back?

JAPAN - Is QUIETLY, an Order Larger Problem than Europe

A Mushroom Cloudy Future: In 2016 Japan, Net Debt Per Capita Will Be $140,000 10-23-12 Deutsche Bank via ZH

Sometimes you just have to laugh; or else committing harakiri comes dangerously close to mind. Japan's increasingly terrifying fiscal situation combined with a central bank that is rapidly becoming the laughing stock of the world (though all the other central banks are merely mimicking its actions) is becoming so self-referential (with its almost total domestic ownership of government debt), so short-termist (with its dramatically high short-term funding requirements constantly rolling), and demographically challenged (with its elderly almost entirely reliant upon government transfer payments) that it is hard to comprehend how much longer this farce can carry on. We have previously discussed Japan's WTF charts, but the following collection from Deutsche Bank's Torsten Slok must be seen to be believed. For now - the problem in a nutshell is government-debt per working-age person in Japan will be $140,000 in 2016 - almost triple the rest of the G7.

DEMOGRAPHIC PROBLEM

A DEBT PROBLEM

• Significant Fiscal Deficits
• Gross Financing Needs Are Remarkable
• Debt/GDP now above 80% in all G7 Countries
• Debt/GDP ratio up significantly in Spain, Greece, Portugal, and Japan
• In most G7 countries short term debt is 20% to 30% of total debt outstandin

Financial Repression and Domesticization has become rife...

• For Japanese investors JGBs look attractive
• Foreigners own only 5% of JGBs
• Japan: Holders of government debt as % of total outstanding. Foreigners hold 5%
• Institutional investor holdings of government debt

which has lead to a nation (people and banks) that are entirely as one connected to this SNAFU...

• Japanese banks have been increasing their holdings of Japanese government bonds
• Japanese banks: Deposit growth higher than loan growth
• Japanese banks buying JGBs for their surplus deposits
• Japan’s elderly rely mainly on public transfers when they turn 70

So - how does this all end? Who knows but the build up of outliers, black swans, bugs in search of windshields, and mushroom clouds waiting to happen is simply remarkable - and there is little doubt that with the right convexity the upside from this debt saturation's final death will be huge. The background can be found here - on how we got here and while Richard Koo can prescribe an ever-increasing budget of fiscal stimulus to plug the deflationary spiral - in the end, there is only one way out for Japan.

Please do not repeat the simplistic response to a Japan 'crisis' bet - that it has ruined many traders - this is simply incorrect in the last decade or more - with JGBs practically unchanged (it has merely been a carry loss) and their broad equity market down over 50%.

As SocGen's Dylan Grice once noted, Will 2012 be the beginning of the end of flawed Keynesian economics?

Maybe Japan's will be the crisis that wakes up the rest of the world and triggers some tough decisions on world-wide debt loads. Or maybe not - maybe the Greeks will beat them to it? or the Irish or the UK, or the US? Like banks in 2007, developed market governments today rely on sustained capital markets more than any time in their history. What if they shut?

Charts: Deutsche Bank

JAPAN - QE 9 a Complete Failure - Actually "Tightens" versus It's Intended Easing

When ¥11 Trillion Is Not Enough: Japan's QE 9 Disappoints, Halflife Zero, Time For QE 10 10-30-12 Zero Hedge

It was only yesterday that we pointed out the ever decreasing halflives of central bank interventions. We are grateful that none other than the biggest intervention basket case of all came out and proved us 100% correct, when the BOJ announced none other than QE 9 just one month after the impact from QE 8 fizzled about 8 hours after it was disclosed. This time around, the destructive "benefit" to the JPY was negative from the first second, resulting in the first instance of monetary easing that.. wasn't. Japan just came up with a brand new New Normal concept: tightening through easing, when its ¥11 trillion intervention proved to be woefully insufficient for a market addicted to ever more liquidity injections.

First, this is what QE 9 formally was (full statement here):

Click To Enlarge

The assets affected by QE 9 were across the board. The BOJ would monetized the following assets:

• JGBs: + ¥5 trillion
• Bills: + ¥5 trillion
• ETFs: + ¥0.5 trillion
• Corporate Bonds: + ¥0.3 trillion
• CP: + ¥0.1 trillion
• Japanese REITs: + ¥0.01 trillion

Alas all of this was for nothing, and as we showed previously, the USDJPY, which had been trading at 80.00 before the announcement, ad dropped immediately by 50 pips on the announcement of QE 9, presenting the first zero (effectively negative) halflife monetary intervention ever!

"The 10 trillion-yen increase was seen as a minimum expansion, and the failure to reach 15 trillion yen is very disappointing for markets," said Yunosuke Ikeda, head of Japan foreign-exchange research at Nomura Securities Co. in Tokyo. "The yen is being bought as risk sentiment is worsening in part because of Sandy." But at least US futures are pretending to be distracted for now, and while QE 9 failed in Japan, it has succeeded in its primary job: to push America higher, if only briefly.

And a full post-mortem of the now failed, for Japan, QE 9 from SocGen:

BoJ increased the APP by about 11 trillion yen

The BoJ decided to increase the total size of the Asset Purchase Program (APP) from about 80 trillion yen to about 91 trillion yen. Among the increased amount, 5 trillion yen will be directed at JGBs, 5 trillion yen at t-bills, 0.1 trillion yen at CP, 0.3 trillion yen at corporate bonds, 0.5  trillion yen at ETFs, and 0.01 trillion yen at J-REITs. The increased purchases of assets will be completed by December 2013. The market was expecting an increase in APP by at least 10 trillion yen in JGB and T-bills, plus some risk assets. Therefore, today’s announcement turned
out to be broadly as expected.

Second easing within one month

Last time the BoJ took additional easing action was only a month ago in September. Over the past month, economic conditions have worsened further. Political tensions with China over the island dispute have led to an unexpectedly serious economic slowdown, as many Chinese are boycotting Japanese products. Moreover, since the cabinet reshuffle at the beginning of October, there has been increasing political pressure on the BoJ to act with stronger monetary easing policy. For these reasons, the BoJ could not just wait and see the implication of the September action - the BoJ had to take action towards further easing.

Cooperation with government to fight deflation

In addition to the monetary policy statement, the BoJ released a separate report on “Measures Aimed at Overcoming Deflation”, which explains the shared understanding of the roles of the government and the BoJ. In this report, the BoJ confirms that it will continue with powerful easing until it judges the 1% CPI goal to be in sight - mainly by conducting virtually zero interest rate policy and implementing APP through the purchase of financial assets. The government also expects the BoJ to continue powerful easing until deflation is overcome, and to take economic policy measures to counter risks of an economic downturn.

It is unusual to publish a separate statement in cooperation with the government regarding monetary/economic policy. This is probably a result of increased pressure by the government on the BoJ to be more aggressive in fighting deflationary environment. However, in our view, it is simply a commitment which is interesting theoretically, but will probably not have any immediate impact on the economy.

Establishing a new framework to stimulate bank lending

Furthermore, the BoJ decided to provide long-term funds at a low interest rate to depository financial institutions in order to promote the supply of credit to firms and households. The total amount of funds provided will be unlimited, and the interest rate will be a long-term fixed rate equivalent to BoJ’s target for uncollateralized overnight call rate at the time the loan is granted (currently 0.1% per annum). The duration of loans will be 1 to 3 years, and can be rolled over up to 4 years.

This new facility is similar to the BoE’s measure to facilitate funding for lending. However, Japanese banks are currently not suffering much on the funding side, and the impact is likely to be less than in the UK. That said, in our view, it does have a significant impact from the point of view that the interest rate will be fixed long term, which would free the banks from any interest rate risk on their loans. The BoJ governor explained in a press interview that details of the facility will be discussed further by the end of December.

JAPANESE QUANTITATIVE EASING - References

• Bank Of Japan Expands Quantitative Easing (Again) While Economy Misses Forecasts (Again) 10-30-12 BI -- The Bank of Japan expanded its asset-purchase program for the second time in two months, a move that failed to cheer investors as stocks slumped amid mounting evidence that the economy contracted last quarter. e fund will increase by 11 trillion yen ($138 billion) to 66 trillion yen while a separate credit loan program will stay at 25 trillion yen, the bank said in Tokyo, acting hours after data showed the biggest decline in industrial output since last year’s earthquake. The BOJ will also offer unlimited loans to banks to boost credit demand.
• Japanese Government Demands BOJ Do QE 9 One Month After Failed QE 8 10-22-12 Zero Hedge -- Almost exactly a month ago, the BOJ surprised most analysts with an unexpected increase in its asset purchase agreement by JPY10 trillion bringing the total to JPY80 trillion. There was one small problem though: the entire impact of the additional easing fizzled in under half a day, or 9 hours to be precise. This was, as Art Cashin summarized the following day, Japan's failed QE 8. It is now a month later, and with nothing changed in the global race to debase status quo, the time has come for the BOJ to attempt QE 9. Or that's the case at least according to the toothless Japanese government, which has formally demanded that Shirakawa do a nine-peat of what has been a flawed policy response for over 30 years now, this time with another JPY 20 trillion, or double the last month's intervention.

JAPANESE FISCAL STIMULUS - References

• Japan Adds Stimulus Amid Threat of Bond-Sale Disruption 10-26-12 Bloomberg -- .Japan Adds Stimulus Amid Threat of Bond-Sale Disruption By Keiko Ujikane and Mayumi Otsuma - Oct 26, 2021 5:48 AM ET ..Facebook Share LinkedIn Google +1 5 Comments Print QUEUEQ..Japan announced 750 billion yen ($9.4 billion) of fiscal stimulus to shore up growth as bond investors told the government they’re worried about delays in financing more spending. Finance Minister Koriki Jojima said last week that the government will run out of money by the end of November if the financing bill is not passed.
• Japan PM says govt 'will stall' without bond bill 10-29-12 The West Australian
• Japan Grapples With Its Fiscal Cliff 10-25-12 CNBC -- Japanese politicians are at loggerheads over a bill that would allow the government to borrow the Y38.3 trillion ($479 billion) needed to finance the budget deficit this year. As a condition for supporting the bill, opposition parties are demanding that Yoshihiko Noda, prime minister, fulfil a pledge to call a general election. Mr. Noda has so far refused to set a date out of fears that his ruling Democratic Party of Japan, which is adrift in the polls, will be voted out of office.

CURRENCY WARS - Japan Continuously Under Attack

Japan to join currency wars as exports slump 10-22-12 Ambrose Evans-Pritchard, Telegraph

CURRENCY WARS - Vast foreign US$ Coming Home for "Claim"

At Long Last, Corporate Japan Is Going On Its Big Acquisition Spree In America 10-22-12 BI

SOUTH KOREAN CANARY - Caution Advised Regarding Positive Export Turnaround

THE GLOBAL TRADE SLOWDOWN HAS ENDED 11-01-12 BI

UK - Small Business Credit Squeeze Now Acute - Loan Rejections Rising

Firms 'facing a loans shortfall of £21bn' 10-29-12 The Independent

• Cash-starved companies face a £21bn loans squeeze this year as business lending falls to its lowest level since 2006, according to alarming new forecasts today.
• Smaller businesses will bear the brunt of a 4.6 per cent fall in corporate loans to £429bn this year, Ernst & Young's latest forecasts for the financial sector warn.
• Business lending should return to growth next year but will not recapture 2008 heights for another four years, it adds.
• The accountant blames
  • A poor economic backdrop and
  • Tougher capital requirement for the shortfall as
  • Britain's banks shrink their balance sheets by an estimated £300bn this year.

Carl Astorri, senior economic adviser to the Ernst & Young ITEM Club, said: "The good news is that 2012 is likely to be the last year of such marked deleveraging in the UK – the bad news is that, once again, SMEs will bear the brunt of it. Government schemes to increase lending may help a lucky few but, as banks are encouraged by regulators to store up more capital and to look again at their forbearance policies and so-called bad-loan books, most small business are going to continue to feel the squeeze."

Ernst & Young added that loan rejection rates for businesses were rising, and warned that attempts to boost lending through the business bank set up by Business Secretary Vince Cable, pictured, are likely to fall well short of filling a £19bn "financing gap" faced by SMEs.

Mr Astorri said: "The figures suggest that the business bank's lending capacity could be exhausted in less than a year. Its impact will also be reduced by competition with private sector lending activity: even if the Government aims to lend at market interest rates, it is unlikely to be able to avoid displacing existing lending activity. Indeed, we expect the business bank will have to compete for projects that are commercially viable, and so we do not think the scheme will have a tangible impact on the economy."

UK - In A Recession

UK Economy Update 10-25-12 Bloomberg Brief

The U.K.’s first double-dip recession since the 1970s ended in the third quarter, today’s GDP figures show, assisted by one-time effects including ticket sales for the London Olympic Games and a reversal of the negative impact of an extra public holiday in June. The U.K. economy grew at the fastest pace in five years after GDP rose 1 percent from the three months through September. While the return to growth may cheer the government, the outlook is only for a weak recovery. Stripping out the temporary factors from the third-quarter data may leave underlying growth closer to 0.1 percent.

GDP has shrunk in nine of the past 19 quarters, leaving output 3.1 percent below pre-crisis levels through the third quarter. While the recession may have ended, the National Institute of Economic and Social Research defines a depression as “a period when output is depressed below its previous peak.”

The BOE estimates it will take until 2014 before the U.K. returns to the 2008 level, longer than after the Great Depression of the 1930s.

The first GDP estimate is based on 44 percent of the required information and the ONS frequently makes revisions. The chart shows the difference between the first estimate and the last revision over 52 quarters. There have been no revisions in just three quarters over that period. While the average change is 0.1 percentage point, upward revisions have a mean of 0.4 percentage point.

Consumers may be worse off than the GDP figures suggest. Net national income per person has dropped by 13.2 percent since its peak in 2008, according to the Office for National Statistics. That compares with a 7 percent fall in GDP per person over the same period. While reaching a new low 12 quarters on from its peak, NNI per head recovered to the prerecession peak in 10 quarters and 13 quarters following the recessions that began in 1990 and 1980, respectively.

Underlying third-quarter growth may have been about 0.1 percent, according to Markit, as the composite PMI averaged 50.9 in the period. The repair of overstretched private and public balance sheets is likely to weigh on domestic demand in the coming quarters. BOE Governor Mervyn King said this week the recovery is proceeding at a “slow and uncertain” pace.

Q3 EARNINGS SEASON - Q4 Earnings Hockey Stick now Officially in Jeapordy

We May Have To Wait A Lot Longer For The Corporate Earnings Rebound 10-31-12 BI

After third-quarter earnings reporting, during which profit growth is expected to turn negative for the first time since the financial crisis, most Wall Street strategists were hoping that the worst would be over, setting up for a nice rebound in Q4. As it turns out, however, the negativity coming through so far in corporate guidance for fourth-quarter earnings is nothing short of "stunning," says National Bank Financial economist Matthieu Arsenau. As the chart below shows, the ratio of negative earnings preannouncements to positive preannouncements for Q4 is at an all-time high:

Q3 EARNINGS SEASON - Headlines & Highlights Suggest a MAJOR DEMAND Problem

Earnings Cliff Ahead? Profit Outlooks Are 90% Negative 10-22-12 CNBC Fast Money

• Earnings conference calls are beginning to resemble crisis hotlines as corporate executives slash profit forecasts because of fears of higher taxes, a recession in Europe and slowing economy in China.
• Of the 20 companies in the S&P 500 that have provided guidance for the fourth quarter during the current earnings reporting season, 18 have slashed their forecasts, according to Goldman Sachs. That's a 90 percent negative run rate that many investors and analysts have never seen before.
• “Although guidance tends to be downbeat, this is especially negative,” wrote Goldman’s David Kostin, in a note to clients over the weekend. The strategist sees this negativity leading to a 14 percent drop in the S&P 500 this quarter.
• “Companies are taking the opportunity to lower the bar,” said Mike Murphy of Rosecliff Capital. “All have one eye on the fiscal cliff, so might as well bring expectations down in case we go over the cliff.”
• The most discussed topic on earnings conference calls is in fact the year-end “fiscal cliff,” when the Bush tax cuts are set to expire and mandatory spending cuts go into effect, barring any action from a lame-duck Congress. Executives fear this may occur whether or not President Barack Obama retains office or Mitt Romney unseats him.

When speaking of demand from truck companies on the conference call, Alcoa CEO Klaus Kleinfeld said:

“messages like fiscal cliff, euro news, China … all of that influences that sentiment, and I guess that that makes them push their orders out.”

This Ugly Earnings Season Summarized In One Paragraph 10-24-12 BI

BTIG's Dan Greenhaus has the sumup:

If you want to see an ugly chart, check out MNST. Or DD. Or APOL, CMG, XRX or IBM for that matter. These companies like many, simply haven’t made it through earnings season unscathed. But the S&P 500? If you can believe it, since AA reported after the close on the 9th, the S&P 500 is down less than 2% or so while the index is down roughly 3.5% since its near term high in mid September. Certainly there’s been rotation; tech is down the most this month after running higher all year but that’s a function of earnings (IBM, RHT, GOOG, semis). Financials are/were the best sector year to date heading into October and that sector is up 1.7% this month.

Bottom line: Some notable bombs, but overall, the market isn't THAT much of a disaster YET.

Drumbeat of Weaker Revenues 10-21-12 Mish

Earnings and revenues can’t diverge forever 10-25-12 James Saft Reuters

• Corporate earnings and revenues can’t, as they are doing this earnings season, diverge forever.
• Just about halfway through the U.S. third-quarter corporate reporting season and we find that 59 percent of S&P 500 companies have beaten their earnings estimates, down a bit from last quarter but still an upbeat number.
• And yet about 60 percent have missed their SALES targets, meaning that corporate America is somehow extracting more profit than promised despite bringing less money into the tills than expected. That’s admirable, but perhaps a bit disturbingly close to magical.
• On many readings, all is rosy in the land of equities. Not only does the market have crucial support from central banks bent on forcing money into risk assets (and hoping some of the profits get spent), earnings are at record highs and the amount investors will pay for a share of those earnings is going up.
• Analysts are forecasting fourth-quarter earnings to grow at a near 9 percent clip, down from the 17 percent they were penciling in earlier but still enough to take the earnings of the S&P 500 to almost $27 per share, in what would be yet another record.
• And next year analysts are looking for growth of about 12 percent.
• That optimism, combined with quantitative easing fever and complacency over the euro zone, has allowed price-to-earnings multiples to expand, and not just in the United States.
• On a global basis, forward-looking P/E valuations have gotten richer since early June, according to Morgan Stanley analysis, most notably for companies in mining, materials, energy and even finance.
• That’s all well and good, but very hard to square with the increasing number of companies saying they haven’t been able to deliver promised growth in revenues.
• The huge majority of S&P 500 companies giving revenue or earnings guidance for the coming quarter have guided downwards, according to data from FactSet.
• DUPONT: Third-quarter revenue for chemicals company DuPont dropped 9.2 percent from the year-before quarter, to $7.4 billion, below the $8.15 billion analysts expected, a miss the company blamed on global drops in demand. DuPont slashed its full-year earnings estimate to between $3.25 and $3.50 a share from about $4.20 before.
• CATERPILLAR: Similarly, farm and construction equipment maker Caterpillar Inc lowered its forecasts for the second time in a year, citing economic weakness and uncertainty.

WHERE’S THE GROWTH?

• So, we have a trend towards lower revenue growth, a dwindling number of companies beating expectations and yet a world in which investors see this combination as growing in value.
• In some ways this is reminiscent of the housing market in the middle years of the last decade, where prices, year after year, outpaced wage and income gains. The argument then was that incomes would soon catch up and that housing was cheap on a financing basis. Housing, of course, was brought down with a thump when people finally worked out that the two numbers – cost and the amount of money available to service the debt backing that cost – could not forever drift further apart.
• So it may prove for shares. Surely some of the growth of earnings is a credit to company managers, who are proving unrelenting in wringing efficiencies from corporate structures, allowing for earnings growth even in challenging times.
• Earnings are, on some level, an opinion. There is art to it as well as just math. Think about a bank which values assets and that drives earnings: those marks are ultimately subjective. While earnings may be more or less than meets the eye, a dollar in revenues is always a dollar.
• Try this: compare earnings on an economy-wide basis and compare to overall economic output. On this measure, corporate America does not have a lot of room to expand its share of the pie, because earnings as a percentage of GDP are at near-record highs and are about half as high again as the kinds of figures we saw in most of the past 50 years.
• The upside is, if the growth of earnings is confirmed over time by growth in the economy, this would send money flooding into corporations and allow for equity prices to rise even more relative to earnings. That, of course, depends on the fiscal cliff, the euro zone, China and any number of other tough-to-call macro issues.
• The downside, of course, is that earnings revert to mean in terms of their share of overall output. When you track U.S. wages against profits, you see where most of the expanding share is coming from.

It may well be, especially if the government is not going to become much more leveraged, that profits will be limited by wage growth within a context of low overall growth. That particular scenario is only an outside chance, but one which would cause a big fall in shares. Ultimately, the pie is going to have to grow for equities to hold their ground, much less gain more.

Q3 EARNINGS SEASONS - Revenues Continue to Be the Problem & Accelerating

Earnings Roundup: The Revenue Picture Starts to Look More Bleak 10-29-12 Thomson Reuters ALPHANow

While S&P 500 companies continue to do a reasonable job of beating profit forecasts this quarter, when it comes to revenues, the picture is entirely different, raising concerns about what may lie ahead in the fourth quarter.

At the midway point in the third-quarter earnings season, with about half of the companies in the S&P 500 having reported their results for the quarter, the pace at which those firms are announcing disappointing revenues appears to be accelerating.

So far, 37% of the companies that have reported their earnings have failed to meet analysts’ expectations with respect to the top line. This is far below the long-term average revenue beat rate of 62%, but that isn’t all that is worrying: the downward trend displayed throughout this earnings season is of equal concern.

As shown in Exhibit 1, below, the rate at which companies are announcing revenue “beats” has declined as the number of companies reporting their results has climbed. Last week we saw the worst revenue performance relative to expectations, with only 34% of companies beating revenue estimates.

The problems companies have in beating revenue forecasts haven’t shown up when it comes to earnings, however. As of last week, the rate at which S&P 500 companies were announcing earnings that came in above estimates was within a normal range, and the consensus for third-quarter earnings growth for the S&P 500 has increased slightly: analysts now are forecasting a decline of 1.2%, an improvement from the decline of 2.1% predicted at the beginning of October. Earnings beat rates are higher than revenue beat rates in every sector with the exception of Telecommunication Services, as shown below in Exhibit 2. This discrepancy is especially pronounced in the Industrials sector, where 69.2% of companies have beaten earnings estimates but a mere 20.5% have done so for revenue, a difference of 48.7 percentage points.

United Parcel Service Inc. (UPS.N) was one of the companies within the Industrials sector to report revenues that fell short of analysts’ estimates. It reported revenues of $13.1 billion, compared to a forecast of $13.3 billion, although it did report earnings that matched the consensus estimate of $1.06 per share. UPS credited e-commerce activity for the strength in its U.S. domestic business, although export activity was weak. “In Europe, more countries are slipping into recession as they impose austerity measures,” said UPS’s CEO, Scott Davis. “In Asia, although projections have come down, economic growth there leads the world.” Still, he noted, Asia’s export activity continues to lag its GDP growth. Davis also expressed concern about the impact of the impending fiscal cliff on UPS. ”The lack of clear direction on future tax and spending policy has and will continue to slow business investment,” he said. “This will clearly impact the B2B small package market.”

The Boeing Company (BA.N) also saw the effects of lower demand on the shipping business on its third-quarter results, as weakness in air freight hurt revenues. Boeing earned profits of $1.35 per share, significantly higher than the consensus of $1.13. Nonetheless, it, too, struggled and failed to match its revenue estimate of $20.03 billion, falling very slightly short when it announced revenues of $20.01 billion.

Companies in the Materials sector have reported results that show a smaller divergence between earnings and revenue beat rates than most other groups in the S&P 500. Unfortunately, that’s for the wrong reason: this is the group whose 41% earnings beat rate is the second lowest for the quarter. (Its revenue beat rate is only 18%.) E.I. du Pont de Nemours and Co. (DD.N) is representative of the troubles facing the sector, having announced big misses on both the top and bottom lines. The company’s quarterly earnings of 32 cents per share represents a 54% decline from last year’s level, and fell well below the 46 cents per share estimate. Revenue was weak as well, as the company’s report that it pulled in $7.4 billion in revenues was below the $8.1 billion forecast, as well as falling 20% below last year’s sales. In response to the weak performance, CEO Ellen Kullman announced an initiative to try to cut costs and boost productivity to try and help improve margins in the environment of declining revenues in which the company now finds itself.

With 114 companies in the S&P 500 scheduled to report their results next week, investors will be watching to see whether this string of revenue disappointments continues. So far this quarter, of the 96 companies that have beaten earnings estimates, 56% of them did so while falling short on revenues. That is the worst ratio on record since 2002. As long as companies continue to display this pattern – positive surprises on earnings accompanied by revenue shortfalls – profits will be generated only through cutting costs and increased productivity. That raises the question of what will happen to profits in the fourth quarter, which may be at risk if that pattern continues. The current fourth-quarter estimate for revenue growth stands at 2.5%; while not very high, it has so far remained quite steady. That could change, however: if companies continue to report weak revenues this earnings season, this may well prompt downward analyst revisions.

Q3 EARNINGS SEASON - UGLY!

Q3 Earnings Season To Date Summary: Ugly... And Getting Worse 10-21-12 Goldman Sachs via ZH

Roughly one third of the S&P has reported earnings so far, with another third reporting in the next five days and almighty AAPL on deck Thursday evening, and if there is one word to describe what has happened so far, that word would be "ugly." The same word would be used to describe how Q4 is shaping up to be. And that word will be very a optimistic prediction of what 2013 will bring unless a major catalyst develops that pushes Congress to resolve the fiscal cliff situation. So far that catalyst is missing. But going back to Q3 earnings, here is how Goldman's David Kostin summarizes events to date: "3Q reporting season is roughly one third finished. Two early conclusions: (1) Information Technology results have been startlingly weak with high-profile revenue disappointments by the four horsemen: MSFT, GOOG, IBM, and ORCL. (2) EPS guidance for 4Q has been overwhelmingly negative across all S&P 500 sectors with 18 of 20 firms lowering 4Q earnings guidance by a median of 5%. Analysts have lowered 4Q EPS estimates for stocks already reported by 0.4%. We expect further EPS cuts of 6% loom ahead. Firms reporting next week: AAPL, T, PG, MRK, CMCSA, AMZN, COP, AMGN, OXY, MO, UTX, MMM, CAT, DD, and FCX." Sorry Bob Pisani, better luck spinning earnings favorably next QE.

More detail on what is shaping up as the ugliest earnings season (even with DVA and loan loss-reserves included) in years:

Two early conclusions from 3Q earnings season: (1) Information Technology top-line sales results have been weak lead by MSFT, GOOG, IBM, and ORCL. Since the start of 3Q reporting season, analysts have cut 4Q sales forecasts for those Information Technology firms  reporting results by 70 bp, lowered margin forecast by 43 bp and cut expected EPS growth by 260 bp. (2) Earnings guidance for 4Q has been overwhelmingly negative across the S&P 500 with 18 of 20 firms lowering 4Q earnings guidance by a median of 5%. Analysts have lowered 4Q EPS estimates for stocks already reported by 0.4%. We expect reductions of perhaps 6% still need to take place.

The distribution of 3Q results has been lower than the historical average. 117 firms in the index have now reported 3Q results (34% of total cap). 37% of companies beat earnings estimates and 21% missed. In a typical quarter, 41% of companies exceed EPS expectations and 13% miss.

The bar for 3Q earnings season is very low. First, 2Q results disappointed with twice as many revenue misses and one half as many beats compared with a typical quarter. Second, guidance heading into reporting season was more pessimistic than usual with 80% of firms guiding below consensus compared with prior quarters when the midpoint of guidance falls below the average analyst estimate roughly 67% of the time. Third, analysts slashed 3Q earnings estimates by 5% during the quarter, leading to the expectation that 3Q 2012 would witness a 1% year-over-year decline in EPS versus 3Q 2011.

Sales are disappointing again in 3Q with year/year growth of just 2% and negative surprises of 30 bp. 15% of firms beat consensus sales expectations by more than one standard deviation (below the historical average of 35%). In addition, 36% of firms have missed sales  estimates by that magnitude, versus 19% historically. Revenue estimates for 4Q have declined by 30 bp.

Margin of 8.6% is slightly below the expectation at the start of earnings season (8.7%) and represents a

year-over-year decline of roughly 33 bp. Information Technology results have been particularly disappointing. Microsoft (MSFT) and Google (GOOG) missed revenue and earnings estimates and IBM and Oracle (ORCL) missed sales estimates. The sector actually posted a nearly 1% positive surprise in revenue relative to analyst expectations. However, analyst methodology for forecasting financial results for certain Information Technology companies differs from the Standard and Poor’s definition of revenues and operating earnings.

Apple reports on Thursday evening. Consensus expects the company will grow 3Q EPS by 28% versus last year. AAPL sales are forecast to rise by 31%. Consensus expects margins will fall by 46 bp to a still stellar level of nearly 23%. Analysts expect AAPL will be the second largest contributor to S&P 500 earnings representing 3.7% of 3Q 2012 EPS and 20% of Information Technology earnings. AAPL represents 4.5% of S&P 500 equity cap and 24% of the Information Technology sector. While Apple’s share of 3Q EPS is not in proportion to its share of market cap, this appears to be a seasonal issue. Next quarter, consensus expects AAPL will contribute 6% of S&P 500 EPS. Information Technology sector is expected to grow 3Q earnings by 7% year/year. However, the sector earnings growth is just 3% excluding AAPL.

Managements are lowering guidance, indicating downside to 4Q EPS. Fully 20 companies have provided 4Q guidance following their 3Q earnings announcements and 18 of these firms have reduced 4Q profit guidance. The midpoint of guidance was below the mean consensus estimate in all but two cases. Although guidance tends to be downbeat, this is especially negative.

4Q EPS estimates for reported companies are down by just 40 bp. We expect further negative 4Q EPS revisions will occur most likely as a result of reduced margin estimates. We forecast full-year 2012 S&P 500 earnings of $100 per share. Assuming no change in 3Q EPS, 4Q estimates would have to fall by 6% to reach our full-year estimate.

Next week 160 firms representing 31% of S&P 500 market cap will report results. At the sector level, 41% of Health Care, 39% of Industrials, and 35% of Information Technology as measured by market cap will release results. Large companies reporting include: AAPL, T, PG, MRK, CMCSA, AMZN, COP, AMGN, OXY, MO, UTX, MMM, CAT, DD, and FCX.

Click to Enlarge

Q3 EARNINGS SEASON - A Bigger Disappointment than Initially Expected

Why The Real Earnings Picture Is Bad And Getting Worse 10-26-12 Citi via ZH

Listening to the incessant chatter of confirmation bias from CNBC, you could be forgiven for thinking that earnings are 'not that bad'. Headline-makers like AMZN, GOOG, and AAPL scare for a few moments but we are reassured back to numb BTFD-land by some disingenuous analyst (or worse a PM) who says he is buying with both hands and feet. The misleadingly top-down positive impression of looking at a 'beats-to-total ratio', suffers from one rather annoying bias (that often gets forgotten):  analysts constantly revising their expectations throughout the reporting period, and hence rarely deviates from the current level of 71%. But, as Citi notes,

if one examines results relative to analyst expectations prior to the reporting season, it's clear just how disappointing Q3 has been

- especially given the sell-side mark-downs already factored-in.

If one uses unrevised expectations - which simply anchor lower and make every succeeding number look relatively better and better as earnings season progresses in one direction or another -  then the S&P 500's earning surprises are even worse than Q2 - making the sixth quarter in a row of 'missed' pre-expectations...

Via Citi:

Third quarter earnings have surprised to the downside even more than in the second quarter.

What's more, earnings have been particularly disappointing given that sell-side expectations already underwent significant downward revisions months ago.  Indeed, the bottom-up estimate for S&P500 third quarter earnings per share dropped quite precipitously from above 28 down to 26.5 in July as management teams lowered their own guidance. Intriguingly, for as downbeat as third quarter results have been, we've yet to see the sell-side revise down estimates for next quarter or 2013 (see chart).

That could be an ominous sign given that the commentary on many a third quarter earnings call has been so cautious, particularly with respect to the fiscal cliff. Qualitatively speaking, we worry that with almost all companies missing top line revenue targets (most notably OC, AVT, NSC, LLY), fourth quarter earnings may end up disappointing sell-side analyst even more than Q3. Moreover, the weakness we’ve seen in the basics/cyclicals as a result of slower growth in China and Europe (DD, DOW, FCX) and the headwind that sequestration looks like it will pose to the defense industry (NOC, GD, LMT) create potentially formidable challenges for those sectors in particular.

Q3 EARNINGS SEASON - Worst Earning Guidance in Over 5 Years

Charting The Worst Earnings Guidance In Over Five Years 10-22-12 Morgan Stanley and @Not_Jim_Cramer via ZH

With over a third of the S&P 500's market cap having reported, results have been mixed. Aggregate earnings are tracking ahead of expectations but this miracle is driven almost entirely by financials (which account for 85% of the beat) as lower expenses and higher reserve bleeds offset contracting NIMs (combined with a lack of MtM) to enable a total manufacturing of what S&P 500 EPS is. As Morgan Stanley's Adam Parker notes, the quality of the beats has been low, with companies benefiting from a mix of lower operating costs and lower taxes. Revenues are missing estimates (hurt by a stronger USD and macro weakness) and Tech has been particularly weak. More importantly, for all the hope-driven, recovery-is-around-the-corner, 'fiscal-cliff'-won't-happen believers, the majority of forward guidance has been negative resulting in the highest negative-to-positive ratio since 1Q07 but this is not priced in as top-down 4Q12 estimates have hardly budged.

Earnings are slightly ahead of expectations - thanks almost entirely to financials! Do you tust that data?

Negative guidance is dominating positive outlook changes...

yet top-down EPS estimates remain unchanged (to slightly higher - again thanks to financials)

as for the 24th week in a row, net earnings revisions are negative...

and where are the world's EPS estimates being cut the most? (i.e. where was hope highest?)...

So you still believe in miracles?

Charts: Morgan Stanley and @Not_Jim_Cramer

Q3 EARNINGS SEASON -Three Disappointments

3 scariest things about this disappointing earnings season 10-25-12 CNNMoney

So far the reports in general haven't been upbeat. Top strategist Rob Arnott back in March made the case to me that earnings growth was bound to slow. (I had my doubts.)

Now Arnott looks sage-like. S&P estimates earnings of the 500 companies in their index fell 3% in the third quarter from a year ago. That would be the first drop in corporate profits since the end of the recession.

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There are two ways to see that stat. Earnings growth has been phenomenal this recovery, and the third quarter a year ago was a record for the S&P 500. So the fact that we are slightly off the peak isn't too bad. What's more, analysts expect earnings in the fourth quarter to rebound sharply, up nearly 10%. So this is just a blip.

The other way to see it: Watch out below. Unfortunately, I see three reasons it could be the latter.

1. PROFITS TURN NEGATIVE-RARE: First of all, it's very rare for corporate profit growth to turn negative. When it does, it's usually because we are in a recession or headed for one. For instance, corporate profit growth turned negative in the third quarter of 2007. The last time it was negative before that was in 2001. Before that, you basically have to go back to 1989. There is one quarter in 1998 when profit turned negative, and then bounced right back. But that's the one exception in the past 25 years, and it was closer to the end of that bull market than the beginning.
2. PROFIT MARGINS: Second, profit margins, already at all-time highs, look tapped out. Companies have benefited, in a way, from a slow economy that's meant they didn't have to add a lot of workers, or hand out raises. Eventually, that's going to change. When it does, lots of other costs are likely to rise as well including energy and materials. Of course, it's natural for profit margins to shrink at this stage in a recovery. That's what happens. And some have argued that we can have strong earnings growth with a return to normal profit margins. But to do that you have to have strong economic growth. And we don't.
3. ECONOMIC GROWTH - Third, economic growth continues to be weak, and it's looking weaker. A number of economists have been pulling down their GDP growth estimates, many of which were below 2% to start with. And while the U.S. might get better after the election, there's no real reason to think that it would change things in Europe or China.

Given all these risks, you would expect the stock market to be cheap. Stocks have risen a lot this year, confounding a number of smart hedge fund managers, who have sat out this rally. And you can say the smart money is always a lot dumber than it gets credit for. But you can't say their fears about where stocks are headed are unfounded.

Q3 EARNINGS SEASON - The TOP LINE Problem is DEMAND

Problem is Demand: First IBM, then Intel, now Google 10-19-12 Mish