Michael Barton

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Saturday, November 3, 2012

A Tale of Two Continents

Through the turmoil and gloom of Superstorm Sandy, US economic data this week was largely a bright spot. The same cannot be said of news from Europe where better than expected economic reports of recent weeks have been dented by this week’s worsening unemployment numbers and crumbling business confidence.

Turning to Europe first and we see that unemployment has now reached yet another record. Across the Eurozone unemployment now stands at 10.6%, with a whopping 18.5 million out of work. Unemployment in Spain and Greece is above 25%. Austria has the Eurozone’s lowest unemployment rate at 4.4%.

Consumer and business confidence has fallen away dramatically, and now stand at 3 year lows. Even the ‘stronger’ economies of France, Germany, and Finland are following the downward confidence trend.

As if things aren’t bad enough in Greece already, its latest call for a further €31.5 billion in emergency funds from the Troika (EU, IMF, ECB) have been knocked back, with ministers requesting the country take further austerity measures. However, Greece will be given more time to reach targets on debt levels and ratio of debt to GDP.

In China, China’s PMI has risen above 50 for the first time since July, indicating expansion may be on the horizon. Meanwhile, the Bank of Japan has upped its monetary easing policies after industrial production fell through the floor.

In the United States, it is estimated that Superstorm Sandy will cost the US economy around 0.5% in the fourth quarter, with uninsured losses accounting for $30 billion and lost business another $20 billion. However, with infrastructure rebuilding and the clean-up required, the impact could be short lived.

On a more positive note, US non-farm payrolls increased by 171,000 in October, though the unemployment rate picked up slightly to 7.9%. Weekly initial jobless claims fell, as did the four week average (to 367,250). Home prices rose by 2% in August, the biggest gain since July 2010. Consumer confidence rose to its highest level since February 2008, and personal spending increased by 0.8% in September. Finally, US factory orders increased by 4.8% in September, the highest rise in 18 months.

On the corporate front, GM, ExxonMobil, Chevron, BP, and Shell all reported lower earnings, as corporate profits continue their downward trend at quite a pace. UBS announced 10,000 job cuts as part of its efforts to restructure its cost base.

After losing two days to Superstorm Sandy, the Dow Jones Industrial Index fell by 0.11% to close at 13,093.16, and the Nasdaq 100 by 0.36% to 2656.28. The S&P, however, managed to post a small gain of 0.16% to rest at 1414.20. In London, the FTSE 100 rose by 1% to close the week at 5868.50.

Trading View
The views of business and consumers in Europe seem to be finally coming into line with my own. Confidence is falling away, as so-called stronger economies such as Germany and France begin to see a less rosy future.
Europe’s leaders have given Greece more time to hit debt to GDP targets, and yet with more austerity measures being taken, which in turn will push its GDP further negative and tax returns fall again, I see this as a very long game. Interestingly, the Troika is taking a far harder line with Greece: is this the beginning of the end game for Greece’s membership of the Euro? I believe that during the last 24 months, Europe and the world’s banks have been positioning themselves to protect against such an event. Whilst I think that, politically, for the time being Europe will want to see Greece remain, I cannot help but believe it will be Germany’s elections next year that see Europe being remoulded as the German public begin to raise concerns about continuing funding of ‘weaker’ countries.

The better and continuing improvement in the US economy is a conundrum to me, and one that I am finding hard to work out. Unemployment is stubbornly high, corporate profits are tumbling, and trade with the rest of the world falling. And yet, economic reports point to a better situation than for years. Perhaps the enormous quantitative easing programs have finally begun to work, though I feel this will lead to a rate of systemic inflation that will be unsustainable after the election. Or, perhaps, and more likely, is that consumers and businesses are spending before the impending Fiscal Cliff next year. My worst fear is that the anomalous US economy is due to a combination of both factors.

Needless to say, I am a seller into any strength in equity markets at this time.

Saturday, October 27, 2012

Earnings Disappoint Markets

Whilst economic data was mostly positive this week, with the European contraction slowing and US GDP pushing forward, news from the corporate sector was largely negative and it was this that focussed most investors’ eyes.

According to official figures, it seems that the Olympic fervour I the UK managed to pull its economy round and out of recession, After three quarters of decline, its GDP grew by a far stronger than expected 1% annualised rate of growth in this year’s third quarter. However, as if to mark the fragility of this data, and the wider economy itself, the news coincided with Ford’s announcement that it is to close two plants in the UK with the loss of 1400 jobs.

From the chilly north to the warmer south, where it seems that Greece’s next bailout instalment is under threat. Greece’s austerity measures are hitting the country hard, and it is currently encountering a worse than expected recession. Though Greece’s government has cut spending and raised taxes in efforts to bring its finances under some sort of control, it is two years adrift in its budget targets and has requested additional aid from the European Commission. The situation is so bad in Greece that there are stories of doctors who have not been paid their base salaries for two months and more.

Non-payment of commitments, however, is not a problem limited to Greece. In Spain, the Valencian region owes pharmacists around six months payments for health prescriptions honoured by those pharmacies. This amounts to around €600 million, and has been earmarked to be paid from emergency funds requested from central government.

Perhaps it is stories like these that have contributed to data that shows efforts to close budget deficits by taking severe austerity measures have been counterproductive. Indeed, where budget gaps have closed most, such as Greece and Spain, the ratio of debt to GDP has actually grown.

The impact of the territorial dispute between China and Japan is beginning to hit home. Japanese exports to China fell by 14% in September compared to a year earlier as the two countries continue to argue over a group of East China Sea islands. Hardest hit sector was automobiles which saw a near 50% fall in volumes exported from Japan to China.

The best economic news came from the US, which conversely saw some poor company reports. GDP growth in the third quarter came in at 2% annualised, following the first quarter’s 2% and second quarter’s 1.3%. Demand for durable goods in September rose by 9.9%, though the volatile aircraft numbers accounted for much of this increase. New home sales saw a further rise, and stand 27% higher than a year ago. With inventories near a record low, the new homes outlook is rosy. However, tempering the general upbeat mood, first came the announcement from the Fed that it sees a slow growth trend continuing with growth in jobs set to remain sluggish. Underscoring this view was the jobs report showing the four week moving average of jobless claims rising this week.

US company reports seem to fly in the face of economic statistics.

UPS saw a fall of 56% in its third quarter earnings as the global slowdown pushed revenue lower.

Caterpillar announced a magnificent rise of 49% in its profits for the third quarter, though revenues fell by 5%, but then said it sees sales and profits falling in the coming months: again blaming the global slowdown.

Apple’s profits rose by 24%, but this was less than expected. Some analysts are now beginning to question Apple’s product mix, with its revenues and profits so reliant on just the iPhone and iPad.

The giant chemical company, DuPont, said its revenue fell 9% in the third quarter and its net income fell through the floor. It also announced a cut of 1500 jobs, or 2% of its workforce.

Over the week, the Dow Jones Industrial Index fell by 1.8% to close at 13,107.21, and the S&P by 1.48% to 1411.94. The Nasdaq 100 also fell, but by a more modest 0.46% to 2665.83, while over in London the FTSE fell by more than 1.5% to close the week at 5806.70.

Trading View

I’ve been saying for some time now that it will be corporate profits that will dictate the direction of the market in the months to come. Investors are becoming used to hearing negative economic reports, and these are largely ignored with positive reports held as proof of the impending global upturn.

Try telling the Ford workers laid off this week in the UK that the economy is out of recession. Then head over the pond to DuPont, and tell its sacked workers that the economy is looking great.

We are now clearly approaching a time when slowing and falling company earnings will dictate company policy, whether that is to cut staffing levels further (how else can costs be cut now?) or to raise end prices to the consumer. Both scenarios are bad for the economy. It is my firm belief that the US economic numbers are being massaged as we move into the election, and that revisions to growth figures are likely to be seen after administrative change (or not as the case may be).

On top of these issues is the Fiscal Cliff now rapidly approaching: I may be the eternal bear, but I see very little upside to this market from current levels, though the downside risk is substantial.

Saturday, October 20, 2012

Markets Show Volatility on Mixed Data and Poor Earnings

Contradictory economic data this week combined with poor earnings reports to confound market traders. After a promising first four days, US markets ended the week barely changed as Google, Microsoft, IBM, and Intel disappoint.

In Europe, Moody’s refused to follow Standard & Poors’ lead of last week when keeping its rating of Spanish government debt unchanged at Baa3 (though, like Standard & Poors’ rating, one rung above junk). Spain’s bonds continued the rally begun last week, as institutions continue to bank on a bailout followed by ECB buying of the country’s bonds. Spain’s 10 year yield has now fallen to 5.46%. However, Spain’s banks continue to suffer in one of the worst hit economies in Europe, and bad loans now account for more than 10% of all loans made by them.

Bonds continued to be in focus at another Eurozone country standing on the brink. Italy sold €18 billion of bonds at auction on Thursday, easing concerns over its ability to finance its deficit this year.

Meanwhile, Eurozone leaders have agreed to have the region’s new banking supervisor in place by next year, which may ease the provision of direct relief to ailing banks. Of some concern, however, was Moody’s warning to German banks, saying that it believes they are overexposed to troubled Eurozone nations.

In China, GDP slipped again in the third quarter, to an annualised 7.4% from the previous quarters 7.6%, though industrial production showed a surprising 9.2% year-on-year rise as exports jumped 9.9% and retail sales by 14.2%.

In the United States, housing starts are increasing at their fastest rate since mid-2008, and sales of the iPhone 5 are considered to be behind September’s rise of 1.1% in retail sales. Of more concern, and helping to spur a market sell-off of 200 points on the Dow Jones on Friday, was the jobless claims number rising by 46,000 to 388,000 after a fall of 27,000 the previous week.

On the corporate front, there are strong signs of the period of rising profits coming to an end. Microsoft (MSFT) saw its quarterly revenue and earnings fall, 8% and 22% respectively, Intel (INTC) reported a fall of 14% on its third quarter profit number, and IBM (IBM) also saw revenues fall.

Google (GOOG), not only reported rising costs denting profits in a quarter that saw revenues grow by 45% year-on-year, but also released its figures in error at midday. The move led to a hit of 9% on Google stock, before trading was suspended. Most worryingly, advertising rates fell by 15% per click from a year earlier, reflecting a trend seen across the market.

Over the week, the Dow Jones Industrial Index rose by just 0.1% to close at 13,343.51, and the S&P by 0.3% to 1433.199. The Nasdaq 100 was hit by flailing profits reports, falling 1.5% to 2678.32. In the UK, the FTSE 100 Index rose by 1.7% to stand at 5896.15.

Trading View

I’ve maintained for some time that the ability to continue to cut costs to raise earnings must come to an end at some time, and I think we are on the cusp of seeing this. It is this that investors may now begin to focus on, as earnings growth drifts lower and dividend growth starts to come under pressure over the coming months.

Whilst the announcement of a new banking supervisor for the Eurozone should be welcomed, the language used in the announcement was rather ambiguous. The 11 hours of talk in Brussels led to the ‘aim’ of a legal framework for a bank supervisor to be in place by the end of the year, and ‘hopes’ that it would be up and running during 2013. The head of the ECB warned that setting up the mechanism ‘would take some time…It’s not a matter of one or two months.

Economic reports over the last couple of weeks have generally been stronger than expected, though this week’s jobless claims number was disappointing. The cynic in me would point to the political necessity of better economic news coming through, with the pre-Presidential election period notorious for such.

Certainly, better than expected numbers in Europe don’t seem to be feeding through to grass roots: just this week we have seen more demonstration in ailing European nations, and these are increasingly turning violent. Not a great indictment of the previous week’s award of the Nobel Peace Prize to the European Union for its efforts at containing and beating the European debt crisis.

Perhaps the most worrying aspect for me is the way that high levels of debt, and the supporting of that debt by central banks around the world is once more becoming accepted practice. Banks and investors are now positioning ahead of potential bailouts and the buying of bonds that would then follow by the ECB.

I see nothing but a postponing of the inevitable, and a storing up of problems for the future. When the next financial crisis hits, which surely it will, it will be more severe than any before. Investors should be prepared. In the meantime, waning profits could lead to a slow bleed downturn in stock markets.