Declining Long Term Trendline Suggests Near Term Peak in Equities

Tuesday, August 14th, 2012

by Don Vialoux, EquityClock.com

Upcoming US Events for Today:

1. Retail Sales for July will be released at 8:30am. The market expects an increase of 0.3% versus a decline of 0.5% previous. Excluding Autos, the market expects an increase of 0.4% versus a decline of 0.4% previous.
2. Producer Price Index for July will be released at 8:30am. The market expects an increase of 0.2% versus an increase of 0.1% previous. Core PPI is expected to increase by 0.2%, consistent with the previous report.
3. Business Inventories for June will be released at 10:00am. The market expects an increase of 0.2% versus an increase of 0.3% previous.

Upcoming International Events for Today:

1. French GDP for the Second Quarter will be released at 1:30am EST. The market expects a year-over-year increase of 0.2% versus an increase of 0.3% previous.
2. German GDP for the Second Quarter will be released at 2:00am EST. The market expects a year-over-year increase of 1.0% versus an increase of 1.2% previous.
3. Great Britain Consumer Price Index for July will be released at 4:30am EST. The market expects a year-over-year increase of 2.3% versus 2.4$ previous.
4. Euro-Zone GDP for the Second Quarter will be released at 5:00am EST. The market expect a year-over-year decline of 0.5% versus no change (0.0%) previous.
5. German Economic Sentiment Survey for August will be released at 5:00am EST. The market expects –18.5 versus –19.6 previous.

Recap of Yesterday’s Economic Events:

The Markets
Equity markets traded mixed on Monday during a low volume session that saw the S&P 500 trade on either side of the 1400 mark. Volume has been a significant factor in recent trade, showing some of the lowest levels in years. Monday was no different with the S&P 500 ETF (SPY) showing the lowest volume day since April 25th 2011, approximately the 2011 peak. Volume has clearly been problematic as it provides evidence of a lack of conviction to equities; investors are showing no impetus to buy or sell. Investors are clearly waiting for a catalyst, preferably in the form of central bank easing to give equities a quick boost, despite how bad economic fundamentals get. The sustainability of this is obviously questionable.

Equity markets have had a substantial run since the low set at the beginning of June. The S&P 500 has added over 140 points from the low of 1266 to the recent high of 1407. Resistance is now at hand, as presented by the March and April peaks. Reaction to this peak will be critical in determining the strength behind this market. Rejection from this level could chart a double top, which would likely follow with a significant selloff. A healthy breakout, ideally accompanied by a pickup in volume, could see the continuation of this rally into the fall, a period that is typically negative on a seasonal basis. An increase in the number of stocks breaking out to new 52-week highs is an ideal tell to hint of a breakout to come. Unfortunately, the number of stocks breaking to new 52-week highs has been declining since the start of July, a situation similar to what was realized from February through April of this year in which equity market trends remained positive, but momentum deteriorated prior to a peak. This divergence compared to recent price activity could be warning of a near-term peak in equities.

World equity benchmarks are also approaching a level of resistance presented by a declining long-term trendline. Reaction to this point of resistance is expected, potentially bringing an end to the bullish rally that has remained intact for two and a half months. Descending triangle patterns, potentially a bearish setup, can also be derived from the charts, suggesting negative things ahead for equities. June’s lows will be critical point to watch upon any pullback from the recent intermediate positive trend.

Sentiment on Monday, as gauged by the put-call ratio, ended bullish at 0.80. The ratio is back within the bounds of the falling wedge pattern.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

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Tags: Amp, Business Inventories, Consumer Price Index, Conviction, Core Ppi, Decline, Don Vialoux, Economic Events, Economic Sentiment, ETF, ETFs, Euro Zone, GDP, German Gdp, great Britain, Impetus, Producer Price Index, Report Business, Retail Sales, Second Quarter, Thackray, Trendline, Volume Session
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David Rosenberg On Headless Chickens, Topless Americans, And Bottomless Europeans

Thursday, August 2nd, 2012

The S&P 500 has made little headway for two years running and as Gluskin Sheff’s David Rosenberg points out, it first crossed 1380 on July 1, 1999 and since then has run around like a headless chicken (while other asset classes have not). Meanwhile, Europe’s bottomless pit of debt deleveraging (which is as much a problem for the US and China but less ion focus for now) makes the entire discourse of some new and aggressive intervention by the ECB even more ridiculous (and all so deja vu); and the US is facing up to an entirely topless earnings season as revenues are coming in at only 1.2% above last year as it appears Q2 EPS is on track for a 0.2% YoY dip – with guidance falling fast. But apart from all that, Rosie sees the only source of real buying support for the stock market is the stranded short-seller forced to cover in the face of CB-jawboning as there is little sign of long-term believers stepping into the void.

Headless Chicken Markets: BULL OR BEAR?

The cup is half full camp would lay claim that the S&P 500 is not only still up on the year in what has been a challenging 2012 but it is more than twice the lows posted in March 2009.

A discerning bear, however, would point to the fact that the index has made little headway for two years running and keep in mind that it first crossed the 1,380 mark on July 1, 1999 and since then:

• It has crossed 59 times above and below the 1,380 level on a closing daily basis
• Gold is up 515%
• The producer price index is up 45%
• The consumer price index is up 37%
• The 10-year Treasury total return index is up 160%
• The 30-year Treasury total return index is up 215%

So bench-marked against gold prices, producer prices, consumer prices, or bond prices, the secular bear market in equities remains an ongoing phenomenon.

Bottomless Europe: UNRESOLVED DEBT ISSUES

Quote of the day:

What can they do and what would bring about a sustained turnaround in market confidence? There I struggle to find something that would really be convincing.

 

From Jacques Cailloux, chief European economist for Nomura, in yesterday’s NYT (page B3).

Indeed, this entire discourse on some new and aggressive intervention by the ECB is all so ridiculous, and all so déjà vu. The ECB has already done two LTROs and bought bonds outright before. Draghi is still throwing spaghetti against the wall to see what sticks. The bottom line is that monetary policy is a blunt tool to deal with structural insolvency issues as they pertain to bank and government balance sheets. The ECB has only a temporary effect and then bond yields go back up in the periphery. Until there is a move to solve the issue of too much debt relative to the economy’s capacity to service the debt, the problem will re-emerge.

Meanwhile, the credit crunch in the euro area continues unabated, exacerbating recessionary pressures. Cross-border lending by German banks to the periphery has declined nearly 20% in the past seven months to stand at the lowest level since 2005. Overall bank loan books in Spain. Greece and Portugal have contracted 2% as deposits shift to the northern regions. At the same time, the entire regional banking sector is beset by a trillion euros worth of impaired loans, which have expanded 9% from a year ago (2.5 trillion euros are non-performing) with Spain, Ireland and Italy suffering with the largest increases.

Europe for some reason continues to believe that a debt crisis can be fought with more debt. Maybe because they think this strategy has worked in the United States. But it hasn’t and the U.S. is either recession-bound or at best left with a listless economy, and also will likely soon face its own existential moment from a fiscal crisis perspective if it doesn’t get its act together. If left unchecked, the day will come when the entire revenue base will be absorbed by interest expense, defense, health care and social security.

TOPLESS EARNINGS SEASON

The numbers vary by the hour and the data source. but it looks like Q2 operating EPS of S&P 500 companies is on track for a 0.5% YoY dip — by far the weakest since the recovery began three years ago (and well below consensus views of +3% a month ago) . The big problem !s revenues which are coming in just 1.2% ahead of year-ago levels and only 43% are beating their sales targets the lowest since the first quarter of 2009 (only the fourth time in the past 10 years that the beat-rate was under 50%).

The other problem is guidance. The WSJ cites research that finds that 40 companies have already warned about Q3 versus only eight who have raised guidance. We have not seen a gap like this since the onset of the tech wreck in the second quarter of 2001. The bottom-up consensus is now looking for just +3.3% for YoY EPS growth for Q3 — last October, the analysts collectively were calling for 14.5% for the quarter. Talk about a mea-culpa.

Summing It All Up

All that said, the key for all of us is to understand that we are still in the throes of a debt deleveraging cycle that first engulfed the housing and consumer sectors and is now attacking the government sector in country after country. It is not only Europe. China and the U.S.A. too. There is still far too much debt at all levels of society relative to the world’s capacity to service it. This is a critical reason why government and central bank policies aimed at fighting traditional recessions in the past have so far been ineffective and now we have monetary authorities dipping into the toolbox of unconventional balance sheet expansions and contortions.

We have governments battling a debt deleveraging cycle of epic proportions, and by definition, these phases involve debt paydowns, defaults, and rising savings rates — a highly deflationary brew. And it also means that we now reside in a world of fat-tail distribution risks, where the range of outcomes is unusually wide, as opposed to the comfort zone of a classic post-WWII cycle, where we understood what caused recessions and we knew exactly what it took to get out of them, and where there was a much thinner tail to the probability curve.

May those days rest in peace. But once we can acknowledge that we are in a fat-tail world, it is akin to moving into the acceptance phase of the classic five Kubler-Ross stages of grief. This is no time for denial.

Tags: 10 Year Treasury, 30 Year Treasury, Aggressive Intervention, Asset Classes, Basis Gold, Bond Prices, Bottomless Pit, Chicken Markets, Consumer Price Index, Daily Basis, David Rosenberg, Debt Issues, Earnings Season, Gluskin Sheff, Gold Prices, Headless Chicken, Headless Chickens, Producer Price Index, Producer Prices, Secular Bear Market
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The Economy and Bond Market Radar (July 16, 2012)

Saturday, July 14th, 2012

The Economy and Bond Market Radar (July 16, 2012)

Treasury yields headed lower again this week but not dramatically so. The minutes from the June Federal Open Market Committee meeting were released this week and indicate that Fed members remain divided on an additional round of quantitative easing (QE). In the past few years bonds have tended to rally into the QE announcement and sell off when announced as expectations are for the easing to boost the economy and financial assets. There was little in the way of real market moving economic data released this week in the U.S. but China released second quarter GDP results showing a deceleration to 7.6 percent on a year-over-year basis. This was the slowest growth since the financial crisis but is far from the “hard landing” that many were expecting. Treasury yields moved higher on Friday and the stock market rallied, in what was likely a “relief” rally for stocks.

Strengths

• We did get some inflation data this week with import prices and the producer price index; both continue to show a benign inflation environment.
• Brazil and South Korea cut interest rates this week, following the coordinated actions last week from the ECB, Bank of England and the Bank of China.
• Consumer credit hit a five-month high in May as the consumer appears to be more comfortable and banks are lending.

Weaknesses

• Chinese imports slowed dramatically in June to 6.3 percent, well below estimates. This raises concerns about the depth of the slowdown in China.
• Japanese core machinery orders plummeted 14.8 percent in May, dramatically below estimates.
• Quarterly earnings reports will pick up sharply next week but we had many companies warn this week that the economy is weakening. This was particularly true in technology and industrials.

Opportunity

• The Fed reaffirmed its commitment to an ultra low interest rate policy through 2014 and additional monetary easing is possible in the near future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

Tags: Bank Of China, Bank Of England, Bond Market, Chinese Imports, Deceleration, Ecb Bank, Economic Data, Federal Open Market Committee, Financial Assets, Import Prices, Inflation Data, Interest Rate Policy, Japanese Core, Machinery Orders, Market Radar, Open Market Committee, Producer Price Index, Quarter Gdp, Quarterly Earnings Reports, Treasury Yields
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The Economy and Bond Market Radar (May 14, 2012)

Sunday, May 13th, 2012

The Economy and Bond Market Radar (May 14, 2012)

Treasury yields have had a slight downward bias again this week, which has become a persistent pattern over the past few weeks. With global economic data exhibiting a weak trend recently and European concerns back on the front page it is not surprising that treasuries have been rallying recently. This time last year there was considerable concern regarding rising inflation but that dynamic has completely changed. Both the import price index and the producer price index were reported this week. As the chart below shows, both are in an undeniable downtrend which validates the Federal Reserve’s policy to stay the course with easy monetary policy.

Strengths

• Consumer borrowing jumped $21.4 billion in March indicating that consumers feel comfortable enough to borrow again after several years of retrenchment.
• German industrial production jumped 2.8 percent in March, well ahead of expectations and indicating surprising strength.
• The National Federation of Independent Business small business optimism index hit a 14 month high in April.

Weaknesses

• Economic data out of China this week showed continued slowdown as industrial production and retail sales disappointed.
• Brazilian consumer prices rose 0.64 percent in April, ahead of forecast and the biggest increase in a year.
• British retail sales fell 3.3 percent in April. The U.K. economy fell into an official recession recently as first-quarter GDP fell 0.2 percent after falling 0.3 percent in the fourth quarter.

Opportunity

• Bonds continue to grind higher and appear to be forecasting a benign inflation and slow growth.

Threat

• China’s economy is slowing faster than expected and government policy makers appear comfortable with this dynamic.
• Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.

Tags: Austerity Programs, Bond Market, Brazil, Business Optimism, Chart Below Shows, Economic Data, European Concerns, Federation Of Independent Business, Government Policy Makers, Import Price Index, Market Radar, Monetary Policy, National Federation Of Independent Business, Persistent Pattern, Producer Price Index, Quarter Gdp, Retail Sales, Retrenchment, Slowdown, Treasuries, Treasury Yields
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Emerging Markets Radar (April 16, 2012)

Sunday, April 15th, 2012

Emerging Markets Radar (April 16, 2012)

Strengths

• China’s new loans were RMB 1.01 trillion in March, better than Bloomberg survey of RMB 797.5 billion and amount of new loans in February. In addition, China’s money supply (M2) grew 13.4 percent in March versus an estimate of 13 percent. By the end of March, China’s foreign reserve went up to $3.31 trillion by the end of March; indicating China had reversed the capital flight that began during the fourth quarter of last year.
• A 5.3 percent rise in inbound shipments and 8.9 percent increase in exports from a year earlier created an unexpected trade surplus of $5.35 billion for China, substantially different than the medium projection of a $3.15 billion trade deficit.
• China’s passenger car sales to dealerships rose 4.5 percent in March, exceeding the estimate of 3.9 percent. March retail sales and fixed asset investment also outpaced estimates, rising 15.2 percent and 20.9 percent, respectively.
• China’s Housing Ministry suggested a policy of withholding new home sales permits to developers unless at least 70 percent of their previous projects have been sold out, the National Business Daily says. If it becomes a policy, it should positively impact inventory and may clear the way for new projects.
• Improving electronics shipments drove a 14.6 percent rise in Philippines exports in February, beating estimates.
• South Korea’s workforce increased by 419,000 jobs in March, pushing the country’s unemployment rate down to 3.4 percent. All Asian countries have full employment.
• Turkey’s current account deficit (CAD) narrowed to $75.2 billion for the 12 months ended February 2012. The share of foreign direct investment (FDI) also strengthened.

Weaknesses

• Higher food prices pushed China’s Consumer Price Inflation (CPI) up 3.6 percent (year-over-year) in March, more than the forecast. Meanwhile, the Producer Price Index decreased in-line with expectations. Most market watchers believe China’s food prices will stabilize in the coming months.
• China’s GDP grew 8.1 percent during the first quarter, lower than market expectation of 8.3 percent. The market reacted positively to the number as many believe that it might be the bottom for China’s GDP growth this year.
• GDP growth in Russia had decelerated to 3.9 percent on a year-over-year basis in January 2012, according to Russia’s Ministry of Economic Development. This is down from the estimated 4.9 percent growth in the fourth quarter of 2011.

Opportunity

• China’s new loans were RMB 1.01 trillion in March, better than Bloomberg survey of RMB 797.5 billion and amount of new loans in February. The composition of new loans shows improvement of household long-term borrowing. These are usually mortgage loans, indicating housing market is normalizing. During a visit to Southern China, Premier Wen Jiabao reaffirmed that the government will “fine tune” its economic policy preemptively and the jump in inflation won’t change the government’s direction of monetary policy easing.

Tags: Asian Countries, Asset Investment, Capital Flight, Consumer Price Inflation, Current Account Deficit, Fdi, Food prices, Foreign Direct Investment, Full Employment, Housing Ministry, Inbound Shipments, Inflation Cpi, Money Supply M2, National Business, Passenger Car Sales, Producer Price Index, RMB, South Korea, Trade Surplus, Unemployment Rate
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The Economy and Bond Market Radar (January 23, 2012)

Sunday, January 22nd, 2012

The Economy and Bond Market Radar (January 23, 2012)

Long-term treasury yields rose sharply as once again the schizophrenic market gyrates up one week and down the next, which is what we have experienced since mid-November.

Yields rose throughout the week as we appear to be in another “risk on” mode where risky assets rise and safe assets fall.

Economic data generally met expectations this week as inflation continued to slow on a year-over-year basis and housing data was generally in line with forecasts. The big surprise of the week was initial jobless claims, which hit the lowest levels since 2008. This number is often viewed as a leading indicator, which bodes well for the economy going forward.

Strengths

• The weekly initial jobless claims are indicating the economy is picking up steam.
• Both the Producer Price Index (PPI) and Consumer Price Index (CPI) came in below expectations, giving the Fed plenty of room to maneuver if it were to decide additional stimulus is needed.
• China reported fourth quarter GDP which rose 8.9 percent and beat expectations. The Chinese hard landing many pundits were worried about has yet to materialize and government policy has already shifted to an easing bias, likely resulting in a reacceleration in the second half of 2012.

Weaknesses

• Overnight deposits with the ECB hit another record high at roughly $685 billion as banks are still unwilling to lend to each other in the overnight interbank market. This indicates significant lack of confidence in the European banking sector and is at odds with the equity performance of many European banks of late.
• Greece has yet to come to an agreement with private creditors on the level of haircut that will be taken. This remains an overhang on the financial markets.
• Industrial production rose 0.4 percent but came in shy of expectations.

Opportunities

• The Fed is expected to release its Fed funds rate forecast at the conclusion of the Wednesday Federal Open Market Committee (FOMC) meeting. This new openness is welcome but depending on the detail and how well the information is explained, will ultimately determine how the market takes this new news.

Threats

• The situation in Europe remains extremely fluid and negative news is almost expected at this point. Unfortunately it is politically driven and difficult to predict outcomes and ramifications.

Tags: Banking Sector, Bond Market, Consumer Price Index, European Banking, European Banks, Fed Funds Rate, Index Cpi, Initial Jobless Claims, Interbank Market, Lack Of Confidence, Leading Indicator, Market Radar, Overhang, Private Creditors, Producer Price Index, Producer Price Index Ppi, Quarter Gdp, Risky Assets, Schizophrenic Market, Treasury Yields
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The Economy and Bond Market Radar (December 19, 2011)

Sunday, December 18th, 2011

The Economy and Bond Market Radar (December 19, 2011)

Long-term Treasury yields ended the week sharply lower as the reprieve from the euro crisis was short lived. Ten-year Treasury yields fell decidedly below 2 percent and are at the lowest levels since early October.

Recent economic data has been mixed and global economic news flow has generally been weak. One positive outlier worth mentioning is initial jobless claims which have declined to the lowest level since 2008. Historically, initial jobless claims have been a good indicator on the overall economy, so the economy may be in better shape than many currently believe.

Strengths

• Initial jobless claims fell to the lowest level since May 2008.
• Several inflation measures were reported this week for November (Consumer Price Index, Producer Price Index and import prices) and all signaled flat to declining inflation trends.
• The National Federation of Independent Business’ November small business optimism index hit a 9-month high as strength was seen in many areas.

Weaknesses

• November Industrial production fell 0.2 percent.
• November retail sales were disappointing, rising a modest 0.2 percent.
• The excitement over the European Union (EU) accord that was reached last Friday barely lasted the weekend and sentiment turned sour this week.

Opportunities

• There is quite a bit of economic data due out next week with numerous housing measures, durable goods orders and leading indicators.

Threats

• The situation in Europe remains extremely fluid and negative news is almost expected at this point. Unfortunately it is politically driven and difficult to predict outcomes and ramifications.

Tags: Bond Market, Business Optimism, Consumer Price Index, Durable Goods Orders, Economic Data, Economic News, Federation Of Independent Business, Import Prices, Inflation Measures, Initial Jobless Claims, Last Friday, Leading Indicators, Market Radar, National Federation Of Independent Business, Negative News, Producer Price Index, Ramifications, Reprieve, Retail Sales, Treasury Yields
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Emerging Markets Cheat Sheet (October 17, 2011)

Saturday, October 15th, 2011

Emerging Markets Cheat Sheet (October 17, 2011)

Strengths

• China’s Consumer Price Index (CPI) is stabilizing at 6.1 percent for the month of September, 0.10 percent lower than the 6.2 percent a month earlier. The highest level reached was in July, with CPI at 6.5 percent. Although September’s CPI was not low enough for the People’s Bank of China (PBOC) to loosen monetary tightening, it provides time for the government to increase food supply. China’s Producer Price Index (PPI) was 6.5 percent, lower than market estimate of 6.9 percent.
• Korea’s unemployment rate was 3.2 percent for September, while it was 3.1 percent for August. It is still very close to the 10-year low of 3 percent, showing the economy and businesses are currently stable in spite of a deteriorating external economic environment.
• China’s Central Huijin, a government entity that owns SOEs, started buying Chinese big-four banks, i.e., Industrial and Commercial Bank of China, Bank of China, China Construction Bank of China and Agricultural Bank of China in the A-share market. This shareholder buyback indicates Chinese government support to the A-share market, which is positive for the Hang Seng Index.
• China’s State Council, the Cabinet, unveiled monetary and fiscal policy measures on Wednesday to help the country’s troubled small companies by forcing financial institutions to increase lending support. China recently had seen increasing financing troubles for small, privately-owned companies, particularly in Wenzhou, a booming town in the province of Zhejiang.
• China’s passenger-car sales to dealerships in September rose 8.8 percent from a year earlier to 1.32 million units, the China Association of Automobile Manufacturers said on Thursday.
• Bank of Korea (BOK) maintained its benchmark interest rate at 3.25 percent. This was the fourth successive BOK meeting where the rate remained unchanged.
• Indonesia cut its benchmark interest rate from 6.75 percent to 6.50 percent, while the market had expected no move. This is the first rate cut since August 2009. The government is ready to help the economy in case the European debt crisis hits hard on its export business.
• Korea’s producer price index climbed 5.7 percent on a year-over-year basis in September, growing at the slowest pace in nine months.
• Korea’s automobile production grew 10.3 percent year-over-year in September due to solid demand from both domestic and overseas markets.
• Malaysia’s industrial production gained 3 percent year-over-year in August as manufacturing and electricity output climbed. The result far exceeded expectations for a 0.4 percent jump. Malaysia is not an export-driven economy compared with other Asian countries.
• During China’s Golden Week holiday that ended on October 7, 302 million tourists traveled throughout the country, an 18.8 percent increase year-over-year. Tourism revenue for the week reached 145.8 billion Rmb, a 25.1 percent increase year-over-year. This shows consumer spending in China is still robust, probably a bright spot in the slowing Chinese economy.
• The Slovakian parliament approval removed the final obstacle to expanding the eurozone’s rescue fund. The measure received support from 114 members, with 30 voting against and three abstaining. The European Financial Stability Facility will be increased to $600 billion.

Weaknesses

• September’s inflation was still mainly due to food price hikes, which went up 13.4 percent on year-over-year basis and up 1.1 percent month-over-month, contributing 4.05 percent of total CPI.
• China’s September exports were up 17.1 percent, and imports were up 20.9 percent, versus consensus estimates of 20.5 percent and 24.2 percent. The slower growth rate in exports had been indicated in September’s Purchasing Manager’s Index (PMI) lower new order book.
• Thailand consumer confidence fell to 72.2 in September from 73.8 in August, falling for a second straight month due to the worst flooding in five decades. The Bangkok stock market fell on Wednesday reacting to the flood damages. However, Thailand Prime Minister Yingluck has said yesterday that the country has avoided the worst scenario by finding channels to redirect the waters out of Bangkok.
• Korea’s third quarter foreign direct investment declined 24.6 percent, the most since the first quarter of 2009. All indicators are pointing to an economic slowdown due to external factors that are the European and U.S. economies. A slowing Chinese economy is also negative for Korea since a third of its export goes to China.
• Philippine exports declined 15.1 percent year-over-year to $4.5 billion in August as sales of electronic goods dropped. The decline was the biggest since September 2009.
• Brazil inflation climbed after the 0.5 percent interest rate cut at the end of August. Inflation rate rose 7.31 percent in September from a year earlier, the highest level in more than six years.

Opportunities

• The Chinese corporate Inventory to GDP ratio remains at a decade low level.
• The chart below by BCA research shows that after destocking in 2009, Chinese corporate inventory has remained lean. That means if there is another 2008 shock in the export decline, a plummeting in inventory is less likely, so there would be less negative impact on Chinese production activities.  This is another positive factor that helps China’s soft landing.
• In a positive development for the Russian consumer sector, Unilever is acquiring cosmetics producer Kalina for $535 million. The deal comes at 46 percent premium to Thursday’s close and implies multiple of 12 times the enterprise value (equity plus debt), well above the average multiple for the sector.

Threats

• The U.S. Senate has just passed a currency bill to threaten China with a 30 to 60 percent tariff on all Chinese imports to the U.S. If it becomes law, a trade war between the two countries could start, though we believe it is unlikely the bill will pass in the Congress. The proposed law would hurt both China and the U.S.
• The main challenge of the newly elected government in Poland is to commit itself to cutting the budget deficit to 3 percent of GDP in 2012 from this year’s 5.5 percent of GDP. This should enable Poland to stay below the 55 percent of GDP public debt prudential threshold.

Tags: agricultural, Agricultural Bank Of China, Bank Of China, Benchmark Interest Rate, Brazil, China Association, China Construction Bank, Commercial Bank Of China, Consumer Price Index, Environment China, External Economic Environment, Gold, Hang Seng Index, Index China, Index Cpi, Industrial And Commercial Bank Of China, Monetary And Fiscal Policy, Passenger Car Sales, Producer Price Index, Producer Price Index Ppi, Supply China, Support China, Zhejiang China
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Staring Down China’s Inflation Dragon

Monday, July 11th, 2011

China’s inflation jumped to its highest in three years with consumer price index (CPI) surging 6.4% year-over-year in June (See Chart Below). The spike has been fueled by escalating food prices despite that the central bank’s effort to tame inflation by pushing up the RRR (Reserve Requirement Ratio) for commercial banks six times this year, while raising interest rates five times since September, most recently on July 6.

Inflation Hinges on Hogs

Food prices, which weight about 30% of the CPI basket, climbed 14.4% from a year earlier, and the price of pork, in particular, increased 57.1% year-on-year, and 11.4% month-on-month, is the engine behind the runaway consumer inflation train (See Chart), according to the figures released by the National Bureau of Statistics (NBS) and reported by China Daily.

The price of pork is a staple of the Chinese diet, hit a new high in June due to rising costs and short supply. One analyst based in China warned that price increases in pork, which accounted for 65% of China’s meat consumption, risked sending the costs of grains and vegetables up as consumers seek alternatives to meat.

Bloomberg reported that many investment banks and economists believe that the future direction of China’s CPI will still be mainly influenced by pork prices.

In addition to monetary policy, Beijing is also using other tools, such as sales of grain reserves, to cool prices. But rising food prices is a world-wide phenomenon with FAO food Price Index rising 39% year-over-year in June, according to the Food and Agriculture Organization of the UN.

So Beijing’s effort fell short, and the CPI now stood high above the government’s target of 4% for the year.

Far From Reaching Peak

Meanwhile, China’s Producer Price Index (PPI), measuring inflation at the wholesale level, rose 7.1% year-on- year (See Chart Above) in June mostly due to production materials costs which was up almost 8% in June.

Many analysts, expecting Beijing’s “intervention” to take effect, have been predicting China inflation to peak each month for the last 9 months. The latest verdict is that the inflation probably peaked in June and will trend down in the second half of this year.

However, the wide differential between the two inflation measures–CPI and PPI (See Chart Above), would suggest increasing pressure to pass on the price increases to consumers most likely well into at least the first half of 2012.

Price Control Could Backfire

On the other hand, if due to price control by the central government, producers and business are unable to pass through the cost increases, that could mean reduced production and profits for corporations, which is partly why China had to face summer power shortage. Coal power plants in China cut run rate in protest as operators could not make ends meet amid soaring coal prices and the government-imposed price cap.

30% Property Price Drop?

China’s expansionary monetary and fiscal policies since the Recession coupled with huge investment inflow into the real estate and other markets has not only exacerbated the pricing pressure, but also has also created overcapacity in some sectors.

The country has introduced a series of measures to curb rising property prices, while construction of 10 million government-subsidized homes is expected to start before the end of October. Price drop in the real estate sector could be in the second quarter of next year when a large amount of government-subsidized houses will flood the market.

China Daily quoted a research report by the National Institute of Property Finance and Beijing Beta Consulting Center that China’s first-tier cities will probably see a 30% fall in property prices. Second-tier cities could see drops of 10-20 % in coming months.

Even More Fixed Asset Investment

Urban fixed asset investment rose to 9.03 trillion yuan ($1.39 trillion) in the first five months, up 25.8% year-over-year (See Chart), while investment in residential housing reached 1.33 trillion yuan, up 37.8% from the same period last year. This has partly contributed to the current escalating inflation in China.

However, there’s no slowing down for construction any time soon even with current rampant inflation levels. Business China, in a June report, quoted an analyst from Northeast Securities that

“Affordable housing projects and high-speed trains ensure the “intensity” of China’s fixed asset investment… [this] will be around 20% per year in the 2011-2015 period, helping the nation’s construction machinery sector to realize its sales target of RMB 900 billion.”

The paper further noted,

“China’s construction machinery market is expected to grow by about 17% per year over the next 5 years…..citing the 12th five-year plan for the industry. According to the China Construction Machinery Association, the plan has been submitted to senior government departments and is expected to be issued before the end of this year.”

Expansionary Policy to Continue?

With the increasing bank tightening, many small businesses and companies are getting squeezed.  This news about fixed asset investment seems to suggest Beijing expects a mid-term weak domestic demand and possibly widening income gap that government “infrastructure stimulus” is the only reliable means to fuel growth, jobs and income.

Most likely Beijing is worried once it stops “intervention” and let the chips fall where they may, riots and revolution would ensue.

Nevertheless, China’s leaders pledged to give a greater priority to stabilizing prices in 2011 and better manage liquidity and also noted maintaining proper pricing levels is vital to the country’s stability and security.

So for now, depsite the recent revelation of a ticking bomb from high local government debt, there’s no reason to think China would not come through eventually.  However, in light of many other social economic issues, the battle of inflation most likely will need to go far beyond controlling food and energy prices.  That means it will be an vertical battle climb that could last well into 2013 and beyond, much longer than most market players have anticipated.

China & XXIII Winter Olympics Construction

Now, in the face of rising inflation, gold is the typical hedge.  But in the case of China, there are a few more options that could also stare down the inflation dragon.

For the ongoing construction boom and monetary tightening in China, listed domestic construction machinery companies like Sany Heavy Industry Co. Ltd (600031.SH) and Guangxi Liugong Machinery Co. Ltd. (000528.SZ) are cited as the most competent candidates for this big pot of government cash.

Metals such as copper, iron ore of which China is a big importer, producers like the World’s Big 3— BHP Billiton, Vale, Rio Tinto, and Cleveland-Cliffs, and Arcelor Mittal, etc. would also benefit from the steady high price supported by strong Chinese demand and the infrastructure build-out for the 2018 XXIII Olympic Winter Games at Pyeongchang, South Korea.

Status Symbols – Money’s No Object

Some “status symbol” consumer goods companies like McDonald’s, Starbucks and luxury car maker like Audi and BMW seem to have better luck (than the coal power plants at least) passing through some of their costs. So companies in this niche sector could weather the coming monetary tightening in China better than some other sectors.
Red Hot Hogs

Another long idea came from Phupinder Gill, president of CME Group who told China Daily that

“It makes sense to launch hog future contracts soon on Chinese commodity exchanges. Launching hog futures can help local farmers and relative food producers to better hedge price-surge risks, and “it is the smartest thing that the Chinese commodity exchanges can do now.”

And there’s an ETF for that - ETFS Lean Hogs (HOGS) tracks the DJ-AIG Lean Hogs Sub-Index.  Agriculture ETF or mutual funds such as Oppenheimer Commodity Strategy Total Return Fund (QRAAX) or Market Vectors Global Agribusiness ETFs (MOO) would also be good investing vehicles to diversify one’s portfolio.

Disclosure: No Positions

Tags: China Daily, Chinese Diet, Commercial Banks, Consumer Inflation, Consumer Price Index, Food And Agriculture Organization, Food Price Index, Grain Reserves, Index Cpi, Inflation Dragon, Infrastructure, Investment Banks, Meat Consumption, National Bureau Of Statistics, Pork Prices, Producer Price Index, Producer Price Index Ppi, Production Materials, Tame Inflation, Target, Wholesale Level
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The Economy and Bond Market Cheat Sheet (June 20, 2011)

Saturday, June 18th, 2011

The Economy and Bond Market Cheat Sheet (June 20, 2011)

The yield on the 10-year U.S. Treasury note declined 3 basis points this week to end at 2.94 percent.

A fixed-income research report from RBC Capital Markets provided a positive note for municipal bonds, pointing out that the May 2011 employment data included a 30,000 reduction in state and local government employment for the month. The report states that general local government employment (which excludes education jobs) is back to mid-2006 levels, and state general government employment is at levels last seen in January 1999. The report notes that, when analyzed in terms of employees per one thousand population, state general government employment is now about 8.7 per 1,000, a figure which has not been this low since 1976. The report takes issue with “the glib pronouncements in the media about the precarious position of municipal credits.”

The graph below shows the producer price index for the U.S. on a year-over-year basis, not seasonally-adjusted. The last data point for May 2011 shows a rise of 7.3 percent, the fastest rise since September 2008. Excluding food and energy, the year-over-year rise was 2.1 percent.

Strengths

• Initial jobless claims declined by 16,000 to 414,000 in the week ended June 11, below the 420,000 consensus.
• Housing starts in May were at an annual pace of 560,000, above the 545,000 median forecast. Building permits were 612,000, above the 557,000 consensus.
• Retail sales fell 0.2 percent in May from April, less than the 0.5 percent decrease in the forecast.
• The Conference Board Index of Leading Economic Indicators rose 0.8 percent in May. Economists had forecast a 0.3 percent gain.
• The Mortgage Bankers Association’s index of mortgage applications increased 13 percent in the week ended June 10 from the prior week. This was the largest percentage gain since the week of March 4.

Weaknesses

• Wholesale costs in the U.S. rose more than forecast in May. The Producer Price Index rose 0.2 percent month-over-month, more than the 0.1 percent forecast, and it rose 7.3 percent year-over-year compared to the 6.8 percent consensus. Excluding food and energy, the index rose 2.1 percent year-over-year, in line with the forecast.
• The consumer price index in the U.S. rose more than forecast in May, up 0.2 percent month-over-month versus a forecast of up 0.1 percent. It was up 3.6 percent year-over-year in May compared to the 3.4 percent consensus. Excluding food and energy, it gained 1.5 percent year-over-year versus a 1.4 percent forecast.
• The University of Michigan Consumer Sentiment Index decreased to 71.8 in June from 74.3 in May, and it was below the consensus of 74.
• The Federal Reserve Bank of New York’s general economic index dropped to minus 7.8 in June, the lowest level since November. The forecast was for a positive 12.0.
• The Federal Reserve Bank of Philadelphia’s general economic index fell to minus 7.7 in June from 3.9 in May. Readings less than zero signal contraction. The median forecast was 7.
• The National Association of Homebuilders sentiment index for June fell to 13 from 16 in May. The consensus was 16. Readings below 50 mean more respondents said conditions were poor.

Opportunities

• The Fed may be forced into another round of quantitative easing if employment and the economy do not improve soon. This is not consensus and the market is applying low odds of this occurring, but if it were to come to pass, the fixed income markets would likely rally from here.

Threats

• Another Greek bailout appears inevitable and others are likely to follow which increases the eventual risk of default and is a potential threat to the global banking system.

Tags: Bond Market, Employment Data, Fixed Income Research, General Government, Government Employment, Index Of Leading Economic Indicators, Initial Jobless Claims, Leading Economic Indicators, Mortgage Applications, Mortgage Bankers Association, Municipal Bonds, Percentage Gain, Precarious Position, Producer Price Index, Rbc Capital Markets, Report States, State And Local Government, Treasury Note, U S Treasury, Wholesale Costs
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