Michael Barton

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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.

Saturday, October 13, 2012

IMF Warning runs Counter to Data Releases

Economic news was mixed through the week, with the positives in Europe and the US overshadowed by a damning forecast from the IMF.

Firstly to Europe, where the EU was awarded the Nobel Peace Prize for its work to contain the Eurozone debt crisis. Further positive news came when industrial activity numbers showed a second consecutive month of growth. Though output was 2.9% below the level seen at the same time last year, countries where the economy has been weakening markedly saw a bounce, with August output expanding by 1.5% over July in France and Spain, 1.7% in Italy, and a whopping 6.8% in Portugal. However, Germany’s industrial output fell by 0.4%.

On the debt front, Greece failed to agree terms with its creditors and Standard & Poors downgraded Spanish government debt to one notch above junk grade. The market expects the move will force Spain to request a bailout, which in turn will trigger buying of its bonds by the ECB, under the new unlimited bond buying program. Because of this, Spanish 10-year bonds actually saw support and the yield eased back slightly. In the United States, consumer confidence rose to the highest level since 2007, home sales improved again, and foreclosure filing numbers in California collapsed to a near 6 year low.

Perhaps the best news of all came with the release of the jobless claims numbers, which showed a fall of 30,000 to 365,000 for the week ending October 6.

Meanwhile, flying in the face of all this positive news, the IMF cut its global growth forecasts for this year and next, and warned of a greater downside risk. Its forecast for 2012 is now 3.3%, and for 2013 just 3.6%. It stressed that it sees ‘an alarmingly high’ risk of a far worse slowdown, and a near 20% chance of sub 2% growth this year and next. Within these figures is a dark forecast for the Eurozone: a contraction of 0.4% this year and a bounce of only 0.2% next. It also sees growth in the US throughout the period of no more than a shade above 2%.

Over the week, the Dow Jones Industrial Index fell by 2.1% to close at 13,328.85, and the S&P drooped by 2.2% to 1428.59. The Nasdaq 100 was worst hit, falling 3.2% to 2720.14, as Apple and Facebook moved lower. In the UK, the FTSE 100 Index dropped 1.3% to stand at 5793.32.

Trading View

With demonstrations against austerity measures forced by the EU in countries such as Greece and Spain in recent weeks, some of which have turned violent, and calls for autonomy from national governments and the EU itself, it seems an inopportune moment for the EU to receive the Nobel Peace Prize. But, then, I’ve felt for a while now that the Nobel Peace Prize is a waste of time.

I have to question the growth in industrial production seen in the weakest of the Eurozone countries. Is this the beginning of a sustainable rally, or a blip in the downward lurch? We mustn’t forget that most of the austerity measures already announced don’t kick in until next year, and then the following 12 months. A ‘dead cat bounce’ is a phrase that springs to mind, particularly with Europe’s largest economy now seeing industrial contraction.

As for Standard & Poors’ downgrade of Spanish Government debt: the market reaction says all it needs to. The market expects Spain to request a bailout, and this will pave the way for buying of its debt by the ECB. Traders are positioning themselves ahead of this, buying bonds now to offload to the mug punter who comes in at the wrong level later. This mug punter, however, is the muggest of the lot: it has already said that this is exactly what it will do. Banks buy the bonds now, with money that they mostly received from the ECB and the EU to bail them out, then they wait for the Spanish bailout and the buying of bonds by the ECB to begin. They then sell the bonds to the ECB, banking a healthy profit. The ECB then gives the banks a better than average interest rate on the cash they deposit with it as part of the ‘bond sterilization program’ that goes hand in hand with its bond buying program.

Net effect? No extra cash is pumped into the economy to help it grow, the Spanish tax payer will be landed with a debt bill stretching beyond the horizon of time, Spain’s government will be forced to accede to further and deeper control by central Europe, but at least the banks will be making a bigger profit.

As for Greece’s situation: we’ve been here before. The country is a basket case, and Mother Europe will take it home from its latest shopping spree. It can’t do otherwise.

The big worry looking forward must be the way the market is beginning to accept high levels of debt as the norm. This sentiment may be good for investors in the short term, but the fall will be harder and faster when it comes.

Saturday, October 6, 2012

Global Markets rise as American Star Strips Away Wider Gloom

Despite further Eurozone and Asian economic weakness, and sovereign debt issues seemingly increasing not retracting, positive jobs and economic data from the United States and Canada through the week buoyed stock markets around the globe.

Unemployment numbers from the Eurozone continue to reach record highs. September’s rate of 11.4% across the 17 member states masks wide variations, with the worst numbers still seen in Spain, where unemployment has now hit 25.1% with over 50% of under 25’s out of work. A poll of purchasing managers by Markit showed a further economic retraction in the third quarter: if proved correct with official figures then the Eurozone will officially declared in recession.

The ECB waits to activate its bond buying program, announced last month. With the objective of pushing bond yields down and decreasing borrowing costs for the indebted Euro nations, the ECB is waiting for requests for assistance. Main target, Spain, is stalling with its politicians baulking at the requirement to give up even more fiscal and economic control to European central government. Meanwhile, mass protests in the Catalan region – one of the more prosperous regions of Spain – are calling for independence from the rest of Spain. The yield on Spain’s 10 year bonds, which had fallen from above the dangerous 7% level to nearly 5.5% after the ECB’s bond buying announcement, have risen to around 5.9%.

Greece finds its problems deepening, as the so called troika –IMF, ECB, and European Commission – have rejected part of the country’s austerity plans. Greece is due yet another round of financial aid soon, and this action could put that in jeopardy.

Over in Asia, the Asian Development Bank lowered forecasts for growth across the region, including China and India. The downward revision is dramatic, from 6.9% to 6.1% for this year, and 7.3% to 6.7% next year. It sees Chinese growth this year of 7.7%, but falling next year to 5.6%.

As if to prove the Asian Development Bank correct, Chinese service sector numbers came in weaker than expected, though this helped to lower crude oil prices (China’s oil demand is 10% of world total).

The United States, however, is bucking the trend of global weakness. The world’s largest economy has this week seen manufacturing PMI numbers and New Order figures both rebounding to growth from August’s contracting indications. Consumer confidence has risen for six weeks in a row, with sales at store open more than 12-months increasing by 3.9%. Conversely and strangely, US Factory Orders fell by 5.2% in August: something of a conundrum.

The big news came at the end of the week, with massive revisions to previously-released US unemployment figures. August’s number of payroll increase had been reported at 96,000 but has now been revised upwards to 142,000, and July’s number of 141,000 has been upped to 181,000. September’s estimated number has come in at 162,000.

Over the week, the Dow Jones Industrial Index rose by 1.3% to close at 13610.15, and the S&P slipped by 1.4% to 1460.93. The Nasdaq 100 gained a little less, just 0.4% to 2811.94, as Apple and Facebook gave away gains on Friday. In the UK, the FTSE 100 Index rose by 2.2% to stand at 5871.02.

Trading View

Everywhere the economic numbers seem to be pointing to further contraction and slowdown, and rising unemployment, except in the United States.

In fact, the United States is showing remarkable resilience in the face of massive adversity elsewhere. The way markets have reacted indicates a bit of ‘laisez faire’ on the part of investors: a sense of ‘we’ve been here, seen it, done it’.

Though Spanish bond yields are again rising, the country is putting off the inevitable. This indecision by the Spanish may be more political than economic management. Can the country’s leaders really afford to cede so much to the centre, when its own regions are rising up to try to force a breakaway?

Call me a cynic, but this market seems to have gone into political phase. In the United States, economic numbers are improving rapidly and the unemployment rate has fallen from 8.3% to 7.8% as the Presidential election comes ever closer. Of course, we’ve seen revisions and revisions to numbers before: what odds on a downward lurch coming after the election? If a new President is in, it will be his fault. If Obama stays in, then what does he really care – he’ll have another four years.

In Europe, the masses are protesting against further austerity measures and centralised government, and countries like Spain and Greece are holding back the weight of pressure from its people and the European leaders to act in the manner each side wants. It’s a two way pull, which will snap at some time.
My view remains the same, there’s always calm before the storm.