STALL SPEED : Any Geo-Political, Economic or Financial Event Could Trigger a Market Clearing Fall
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.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY
MONETARY MALPRACTICE : Moral Hazard, Unintended Consequences & Dysfunctional Markets - Monetary Malpractice has had the desired result of driving Investors into becoming Speculators and are now nothing more than low-odds Gamblers. There is a difference between investing, speculating and gambling. At one time these lines were easy to comprehend and these distinctive groups separated into camps with different risk profiles in which to seek their fortunes. Today investing has become at best nothing more than speculating and realistically closer to outright gambling.
The reason is that vital information is either opaque, hidden or manipulated. Blatant examples such as: the world of off balance sheet debt, Contingent Liabilities, Derivative SWAPS, Special Purpose Vehicles (SPV), Special Purpose Entities (SPE), Structured Investment Vehicles (SIV) and obscene levels of hidden leverage make a mockery out of public Financial Statements. Surely if we get our ego out of this for a moment we can see that stockholders are now nothing more than gamblers? What is worse is that the casino is rigged. With Monetary Policy now targeting negative real interest rates, it is forcing the public out of interest bearing savings and investing, and into higher risk vehicles they would have shunned historically. They have no choice as the Monetary Malpractice game is played against them.
There is an old poker player adage: "when you look around the table and can't determine who the patsy with the money is, it is because it is you." MORE>>
The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern. - The "Peek Inside" shows the detailed coverage available this month.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & EXECUTIVE BRIEF
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
As we have painstakingly pointed out, rising equity markets in 2012 have mostly been a function of rising multiples applied to relatively stagnant earnings.
While JPMorgan's CIO Michael Cembalest would have given odds no better than 1 in 4 of a 17% advance in the S&P this year, he does note that forecasting annual equity returns is an entirely treacherous (and we add foolish) exercise as real return variation has completely swamped industry expectations for the last 60 years.
The traditional Graham-Dodd/Shiller valuation model makes equities look expensive currently, but Cembalest notes, valuations might not be the driving factor at this point.
The debasement of money by the Fed has altered the calculus of investing for many participants, and not necessarily for the better (as he notes ongoing work that hints at since the Greenspan/Bernanke era of negative real interest rates began, stock market volatility is even higher than before the creation of the Fed in 1913).
Of course, by driving interest rates down and promising to keep them there, a 7% nominal equity earnings yield (i.e., a 14 P/E) is transformed into a more compelling investment - but critically (especially for social and political reasons) the 'value' of this adjusted earnings yield is questionable given the earnings boom is derived from extraordinarily weak labor compensation and potentially unsustainable demand from Europe/China.
The growth of corporate profits has delinked from nominal GDP growth, a departure from past cycles.
This is unfamiliar territory for investors, since it suggests that you should just ignore weak domestic growth concerns and watch profits keep rising. The political and social risks of this trend are self-evident.
The first shows S&P earnings vs. what S&P earnings had been expected to be by analyst 12 months previous going back to 1991. For the most part, the lines have been close.
But what's really interesting is the second chart showing the relationship as a spread. For basically 20 years, Wall Street earnings forecasters have been habitually over-optimistic, and S&P earnings almost always miss, with just a few tiny exceptions.
It may come as a surprise (until very recently) to many who watch the flashing red headlines spewed forth by Bloomberg and Reuters terminals as each and every firm manages to coincidentally report earnings within a smidge of guidance (and maintain their 'near-perfect' records of 'sustainable' growth) when all around the signals seem to point to an economy in malaise. However, earnings quality - that ephemeral view of just how manipulated the end number really is - remains critical (in the medium-term, if not the short-term thanks to the headline-reading algos). To wit, Bloomberg notes a recent paper (below) that finds 20% of CFOs will "manage earnings to misrepresent economic performance" with 93.5% admitting it is to influence the stock price. 'Red flag's include EPS inconsistent with cash-flows, unusual accruals, or an industry outlier. Amid pressure to maintain stock prices (and keep a career going), 60% of earnings 'management' is to increase income and of course 66% of CFOs hope for fewer accounting rules going forward.
93.45% of CFOs responded the motivation to cheat (our word) was to influence the stock price!!.. and 88.62% to increase their own compensation!!!
So the next time a CEO/CFO says anything - and it is heralded as something other than self-serving tripe - please read this report one more time!!
One of the most egregious aspects of the Great Moderation was the issuance of large amounts of grossly mispriced extremely 'junky' debt at the peak as investors stymied by the lack of spread (return) pushed further and further out the credit risk spectrum. The driver at the time was the liquidity flood triggered by large-scale securitizations (and that ended well eh?); this time it is central banks providing the fuel for investors to seek yield through leverage (either through fundamental leverage in riskier firms or technical leverage through riskier instruments). To wit, the last few weeks have seen a resurgence of issuance of PIK-Toggle bonds.
These extreme junk credit-rated bonds with very high default risk offer 'attractive' yields relative to the financially repressed idiocy of the rest of the capital markets but the Pay-In-Kind nature means simply - do not expect coupons and principal return in cash, but we promise to pay that principal back by offering you more 'junky' bonds (extending maturity for example).
Issuance of PIKs has re-surged once again
The last time we saw a surge like the current one was during the ECB's LTRO fiasco, and once again with QEternity on the table, that excess liquidity 'forces' money to work in these over-leveraged and under-compensated (risk-wise) instruments. With rates held low and IG and HY spreads technically compressed, we suspect we will see more PIK-Toggle, Cov-Lite, Junior-Mezz CLOs - and suspect this won't end well.
and CNBC's Gary Kaminsky pointing out the junkiness of these deals..."This is Junk, This is Bad!"
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK -Oct 7th- Oct 14th, 2012
Companies are taking advantage of investors' appetite for yield—and fear of riskier bets—by issuing more long-term bonds, aiming to reduce their refinancing needs in coming years, when interest rates are likely to be higher.
Investment-grade companies have sold more 30-year bonds in the U.S. so far in 2012 than in any full year since 1995, according to data provider Dealogic.
The $91.9 billion of 30-year bonds sold in 166 offerings this year, is about 26% more than the $73.2 billion sold in 145 deals during all of 2011.
Issuers are being drawn to the longer maturities by low interest rates, the result of the Federal Reserve's loose monetary policy and the global economy's continuing weakness. For investors, the longer maturities provide better returns than shorter-term debt without the default worries associated with the high-yielding debt of some of Europe's troubled economies.
However, more long-term debt issuance now could limit the supply of bonds in the future, meaning investors will need to find other places to put their cash. For corporations, there is a sense that now is as good a time as any to raise debt, particularly as the near-term economic outlook dims.
That view helped make
September the second busiest month for 30-year issuance this year, with 24 companies raising $12.3 billion.
"No treasurer or CFO wants to be the one treasurer or CFO who didn't get cheap long-term money when it was available," says Mark Gray, an analyst with Moody's Investors Service.
UPS: Among those tapping the market was United Parcel Service Inc. UPS -1.00% On Sept. 24, UPS refinanced $1.75 billion of five-year bonds coming due in January 2013 through a three-part bond deal, including $375 million of 30-year bonds that paid 3.625% annually. The timing of the deal "was a combination of the current credit market and looking at avoiding fourth-quarter uncertainty," said UPS spokeswoman Susan Rosenberg. Ms. Rosenberg said that there was seven times the demand for the bonds than the amount available. She added that the company wanted to raise the funds ahead of any disruption to the economy caused by government negotiations over tax and spending cuts.
GE: The corporate-debt market is enticing many companies that haven't issued long-dated bonds for years. General Electric Co. GE -1.03% jumped in on Oct. 1, selling $7 billion of bonds, including $2 billion of 30-year bonds. Although GE's finance arm, GE Capital, is a frequent bond issuer, the recent offering was the first by the parent company in five years. The company plans to use part of the proceeds to refinance $5 billion of debt coming due in February 2013. A GE spokesman said the issuance was consistent with its strategy of being "opportunistic in accessing markets and prefunding maturities, particularly with interest rates at historically low levels."
COMCAST: On Sept. 28, Comcast Corp. CMCSA -1.77% sold $1 billion of 30-year bonds for its NBCUniversal subsidiary, with a 4.45% rate, compared with rates ranging between 6.5% and 7% for 30-year bonds Comcast sold in past years. That difference represents an annual interest-payment savings of roughly $20 million on $1 billion of debt.
SPREAD: Investor demand for corporate bonds has narrowed their spread with benchmark 30-year U.S. Treasurys. The spread measures how risky investors consider the bonds relative to U.S. Treasurys, which are considered among the safest investments. On Thursday, the spread between 30-year Treasurys, which yielded 2.89%, and 30-year corporate debt was 1.83 percentage points, the lowest since Aug. 10, 2011, according to S&P Capital IQ's Leveraged Commentary & Data unit. The tighter spread suggests investors see less risk in corporate bonds.
The low yields present a problem to investors, because they are buying bonds at historically high prices that will fall if the Fed begins raising interest rates. Bond prices move in the opposite direction of interest rates. However, bond-fund managers have little choice but to buy the debt, if they can, especially when highly regarded issuers like GE re-enter the market.
Investment-grade companies have been very stable lately. Moody's Mr. Gray said that only four companies have suffered ratings downgrades since July, "which speaks to the fact that things are pretty stable out there." He added that the long-term issuance is a positive for companies.
"If a company can lock in cheap long-term money for a refinancing, it takes maturity risk out of the equation for a long time. Over the near term it gives a company breathing room," Mr. Gray said. The demand is making it easy for companies to come to market, particularly those with the higher ratings. "Whether you're mid-BBB or mid-A, if you're a solid, large market cap company in a noncyclical industry, you've got very, very good access," said one investment-grade bond banker.
CREDIT / BONDS / SPREADS / YIELDS
6- Bond Bubble
FISCAL CLIFF - Congress Bying Time Before the Inevitable
BASICALLY A "STALL PROGRAM" before the inevitable arrives.
With US Federal tax (mostly) and spending (far less) policy having become two of the key issues of the ongoing presidential debate, we wish to present to our readers 111 years of US revenue and spending data, both in absolute terms, and as a percentage of GDP.
Two things to observe:
Between the passage of the 16th Amendment, which ushered in the modern Federal income tax, in 1913, and the end of WW I, the US somehow managed to exist with only 2% of Federal tax revenue as a % of GDP. Then the war ended, and it was all downhill from there, with Federal tax as a % of GDP first flatlining around 5-6% of GDP, and then after WW II, it found a new home just shy of 20%. One wonders what the new benchmark support for US Federal tax will be after the next global war.
Spending, unlike taxes, have been far more erratic, and far larger on average, than Tax revenues. In fact, in the 82 years after 1930, there have been only 14 budget surpluses. Of note: the four years of Clinton budget surpluses between 1998 and 2001 were the first time Federal tax revenues surpassed spending since 1969. Judging by the recent explosion in government spending, which we doubt will ever be reduced to historical trendline again, the US can kiss the concept of budget surplus goodbye for ever.
Federal tax and spending in absolute dollars - 1900-2011:
Federal tax and spending as % of GDP - 1900-2011:
13 - Global Governance Failure
GLOBAL GROWTH - IMF Cuts Growth from 3.9% to 3.6%and Increases Deficit Multiplier by 100 to 200%
The IMF now believes economic output will expand by 3.6 per cent in 2013, down from its July estimate of 3.9 per cent. But this assumes the US Congress will take action to avoid the “fiscal cliff” – the automatic expiry of tax cuts and introduction of spending reductions next year – and that eurozone governments will follow the European Central Bank’s plan to buy sovereign debt by committing to economic reform and closer integration.
“A key issue is whether the global economy is just hitting another bout of turbulence in what was always expected to be a slow and bumpy recovery or whether the current slowdown has a more lasting component,” the IMF said. “The answer depends on whether European and US policy makers can deal proactively with their major short-term economic challenges.”
Economic uncertainty would continue to weigh on output in both advanced and emerging markets, the fund added, though it remained comparatively upbeat on the outlook for China.
CHINA: Growth estimates for China for this year and next were revised downwards by a fifth of a percentage point to 7.8 per cent and 8.2 per cent respectively, but the IMF believed there would be a soft landing for the world’s second-largest economy, along with the rest of the region. “The outlook is for a modest pick-up in growth on the back of recent policy easing,” the IMF said.
UK: The IMF slashed its forecast for the UK economy this year from growth of 0.2 per cent to a contraction of 0.4 per cent. The fund now expects growth of 1.1 per cent next year, down from an estimate of 1.4 per cent. The new forecasts are broadly in line with those of private sector economists.
The fund points to new analysis showing that governments’ assumptions about the trade-off between fiscal consolidation and growth had been too favourable, and cutbacks would do more damage to output than their economic forecasts predicted.
The IMF said that evidence from 28 countries shows that so-called fiscal multipliers, used by governments to assess the impact on growth of fiscal cutbacks, have underestimated the damage to the economy. “The multipliers used in generating growth forecasts have been systematically too low since the start of the great recession,” the IMF said. A smaller multiplier implies fiscal consolidation is less costly.
Olivier Blanchard, chief economist, indicated on Tuesday that the analysis had influenced the Fund’s policy prescriptions for countries under IMF programmes. Mr Blanchard cited the troika’s recent relaxation of Portugal’s deficit target for 2013 to 4.5 per cent of gross domestic product from 3 per cent, saying: “When the case is fair, we have to get ready to adjust targets given that fiscal multipliers are so large.”
According to the IMF, policy documents seen by fund officials suggest that governments are commonly using fiscal multipliers of about 0.5 to calculate the impact of austerity on growth. A multiplier of 0.5 would mean that for every $1 lost in government spending, 50 cents is wiped from output.
“Our results indicate that multipliers have actually been in the 0.9 to 1.7 range since the great recession,” the fund said.
Mr Blanchard said fiscal multipliers were substantially larger than usual because the impact of fiscal cutbacks could not be offset by looser monetary policy. “We are in a period where many countries are in a liquidity trap and monetary policy is much more constrained than in normal times,” he said.
The chief economist said Spain and Italy should receive financial assistance in the form of direct bank recapitalisations and lower borrowing costs, once they followed through with adjustment plans.
The IMF called for the European Stability Mechanism, the eurozone’s permanent bailout fund, to be made operational as soon as possible to inject capital directly into banks based in the periphery. Funds to ensure sovereigns could borrow “at reasonable cost” could be channelled through either the ESM or the European Financial Stability Facility, the bloc’s temporary rescue vehicle.
17 - Shrinking Revenue Growth Rate
GLOBAL GROWTH - IMF Cuts Advanced Economies Growth by 25% from 2.0% to 1.5%
The IMF has cut global growth expectations for advanced economics from 2.0% to only 1.5%. Quite sadly, they see two forces pulling growth down in advanced economies: fiscal consolidation and a still-weak financial system; and only one main force pulling growth up is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general. A general feeling of uncertainty weighs on global sentiment. Of note: the IMF finds that "Risks for a Serious Global Slowdown Are Alarmingly High...The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO. For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area." And yet probably the most defining line of the entire report (that we have found so far) is the following: "Central bank capital is, in many ways, an arbitrary number." And there you have it, straight from the IMF.
Global growth is too weak to bring down unemployment and what little momentum exists is coming primarily from central banks, the International Monetary Fund said in its World Economic Outlook, released ahead of its twice-yearly meeting, which will be held in Tokyo later this week.
The keyword is momentum. Or rather lack thereof:
Policy tightening in response to capacity constraints and concerns about the potential for deteriorating bank loan portfolios, weaker demand from advanced economies, and country-specific factors slowed GDP growth in emerging market and developing economies from about 9 percent in late 2009 to about 5¼ percent recently. Indicators of manufacturing activity have been retreating for some time (Figure 1.3, panel 1). The IMF staff’s Global Projection Model suggests that more than half of the downward revisions to real GDP growth in 2012 are rooted in domestic developments.
Growth is estimated to have weakened appreciably in developing Asia, to less than 7 percent in the first half of 2012, as activity in China slowed sharply, owing to a tightening in credit conditions (in response to threats of a real estate bubble), a return to a more sustainable pace of public investment, and weaker external demand. India’s activity suffered from waning business confidence amid slow approvals for new projects, sluggish structural reforms, policy rate hikes designed to rein in inflation, and flagging external demand.
Real GDP growth also decelerated in Latin America to about 3 percent in the first half of 2012, largely due to Brazil. This reflects the impact of past policy tightening to contain inflation pressure and steps to moderate credit growth in some market segments—with increased drag recently from global factors.
Emerging European economies, following a strong rebound from their credit crisis, have now been hit hard by slowing exports to the euro area, with real GDP growth coming close to a halt. In Turkey, the slowdown has been driven by domestic demand, on the heels of policy tightening and a decline in confidence. Unlike in 2008, however, generalized risk aversion toward the region is no longer a factor. Activity in Russia, which has benefited various economies in the region, has also lost some momentum recently
IMF isn't happy about Europe:
Notwithstanding policy action aimed at resolving it, the euro area crisis has deepened and new interventions have been necessary to prevent matters from deteriorating rapidly. As discussed in the October 2012 Global Financial Stability Report (GFSR), banks, insurers, and fi rms have swept spare liquidity from the periphery to the core of the euro area, causing Spanish sovereign spreads to hit record highs and Italian spreads to move up sharply too (Figure 1.2, panel 2). Th is was triggered by continued doubts about the capacity of countries in the periphery to deliver the required fi scal and structural adjustments, questions about the readiness of national institutions to implement euro-area-wide policies adequate to combat the crisis, and concerns about the readiness of the European Central Bank (ECB) and the European Financial Stability Facility/ European Stability Mechanism (EFSF/ESM) to respond if worst-case scenarios materialize.
These concerns culminated in questions about the viability of the euro area and prompted a variety of actions from euro area policymakers. At the June 29, 2012, summit, euro area leaders committed to reconsidering the issue of the seniority of the ESM with respect to lending to Spain. In response to escalating problems, Spain subsequently agreed on a program with its European partners to support the restructuring of its banking sector, with financing of up to €100 billion. Also, leaders launched work on a banking union, which was followed up recently with a proposal by the European Commission to establish a single supervisory mechanism. Leaders agreed that, once established, such a mechanism would open the possibility for the ESM to take direct equity stakes in banks. This is critical because it will help break the adverse feedback loops between sovereigns and banks. Moreover, in early September, the ECB announced that it will consider (without ex ante limits) Outright Monetary Transactions (OMTs) under a macroeconomic adjustment or precautionary program with the EFSF/ESM. The transactions will cover government securities purchases, focused on the shorter part of the yield curve.
Importantly, the ECB will accept the same treatment as private or other creditors with respect to bonds purchased through the OMT program. (ZH: not really - especually not when the ECB has to see its bonds incur losses - see Greece)The anticipation of these initiatives and their subsequent deployment set off a relief rally in financial markets, and the euro appreciated against the U.S. dollar and other major currencies. However, recent activity indicators have continued to languish, suggesting that weakness is spreading from the periphery to the whole of the euro area (Figure 1.3, panel 2). Even Germany has not been immune.
.. or the US:
The U.S. economy also has slowed. Revised national accounts data suggest that it came into 2012 with more momentum than initially estimated. However, real GDP growth then slowed to 1.7 percent in the second quarter, below the April WEO and July WEO Update projections. The labor market and consumption have failed to garner much strength.
Could have fooled the BLS and the brand spanking news "7.8% unemployment rate."
The IMF concludes there is little to worry about as a result of global QEternity, an observation that certainly explains the following statement: "Central bank capital is, in many ways, an arbitrary number." ... right.
Risks related to swollen central bank balance sheets
The concern is that the vast acquisition of assets by central banks will ultimately mean a rise in the money supply and thus inflation (Figure 1.5, panel 3). However, as discussed in previous WEO reports, no technical reason indicates this would be inevitable. Central banks have more than enough tools to absorb the liquidity they create, including selling the assets they have bought, reverting to traditionally short maturities for refinancing, raising their deposit rates, and selling their own paper. Furthermore, in principle, central bank losses do not matter: their creditors are currency holders and reserve-holding banks; neither can demand to be paid with some other form of money. The reality, however, may well be different. A national legislature may see such losses as a symptom that the central bank is operating outside its mandate, Central bank capital is, in many ways, an arbitrary number, as is well illustrated by the large balance sheets of central banks that intervene in foreign exchange markets (Figure 1.5, panel 4). which could be of concern if it led to efforts to limit the central bank’s operational independence. A related concern is that economic agents may begin to doubt the capacity of central banks to fight inflation. Two scenarios come to mind:
Public deficits and debt may run out of control, causing governments to lean on central banks to pursue more expansionary policies with a view to eroding the real value of the debt via inflation. Similarly, losses on holdings of euro area, Japanese, and U.S. (G3) government securities may cause emerging market economies’ central banks or sovereign wealth funds to buy fewer G3 government assets, investing instead in better opportunities at home and triggering large depreciations of G3 currencies.
Policymakers may falsely perceive central bank balance sheet losses to be damaging to their economies. Such perceptions may make central banks more hesitant to raise interest rates, because doing so would decrease the market value of their asset holdings. The mere appearance of such hesitation may lead private agents to expect an increase in inflation
And some absolute profundity:
Risks related to high public debt levels
Public debt has reached very high levels, and if past experience is any guide, it will take many years to appreciably reduce it (see Chapter 3). Risks related to public debt have several aspects. First, when global output is at or above potential, high public debt may raise global real interest rates, crowding out capital and lowering output in the long term.3 Second, the cost of debt service may lead to tax increases or cutbacks in infrastructure investment that lower supply. Third, high public debt in individual countries may raise their sovereign risk premiums, with a variety of consequences—from limited scope for countercyclical fiscal policies (as evidenced by the current problems in the euro area periphery) to high inflation or outright default in the case of very large increases in risk premiums.
Simulations with the GIMF suggest that an increase in public debt in the G3 economies of about 40 percentage points of GDP raises real interest rates almost 40 basis points in the long term (Box 1.2). This simulation and discussion necessarily abstracts from the potential long-term benefits of fiscal stimulus. The 2009 stimulus, for example, was likely instrumental in averting a potential deflationary spiral and protracted period of exceedingly high unemployment, macroeconomic conditions that general equilibrium models such as the GIMF are not well suited to capture. Bearing this in mind, the simulation suggests that in the long term the higher debt lowers real GDP by about ¾ percent relative to a baseline without any increase in public debt. This is because of the direct effect of higher interest rates on investment and the indirect effect via higher taxes or lower government investment. The GIMF simulations indicate that within the G3 the negative effects would be larger, with output 1 percent below baseline projections. The loss of output over the medium term would be even larger if, for example, savings were to drop more than expected because of aging populations in the advanced economies or if the consumption patterns of emerging market economies with very high saving rates align more quickly than expected with those of advanced economies.
Scenarios that involve very high levels of debt and high real interest rates may not only result in lower growth but may also involve a higher risk of default when fiscal dynamics are perceived to be unstable. This combination of high debt and high real interest rates can lead to bad equilibriums, when doubt about the sustainability of fiscal positions drives interest rates to unsustainable levels.
In other words, according to the IMF's brain trust, soaring debt, and exploding interest rates may lead to default. And that is why they get paid the big SDRs.
Risks for a Serious Global Slowdown Are Alarmingly High
The WEO’s standard fan chart suggests that uncertainty about the outlook has increased markedly (Figure 1.11, panel 1). The WEO growth forecast is now 3.3 and 3.6 percent for 2012 and 2013, respectively, which is somewhat lower than in April 2012. The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO.
The IMF staff’s Global Projection Model (GPM) uses an entirely different methodology to gauge risk but confirms that risks for recession in advanced economies (entailing a serious slowdown in emerging market and developing economies) are alarmingly high (Figure 1.12, panel 1). For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area.
For the first time in 11 quarters, companies in the Standard & Poor's 500-stock index are likely to show a decline in profits, overall
Estimates from S&P Capital IQ call for a 1.34% decline, while in the second quarter, earnings managed to cling to positive territory with a 0.81% growth rate.
The consensus forecast for aggregate third-quarter earnings on S&P 500 companies is now $25.01 a share, down 4.5% from June 30, according to FactSet Research SystemsFDS +0.22% . FactSet notes, however, that the decline is only a touch bigger than the average downward revision over the past 10 years of 4.3%.
Paying particular attention to the number of earnings warnings compared with the number of upbeat announcements. He pegs the ratio at 4-to-1, the highest since the third quarter of 2001, when the economy was lumbering after the bursting of the technology-stock bubble. Mr. Bohnsack said the combined weakness of the second and third quarters is significant, a bearish sign for stocks over the long term, even if the Fed helps prop up the market initially.
declining revenue and shrinking profit margins, would signify a serious deterioration in corporate health that could undermine any stock-market gains over the long haul.
"This foreshadows a prolonged deceleration in earnings". Strategas, which counts itself in the "defensive" camp on stocks, expects 2012 S&P 500 earnings to come in at $100.50 per share, compared with a FactSet consensus forecast of $103.24.
21 - US Stock Market Valuations
EARNINGS ESTIMATES - 4.3 Up versus Down Revisions Highest Since 2001
Downward EPS revisions have outnumbered upward revisions for 22 weeks
For the S&P 500 companies, there have been 91 negative pre-announcements versus 21 positive
The 4.3x negative-to-positive pre-announcement ratio is the highest since 2001
Of the S&P 500 companies that have reported thus far (25 total), only 52% have exceeded expectations (long-term average is 63% and last four quarters average 67%)
Overall Q3 earnings are expected to fall 2.5%
And as a reminder - Via Citi:
When investors consider the earnings expectations for the next several quarters, it must be noted that a few sectors seem to have an abundance of optimism that may or may not be warranted. For example, the Materials sector is showing a big bounce in 1H13 earnings projections that may require much more clarity on global economic reacceleration, while Financials are expected to rise sharply as well. Hence, these two areas might require some ratcheting down of forecasts and management teams may begin to do so in the next few weeks.
We have highlighted some of current measures of complacency, which may not be entirely appropriate in the very near term (next couple of months) given the US elections and the related fiscal cliff, recent European social unrest and the need to curtail some of the profit growth enthusiasm. In the medium term (2013), many of the analytical models we use still argue for overall market gains, and thus we believe weakness should be seen as a buying opportunity.
Companies in the S&P 500 had $1.5 trillion parked outside the U.S. for which they hadn't accrued tax expense in 2011, more than double the amount five years earlier.
When companies park cash overseas indefinitely, they are essentially saying there is a pool of profit that is out of the reach of shareholders. This also means part of a company's "free" cash flow may be anything but. So these profits essentially become "look, but don't touch earnings," Jack Ciesielski, editor of the Observer, argued late last month at a Senate hearing examining offshore profit shifting and the U.S. tax code. Of course, a company can decide to bring the profits back to the U.S. But if it chose not to take an expense for future taxes when the overseas profit was first generated, this would result in a potentially enormous hit to earnings.
Goldman's equity strategist David Kostin has been very quiet for the past year, having not budged on his 2012 year end S&P target of 1250 since late 2011. Today, he finally released a revised forecast, one that curious still leaves the year end forecast unchanged at a level over 200 points lower in the S&P cash, and thus assuming a ~15% decline. The reason: the same fiscal cliff (which would otherwise deduct 5% in GDP growth) and debt ceiling debate we have warned will get the same market treatment as it did in August of 2011 when the only catalyst was a 15% S&P plunge and a downgrade of the US credit rating. However, one the fiscal situation is fixed, Kostin sees only upside, with a 6 month target of 1450 ("We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed."), and a year end S&P target of 1575, calculated by applying a 13.9 multiple to the firm's EPS forecast of 114. Of course, this being bizarro Goldman Sachs it means expect a continued surge into year end, then prolonged fizzle into the new year. Why? Because there is not a snowball's chance in hell the consolidated S&P earnings can grow at this rate, especially not if the Fiscal Cliff compromise is one that does take away more than 1% of GDP thus offsetting all the "benefit" from QE.
Simply said, companies who have already eliminated all the fat, and most of the muscle, and are desperate for revenue growth to generate incremental EPS increase, have not invested in CapEx at nearly the rate needed to maintain revenue growth (see How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement) having dumped all the cash instead in such short-sighted initiatives as dividends and buybacks. Also, recalling that revenues are now outright declining on a year over year basis, and one can see why anyone assuming a 14% increase in earnings in one year, is merely doing all they can to make the work of their flow desk easier.
Equities are attractive for long-term investors but face near-term risks. We forecast S&P 500 will reach 1575 at year-end 2013 based on our new 2014 EPS estimate of $114 and a fair value P/E of 13.9X. The FOMC’s open-ended easing program allows investors to look past current stagnant economic growth and focus on corporate fundamentals. So far QE has reduced the equity risk premium but not yet improved growth expectations. However, in the near-term we apply a valuation discount due to fiscal policy uncertainty. Our year-end 2012 price target remains 1250
Downside risk through year-end stems from ‘fiscal cliff’ uncertainty Investors are too complacent that Congress reaches compromise on the divisive issues of taxes and spending during the six weeks between the Nov 6 election and Jan 1 when $576 billion of fiscal contraction starts.
New QE policy supports rising EPS in 2014 and the market will follow Although Congress may stumble, we assume it reaches agreement in early 2013 to delay full impact of the ‘fiscal cliff’. Open-ended QE has eased financial conditions and will continue to support GDP growth. We raise our 2013 S&P 500 EPS estimate to $107 and introduce a 2014 estimate of $114.
S&P 500 will establish a new high of 1575 at year-end 2013 We forecast S&P 500 will reach 1575 by year-end 2013, 9% above current and 1% above the 2007 peak. Once policy risks are addressed investors can focus on the trajectory of EPS growth, high ROE, and valuation metrics.
We apply a valuation discount to S&P 500 through year-end due to fiscal policy risks but see attractive upside over the medium-to long-term. Open-ended QE allows investors to look past current stagnant economic growth and assign valuation consistent with strong fundamentals. We introduce a 2014 EPS estimate of $114 and a year-end 2013 S&P 500 target of 1575 but maintain our 2012 year-end target of 1250.
Two of the three pillars of our 2012 framework for analyzing the US equity market have stood firm, but one has not – valuation. US GDP growth has been below trend at 2% and our top-down 2012 S&P 500 EPS estimate has remained unchanged at $100 since the start of the year. Meanwhile, consensus sales and earnings estimates have dropped by 1% and 5%, respectively, since early 2012. Despite that, valuation is notably higher.
Our expectation that S&P 500 valuation would remain flat in 2012 in the face of stagnating economic and earnings growth has been incorrect. Investor response to Fed and ECB policy actions since June 2012 was far more dramatic than we anticipated. The forward P/E multiple has expanded by 15% to 13.4x and S&P 500 has advanced by 15% YTD, reversing the pattern of 2011 when EPS rose by 15% but S&P 500 ended flat at 1258.
We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed. The FOMC’s commitment to pursue a loose monetary policy until unemployment falls should allow investors to look through the current period of stagnation and assign a valuation multiple consistent with corporate fundamentals, once fiscal policy risk abates.
Our S&P 500 price targets are 1250 at year-end, 1450 in 6 months and 1575 at yearend 2013. Those estimates suggest returns of -14%, 0%, and +9% over those time periods. Our year-end 2012 forecast is below our estimate of fair value due to high uncertainty from the impending December 31 ‘fiscal cliff’.
Our baseline assumption is that fiscal issues will be resolved during 1Q 2013 but they remain the largest medium-term risk to US equity performance and economic growth. Our US Economists expect $193 billion of fiscal consolidation out of the potential $576 billion total, representing a drag of about 120 bp on 2013 GDP.
Although we forecast a rising stock market in 2013, numerous headwinds remain for equity performance that policy action must overcome: Consensus 2013 EPS estimates remain too high despite sales and EPS revisions that have been consistently negative in 2012; S&P 500 margins have declined for three quarters; US GDP growth continues to stagnate near 2%; China economic growth has been reduced ahead of an important political transition in November; and political and policy uncertainty remains high in Europe along with risk to Euro area growth. The major near-term policy risk relates to possible 1Q 2013 fiscal consolidation of roughly 4% of GDP under a worst case outcome.
Our S&P 500 EPS, revenue and ROE estimates remain largely unchanged as QE was already an element of our US GDP forecasts. We expect S&P 500 will earn $100 per share in 2012, $107 in 2013 and $114 in 2014, with revenue growth of approximately 5% in each year. Our ROE forecasts remain 17.5% for 2012 and 17.3% for 2013 for the S&P 500 due to weak Financials ROE but 19.7% and 20.7% on an ex-Financials basis.
Slow growth, low inflation and high unemployment justify additional easing. Goldman Sachs US Economics forecasts real US GDP growth of 2.2% in 2012 and 1.9% in 2013. They forecast benign core PCE inflation below 2% and expect the US unemployment rate will remain above 8%. Our forecasts are modestly more conservative than the FOMC central tendency outlook as well as consensus expectations. We assume GDP growth of 2.5% in 2014 as an input in our top-down sales, margin, and EPS.
We revise our 2013 S&P 500 earnings estimate to $107 (from $106) and introduce a 2014 EPS forecast of $114 per share. Our new estimates imply EPS growth of 4% in 2012, 7% in 2013, and 6% in 2014. Our EPS estimates are below current bottom-up consensus EPS estimates in 2012, 2013 and 2014 of $102, $115 and $128, respectively (see Exhibit 1).
Our regression-based model of sales and net margins for each sector drives our earnings forecasts for individual sectors and for the overall S&P 500. Variables included in our sales and margin models encompass US GDP growth, world GDP growth, 2-year and 10- year US Treasury rates, Brent crude oil, core inflation, and the tradeweighted US Dollar (see Appendix A for our macroeconomic assumptions).
The level of sales is highly correlated with nominal economic growth. We assume the nominal size of the US economy will grow by 3.7% in 2013 and by 4.6% in 2014. Given more than 30% of aggregate revenues of S&P 500 companies take place outside of the US, our model forecasts S&P 500 sales will rise by 4.4% in 2013 and 4.7% in 2014, respectively.
Our revenue growth forecast is in-line with consensus expectations. We forecast trailing four quarter net margins will return to the previous peak of 8.9% by 2013 before rising to a new peak of 9.0% in 2014. Higher labor costs and decelerating margin expansion in the Information Technology sector are headwinds to further margin expansion at the index-level (see Exhibit 4). Consensus expects aggressive margin expansion of 60bp in both 2013 and 2014. Bottom-up consensus forecasts S&P 500 margins will reach new peak levels by 1Q 2013.
To summarize: Goldman rejoins the sellside groupthink. It will be wrong once again.
21 - US Stock Market Valuations
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
MONETARY POLICY - Focused on Avoiding US Debt Insolvency
S&P 500 EPS is forecast by consensus to decline 2% both sequentially and YoY in 3Q12 driven by net margin compression. As Morgan Stanley's Adam Parker notes, it appears (for now) that we can have an earnings recession without an economic recession; but the disconnect may be a lag as opposed to a decouple. Roughly 50% of companies are expected to experience YoY contraction in net margins but - and this is the 'funny' segment of this post - consensus expects an 18.2% incremental margin expansion in 2013 (from a 7.2% rise in 2012 which is down from 13.1% rise in 2011); and while 3Q EPS is expected to be negative, the following three quarters EPS growth are expected to rise dramatically (double that of 2012 on average). It seems investors (and analysts) are still willing to believe in miracles.
This is one of Morgan Stanley's chief concerns. Currently, the consensus embeds very optimistic 2013 incremental margin expectations, accelerating at a time when a potential fiscal cliff is imminent and profit margins are already at record levels.
We doubt that companies can drop through 18 cents for every dollar they grow revenue in 2013.
Remember, earnings are declining for the entire S&P500 right now!
but are expected rise dramatically in the quarters to come - again by some miracle - even after 3Q2012 EPS has been reduced notably already - with 4Q12 EPS dropping to wher 3Q12 was 7 months ago...
Priced In? Only if you think Fed-driven multiple-expansion is the 'alter-ego' of reality...
The following two slides come from Alcoa's earnings presentation. The first looks at demand growth from industrial end markets. The second looks at demand growth based on regional end markets. One stat that stands out is the huge decline in truck and trailer production in China, which confirms the warning that truck engine maker Cummins gave tonight.. As you can see in the second slide, demand in much of the world is expected to have decelerated in the second half.
Cummins Lowers 2012 Revenue and EBIT Guidance. Company Also Announces Necessary Actions to Respond to Global Economic Slowdown.
“We continued to see weak economic data in a number of regions during the third quarter increasing the level of uncertainty regarding the direction of the global economy.
Demand in China has weakened in most end markets and we have also lowered our forecast for global mining revenues. EBIT margins will also be below our previous guidance primarily due to the sharp reduction in revenues.”
CMI is down over 7% after-hours (to three-month lows) as it seems the 16% cut expectations in Aluminum demand that Alcoa just announced can no longer be ignored. Reality is that Cummins is slashing guidance and cutting jobs in "response to the weakening global economy."
*CUMMINS TO CUT UP TO 1500 JOBS, LOWERS YEAR REV, EBIT FORECASTS
*CUMMINS SEES YEAR EBIT ABOUT 13.5%, SAW 14.25%-14.75% :CMI US
*CUMMINS PRELIM 3Q REV. ABOUT $4.1B, EST. $4.425B :CMI US
*CUMMINS SEES 2012 REV. $17B, SAW $18B, EST. $18.11B :CMI US
CORPORATOCRACY -CRONY CAPITALSIM
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