EARNINGS - Negative Guidance Worst Since Early 2012

Global Earnings Downgrades Worst In 12 Months 07-05-13 Citi Research via ZH

As we head into earnings season in the US (amid hopeful margin expansion), the big picture for earnings remains bleak. Markets are back close to highs as negative guidance is piling up and as Citi notes, their global earnings revision index is at its worst since early July 2012. If the Fed is heading towards a Taper then this fundamental fear may once again become relevant - or hope-fueled multiple expansion will fill that gap.

EARNINGS - Q2 EPS Estimates

Because Fundamentals Matter? 07-07-13 Zero Hedge

Presented with little comment aside to note that US equities are once again resurgent near all-time highs fully supported by err... umm... fundamentals.

Bottom-Up?

Top-Down?

Charts: Bloomberg and @Not_Jim_Cramer

RISK - Hayman Capital Dramatically Reduces Risk

Kyle Bass Hunkers Down: "We Dramatically Reduce Portfolio Risk" 07-04-13 Hayman Capital via ZH

Kyle Bass goes to Japan and finds all as expected...

After traveling through Japan for the past couple of weeks and with their economic experiment at the forefront of the financial press, it is an appropriate time to give an update on Hayman’s current thoughts regarding the island nation. My travels took me from Kyoto, the cultural heart of Japan to Tokyo, Japan’s financial epicenter. I met with all kinds of thoughtful and wonderful people throughout my trip – from tea service with Zen priests in Kyoto to the metaphorical Zen priests of finance in Tokyo. The Japanese people are some of the most inviting, respectful, and thoughtful people with whom I have ever had the opportunity to spend time. There is no doubt that culturally and historically, Japan is one of the richest countries in the world.

Unfortunately, I had this overriding feeling of sorrow and empathy for most of the people with whom I met because my conclusions regarding their potential financial fate were reinforced on this trip. Most large and complex problems do not have a single cause, and there are countless decisions and circumstances that have led Japan to its current situation. While there is no formulaic determination for the solvency of a sovereign balance sheet (despite many attempts to develop one), the inescapability of economic gravity remains constant. Japan and its leadership face an unsolvable equation in my opinion. The structural problems in Japan have existed for years and were evident during our original analysis of the situation in late 2009, but it is fascinating to observe the progression of the decline over time and the recent broad acknowledgement of their plight.

And also learns something new, if not unexpected...

Despite the abundant quantitative data indicating the fragility of the financial system and the risks posed by further indebtedness, very few individuals in Tokyo have expressed a willingness to embrace the difficult choices required to resolve this looming crisis. During my trip to Kyoto, I was introduced to a Japanese phrase that encapsulated the strangely fatalistic viewpoint that many local Japanese market participants have toward the twin threats of debt and deflation. This concept explains a resignation to the unfolding of events and a willingness to submit to this unfortunate reality rather than to fight a seemingly inevitable or impossible challenge. It seems apposite to reprint it here as we watch the beginning of this endgame in the Japanese debt markets unfold:

“Shikata ga nai”

It cannot be helped.

But perhaps most interesting are Bass' thoughts on China:

The speed and depth of the Chinese policy response will help determine the severity and duration of this crisis. If the Chinese address the issue quickly and move decisively to rein in credit expansion and accept a period of much lower growth, they may be able to use the government and People’s Bank of China’s balance sheet to cushion the adjustment in the economy. If, however, they continue on the current path and allow this deterioration to reach its natural and logical limit, we will likely see a full?scale recession as well as a collapse in asset and real estate prices sometime next year.

China’s direct contribution to global growth is enormous, but perhaps equally as important is its role in generating growth in developed and emerging economies. A slowdown, whether significant or extreme, in the Chinese economy heralds very bad news for asset prices around the world. A growth crisis centered in Asia will further exacerbate the instability and volatility in Japan and have a devastating impact on second derivative marketplaces such as Australia, Brazil and developing markets in South East Asia. The combination of rich valuations and further threats to growth has led us to dramatically reduce risk in the portfolio and actively position ourselves to withstand the uncertainty and instability ahead.

In short, Bass is once again hunkering down.

Full Hayman Capital investor letter below, courtesy of Valuewalk:

Hayman June 2013.

PATTERNS - An Artificial Market

Guess What The Fair Value Of The S&P Is 07-04-13 Zero Hedge

On the off chance there is still any confusion about what would happen should the Fed "step away"...

EARNINGS REVISIONS - Disconnected From Steepening Treasury Term Structure

A Tale Of Two Growth Outlooks 07-07-13 Bloomberg Charts via ZH

Just over a month ago, global earnings revisions were on the upswing (admittedly off markedly low levels); since then they have turned sharply lower to the worst levels in a year (based on Citi's Global Earnings Revision index - ERI). Critically though, as 'hope' is pinned on a steepening term structure as indicative of 'growth' and happy times ahead for stocks, the ERI has dramatically diverged from the yield curve. As Citi notes, it is evident that analysts are not at all convinced about the improvement in the growth outlook that this steeper curve has historically suggested. What is perhaps more worrisome for the "it's different this time" crowd is that the last time we saw this kind of dramatic divergence between global earnings and the US term structure was in the run-up to Lehman - and that did not end well...

Global earnings revisions typically track the US Treasury term structure very closely - both implicitly suggesting growth or no growth expectations...

But in recent weeks, the steepening of the US Treasury curve (growth - whether due to Fed Taper discussions explicitly reducing the flow or implicitly by the Taper meaning the Fed is more optimistic about the future - which has never ended well) has been entirely dismissed by the analyst community globally as earnings revisions have been slashed to their lowest in a year!

The last time we saw this kind of divergence was in September 2008...

And that did not end well...

Charts: Bloomberg