NEW$ & VIEW$ (9 FEBRUARY 2016): Banking on Bankers?

IEA Warns Oil Prices Could Fall Crude-oil prices could fall even further as the world’s vast oversupply of petroleum only got worse in January with a surge in production from OPEC, a top global energy monitor said.

(…) The cartel flooded the market with an additional 280,000 barrels a day last month, said the International Energy Agency, which tracks oil and gas data for industrialized countries. (…)

Non-OPEC supplies slipped by 0.5 million barrels a day, the IEA said, as lower oil prices forced costly North American producers to shut down some of their production.

Iran boosted its output to 2.99 million barrels a day in January, the IEA said, the first month since 2012 that its crippled oil industry was free of western sanctions over its nuclear program. The 80,000 barrels a day increase represented the first installment in what Iranian officials say will amount to 500,000 barrels of new oil that the country will send to the market in the next few months.

Saudi Arabia also increased its production by 70,000 barrels a day to 10.21 million barrels a day. Meanwhile, Iraq set a new output record of 4.35 million barrels a day thanks to increased production of 50,000 barrels a day. (…)

The IEA said it saw no reason yet to change its demand-growth outlook of 1.2% for the year—a “very respectable rate”—but “economic headwinds suggest that any change will likely be downwards.” (…)

Commercial oil stockpiles rose to more than 3 billion barrels in December, the IEA said. Those inventories will build by 2 million barrels a day in the first three months of 2016, before slowing a bit to 1.5 million barrels a day in the second quarter.

Oil Drillers Must Slash Another $24 Billion This Year, IHS Says

North American oil and natural gas drillers will need to cut an additional 30 percent from their capital budgets to balance their spending with the cash coming in their doors even if crude rises to $40 a barrel, according to an analysis by IHS Inc.

A group of 44 North American exploration and production companies are planning to spend $78 billion on capital projects this year, down from $101 billion last year. Those companies need to cut another $24 billion this year to get their spending in line with a historical 130 percent ratio of spending to cash flow, IHS said Monday.

“These spending cuts will be particularly troublesome for the highly leveraged companies,” said Paul O’Donnell, principal analyst at IHS Energy. “These E&Ps are torn between slashing spending further to avoid additional weakening of their balance sheets, and the need to maintain sufficient production and cash flow to meet financial obligations.”

The analysis is based on IHS’s low-case price scenario of $40-a-barrel oil and $2.50-per-million-cubic-feet natural gas prices. (…)

FYI: Markit’s survey covers the Dubai non-oil private sector economy


German Industrial Production and Exports Drop in December

Industrial production, adjusted for seasonal swings and calendar effects, fell 1.2% from the preceding month, the economics ministry said Tuesday. Economists polled by The Wall Street Journal had forecast a 0.5% gain. Production data for November were revised to show a 0.1% monthly fall compared with the 0.3% drop previously reported.

“Industrial production went through a dry spell at the end of 2015,” the economics ministry said, but noted that industrial activity should pick up at the start of this year, given the improved orders’ situation.

In a separate publication, the Destatis statistics office said that Germany’s exports in December fell 1.6% from the preceding month, in adjusted terms; imports declined by the same rate.


Markets have come to doubt the central bank puts and stop the blind “buy on dips” reflex of 2010-2015. This growing realization of questionable leadership has been an important factor for the recent decline in earnings multiples.

Central banks’ ultra-loose monetary policy is putting the world economy at risk, said William White, a senior adviser to the Organization for Economic Cooperation and Development.

Negative interest rates and quantitative-easing programs from the U.S. to Japan may have unintended side effects such as higher debt levels for both sovereigns and consumers, said White, who leads the OECD’s Economic and Development Review Committee. Central bankers have been dragged away from their focus on inflation as governments struggle to generate sustainable growth, he added.

“The objective of that policy has changed totally — it’s trying to stimulate aggregate demand and the honest truth is that it’s not capable of doing that in a sustainable way, ” White said in Bloomberg Television interview on Tuesday. “If people thought we were in a period of deleveraging that would set the scene for a period of robust growth. We haven’t even started yet.” (…)

White said he is “skeptical” about the benefits of such moves because of the strain they put on the banking system.

“Negative rates on reserves are actually squeezing bank profits, and this is something we don’t want in these circumstances, we want them to build up their capital buffefs,” he said. “This is all experimental.”

White said that the global economy needs those governments with budget leeway to boost spending and said policy makers should pay more attention to wage growth, which remains “too low.” He said governments also need to make further structural reforms to boost growth and take a more systematic approach to debt reduction.

Now, people will look for politicians to do something, after having relied on central banks to compensate for politicians’ inertia…

(…) Yellen’s remarks [on Wednesday] will influence the markets’ outlook for the U.S. economy and the prospects for Fed policy, including the potential frequency and timing of future interest rate actions.

Unfortunately, her comments are unlikely to serve — for the moment, at least — as the catalyst for the most urgently required action to ensure sustainable economic prosperity and genuine financial stability: A decision by lawmakers on Capitol Hill to shift U.S. macroeconomic policy away from excessive reliance on the Fed and toward a more comprehensive approach that removes structural impediments to growth, including outdated infrastructure, tax distortions and inadequate investments in human capital. This change also would need to deal with aggregate demand deficiencies, eliminate crushing pockets of over-indebtedness and help restore U.S. leadership thanks to  more effective global policy coordination.

  • Bank of Canada’s Timothy Lane on Monday:

(…) Thus, it is possible that, in a situation of sustained weak aggregate demand, relying primarily on monetary policy to provide stimulus may lead to financial vulnerabilities that macroprudential policy cannot, or should not, offset. In such circumstances, fiscal policy may be called upon to provide stimulus, particularly since it is likely to be more effective at low interest rates.

(…) “I am concerned that the bank’s introduction of a negative interest rate could lead to a competition with central banks in other countries . . . to lower interest rates deeper into negative territory,” wrote one member of the policy board.

Another board member wrote: “Looking ahead, I am concerned that financial markets would expect further cuts in the interest rate into negative territory, leading to confusion and anxiety among financial institutions and depositors.” (…)

Bank Stocks Hit by Growth Fears

(…) U.S. markets staged a late-day bounce that narrowed the Dow industrials’ decline by more than half, but many of the largest U.S. banks closed lower by at least 4%, including Dow component Goldman Sachs Group Inc. Morgan Stanley dropped 6.9%, while Citigroup Inc. fell 5.1%. (…)

European lenders are also suffering. The Stoxx Europe 600 index fell 3.5% on Monday, with Germany’s Deutsche Bank AG sliding 9.5%. Adding to the jitters abroad, a small German lender, Maple Bank GmbH, defaulted on its debt Monday. (…)

While the outlook for banks’ profits has been soft for years, the advent last month of negative interest rates in Japan has jarred many investors, suggesting to them that a profit recovery for financial firms could be years away.

Adding to investor concerns are the sense that the carnage from the oil-market rout of the past two years could hit bank balance sheets and the fear that banks haven’t fully disclosed all the risks they could face in a broad economic downturn. (…)

On Monday, shares of Chesapeake Energy Corp. lost a third of their value amid concerns about the natural-gas firm’s finances, raising concerns about bank exposure to similar firms. (…)

The bonds issued by U.S. banks continue to perform well, a sign of the firms’ relative robustness and the tighter regulations that mark a sharp contrast with 2008. (…)

The KBW Nasdaq Bank Index of large U.S. lenders is down 19% this year. Among the largest U.S. financial firms, Morgan Stanley is down 29%, Bank of America Corp. and Citigroup are down 27%, Goldman is down 17% and J.P. Morgan Chase & Co. and Wells Fargo & Co. are each down 14%.

As a result, all but Wells trade at a discount to their stated per-share net worth, a measure known as book value. (…)

The broad picture from Bespoke Investment:


Financials 5 Yearas

The FT has a better analysis:

Bear market for banks: Tumbling financial stocks hand Fed new challenge

Out of nowhere, bank stocks in the US and western Europe are in a bear market. Credit default swaps — instruments many had hoped never to hear mentioned again — are back on the agenda, as they show a greater risk of default for Deutsche Bank than at any time during the 2008-09 financial crisis.


Markets do not believe that the Federal Reserve will follow through with higher rates, and instead believe that the tightening that has already happened will intensify deflationary pressures. Hence inflation break-evens — the implicit forecast for inflation over the next decade, derived from the bond market — have fallen to their lowest since 2009.

Most critically, this means that long bond yields have fallen far more sharply than shorter-term interest rates (a “flattening yield curve” in the financial argot). Yields on 10-year treasuries now exceed yields on 2-year bonds by less than at any point during the crisis. The yield curve is at its flattest in almost nine years.

This is dreadful news for banks, which make their money by lending money at high interest rates over the longer term while borrowing it at lower rates in the short term. A steep yield curve was a recipe for boosting their profits and allowing them steadily to rebuild their capital. Now, their profit outlook has sharply worsened.

An extra factor comes from the Bank of Japan’s decision at the end of January to move to negative interest rates on some reserves. This was meant as a signal that it would do whatever it took to weaken the yen. But the yen is now stronger than it was before the BoJ’s announcement, and indeed stronger than it was at any time in 2015.

The message the market appears to have heard is that not only the BoJ but any central bank can keep stimulating the economy by cutting rates further into negative territory. And as negative rates would be surpassingly hard for banks to pass on to consumers, that damages their profit outlook still further. (…)

As the Fed’s chair Janet Yellen prepares for testimony to Congress on Wednesday, she has yet another balancing act to pull off — she must step back from plans to raise rates much further, without stoking fears that negative rates are on the agenda.

(…) Banks have issued about 91 billion euros ($102 billion) of the riskiest notes, calledadditional Tier 1 bonds,since April 2013. The problem is the securities are untested and if a troubled bank fails to redeem them at the first opportunity or halts coupon payments investors may jump ship, sparking a wider selloff in corporate credit markets. (…)

The bonds allow banks to skip interest payments without defaulting, and they turn into equity in times of stress. (…)

The notes were issued in Europe and offer some of the highest yields in credit markets, at an average 7 percent, compared with an average yield for European junk credits of less than 6 percent, according to Bank of America Merrill Lynch indexes.

But critics say banks are too opaque, the notes are too complex to be properly understood, they’re too varied and too much like equity to be considered bonds. With so many unknowns, the risks are high.

“Basically you have the upside of fixed income and the downside of equity,” said Gildas Surry, a portfolio manager at Axiom Alternative Investments. “AT1s are instruments of regulators, by regulators, and for regulators.”

HOW DO YOU LIKE YOUR BEAR, Medium or Well-Done?

About 31% of stocks in the S&P 500 are down 30% or more from their 52-week highs, Citigroup says, close to the figure seen in market selloffs of 2011 and 2012, but well below the 80% figure in the 2008 tumble ahead of the economic slump.

Until recently, few stocks had been bigger winners than Facebook Inc., Inc.,Netflix Inc. and Google Inc.—a group nicknamed the FANG stocks. These shares scored gains averaging nearly 73% last year, including dividends, compared with a 1.4% total return for the S&P 500. As the shares soared, many investors jumped in, eager to invest in some of the few companies seeing heady growth in an otherwise limp economy.

That has all changed this year. The four stocks are down 17.3% so far in 2016—falling 1.6% on Monday alone—compared with a loss of 9.3% for the S&P 500 this year.

The index is off 14% so far this year. The Nasdaq Internet Index has fallen 21%, and cloud stocks tracked by the BVP Cloud Index are off more than 31%. (…)

First, in an era when U.S. companies at large have become steadily more dependent on their foreign operations for sales, tech companies’ overseas exposures stand out.Hewlett-Packard, for example, generates only about a third of its sales in the U.S, whileIntel books less than a fifth of its sales domestically. As a result, many tech companies are taking unusually hard hits from economic weakness abroad. The dollar’s strength against other currencies—the greenback averaged 12% higher on the year on a trade-weighted basis versus other currencies in the fourth quarter—has made a bad situation even worse.

Second, worries about the global economic environment have prompted many companies to rein in capital spending and other investments. This can hurt the flow of new deals that is the lifeblood of software companies that sell cloud-based services. Tableau Software trimmed its full-year forecast last week, citing “softness” in business-tech spending. That sparked a huge selloff that cut Tableau’s market value by more than half and badly damaged many peers., Workday and Splunk—which will report results later this month—are off more than 20% in just the past two sessions.

Finally, there is the issue of price. Most cloud and Internet companies carry lofty valuations. is still more than 100 times forward earnings despite losing nearly 30% of its value since the first of the year. The Nasdaq Composite still carries a premium of nearly 24% to the S&P 500 on the same basis. (…)

  • 80% of the market is on track to report EPS growth of 5% (assuming the current beat rate). Meanwhile, the other 20% ‒ Energy, Materials, and Industrial ex-Airlines ‒ are experiencing earnings declines resulting from commodity-related pressure.
  • 320 companies (76.5% of the S&P 500’s market cap) have reported. Earnings are beating by 4.5% while revenues have missed by 0.1%.
  • Expectations are for a decline in revenue, earnings, and EPS of -3.4%, -4.8%, and -3.0%. EPS is on pace for -1.9%, assuming the current beat rate for the remainder of the season. This would be +4.2% excluding Energy. (RBC Capital)

Corporate pre-announcements vs same time last year and in Q4’15 (per TR):


Based on this a.m.’s pre-opening of 1835, the Rule of 20 P/E is at 17.7. The last 2 selling climax periods of June 2010 and June 2012 troughed at 15.4 and 15.1 on the Rule of 20 P/E respectively which would be around 1550 on today’s earnings and inflation parameters, a further 15% drop! That would mean an actual P/E of 13.2 on trailing EPS, below the 13.8 L.T. average and median of 13.8 and back to the most recent lows of 1989! Given current interest rates and inflation, that seems like unlikely bargain basement levels.


More likely is a trough in the 16.0-16.5 range on the Rule of 20 scale like in Dec. 2011 and Dec. 2012. That would take the S&P 500 to the 1670 area, nearly 10% below current levels.


Confused smile Risk parity strategy shows strain Commodity slide coinciding with sluggish bond market hits model

Last year was a terrible one for “risk parity”, once one of the hottest strategies in the investment world, as losses mounted and some analysts blamed it for exacerbating market turbulence. So far 2016 has offered little respite.

At its core, the risk parity strategy is about balance. Rather than spread investments according to old-fashioned rules of thumb — such as 60 per cent in equities and 40 per cent in bonds — risk parity funds invest equally in asset classes according to their mathematical volatility, so each contributes equally. (…)

But the performance started to sag in 2014, and nosedived last year, ruining its reputation for resilience in almost any conditions. The Salient Risk Parity index slumped 12 per cent in 2015 and JPMorgan’s gauge of risk parity fund performance fell more than 8 per cent. (…)

While commodities are just one, often minor, component in a typical risk parity fund, “the moves have been so sharp that they’ve had a big, negative impact”.

Adding to the woes, bonds — a big part of risk parity portfolios — have failed to act as a suitable counterweight for the once seemingly bulletproof strategy. (…)

He offers another factor that has contributed to the limp performance: currencies. Most risk parity funds invest globally, but the dollar climbed sharply against most of its counterparts last year, weighing on the returns in dollar terms. (…)

There’s got to be one or two good news out there?

Fingers crossed Bloomberg says he is eyeing 2016 run Media billionaire’s entry would reshape White House race


Factset sums up the Q4’15 earnings season so far:

With 63% of the companies in the S&P 500 reporting actual results for Q4 to date, more companies are reporting actual EPS above estimates (70%) compared to the 5-year average, while fewer companies are reporting sales above estimates (48%) relative to the 5-year average. In aggregate, companies are reporting earnings that 3.7% above the estimates. This surprise percentage is below both the 1-year (+4.9%) average and the 5-year (+4.7%) average.

The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for Q4 2015 is now -3.8% (vs -4.6% last week and –3.9% on Dec. 31). If the Energy sector is excluded, the blended earnings decline for the S&P 500 would improve to 2.2% (+0.5% last week) from -3.8%.

The blended revenue decline for Q4 2015 is now -3.4%. If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would jump to 0.7% (+0.9% last week) from -3.4%.

In reality, 7 of the 10 sectors are showing better than expected results. Among the poorer reports, Financials stand out as Q4 estimates for Financials dropped from +5.6% last week to +1.1%.


There were 26 Financial companies reporting last week bringing the quarter-to-date total to 66 out of 87 (including REITs). Of the 15 non-REITs that reported last week, only 7 beat estimates.

Financials continue to mess things up. For example, the $1.5B litigation expense at GS and the $2.4B reserve charge at AIG subtract $3.9B (1.4%) from S&P 500 earnings. Whether these are included or not in “Operating Earnings” varies from one aggregator to the next, bringing more confusion on Q4 results and growth rates.

Confused smile Combined with previous other “special charges” (e.g. pension expenses) reported in previous quarters and accounted differently by aggregators, investors will be shown Index EPS for 2015 ranging from $104.07 (S&P) to $117.28 (Thomson Reuters) and to $121.05 (Factset). This HUGE 16.3% gap between the low and the high 2015 EPS is highly consequential. For example, is the S&P 500 Index currently selling at 15.5x per Factset or at 18.1x per S&P? What was the growth rate in 2015? S&P says –7.9% but Factset is at +3.4% and TR is at –1.3%.

The various methodologies also impact 2016 estimates and growth rates. S&P is at $119.91 (+15.2%) while TR is at $122.81 (+4.7%) and Factset sees $136.37 (+12.7%). On forward EPS, the S&P 500 Index sells for 13.8x, 15.3x or 15.7x according to one’s earnings source. What a mess! And I spare you the earnings numbers “calculated” by investment banks and brokers.

One can have his own opinions but not his own facts. Yet, in the current earnings environment, one can now pick and choose earnings to suit his own mood or bias. Get ready to be confused with facts during most of 2016.

For my part, after using S&P data most of the time, I have switched to Thomson Reuters since Q1’15 seeing it as a good. more stable middle ground, for now. I keep monitoring diligently (!)…

Getting back to the pertinent facts, at this point in time, Factset says that 71 companies in the index (62 at same time last year) have issued EPS guidance for Q1 2016. Of these 71 companies, 57, or 80%, (52 or 84%) have issued negative EPS guidance and 14 (10) have issued positive EPS guidance. The 5-year average is 72%. Six Consumer Discretionary companies have negatively pre-announced so far, down from 8 at the same time last year.


FYI, Thomson Reuters’ data show 59 pre-announcements with 51 (86%) negative. This compares with 64 pre-announcements with 51 negative (80%) at the same date last year.

If you are still reasonably sane at this point, here’s my take on the earnings season three-quarters of the way:

  • Excluding Energy and Financials which, for their own respective reasons, are blurring the overall view, Q4’15 earnings are good and are not collapsing.
  • The fact that ex-Energy earnings could grow 4.2% YoY (per RBC) in the current economic and financial environments is remarkable.
  • The important Consumer Discretionary and Industrial sectors are showing strong resilience amid a complex economic environment. CD earnings are up 9.7% (per TR) dealing with a fickle consumer and generally deflating prices and rising wages. Industrials’ EPS are down 1.8% in spite of very hostile domestic and international environments.
  • Overall, guidance is not bad given the economy and the number of uncertainties for 2016.
  • Still, TR data show that Q1’16 estimates have declined from +2.3% on Dec 31 to –3.9% and that sector breadth has significantly worsened. Seven of the ten sectors are expected to report a down quarter YoY including Financials and Technology

We all know that estimates are meant to be exceeded but unless and until momentum improves, it is best to remain cautious. Although no longer excessively valued, equities are not cheap enough to dismiss negative earnings trends, especially when just about everybody is confused by …

  • the economy;
  • the consumer;
  • the dollar;
  • the Fed;
  • China;
  • oil;
  • credit;
  • inflation/deflation;

…and U.S. politics…coming soon enough!


The dependable Rule of 20 shows that equities are back into the Lower Risk area. However, the trend in the Rule of 20 Fair Index Value (yellow line) is not positive as earnings are weakening and inflation has risen from 1.6% to 2.1% (core CPI) in the last 12 months. We need better trends in these two crucial variables before getting more enthusiastic on stocks.

NEW$ & VIEW$ (8 FEBRUARY 2016): Recession Or Not?

Job Market Leaves Fed in Limbo Slower pace of hiring, higher wage gains yield mixed signals; jobless rate under 5%

The U.S. job engine slowed in January while unemployment hit an eight-year low and wage growth accelerated, complicating the outlook for Federal Reserve officials as they assess whether the economy is strong enough for further interest-rate increases.

Employers added 151,000 jobs last month, the Labor Department said Friday, the weakest reading since September and well off last year’s average monthly gain of 228,000. The unemployment rate fell to 4.9%, falling below 5% for the first time since February 2008 just as the recession began. (…)

Average hourly earnings for private-sector workers surged 0.5% from December to $25.39, the second-strongest monthly gain of the expansion. Wages were up 2.5% from a year earlier, a pace that could reassure central bankers that overall inflation will return to a healthier pace with a tightening labor market. (…)

Average hourly earnings for production and nonsupervisory employees—over 80% of workers—rose 0.3% from a month earlier.

The jobs market is better than headlined (charts from WSJ):

  • Despite its natural monthly volatility, employment growth has been steady. The facts are that payroll employment increases over the past three months averaged +231k compared with +225k over the past 12 months.

  • Slack is almost gone:
  • Hence, a pretty clear trend…
  • …even though:

there is some evidence that managers caused the recent gain. Hourly pay for all workers advanced 12 cents an hour last month from December. But pay for only production and nonsupervisory workers—rank-and-file Joes and Jills—increased just 6 cents last month. (The Labor Department doesn’t break out managers’ wages.)

“This means the supervisors and management, accounting for only 15% of the work force, saw a huge jump in their pay,” said Megan Greene, an economist at John Hancock. “Part of this can probably be explained by end-of-year boss bonuses being deposited in January.”

The FT:

Friday’s report suggests the recent market turmoil has not yet had a deep impact on the US jobs market, even if hiring was weaker than the 262,000 recorded for December. Manufacturers surprisingly added the most jobs since August 2013, while employers in retail added 58,000 jobs and restaurants increased headcounts by 47,000.

And the diffusion index in manufacturing reached 62.2% from 59.5% in December, a 13-month high! So much for the low January ISM (validating Markit’s somewhat better PMI reading).

The income math is this:

  • employment: +1.9% YoY
  • workweek:     +0.2%
  • = hours:         +2.1%
  • Hourly pay:     +2.5%
  • = income:       +4.6%

Inflation, near zero.

David Rosenberg: “It will be very difficult to tip the economy into recession with real personal incomes running close to 4%”

(…) Their model, based on a series of economic and market indicators, points to just a 25 percent risk of recession in the industrial economies in the next four quarters and 34 percent over the next two years. Both undershoot the average risk of the past 35 years despite the recent fears of financial markets.

The probability of a slump in the U.S. is just 18 percent and 23 percent over the two timeframes respectively, while the euro-area threat is greater at 24 percent and 38 percent, according to Goldman Sachs. (…)

Their prognosis is aligned with that of Bruce Kasman of JPMorgan Chase & Co., who says the probability of a U.S. recession in the next 12 months has grown yet is still only about a third. (…)

Before every one of the past seven U.S. recessions, long-term interest rates fell below short-term rates, producing what economists call a yield curve inversion. Historically, the slope of the yield curve has been such a reliable predictor of economic conditions that economists at New York and Cleveland Federal Reserve banks use it to calculate the probability of recession.

Ultralow yields on short-term bonds, however, may prevent the yield curve from inverting even if the economy is about to contract. (…)

The difference between yields on 3-month Treasury bills and 10-year notes is regarded by economists at the Fed as the best yield curve predictor of recessions. This is currently at 1.54 percentage points, according to Tradeweb. That is down roughly half a percentage point since the end of last year, but remains wide by historical standards. By the New York Fed’s calculation, this means there is less than a 5% chance of a recession in 12 months. The Cleveland Fed puts the chances slightly higher, at 6.19%. (…)

But with short-term rates already so low, long-term rates would have to go very close to zero for the yield curve to invert. Since that seems highly unlikely, the inversion indicator may be broken.

Some investors and analysts believe the slope remains positive only because of extensive central bank easing, which tends to push harder on short-term rates.

Mark Yusko, chief executive of Morgan Creek Capital Management, said last week that he believes the curve would already be inverted if not for the relentless pressure on short-term rates. (…)

Japan’s experience with ultralow rates may be instructive. During each of its past four recessions, the yield curve didn’t invert. Analysts at Deutsche Bank AG argue this indicates the yield curve won’t invert when short-term rates are below 1%. (…)

Here’s how the curve can still invert:

Nearly $6tn of core government bonds sold by Japan and various European countries currently feature yields below zero, and this figure will continue growing according to the chatter of central bankers. (…)

Now as the 10-year Bund loiters at 0.25 per cent, the global market eyes whether Japan’s equivalent benchmark will break zero. In a world of limited high-quality collateral, the prospect of the Bank of Japan and the ECB pushing policy further into the negative sphere has global ramifications. (…)

With two-thirds of Japanese government bonds now negative, it is not surprising record amounts of domestic money left the country last year towards other core government markets. Expect further flows into positive yielding areas of the eurozone, while 10-year Gilts at 1.51 per cent and US Treasuries at 1.81 per cent stand out as global high yielders.

The trend will only gather pace should emerging markets continue their descent, as global investors seek ‘safe’ places to park their cash and raise the odds of a global recession this year. With oil yet to find a bottom and China seeking a weaker currency to offset slowing activity, central banks want lower bond yields as they fight the risk of falling inflation and deflation.

Ultra-low government bond yields should push investors towards riskier assets. The problem in 2016 is this trade has long left the station. After seven years of QE, modest growth in the US and UK has been achieved at the expense of savers, while companies have racked up debts, weakening their balance sheets as revenues have largely flatlined.

The current slump in global equities and credit suggests a reckoning beckons, a prospect that runs counter to the popular asset allocation mix of owning equities and underweighting core government debt relative to bond indices when central banks pump up the printing press.

While some investors understandably balk at the idea of buying low-yielding government bonds; Treasurys, Gilts and Bunds act as ballast in a portfolio, helping investors navigate rough waters for their credit and riskier holdings. And from all indications, early into 2016, the risk of a major storm is very high.

Hence the absence of any meaningful rise for US Treasury yields, no matter a resilient January employment report. This week, Janet Yellen, the Fed chair will probably strike a confident note on the economy, while acknowledging global jitters in testimony before Congress, thus keeping alive the option of further US policy tightening.

True to form, many economists and strategists across Wall Street are steadfast in forecasting much higher long-term Treasury yields by the end of the year and warn investors should shun the market.

This downplays the global links between economies and markets such as sovereign debt. In the current climate, buying US Treasurys with the tailwind of a stronger dollar is an attractive option for foreign investors.

The idea that bond yields beyond the front end have a floor at zero is being dismantled and a period of lower long-term core government bond yields beckons.

Renters Are Buying Again as U.S. Starter-Home Financing Gets Cheaper

(…) Many are compensating for soaring starter-home prices with FHA loans that became cheaper after insurance premiums were cut last year. And they’re giving a lift to the U.S.homeownership rate, which rose in the second half of 2015 after steadily declining for almost two years.

An increase in apartment rents — which rose 4.6 percent nationally in the fourth quarter from a year earlier, according to Reis Inc. — also is helping drive young people to buy instead of lease. They’re entering a market with few affordable houses available. The U.S. inventory of starter homes — the bottom third of the market — is down 39 percent from three years ago, according to data from brokerage Redfin.

FHA-insured mortgages, used mostly by first-time buyers, nonetheless accounted for 22 percent of all loan originations in December, up from 17 percent a year earlier, according to data compiled by Ellie Mae Inc. (…)

(…) The FHA reduced annual mortgage-insurance premiums in January 2015 to make homebuying more affordable. The Department of Housing and Urban Development estimates the decrease in costs will save borrowers an average of $900 a year. 

As a result of the mortgage-insurance decrease, FHA purchase originations increased more than 30,000 a month last year from 2014, said Sam Khater, deputy chief economist for CoreLogic Inc. That means that more than 250,000 first-time homebuyers were added to the market. (…)

Rob Nunziata, chief executive officer of FBC Mortgage LLC in Orlando, Florida, said lenders are feeling more confident as the real estate market recovers. In the past year, his firm has dropped its minimum credit score for a FHA mortgage to 580 from 640.

“Credit standards were a little too tight — now they’re easing toward a more acceptable level,” Nunziata said. “Defaults have decreased, the economy is doing better and the housing market has stabilized.”

Pointing up BTW: speaking of first-time home buyers: that’s +429k newly employed young adults last month, second biggest monthly jump on record (nearly 70 years).


Mirroring the USA: oil winners and losers:

Canada: Full-time jobs at record high in the big three provinces

Full-time employment is losing momentum at the national level but the weakness remains concentrated in oil-reliant provinces. After being pummelled in 2015, Alberta (AB) and Newfoundland (NL) started 2016 with another thud: full-time jobs contracting at 6.5% annualized rate in AB and by 8.8% in NL in January. Fortunately for the country, other provinces have been able to pick up the slack. As the chart below shows, the three largest provinces (Ontario, Quebec and British Columbia) are still doing quite well when it comes to creating full-time employment. We expect this divergence to continue well into 2016. (NBF)

 U.S. Trade Gap Expanded in December The month’s level of goods exported was the lowest since February 2011

Exports fell 0.3%, while imports increased 0.3%. For all of 2015, the U.S. trade deficit grew 4.6% from 2014. Exports fell 4.8% on the year. Imports declined 3.1% last year. (Charts from Haver Analytics)

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Auto Ford to More Than Double Mexico Production Capacity in 2018 The move represents the latest shift of investment abroad by a Detroit auto maker following the signing of a costly new labor deal.

The No. 2 light-vehicle seller in the U.S. plans to add 500,000 units of annual Mexican capacity starting in 2018, more than double what it built in 2015, according to people briefed on the plan. The plan mirrors General Motors Co.’s $5 billion investment to double Mexican capacity by 2018. (…)

Ford last year built 433,000 vehicles in Mexico, or 14% of its North American production.

Costs for the project likely will exceed $1 billion, people familiar with the details said, with factory construction beginning later this year. It follows a $2.5 billion investment Ford announced last spring to build an engine and a transmission plant in Mexico. (…)

Labor rates in Mexico are roughly one-fifth of those earned by unionized workers in the U.S., a gap that is only expected to widen as UAW wages approach nearly $30 an hour in coming years, representing as much as a $10 increase for some newer hires.

Auto factories in Mexico produced 3.4 million vehicles last year, or about one-fifth of North American production, according to LMC Automotive.

Still, roughly three-quarters of Ford’s North America production is in the U.S., according to WardsAuto, and the company committed to invest $9 billion in U.S. assembly and parts factories through 2019.

Mexico auto output is poised to thrive during that time. LMC expects the industry’s Mexican production to grow 53% to 5.2 million vehicles by 2019 as the share of production in the U.S. and Canada falls. Mexico’s economy minister, Ildefonso Guajardo, said last month there would be several significant auto investments announced in the first quarter involving plants and new models but declined to elaborate on specific deals. (…)


  • Oil-Price Drop Squeezes States A deep and prolonged drop in oil prices is increasingly squeezing tax collections in energy-producing states, fueling calls for tax increases and cuts to schools, road projects and other government services.

Total tax collections in the top six oil-producing states in the four quarters ended Sept. 30 fell 3.6% from a year earlier, compared with a 5.4% increase nationally, according to a recent report from the Nelson A. Rockefeller Institute of Government. Its authors say those numbers continue to weaken.

(…) Baker Hughes, the oilfield services group, said 467 rigs were drilling oil wells in the US this week, down 31 from last week. It was the steepest drop for 10 months.

The number of working US oil rigs has dropped 71 per cent from its peak in October 2014, to its lowest level in almost six years.

The slowdown in activity is expected to contribute to a decline in US oil production over the coming months.

RT Dukes of Wood Mackenzie, a consultancy, said the sharp drop was a sign that the slowdown in the rig count was “not over yet”.

He expects the number of rigs drilling the more productive horizontal oil wells in the US to drop from 372 this week to less than 250. (…)

Wood Mackenzie on Friday published an analysis showing that although about 3.4m b/d of production worldwide was losing money with Brent at $35 per barrel, most of it was not being shut down.

The largest share of that, about 2.2m b/d, is in Canada’s oil sands, where if operations are shut down they are expensive to restart, and there is a risk of damage to equipment or the reservoir.

About 96.5 per cent of global oil production can cover its operating costs with Brent crude at $35 per barrel, including most of the US shale industry, but that does not include the cost of drilling and completing new wells. Analysts say very few US shale wells can cover their full costs with oil at $30. (…)

More on Wood Mac’s report here.

As U.S. natural gas prices collapse to 1990s-era lows, producers in four shale plays are cutting their losses.

Surging output has sent gas futures tumbling, forcing drillers to abandon marginal plays in favor of more profitable areas. Drilling has ground to a halt in two gas basins in Oklahoma, along with the Fayetteville reservoir in Arkansas and the Niobrara formation in Colorado and Wyoming, data from Baker Hughes Inc. show.

Even as U.S. gas rigs drop to the lowest on record, there’s still no sign of declining production — at least, not yet. Output from shale formations has left stockpiles at a seasonal record as a mild winter curtails demand, expanding a supply glut that’s threatening to keep prices depressed into the second half of the year. (…)

Lending to emerging markets comes to halt BIS fears ‘vicious’ circle’ of deleveraging and turmoil

(…) The total stock of dollar-denominated credit in bonds and bank loans to emerging markets — including that to governments, companies and households but excluding that to banks — was $3.33tn at the end of September 2015, down from $3.36tn at the end of June.

It marks the first decline in such lending since the first quarter of 2009, during the global financial crisis, according to the BIS.

The BIS data add to a growing pile of evidence pointing to tightening credit conditions in emerging markets and a sharp reversal of international capital flows. (…)

The Institute of International Finance, an industry body, said last month that emerging markets had seen net capital outflows of an estimated $735bn during 2015, the first year of net outflows since 1988.

In November, the IIF warned of an approaching credit crunch in EMs as bank lending conditions deteriorated sharply. This month, it said a contraction over the past year in the liquidity made available to the world’s financial system by central banks, primarily those in developed markets, now presented more of a threat to global growth than the slowdown in China and falling oil prices.

(…) leverage in emerging economies had increased further as profitability had decreased, with exchange rates playing an important role.

“Stronger EM currencies fed into more debt and more risk taking. Now that the dollar is strengthening, we have turned into a deleveraging cycle in EMs. So there is a sudden surge in measurable risk; all the weaknesses are suddenly being uncovered.”


He added: “The issue is not just for emerging markets. It is spilling back into developed markets. The broader financial markets are recoiling from risk, and that spreads across all markets. The problem now is that the real economy is being affected.” (…)

Auto Surprised smile Russian Car Sales Decline More Than Forecast as Distress Spreads

Sales of new cars and light commercial vehicles fell 29 percent from a year earlier after a 46 percent drop in December, the Association of European Businesses in Moscow said in a statement on Monday. The median of four estimates in a Bloomberg survey was for a 23 percent decline. (…)

The government has stepped in to coax crisis-scarred Russians into buying cars, offering subsidies on auto loans and discounts for drivers willing to part with their old vehicles. The state-support measures have slowed the decline in the car market by half, according to Industry Minister Denis Manturov.

Demand for cars will probably decline another 4.7 percent this year after a 36 percent drop in 2015, the AEB’s Schreiber said last month. (…)

Tech Stocks Swoon Amid Worries Over Economic Growth A sharp dive in technology shares underscored investor worries about uneven U.S. economic growth, as the latest lackluster corporate outlook, this time from LinkedIn, fueled a rush out of stocks.

(…) LinkedIn’s shares tumbled 44% on Friday following a disappointing earnings forecast. (…)

The tech-oriented Nasdaq Composite Index dropped 3.2% on its way to a 5.4% drop for the week. The tech sector has been an investor favorite in recent years, reflecting the strong growth and popularity of big firms such as Facebook Inc., Inc.,Netflix Inc. and Google parent Alphabet Inc.

But those firms all slumped at least 3% Friday, after LinkedIn and another smaller technology firm, data-analysis software maker Tableau Software Inc., posted softer-than-expected growth projections for 2016.

Tableau’s shares plummeted 49%, and other tech companies dropped as well, including a 5.8% decline in Twitter Inc.

(…) companies have been trading at high valuations, a factor that makes them vulnerable to selling for essentially any reason.

Nerd smile This is precisely why it is more important to focus on valuation than on stories. Valuation ranges rarely change but stories always vary.

“We saw some softness in spending, especially in North America,” Tableau CEO Thomas Walker told analysts. “We did see our customers continue to expand their use of Tableau in the organizations, but not at the same cadence we’d historically experienced.”

Tableau’s comments helped spark an exodus by investors from other business-software makers.

Salesforce Inc., a maker of customer-relationship software with annual revenue exceeding $6 billion, fell 13%. Smaller firms were hit harder: Splunk Inc. fell 23%; New Relic Inc., 22%, Hortonworks Inc., 17%; Workday Inc., 16%; and NetSuite Inc., 14%. (…)

Even after Friday’s selling, Amazon traded at a 402 times its earnings over the past 12 months. Netflix traded at 296 times, Facebook traded at 81 times and Alphabet at 31 times. (…)

“A Key Technical Indicator Just Rang The Bell On The Cyclical Bull Market”

Here is Albert Edwards showing that the S&P had breached key moving averages normally seen at the start of a bear market.

Back in the mid-1990s, (…) I remember the head of fixed income explaining to me it was far better not to try and pick market tops or bottoms but to wait and observe the market turn, making the trade late rather than prematurely trying to pick the bottom or top.

So the chart below is notable, showing that key 200d and 320d moving averages for the S&P have just been breached to the downside. If one is looking for key technical indicators to ring the bell on the cyclical bull market- maybe it has just rung loud and clear.

A renminbi devaluation will only sever an already badly frayed safety rope.

Ghost Gundlach Says Financials Below Crisis Prices ‘Frightening’

DoubleLine Capital’s Jeffrey Gundlach said it’s “frightening” to see major financial stocks trading at prices below their financial crisis levels.

He cited Deutsche Bank AG and Credit Suisse Group AGas examples in a talk outlining bearish views at a conference in Beverly Hills, California, on Friday. Both banks fell this week to their lowest levels since the early 1990s in European trading.

“We see the price of major financial stocks, particularly in Europe, which are truly frightening,” Gundlach said. “Do you know that Credit Suisse, which is a powerhouse bank, their stock price is lower than it was in the depths of the financial crisis in 2009? Do you know that Deutsche Bank is at a lower price today than it was in 2009 when we were talking about the potential implosion of the entire global banking system?”

The manager of the $54.7 billion DoubleLine Total Return Bond Fund said the dollar is headed lower in 2016 and that he’s buying non-U.S. currencies for the first time in five years. The euro is likely to strengthen against the greenback as the probability that the Federal Reserve will increase borrowing costs at its March meeting is virtually zero, and only 50 percent for the rest of the year, he told the Tiger 21 conference for high-net-worth investors.

Gundlach, 56, said he’s considering buying corporate bonds later this year as prices continue to fall, including investing his personal money.

“The whole question for me is when am I going to buy enormous amounts of corporate credit, because it’s crystal clear that that’s the next opportunity that’s out there,” Gundlach said. “There’s plenty of things out there that will have 100 percent returns. It’s a whole question of: Don’t tell me what to buy, tell me when to buy it.”

Debt related to energy and mining is still very risky, because of weakness in China’s economy and a worldwide oil glut, he said.

“There’s simply no bullish case for oil right now,” Gundlach said. (…)

(…) Not all of the problems are peculiar to Europe’s lenders. All investment banks, including those on Wall Street, are struggling with tough trading conditions. But the environment has tipped European banks into the red, weighed down by billions of dollars in costs associated with restructuring and resolving government investigations and lawsuits. Credit Suisse was the most recent loser, and its shares tanked 11% on Thursday—to their lowest level in 24 years—after it disclosed that rich clients had yanked cash from its wealth-management business.

Pointing up Even the recent plunge in oil prices appears to be taking a toll on the shares of European banks. Sovereign-wealth funds and other government-affiliated investors in the Middle East, Africa and Norway have been among the biggest losers from swooning oil prices, causing some to sell assets to drum up money. Those same funds happen to be among the biggest investors in European banks.

About 10% of UniCredit’s shares, for example, are held by funds from Abu Dhabi, Libya and Norway, while Barclays PLC and Credit Suisse are both roughly 10%-owned by Norwegian and Qatari funds and investors, according to FactSet. Sovereign funds from oil-producing nations also own substantial stakes in Deutsche Bank, Italy’s Intesa Sanpaolo SpA, France’s BNP Paribas SA and Société Générale SA, the U.K.’s Lloyds Banking Group PLC and Nordic lender Nordea Bank AB.

It is unclear if the government funds are actually selling their European-bank shares—the funds declined to comment—but the expectation that they are selling or might do so in the future appears to be exerting downward pressure on the banks’ shares. (…)

(…) What’s behind the nonchalance in credit?

Mr. Lichwa said that regulatory and economic shifts since 2012 are part of the reason that credit has not reacted so violently this time. For a start, banks have built up much bigger capital cushions to absorb losses.

Banks also don’t have the same short term liquidity risks now thanks to the billions of euros that the European Central bank has flooded into markets, said Chris Tefler, portfolio manager at ECM asset management.

For Dan Davies, at independent research house Frontline Analysts, the decline in stocks is largely a reflection of the decline in projected earnings.

“That’s obviously not good news for anything in the capital structure, but earnings are not at levels which look like generating capital-destroying losses,” Mr. Davies said.

Shares are also falling because dividends are being cut and cancelled, Mr. Davies said. That would typically benefit credit.

But other analysts ask if the credit market is just being too sanguine over risks.

Mr. Lichwa notes in his research that banks would be “very vulnerable” to an economic downturn.

That means that credit markets could also be vulnerable to a correction, if investors start to believe the outlook for European banks is bleaker than they expected.

NEW$ & VIEW$ (5 FEBRUARY 2016):

German Factory Orders Fall as Export Slowdown Cools Confidence

Orders, adjusted for seasonal swings and inflation, dropped 0.7 percent from the prior month, when they rose 1.5 percent, data from the Economy Ministry in Berlin showed on Friday. Orders dropped 2.7 percent from a year earlier.

Domestic orders fell 2.5 percent, the ministry said, while euro-area orders slumped 6.9 percent and demand from outside the currency bloc rose 5.5 percent. Orders for investment goods declined 0.5, and for consumer goods surged 4.3 percent.

“Order activity somewhat recovered in the fourth quarter,” the ministry said in a statement. “Increasing demand from countries outside the euro area indicates a gradual recovery the global economy. However, industry expectations have somewhat clouded, signaling a more modest recovery in industrial activity.” (…)

  • Markit’s January Manufacturing PMI for Germany points to continued moderate growth in German manufacturing:

Latest survey results signalled a slowing in the rate of production growth at German manufacturers, largely a result of stagnating output at intermediate goods producers. Meanwhile, consumer and investment goods manufacturers reported further solid growth.

Mirroring the trend for output, new business also rose at weaker rate at the start of 2016. In fact, the increase in new business was the least marked in four months. Weaker demand from export markets was one of the reasons for the slowdown in total new business. However, some panellists reported that the weak euro and improved demand from the US helped secure higher new export orders.


But Europe looks slower overall:

Sad smile Super Mario is surely not pleased to see that:

The China Syndrome:

Rate Expectations: Not So Fast, Fed Wall Street is increasingly skeptical about the pace of Federal Reserve interest-rate increases this year, the latest blow to the central bank’s years long efforts to unwind its easy-money policies and return the economy to a normal footing.
Ghost Bond yields send recession signal Universe of negative yielding debt grows beyond $5tn as central banks indicate further easing

If major government bond markets are right, the global economy is sliding towards recession and central bank easing policies will pull borrowing rates deeper into negative territory. (…)

In Europe and Japan, government bonds worth nearly $6tn now trade at such highs that buyers will make a loss if they hold the paper to maturity.

Across the Atlantic, talk of recession risk has grown louder in recent weeks among investors, with the 10-year Treasury yield, touching a nine-month low of 1.80 per cent this week. (…)

Investors face the difficult prospect of assessing whether low inflation has become ingrained thanks to the collapse in commodity prices. A greater concern: has central bank interference in financial markets made pricing so opaque that investors are risking the sort of losses incurred last April, when a European Central Bank driven rally in bond markets suddenly expired?

Negative or ultra-low yielding bonds sound unappealing, but with negative interest rates already in use by central banks in Japan, Denmark, Sweden, Switzerland and the eurozone, and major central banks indicating they are willing to do more to address low inflation, they make sense. (…)

Although the negative yields introduced will affect only a small portion of bank reserves, prices for government debt around the world jumped, sending trillions of dollars of bonds into negative territory. Investors bet that other central banks would also signal easier policy, a view that has been affirmed over the past week.

In Europe, ECB president Mario Draghi announced on Thursday that global weak inflation was no impediment to the ECB adding stimulus if needed while Bank of England governor Mark Carney cited the global economy as the cause of a lower inflation forecast for the UK.

Bill Dudley, president of the Reserve Bank of New York, also damped investor expectations of an upcoming rate rise in the US by addressing tighter global financial conditions this week. (…)

The lifespan of the rally in government bonds will depend on how long investors keep faith in central banks, says Tad Rivelle, chief investment officer for fixed income at TCW, a Los-Angeles based asset manager. Every economic cycle has a grand narrative that eventually unravels, he says. In the late 1990s it was the information revolution, in the 2000s it was housing prices.

“This cycle the narrative has been that central banks have got the ball, know what they’re doing and can keep the game going as long as they want,” he says. “But humans have not found a way to abolish cycles.”

S&P 500 Now Yielding 0.5% More Than the 10-Year Treasury



  • 307 companies (75.2% of the S&P 500’s market cap) have reported. Earnings are beating by 4.5% while revenues have met expectations.
  • Expectations are for a decline in revenue, earnings, and EPS of -3.4%, -4.9%, and -3.0%. EPS is on pace for -1.9%, assuming the current beat rate for the remainder of the season. This would be +4.2% excluding Energy.

Yesterday I noticed that Thomson Reuters’ estimate for 2015 EPS had curiously increased in recent days from $117.11 on Jan. 29 to $118.33 yesterday. Turned out this was a typo. T’s estimate is $117.33. Here’s the Barometer on that basis:


To be watched:

U.S. Productivity Decline Lifts Unit Labor Costs


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The long slide (Bespoke):

Citi: ‘We Should All Fear Oilmageddon’

(…) “It appears that four inter-linked phenomena are driving a negative feedback loop in the global economy and across financial markets,” the analysts write, citing the resilient U.S. dollar, lower commodities prices, weaker trade and capital flows, and declining emerging market growth. 

“It seems reasonable to assume that another year of extreme moves in U.S. dollar (higher) and oil/commodity prices (lower) would likely continue to drive this negative feedback loop and make it very difficult for policy makers in emerging markets and developing markets to fight disinflationary forces and intercept downside risks,” the analysts add. “Corporate profits and equity markets would also likely suffer further downside risk in this scenario of Oilmageddon.”

Their case is bolstered by a collection of charts showing the linkages between the four factors cited above, including the importance of lofty oil prices to the ready supply of petrodollars circulating in the world economy and flowing to financial assets. Oil exporters have enjoyed more than $6 trillion flowing into their current accounts, according to Citi’s estimates, implying some $4 trillion of capital in sovereign wealth funds (SWFs).

“But, the collapse in oil/commodity prices and sharp fall in the pace of world trade means that these same economies will likely experience an aggregate current account deficit for the first time since 1998,” says Citi. “In turn, this is likely to put pressure on SWF and broader emerging market liquidity as governments and emerging market economies would need to ‘lean’ on reserves in order to maintain economic, political and social stability. This has clear feedback loops across emerging markets.”

Accordingly, the impact of the feedback loop is being felt far and wide in financial markets, extending even to U.S. inflation expectations. Where once 10-year inflation breakevens had little relationship with the price of oil they have for the past two years moved in tandem.

With house forecasts for a 4 percent strengthening of the trade-weighted U.S. dollar and oil prices at $50 a barrel by the end of the year, Citi offers some hope that the feedback loop can be partially reversed though not necessarily broken. Should the bank’s base case of stabilizing currency and commodities markets materialize, the analysts say, financial assets should respond accordingly and recover.
However, a move “the other way would add fuel to a ‘significant and syncronised’ global recession,” the bank warns warns.

“We should all fear Oilmageddon,” Citi concludes. “Global recession, as we define it, would leave nowhere to hide in equities. Cash wins.”