Emerging Markets Radar (June 11, 2012)

Sunday, June 10th, 2012

Emerging Markets Radar (June 11, 2012)

Strengths

• The People’s Bank of China (PBOC) has cut interest rates. Lending rates were cut by 25 basis points for all maturities. Deposit rates were cut by between 10 and 40 basis points. The move makes the one-year reference lending rate 6.31 percent and the one-year reference deposit rate 3.25 percent. However, banks have also been given increased flexibility to pay deposit rates up to 10 percent above the reference (previously the reference rate was a ceiling) and make loans at rates up to 20 percent below the reference (previously the floor was 10 percent below).
• Chinese banks lent almost 800 billion Yuan in May, Economic Information Daily reports.
• China HSBC Services PMI was 54.7 versus 54.1 in the prior month, indicating retail and services still in an expanding stage.
• The Philippine economy expanded by 6.4 percent year-over-year in the first quarter of 2012, beating expectations with strong services growth of 8.5 percent amid an improving domestic outlook.

Weaknesses

• While the market praised the progress the PBOC has made in liberalizing interest rates by widening the band where the banks can deviate lending and deposit rates from the reference rates, it almost unanimously agreed this squeezes the banks’ profit margin. In fact, there are a couple of reasons that the margin pressure will be much smaller than the market would believe. Those money center banks have a dominant franchise in China and so they can resist reducing lending rates and increasing deposit rates. For depositors, safety is more important than earnings from the deposits. Besides, bank customers place more than 50 percent of their money in demand deposits with large banks, which pay very little interest and provide banks with cheap money.
• Malaysia’s exports unexpectedly fell in April for a second straight month, dropping 0.1 percent as shipments of electronics and palm oil dropped.
• Lackluster external demand is weighing on the Israeli economy, and weak data have led the broad market index (BMI) to revise down the 2012 real GDP growth forecast from 3.2 percent to 2.9 percent.

Opportunities

• India’s external weaknesses are starting to correct. The country’s trade shortfall came in at $13.5 billion in April, down from $15.2 billion in February and $19.6 billion in October 2011. Lower global commodity prices and the weaker currency are likely to lead to a further narrowing of the trade deficit in the coming months.
• The Colombian peso has a potential to further strengthen in the short term, points out Business Monitor International as companies bring in U.S. dollars from abroad to pay annual taxes due on June 25.
• China cut benchmark lending and deposit rates by 25 basis points on Thursday. Historically, such a move will drive up liquidity and the stock market in Hong Kong and in the domestic B share market, as the chart shows.

Threats

• In spite of the interest rate cut on Thursday evening by the PBOC, both Hong Kong and China domestic A share markets went down on Friday. This indicates that the market is worried about the economic data to be released over the weekend. Also, the rate cut of 25 basis points is not to reverse the economic slow-down in China in the short term, but infrastructure investment and government fiscal spending will.
• The Russian central bank feels increasingly uncomfortable with the recent weakening of the ruble. The central bank has now started to intervene on the open market by selling its foreign currency reserves. So far, this intervention, which is partly responsible for a $10 billion decline in foreign reserves in May, had little success in reversing the decline in the ruble.

Tags: Bank Customers, Bank Of China, Basis Points, Cheap Money, China, Chinese Banks, Demand Deposits, Depositors, Economic Information, Emerging Markets, First Quarter, Hsbc, India, Margin Pressure, Maturities, Money Center Banks, Palm Oil, Pboc, Philippine Economy, Profit Margin, Services Pmi, Yuan
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Bill Ackman and Hunter Harrison Discuss Canadian Pacific

Tuesday, May 1st, 2012

 
Bill Ackman, [$11-billion activist billionaire hedgie] on Canadian Pacific [proxy battle]

A snippet from the transcript:

Ackman: “Even if you take the earnings away, they’re still reported. the profitability of the company is worse than it was six years ago. the profit margin, the so-called operating of the business was worse.

CNBC: But on you calling BS, if you will, on these numbers, are you prepared to walk that back or do you think the numbers are real?

Ackman: Unfortunately right now we’re in the middle of a proxy contest. i don’t know who to believe. Let’s just stick with the reported numbers. By the way, if I got them wrong, I’m happy to admit I’m wrong.

CNBC: If the numbers are right, you will say you were wrong?

Ackman: Sure.

CNBC: There are a number of reports where the company has asked you to apologize and —

Ackman: if I’m wrong, I’m delighted to apologize. Unfortunately right now, the company realizes they’re losing so they want to create a side show out of a technicality.

CNBC: Who do people want? Do people want Fred Green to be CEO of the company going forward?

Ackman: The answer is no. Hunter, by the way, is the most decorated CEO in the railroad industry.

 
Hunter Harrison and Bill Ackman on Running a Better Railroad

Tags: Activist, Bill Ackman, Billionaire, Ceo, Cnbc, Earnings, Hedgie, Hunter Harrison, Nbsp, Profit Margin, Profitability, Proxy Battle, Railroad Industry, Running, Six Years, Snippet, Technicality
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Emerging Markets Cheat Sheet (May 9, 2011)

Saturday, May 7th, 2011

Emerging Markets Cheat Sheet (May 9, 2011)

Strengths

• In April, a survey of 24 economists by Diyi Caijing, a financial journal, showed a consensus CPI of 5.2 percent, lower than the March number of 5.4 percent. The economists also predict that China’s trade surplus will be at $2.7 billion in April, versus $0.12 billion in March.
• Xinhua News reported Tan Rongyao, director of the State Electricity Regulatory Commission, as saying that China is able to make short-term increases in on-grid power prices as part of their efforts to reduce supply shortage. Since a drought southwest of China has hindered hydropower, increasing power production has to come from burning more coal, which is positive for coal price and demand.
• Ecorodovias, a Brazilian toll road operator, reported a healthy 11 percent increase in traffic during April underpinned by strong economy.
• Higher remittances to Mexico have been supporting the local retailers – Walmex reported a 7 percent increase in same store sales in April with total sales rising by 15.2 percent. Sales in Central America grew by 18.8 percent.
• Through the first three months of 2011, Turkey recorded a budget deficit of 4.1 billion lira, a noticeable improvement compared to an 11.3 billion lira deficit in the same period last year. Central government revenues are up 20.5 percent year-over-year, while non-interest expenditures increased 10.3 percent year-over-year. The primary balance posted a 9.8 billion lira surplus.

Weaknesses

• Brazil auto sales in April were down 5.5 percent month-over-month, following strong sales in the prior two months.
• Last year, the average profit margin of the Chinese steel makers was only 2.9 percent. This year, it can get worse in the face of increasing iron ore and coal prices without increasing steel prices.
• China’s industrial production continues to expand. In April, China’s official purchasing managers index was 52.9 percent, only 0.5 percent lower than March’s 53.9 percent. However, the new order index decreased 1.4 percent, showing some slowing down.
• Russian inflation pressures edged higher in April, rising 9.6 percent year-over-year, faster than the 9.5 percent year-over-year pace in March. Despite a gradual recovery in economic growth, government stimulus and extra spending from higher-than-expected oil revenues could keep inflation elevated throughout the remainder of 2011.

Opportunities

• According to Citigroup, corporate earnings based on the MSCI Asia ex Japan Index have exceeded a prior high, yet the market is not at a high, nor are valuations. We find the same discrepancy applies to HSCI Index. Therefore, we expect there is room for stock prices in Hong Kong and Asia region to improve. The chart to the right shows Asia’s equity price-to-earnings is at its historical average, despite their earnings at a historical high. Again, it shows the potential for multiples to expand.

• A weakness in commodities, including oil, has created an opportunity for airline stocks, some of which rallied this week. We have a constructive view of Copa with operations in Central America.
• Chilean retailers continue their Latin America diversification – Cencosud is expecting that Brazil will account for 20 percent of its sales this year.
• Despite uncertainty associated with a presidential election in Peru, local companies are in the “business as usual” mode. Grana y Montero (infrastructure/construction play) won a sizeable mining contract in Chile that will take 45 months to complete. Intergroup reported a strong set of numbers during the first quarter of 2011 with a return on equity of 31 percent and earnings per share growing by 20 percent quarter-over-quarter.
• According to Credit Suisse, a relaxation of bank lending standards leads credit growth by 12 months. The current trajectory of lending in Poland appears to be consistent with Credit Suisse’s projection of at least 10 percent private sector credit growth in 2011.

Threats

• In the last three weeks, the People’s Bank of China (PBOC) had a net Rmb 420 billion that matured. The market is worried that the PBOC might increase the bank’s required reserve ratio (RRR) another 50 basis points to withdraw that money. Also in the week, the PBOC governor said there is no limit for the RRR, indicating a further tightening of bank lending, if necessary.
• Domestic demand for gas has remained flat since 2007, but the sale of state giant Gazprom’s gas dropped by 19 billion cubic meters (bcm) on top of the same fall in Europe. Gazprom is coming under pressure from independent gas producers, which are on track to double their production to 116 bcm by 2015.
• The Supreme Court of Mexico backed the ruling of telecom regulator, Cofetel, regarding a 61 percent cut in interconnect rates imposed on America Movil (AMX). The decision has put pressure on the company, which in the past resorted to injunctions. The shares will likely remain volatile until it becomes apparent how the consumer will react and the net impact it may have on the finances of AMX.

Tags: Brazil, Budget Deficit, Coal Price, Coal Prices, Electricity Regulatory Commission, First Three Months, Government Revenues, Grid Power, Infrastructure, Iron Ore, Noticeable Improvement, Profit Margin, Purchasing Managers Index, Remittances, S Industrial, State Electricity Regulatory Commission, Steel Makers, Steel Prices, Strong Sales, Toll Road, Trade Surplus, Xinhua News
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Three Profit Metrics to Avoid Earnings Season Myopia (Hester)

Sunday, April 10th, 2011

by Bill Hester, Hussman Funds

Alcoa, the aluminum producer, announces its earnings on Monday. So begins the reporting season of first-quarter company results. During this period in particular, it may be easy to become enamored with past corporate performance and miss potential forward-looking risks. To counterbalance the deluge of earnings reports to be delivered over the next few weeks, here are a few intermediate-term indicators and trends that investors may want to watch to gauge earnings conditions.

Watch Sales Growth for Clues to the Direction in Profit Margins

The current profit margin of the S&P 500 Index is sky high. During the past 40 years it was only higher during 2006-2007, fueled substantially at the time by record margins and earnings of financial companies that would eventually disappear into the ether. The current profit margin is 50 percent above its long-term average.

One of the primary drivers of profit margins is sales growth. But the important role that sales growth plays is often left out of the discussion. Year-over-year changes in revenue have a strong correlation with changes in profit margins historically. This makes sense, because a large part of company expenses are fixed for a period of time, especially contractual ones like those for labor and supplies. So over the short-term, revenue growth often falls straight to the bottom line. So when sales growth comes in faster than recent trends, those new sales help deliver higher profit margins.

Recent data show a divergence in sales growth, which is moderating, and margins, which continue to expand. This is likely the result of corporate executives who continue to be uncertain of the durability of the economic recovery. Even though sales growth has been strong during the last few quarters, corporate cost structures haven’t changed materially, which has boosted margins. The graph below compares the year-over-year change in sales in the S&P 500 with the Index’s profit margin.

It’s important to highlight the recent rate of growth in sales, which is moderating. Even if corporate executives continue to move slowly in hiring and raising wages, if sales growth continues to moderate, margins are likely to be dragged lower over the next few quarters. Even now, profit margins look extended based on their relationship with sales growth. Typically, high profit margins follow strong sales growth. As sale growth moderates, margins decline. This helps explain why there is also a strong inverse correlation between profit margins and subsequent profit growth, as John Hussman has frequently noted.

There has also historically been a negative correlation between profit margins and subsequent stock market returns. The current trailing 5-year return – which began with profit margins close to current levels – is a bit less than 3 percent annually (with intense volatility and drawdown). Based on historical correlations, current profit margins suggest similarly low returns over the next few years.

Valuation Differences Across Sectors

The first graph above shows that S&P 500 profit margins are near peak levels. And we know that by looking at valuation models that normalize fundamentals, the level of valuation of the Index is also extended. Are the sectors within the Index equally overextended on both a profit margin and valuation basis?

The graphs below attempt to provide some insight. The data for these graphs is provided by Ned Davis Research . NDR’s analysts have calculated sales and income totals for the main sectors of the S&P 500 going back to the early 1970′s, which I’ve used to calculate profit margins. They have also calculated a set of historical median valuation ratios for each sector. To separate the level of valuations from the impact of peak profit margins, I’ve used the median sales yield (sales/price) in the calculations below.

As an example, the first graph presents the data for the Consumer Discretionary Sector. The top half of the graph shows profit margins for the sector – which are at record levels. The bottom half of the graph shows sales yields – which are at record low levels (implying high levels of valuation).

The graph below extends this concept by comparing each sector’s current profit margin and sales yield to its historical range (as a percentage). For example, sectors in the lower right quadrant have profit margins and levels of valuation that are higher than average for those sectors. The lower and further right you go on the graph, the more extended the current profit margins and valuations are. Keep in mind that by using sales yield we are focusing on how expensive sectors are, relative to a fundamental that isn’t influenced by year-to-year fluctuations in the sector’s profit margins.

The S&P 500 itself is in the lower right-hand corner. You can see how extended the Index is based on both the level of profit margin and valuation, compared with historical norms. The Consumer Discretionary sector (COND) is even more extended on both measures. Also interesting are the cyclical components of the S&P Index. The Materials, Energy, and Industrial sectors are all at peak levels of valuation (independent of margins) and have near-record profit margins as well. Consumer Staples and Financial sectors are less overvalued relative to their history (keep in mind how highly valued financials were in 2007 prior to their declines, which likely distorts their current level of relative valuation). The Healthcare sector appears least extended on these measures.

It’s clear from the graph that any argument that the market and the majority of its sectors are fairly valued relies strongly on the assumption that profit margins will remain near their all-time peak levels. Valuation metrics that aren’t influenced by year-to-year fluctuations in profit margins are showing record levels of overvaluation. Near-record profit margins with near-record levels of valuation for most industries suggest potential for risk to the stock market in the event earnings disappoint investors over the next couple of quarters.

Investors May Be Running Out of Surprises

One of the worst-kept secrets in the financial markets is that earnings surprises are not true surprises. Company executives have learned over time that if they provide modest earnings guidance, then beat that guidance, even marginally, their management and company performance look better. Stock prices often react favorably to those ‘surprises’. You can see the development of this sort of “pact” between executives and analysts by looking at the upward drift of earnings surprise rates – which measure the percentage of companies that beat estimates. Surprise rate have generally moved higher from the mid-1990′s when a little less than half of companies typically beat estimates, to the recent high where more than 80 percent of companies beat estimates.

This doesn’t mean that tracking the earnings surprise rate is without merit, as long as you’re mindful of its upward drift. Because of the upward trend in the data, the most useful signals are based not on the level of surprises, but on noticeable reversals of that trend. Bloomberg keeps an index of these earnings surprises, which I’ve mentioned before as a tool for monitoring potential risks. The graph below shows the index on a monthly basis, with a 12 and 24-month moving average that track its smoothed performance.

It’s a relatively short data series that begins in the early 1990′s. But over that time, when the 12-month moving average of the index has fallen below its 24-month moving average, especially from a noticeable peak, poor returns have generally followed. For example, the shorter-term moving average dipped below the longer-term average in early 2001, following a noticeable peak in 2000. The two crossed again in 2007, prior to the profit surprise rate collapsing from 70 percent to almost 50 percent in 2009. During both periods the 12-month moving average stayed below the 24-month moving average until a substantial amount of the decline in stock markets that followed had already occurred. There were less effective signals given in 1996 and 2005. The indicator is plotted against the performance of the S&P 500 Index below.

The 12-month moving average of the surprise line fell below the 24-month moving average last week, which is noted on the graph. Again, it’s a data series with limited history so the signal alone shouldn’t be used for investment decisions. But the deterioration in the positive surprise index will clearly be worth watching as the coming earnings season unfolds.

Earnings reporting season always brings an intense scrutiny of profit metrics, but not always the most helpful ones. During these periods it’s easy to lose focus on intermediate term indicators that can provide useful information. The metrics that track some of these trends – the level of profit margins in relation to sales growth, sector valuation, and a downward drifting earnings surprise rate – are currently highlighting potential intermediate-term risks on the earnings front.

Copyright © Hussman Funds

Tags: Alcoa, Aluminum Producer, Company Expenses, Corporate Executives, Corporate Performance, Deluge, Divergence, Earnings Reports, Earnings Season, Economic Recovery, Enamored, Hester, Hussman Funds, Metrics, Myopia, Profit Margin, Profit Margins, Reporting Season, Term Indicators, Watch Sales
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Chinese Yuan: Bent But Not Bowed

Monday, June 21st, 2010

The currency issue has been a constant tension in relations between the United States and China. Many analysts had expected the Chinese central bank to announce a one-off revaluation in the yuan to appease critics of the exchange rate policy.

However, on Sunday, the People’s Bank of China (PBOC) has ruled out the one-off revaluation that US politicians had sought. This was seen as a largely political move to deflect criticism of its fixed exchange rate ahead of the G20 meeting next week.

For now, Analysts still expect the yuan to slowly rise. Meanwhile, the decision should not have come as a surprise as there are several major risks (discussed below) should China implement a faster yuan move as favored by many.

Yuan-Dollar Peg Since 2008

China allowed the yuan to rise by about 20% beginning in 2005, but halted two years ago to help Chinese manufacturers weather the global financial crisis. Since then, the yuan’s value has been pegged to the dollar at an exchange rate of roughly 6.83 to $1. (Chart 1)

Many Western economists estimate the yuan is still undervalued by 25% to 40%. International pressure has been growing this year for China to end the linkage, because it tends to make Chinese exports cheaper, and is seen as giving them an unfair advantage in global markets.

Major Risk # 1 – Exports & Employment

China has long resisted pressures on yuan revaluation as China is still largely dependent on its export to deliver growth. Some government officials have warned that any further appreciation of the Chinese currency risked driving exporters out of business. .

Tags: Bank Of China, Brazil, BRIC, BRICs, China, Chinese Central Bank, Chinese Currency, Chinese Export, Chinese Exports, Chinese Manufacturers, Chinese Yuan, Currency Issue, Exchange Rate Policy, Export Goods, Global Financial Crisis, Global Markets, India, Pboc, Political Move, Profit Margin, Russia, Trade Surplus, Trade Weighted Exchange, Unfair Advantage, Western Economists, Yuan Revaluation
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China: Profit Margins Recovery Should Help Stocks

Monday, May 11th, 2009

BCA Research has published the following analysis on the strong general corporate earnings recovery in China, May 8, 2009:

Overall Chinese corporate profits will likely recover strongly from deeply depressed levels in the coming months as the broader Chinese economy stabilizes. Rising earnings expectations for listed firms should sustain the rally in the stock market.

Chinese corporate profit cycles have historically been highly sensitive to volume expansion. The reason is that China’s highly competitive business environment has long kept pricing power weak and profit margins trim.

This means that volume expansion, which is highly sensitive to China’s business cycle, has long been the determining factor in corporate profit growth. As various leading economic indicators have all been turning up strongly in recent months, volume expansion has begun to reaccelerate. In addition, input costs have dropped more deeply than output prices.This means that the severe profit margin squeeze for the Chinese corporate sector in 2008 may have also eased.

Thus, a sharp recovery in the corporate profits from currently deeply depressed levels is likely in the coming months. Longer term, we expect the overall macro environment will likely remain challenging for the corporate sector and it is unrealistic to expect an across-the-board profit boom. Investors should focus on equity sectors that are able to capitalize on the economy’s top-line growth.

Tags: Boom, Business Cycle, Business Environment, Chinese Economy, Corporate Earnings, Corporate Profit, Corporate Profits, Corporate Sector, Depressed Levels, Earnings, Input Costs, Leading Economic Indicators, Macro Environment, Profit Growth, Profit Margin, Profit Margins, Rally, Sectors, Squeeze, Stock Market, Volume Expansion
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