Fiscal Plan B Fails House Approval, Ball is now with President

Most recent report on U.S. efforts to address its budget or fiscal cliff shows continued hardship, despite irrational market optimism. For a couple of weeks, President and Speaker of the House John Boehner have been discussing differences in desired fiscal direction. In so doing, both have realized mostly differences, and not common ground.

Boehner announced a Plan B. He took it to a vote in the House tonight and it failed. Obviously Boehner was looking for strength in his own majority party  to push a lead on fiscal policy in the House of Representatives.

Revenue bills must originate and be passed in the House of Representatives. They can't come from the Senate. Revenue bills, or budget setting, are essentially between House of Representatives by passing a bill, and the President by signing it into law. Senate can make changes, but the idea must pass the House of Representatives first.

What's more, President of the U.S. can't dictate to the House of Representatives a revenue bill. Rather, game starts in the House of Representatives, with all knowing that President has veto power. Typically, as a result, negotiations start with the House and President, certainly when the current Democrat Senate is inclined to follow their Democrat President.

When U.S. has a Democrat President and Senate, but a Republican House of Representatives, the obvious negotiation is between the House and the President.

Leader of the House of Representatives is Speaker of the House, John Boehner. Mr. Boehner was elected by a majority of the House, being Republicans.

Though Mr. Boehner's vote failed in the House, ball is now completely and squarely in President Obama's court to propose something that can pass a first hurdle, being the House of Representatives. Even Boehner's plan B didn't pass the House.  Suggested is a substantial width of chasm between House and President expectations.

Looks like President Obama must now realize power over national purse strings held by House of Representatives. To move government requires such realization of balance of power. Election is over, now its governing.

What is degrading to processes of governing is media characterizing an act of compromise as an act of "caving". Recalls base talk shows with lots of violent behavior displayed on set, which only excites crowds to finally encourage self-perceived protagonists, or martyrs.

But how long will it take to close this balance of power chasm, especially given a Christmas recess in the House. Checks and balances were intended to slow action, but more so with social policy as opposed to budgets. Budgets historically haven't proven this difficult.

Continued negotiations remain invited and open among all parties.

Obviously, past market confidence will fail and show declines in equities and an increasing dollar, with suspected correlations. If not, market sees a ghost in fog.

U.S. Expands QE3, But Markets are Disappointed, by being Underwhelmed

Seeing today’s market activity, one becomes concerned with market responses to central bank activity. Federal Reserve today concluded their two day meeting with an announcement turning convinced speculation into what was already convincing.

That is, Fed said it would roll its “operation twist” into some $45B/month in treasury purchases. This becomes a new round of treasury purchases not seen since conclusion of QE2, in 2011. Interesting also is Fed’s tying monetary policy to a 6.5% unemployment rate, as opposed to particular dates. Seems far more logical.

What disappoints is equity responses today when Fed announced additional easing. Dow jumped up in a cheer, but closed down by three points. Currencies, namely U.S. dollar and euro, went into normal correlation with U.S. dollar down and euro up. But ended showing some sign of risk hesitation.

Overall, U.S. markets have demonstrated sound and positive responses to global central bank easing announcements. Generally leading major U.S. equity advance in recent past have been Fed’s September QE3 announcement and ECB’S Outright Monetary Transaction of September as well. Also creating equity increases was ECB's Long Term Refinancing Operation (LTRO) brought in December and expanded in February. Markets went up consistently with all these announcements.

Today, we have existing Fed purchases of mortgage backed securities (MBS), expanded into Operation Twist money going into treasury purchases starting in January. For ECB, they’ve expanded LTRO twice, and announced their Outright Market Transactions in September.

But today, in response to expanded U.S. asset purchases, equities either fell, or remained unchanged in U.S. A disappointment, at least for me.

While all central banking efforts have maintained asset prices, fundamentals for companies have not improved proportionate to central bank liquidity infusions. Or, for the matter, Europe’s LTRO and improvement for bank balance sheets.

Simply stated for companies, only about 40% beat revenue expectations, after expectations were cut several times.  Q3 earnings season saw some surprising disappointment, with Apple and Google, together with McDonalds and Caterpillar…to name a few. Look at S&P or Dow charts through Q3 earning’s season.

When European Union is in GDP contraction, and Japan joins in recession, little space exists for U.S. decoupling.

Essential is improvement in demand and willingness to invest. A U.S. budget starts confidence in growth. Especially where U.S. shows GDP growth currently.

CURRENCY/EQUITY ASSET PRICING CORRELATIONS PART II: AUGUST TO OCTOBER

Equity and Currency Pricing are Looking More Normal, but Currencies also Show Caution

Currency/equity prices showed a noted divergence late last week. S&P went up where euro went down and U.S. dollar went up. Going into this week, risk appetite seems more in play with currencies. But interesting to note is 1.3000 appears to be key resistance for euro and 80 key support for U.S. dollar. Today, Equities are showing strength, but currencies seem less convicted.

Euro’s daily chart shows moderate price increases for Monday and Tuesday. However, MACD histogram continues to weaken with the indicator threatening to turn down. For U.S. dollar, it’s in decline, but its MACD histogram also seems week. Equities, in contrast, simply look strong.

Looking at these asset correlations, one can see decided influences that drove pricing among the three assets. Any divergence in past correlations raises a warning and indicates potential of a change in dynamics, or one asset class front running the others.

Below is a continuation of last article “Currency/Equity Asset Pricing Correlations Part I: July to August.”

Last article looked at July through August market activity among U.S. dollar, euro and equities. Notable were ECB negotiations with Germany. While negotiations initially were framed by public comments and affirmed by markets, an agreed policy was announced in September.

Looking at September, August’s developments came to fruition.

ECB and Fed Comments Brought Cautious Optimism to Markets, But German Comments Confused Markets

After Mario Draghi’s remarks of doing what it takes on July 26, markets found optimism in August due to expressed ECB commitments. Markets held an optimistic caution with release of Fed minutes on August 22.

Until August 22, equity markets moved up on an escalator, with slow steps made every day. On August 2, S&P closed at 1,365, and on August 20, S&P closed up 1,418. Same time period, euro and U.S. dollar proved unconvinced and moved sideways.

Day before release of Fed minutes, August 21 saw S&P drop from a four year high closing at 1,413 and Chicago Board of Exchange equity volatility index (VIX) gained 7% ending at 15.02. Where equities fell and VIX indicated larger declines ahead, U.S. dollar looked decidedly risk on opening at 82.46 to close down bullishly at 81.91. Euro demonstrated a rise breaking its drift.

Early on August 21, equities started a rally on reports that ECB would start buying Spanish and Italian debt. Also encouraging was German Chancellor Angela Merkel remarked that Germany would do whatever it could to support the euro, mirroring ECB’ Mario Draghi’s statement of July 26.

Dashing rallying equities was a Deutsche Bundesbank statement critical of both Draghi’s and Merkel’s remarks. German Central Bank said it was hesitant to engage in euro system sovereign bond purchases with such purchasing posing a risk to stability.

Apparent Consequences of Confused German, European Direction

Close of trade on August 21 saw market participants walk off the field confused over conflicting remarks. Equities took the conflict to hart and went risk off. Currencies saw a brighter side and went risk on with dollar declines and euro advances.

August 22 didn’t revive equities, as otherwise expected. But currencies continued in bullish fashion. Federal Reserve minutes of their July meeting were released. Minutes revealed a consensus to engage in a new QE program soon should no economic improvement develop. This comment made QE almost assured, save a miracle in economic indicators. Given trends in economic indicators, no miracle could reasonably be foreseen.

Despite Fed assurances, equities declined on August 22 and VIX increased. From there, equities went into a mild downward slump until September 6. U.S. dollar on August 22 fell .42 points and euro took off upward.

Euro closed on August 20 at 1.2347 and opened August 21 gapping up to 1.2436, up some .89 pips. By August 22, euro closed at 1.2529.

U.S. dollar then began a slight rise reflecting a mild decline in equities. Euro however engaged in a sideways bullish push up. Overall indications suggest market confusion due to conflicting remarks, but confusion was optimistically skewed given currency movement.

Euro Strength Foretold Market Response to ECB and Fed Easing Announcements

September’s policy statements from central banks kicked off a rally that would gird markets until Q3’s earnings season.

Simply stated, ECB and other European stakeholders worked out an approach despite previously confusing statements. On September 6, ECB announced their Outright Monetary Transactions (OMT). In order to activate such bond purchasing, ECB explained that a country must first request assistance. Thereby the country would subject itself to fiscal review and necessary austerity. Still S&P leaped up opening at 1,403 and closing at 1,432, up 29 points.

Euro experienced a major gap up in overnight trade and opened September 7 in U.S at 1.2704 to close up some 111 pips at 1.2815. U.S. Dollar relaxed finding itself down at 80.25 from an opening of 81.04.

Further juicing a bullish market was a September 13 Fed announcement revealing its $40B/month in mortgage backed securities (MBS), without a time frame. All markets, currency and equity alike, responded in bullish fashion.

Market Euphoria Turned into Sobriety Due to Limitations of Easing Prospects

September 17 marked an S&P multiyear high, a euro high and a U.S. dollar low. Leading to September 17 was a four day bull party for markets resulting from a September 12 German high court decision approving Germany’s participation in Europe’s European Stabilization Mechanism.

September 17 witnessed an end to a party fueled by central bank announcements and a critical German high court decision. On September 17, Dow fell .3% down to 13,553, S&P fell .3% to 1,461 and VIX increased .6% closing at 14.59.

Breaking up a bull party appears to be reality setting in on ECB OMT transactions. Markets realized no major bond buying would occur in Europe. In fact, for bond buying to trigger, it became evident European countries would have to sacrifice sovereignty in exchange for assistance. Also, for Fed announcement, MBS purchases implied bank responsibility to create mortgages in order to create MBS’s, thereby feeding Fed purchases.

Come October, central bank propositions were known and expectations started to price in. From September 17 to October 18, U.S. dollar trended up, euro formed a cup and S&P failed at a triple top.

Q3 Earnings Season Turned Sobriety into Depression and Banks Disappointed with Good Earnings But Bad Interest Margins

Essential reality set in prior to an expected disappointing Q3 earnings season. Reality revealed that ECB efforts would only be triggered upon country request. Meaning markets would not see any immediate bond buying by ECB. Greek experience juxtaposed against Spain to tell hesitation of countries requesting ECB assistance. Still Spanish and Italian bonds cooled.

For U.S., Fed’s QE3 wasn’t an open purchase of assets as in last two QE experiences. Rather, with QE 3 being restricted to MBS, banks realized that they needed to create mortgages to feed the MBS purchasing machine over time. Troubling for this proposition was realized as banks released earnings in Q3. One phrase cooled U.S. equities against QE3: Net Interest Margin.

With Net interest margin having been in decline, and higher earning securities obviously coming to maturity, issuing new mortgages at very cheap interest looked challenging for bank income. Suggested was/is banks must make up difference in margin with fees, service charges or trading. But Dodd-Frank legislation restricts other revenue stream capacity.

Apparent to markets was a Fed effort to grow U.S. economic propositions by growing real-estate. But to do so, banks remain a cautious partner due to interest margins. ECB’s OMT exist only once called upon by a particular country.    

CURRENCY/EQUITY ASSET PRICING CORRELATIONS PART I: JULY to AUGUST

Essential Nature of Asset Pricing Now and Over Months

Price action among assets have over months revealed euro and S&P to be positively correlated, while U.S. dollar moves opposite and is negatively correlated with euro and S&P. Last two trading sessions, however, are showing an odd break from these correlations.

Namely, as mentioned in last article, euro is in decline while S&P is up, and the U.S. dollar is up. Normally, where S&P goes up, one could expect euro to increase and dollar to decline. Stated otherwise, S&P is breaking from correlations to show risk appetite or a bullish sentiment. Euro and U.S. dollar are showing an opposite risk aversion or bearish sentiment.

Looking at past information that moved market price reveals fundamental influences on current asset class divergence today. Without knowing where you’ve been, how can you tell where you will go tomorrow.

July Market Activity Showed Considerable Disappointment, Except Exploratory ECB Comments  

Starting with the July to September period provides a reason for S&P recovering from its low of 1310 level in July. Going into September, S&P levels managed to reach 1470, which amounted to a multi-year high.

July 24 starts this period’s tail by knowing U.S. earnings season was in full bloom. This day marked a third day of 100+ point declines on the Dow Jones Industrial Average, with July 24 down 104 points to close at 12,617. U.S. dollar index was on a rip reaching 84.0, a high. Euro sunk like lead and saw a level below 1.2000.

Reason for S&P and euro declines and a U.S. dollar rise was Q2 earnings reports and renewed Greece problems magnifying Spain’s problems. On July 24 United Parcel Service, a strong bellwether, reported earnings and revenues that missed already reduced estimates and its stock fell 4.6%. Richmond Fed Manufacturing Index showed contraction and Reuters reported Greece would need another debt restructuring.

By July 25, things were looking up. Although Apple’s earnings were a surprising upset, Caterpillar and Boeing reported strong results. Still, sale of new houses reported a June gain of 350,000 when 369,000 was expected by economists. Also known was Spain’s borrowing level stood at an unsustainable 7.75%, German business confidence looked weak and Britain’s economy slumped for a third quarter.

Given these factors, equities closed mixed on July 25 with Dow up at 12,676, and S&P remained down, but only by a fraction.

Reason for July 25 avoiding a fourth day of deep equity losses appears to have come from Europe. While Caterpillar and Boeing looked good in Q2, ECB’s Edward Nowatny made a comment that bazooka power of European Stabilization Mechanism should be justifiably bolstered.

Such comments appeared to light a candle in darkness. ECB hadn’t yet announced their easing measures and Federal Reserve was “watching the economy closely”.

July 26 Activity Affirmed ECB’s Exploratory Comments and Renewed Equities, Euro and Took Stress off U.S. Dollar

July 26 sent a pitch to equity markets in the strike zone. Instead of rebuffing Edward Nowatny’s aggressive comments, ECB President Mario Draghi added to comments. Draghi made his politically charged comment that he would do whatever necessary to protect the Euro Zone. Consequently, Spanish yields retreated from threatening levels. Also helping were U.S. jobless claims coming in less than expected, durable goods beat expectations and where Exxon Mobile disappointed; 3M, Akamai Technology and Whole Foods Markets looked good.

July 26 saw Dow up an unimaginable 212 points, especially given previous trends on closings. Euro gapped up to just under 1.2280 from an abysmal 1.2100 space, U.S dollar took a steep loss into an 82.00 area from a near 84.00 area.

Nature of German and ECB Negotiations to Accomplish a Lasting Market Confidence Through August

ECB statements and some good earnings reports, against reduced earnings expectations, lit a firecracker under the back-side of equities. But more gunpowder was needed to push equities to recent year highs witnessed in September. Despite this gunpowder that would come, currencies stayed within range and correlations.

After July 26, on July 27, S&P made another grand advance, up a sharp 1.9% and Dow up 1.5% or 187 points to cross the 13,000 level, an obviously protected level today.

ECB remarks kicked of discussions among all European contributors, especially with Germany, which funds much of European activity.

Terms of ECB and German negotiation became defined by setting policy expectations in public spaces through exploratory comments. Markets affirmed the comments. ECB thereby gained a lead in negotiations, through placing market expectation “follow-through” on difficult countries that are deservedly difficult, due to imbalances.

Result was a real discussion of where to go, and by how much. Breaking a juggernaut.

Germany parlayed its stressed movement into limiting ECB.  Where ECB expressed open buying of bonds, the two agreed on Outright Market Transactions (OMT)….of buying bonds of countries to support debt pricing…..but only if and when a country asks for help….and thereby sacrifices fiscal sovereignty. It wasn’t until September that German/ECB negotiations resulted in a real policy.

Before German/ECB negotiations resulted in a September announcement, markets went into August with optimism, enhanced by Fed minutes.

Fiscal players in U.S. currently aren’t displaying similar alacrity in discussions as demonstrated by tough German and ECB negotiations.

Currencies Are Risk Off, Equities Are Risk On: A Divergence In Past Asset Performance

Last couple of days show asset classes acting in divergence from past market movement. Since summer of 2012, euro and S&P have traded almost in lock step….providing indications of sentiment. Trading in opposite correlation are U.S. dollars. Such positive euro and S&P correlations and its inverse, U.S. dollar, have not been numerically precise, but have moved with convincing consistency. These three assets have been so consistent; they’ve been market prophets due to all three moving in expected correlation.

Recently, the currency component of these three assets move according to last several months of history. Being when dollar goes up, euros go down. However, and also recently, equities aren't moving according to several months of predictability. S&P and Dow are moving up. Given dollar and euro currency movements, one would expect equities, or S&P and Dow, to go down. But they haven’t, in fact equities are increasing in value.

Equities are breaking from past correlation and rising from side way movement. Still, currencies trade according to months of performance. Currencies are seriously risk off with dollar up and euro down in notable terms. But equities assert a serious risk on look, by going up. Therein resides divergence in currency and equity assets. Equities are now outperforming past correlations with currencies. Why.... is the question now.

Currencies are tied to fundamental country performance….essentially a country’s economic indicators and domestic ability to show wealth…as in consumption, inflation and debt. Equities are tied to  fundamental capacity of companies to increase revenue firstly. Depending on ability of management, revenues are theoretically converted into earnings, boosting shareholder value.

Looking at recent movement in equities against currencies, such divergence doesn't appear to be justified by fundamentals . That is, equity markets or company earnings and revenues don't look that much better versus issues countries are confronting. Conversely, equity markets might be seeing optimism in coming country or company performance. 

Reason for optimism seems remarkably clouded now. Clouds right now come especially from prospects of fiscal solutions in the U.S., and whether the Federal Reserve will expand QE3. 

Fundamentals for both currencies and equities remain challenged after economic indicators and company earnings reports are considered.  

Public Domain Software: Pain From Intellectual Property To Electronic Retailer

Technology is seeing Trending Price Deterioration

Essential problem confronting technology companies, especially original equipment manufacturers, is a price deterioration of product. Anecdotally, if one prices an electronic item at a wholesaler, then looks at same item on a major internet retailer such as E-Bay for instance, a level of price competition can be witnessed. What is disturbing, however, are increasing frequencies when same item will show up at impossibly deep discounts.

Ramification of this effect across supply and distribution chains disrupt business planning prospects from memory suppliers to electronic retailers. This effect has been witnessed for years in memory markets and lower value added electronics. Now, it occurs in tablets, smartphones and equipment in general. Operating system associated with these lower priced products often times is Android.

Lost Value in Intellectual Property, along with Supply and Distribution Chains

Protecting product pricing typically comes from retaining control over intellectual property rights, while also managing business chains. Firstly supply chains need to be managed to prevent outsourced manufacturers robbing technology. Secondly, distribution chains need an ability to show pricing discipline to prevent flooding markets and price declines.

However, first attack to this model is putting intellectual property into the public domain for innovation and new discovery. Android and WebOS are primary examples. Where Android did not involve a deep upfront investment by a single company, WebOS was held by Palm, bought by Hewlett Packard for $1B. Now it’s given to public collaborative development.

WebOS was the intellectual property backing future propositions for Palm. Hewlett Packard’s justification for buying Palm was moving Palm’s technology into currently competitive products. Now WebOS is in the public collaborative space, as opposed to Hewlett Packard’s portfolio of intellectual property.

Apple once had a very unique product. Now Android finds its way into various products sold by various companies. Some of these companies look for market share by defining their products with cheap pricing. Defining a company by distinguishing your products with cheapest price is a losing proposition.

Strength is in Maintaining an “Ecosystem” of Integrated Products that Improve User Experience Across all Products

Apple’s major strength today is their “ecosystem” of products. Which basically equates to intellectually protected products (outside of Samsung’s win, loss or draw) a protected supply chain (again outside of Samsung issues) and a distribution chain that is so far exemplar in sustaining price strength.

Apple’s other major strength is its integrated products which not only communicate with each other, but do so in a synergistic way. For example, seeing your phone on your living room TV set….at least should you be so inclined. And a new Apple TV system is expected.

Android teaches that once intellectual property is released to the public domain, intellectual property value deteriorates for any one company. Result appears that many companies compete against each other for fast deployment of existing technology. A race then occurs to cheapest pricing. Winner in this model becomes the company that adapts new technological creation into equipment production on the cheap. Rising labor costs in China can be a limiting factor, but other ASEAN countries?  

Japan’s Efforts to Avoid Recession, Comparison With Central Bank Activity and Focused Easing

Bank of Japan’s Expansion of Easing and Bank Funding, With other Central Banks

Japan’s economic indicators are showing weakness and expectation is Japan entering recession in Q4. Where European Union has slipped into technical recession, Japan seems next. Company revenues generally disappointed in Q3, though analysts moderated their projections through the quarter. In Q3, analysts also moderated their earnings projections. With revenue disappointing, considerable declines in earnings could be realized.

Real question is what catalysts exist to prevent recession in Japan and sustain demand, and therefore sales.

Countering Japan’s economic numbers are efforts of Bank of Japan. In September, Bank of Japan (BOJ) announced a 10T (Trillion) yen increase in its already existing asset purchase program, raising total easing purchases to a projected 80T yen.

This announcement was relatively concurrent with U.S. Fed’s September QE3 announcement consisting of $40B/month in mortgage backed security (MBS) purchases. European Central Bank also announced their Outright Monetary Transactions (OMT), which cooled Spanish and Italian yields.

Bank of Japan took further steps in October by raising their easing programs another 11T yen, to a total 91T yen. Where U.S. QE3 remains stable and ECB’s OMT remains untapped so far, BOJ is expanding their asset purchases.

Not only does BOJ have an expanding asset purchase program, but also exceptional funding for banks, similar to United Kingdom. BOJ has ear marked 66T yen for asset purchases and 25T yen for bank funding to promote lending.

BOJ’s Asset Purchasing Projections, Japan Market Responses and Other Central Banks

For BOJ’s asset purchasing, it is a diverse program which involves risky assets. According to BOJ’s description of its asset program, the bank has 39T yen earmarked for Japanese government bonds, not unusual. They have 19.5T yen reserved for Treasury Discount Bills, again not unusual.

What is of note, and according to BOJ information, bank is putting 3.2T into commercial paper. 2.1T into exchange traded funds (ETF’s) and .13T into equity issued by real estate investment corporations. Appears BOJ is taking equity stakes.

Interesting for BOJ’s approach is when they announced their enhanced easing in October, Japan’s major stock index, Nikkei 225, fell 1%. Of course concurrent worries of territorial disputes with China existed as with European issues. Still, long term prospects for BOJ’s balance sheet perhaps raised concern.

Contrasting is U.S. QE, which so far remains constricted to MBS’s. Also is ECB’s OMT’s, which remains confined to sovereign bonds of a country requesting assistance. It appears Spain has not made a request most likely out of protection of its sovereignty. Recent Catalonia elections, however, could force matters.

BOJ’s Measures to Promote Bank Lending, Covering Natural Disaster

BOJ also has two bank funding plans. Firstly is its “Growth Supporting Funding Facility” of 5.5T yen, increased in March by 2T yen and currently tapped at 3.4T yen. Then is BOJ’s loan promotion called “Stimulate Bank Lending Facility”, of some 19.5T yen.

Growth Supporting Funding Facility looks to be a rebuilding effort in Japan’s tsunami and earthquake devastates areas. Starting at 2.1T yen, BOJ announced in March an increase of 3.4T yen to a total of 5.5 T yen. BOJ Governor Shirakawa also announced relaxing program restrictions in order to reach smaller lenders and promotion of access to loans for medical providers. Loans under this program look to be .1% and require application review.

When this announcement was made in March, Japan stocks fell and yen rose against U.S. dollar. Apparent was market disappointment in BOJ not announcing other easing measures. But added easing certainly came in September and October.

Promoting Bank Lending on an Organic Basis, Like BOE’s Similar Efforts: Results Awaiting

Next bank funding mechanism for Japan is its “Stimulate Bank Lending Facility” announced in October. This facility appears to have 19.5T yen of ammunition (though “unlimited”) and is a funding facility tied to net bank loans. Much like BOE’s “Funding For Lending Plan”.

BOJ’s Stimulate Bank Lending Facility grows out of what Governor Shirakawa expressed in his November 12 speech in Tokyo. He said “The bank hears from many corporate managers that there are only a few attractive investment opportunities at home.”  Explaining cause for a proposed solution, Shirakawa offered, “Unless we somehow manage to change this view, it will be difficult to stimulate business investment.”

Program details appear rare. Still based on BOJ documents, it is tied to net Japanese bank lending, can be yen or foreign currency denominated.

Analogous is BOE’s Funding for Lending Plan, which started in August and is a collateral swap program. British commercial banks swap their previously authorized collateral for United Kingdom treasuries. Values of U.K. treasuries a bank may swap are tied to amount of new lending the bank undertakes prior to program expiration. Enforcing the program is a penalty fee imposed on a bank should their net lending fall below a baseline.

 

For England, and yet to be known by Japan, is British Banker’s Association reporting progressing increases in mortgage lending, and in the period of October over September. BOE is, however, saying that it is too early in program progress to know actual effects.

 

Currently, it looks that new easing measures among countries are becoming much more directed and focused on particularly weak areas. This contrasts with previous easing that generally tended to flood markets with cash. More precise measures looks to focus liquidity in a manner that increases direct investment demand and employment.  

European Union In Recession, Japan Recession Looks Next

Company Revenue Declines Reflect Progressing Global Slowing

Preliminary U.S. GDP numbers will be announced Thursday with current consensus range being 2.8% to 2.9%. Such numbers seem ambitious given earnings season results. Where over 70% of companies reported earnings above expectations, a startling 60% disappointed on revenues. This marks the lowest beat rate on revenues since Q1, 2009, according to Factset.

Earnings can be made to look good by shifting accruals and creating efficiencies. Revenues are sales and they either exist or they don’t. Through revenues, one gains insight into fundamental demand.

Europe is an obvious explanation for apparent demand weakness. Europe also appears to be trending into added weakness.

Europe is now in recession with two straight quarters of GDP contraction. Most recent Q3 data shows a EU -.1% GDP contraction. This combines with a Q2 contraction of -.2%. Most concerning is Germany, EU’s chief financier. On November 23, Germany reported quarter over quarter GDP decline from Q2 growth of .3% to Q3 growth of .2%. Year over year, Germany’s GDP growth went from 1% in Q2 to .9% for Q3. More concurrent industrial production numbers show German production contracting -2.1% in October.

Japan Q3 GDP Contracts Sharply, Against Its High Sovereign Debt

Projections are next for Japan to fall into recession. Q3 results show Japan’s GDP declined a marked -3.5% versus Q3 2011, its largest contraction since March 2011’s tsunami strike.

Of Japan’s GDP, a cut of .7% came from faltering exports. A concerning feature given Japan’s declining Terms of Trade recently discussed on this space and its implications for Japan to sustain its debt, which ranges 220% of GDP. Highest among G7 countries.

Private capital investment, on the GDP report, saw caution assert with a decline of -3.2% versus Q2.

Japan’s Exports Continue Into Weakness, Now Imports Look To Further Weaken

Troubling for Japanese exports is an ongoing dispute with China over what Japan calls the Senkaku islands (China calls them Diaoyu islands). Consensus is this dispute now creates an outsized impact on trade between China and Japan. China is Japan’s largest trading partner accounting for 20% of Japan’s exports in 2011 compared with U.S. buying 15.3% according to Japan External Trade Organization numbers.

On November 20, Japan reported its merchandise trade results for October. This data reveals balances between exports and imports. According to data, Japan showed a steeper than expected trade deficit of -549B yen, expectation was for a -337B yen deficit. More troubling for global demand is Japan’s exports contracted by -6.5% in October, and its imports also contracted some -1.6%.

Exports for Japan are now down for a 5^th consecutive month, but exports to U.S. have been positive for 12 month and up 3.1% for October. Perhaps demonstrating U.S. decoupling from general global weakness (despite a strong yen). Still, creating real concern for U.S. is Japan’s negative import number of -1.6%, first time in only two months, indicating volatility looking to trend into weakness.

Deflation Marks Japan’s PPI, Japan And China Show Major Weakness In Steel Prices

Released November 11 was Japan’s CGPI (corporate goods price index) which is akin to a producer price index (PPI) and monitors price inflation, or deflation. October price results show deflation in Japan with producer prices falling -.3% month over month and -1.0% year over year. This index is trending into deflation with October bringing a 7^th consecutive monthly decline.

For particular businesses, weakening is most noted in electronics at -3.6% and lumber -3.4%. But what really shows weakness is iron and steel prices down a concerning -9.9%.

Declining steel pricing in Japan combines with a similar result from China’s PPI (released November 8). China’s PPI showed ferrous metals down 11.4% for October, after contracting 12% in September.  

Looking at other economic indicators for Japan, none  point to positive results. General propositions suggest Japan entering recession. However, Bank of Japan has been hard at work with a variety of programs, which includes a very diverse asset purchase program that’s been growing.

Recent Fiscal Talk Meets Declining Company Revenues: Cost of Capital

Widening Credit Spreads Are Supported By Declines In Company Financials

Of notice are current credit spread increases associated with serious winds out of Europe and other matters. Currently, credit spreads are increasing in recognizable terms. Such increases can be noise, or a real deal on market moves. Due to last quarter's moves in fundamental financial performance of companies, namely disappointing sales results, widening spreads aren't surprising. Credit spreads, company sales and sovereign debt all appear correlated.

Credit spreads have been in a condition of widening since October. But over the last few trading sessions, spreads have been moderating. Encouraging in this regard are optimistic market responses brought by politicians addressing U.S. fiscal issues. Because fiscal approaches right now are nascent and undefined, strong market responses seem a little irrational.

Fiscal Talk Starts An Economic Anchor, But For Fundamental Conditions To Improve, The Anchor Must be real  

Where central banks have held the dike, giant leaks are showing not necessarily in company earnings, but in sales, and cash flow. Inevitably declines in revenue and cash flow can appear in considerable earnings disappointment. We are seeing this progressing weakness in most recent reports on earnings.

Company revenue and cash flow issues certainly threaten investor expectations of increased dividends and share buy backs, let alone capacity for fundamental or organic growth. Despite very low interest rates, when declines in revenue are experienced, cost of capital for companies increase especially on the equity side.

Increased cost of capital diverts management's attention to transitioning into cheaper capital, being debt currently given low growth prospects longer term. Cost of debt needs to stay stable. Stability in this area should enhance return rates, confidence and make equity pay. Equity pays only with higher rates of organic business growth. 

Equity comes with increased risk over prioritized debt.

Company Revenues Take Time, Political News Cycles Occur Overnight

What took time to develop was company weakness in revenues and cash flow. What hasn't taken time is  lots of optimistic buying due to fiscal lip service. Company financial statement fundamentals remain necessary for business function, let alone equity growth.

U.S. has an interest rate on its debt not deserved by its fiscal situation. A Q4 question is whether equity prices are reaching a similarly undeserved level, given increased prices of equity due to declining fundamental growth.

Worry exists that news cycle flashes will only create an illusory solution. Should markets respond on illusory lip service....too much encouragement grants a license for continued talk.

U.S. Has a Debt Issue, Compounding is Japan's Debt Issue

Debt Presses Europe, Now U.S., Next Japan

Obvious new dynamics are occurring in highly developed countries. Debt issues are progressing beyond capacity for easy resolution and grow to become a mirror that fiscal policy leaders do not want to see. Also obvious is progression of this dynamic moving from Europe into U.S. Next will be Japan.

Japan is unique in that most of their debt is domestically financed, as opposed to foreign investment. But, for Japan, a shrinking global economy bodes that their ability to domestically finance debt will also shrink congruent with slowed global growth.

On November 8, Japan's finance ministry reported a current account deficit for September. First time in 30 years. Japan's terms of trade (a ratio of export prices against import prices) has been in deterioration as value from exports wane against costs of imports. From 1960 through 2012, terms of trade for Japan have averaged 174.56. In August, 2012, Bank of Japan said the number stood at 90.50.

Based on more concurrent indicators, terms of trade numbers aren't improving for Japan.

Where Europe has managed to kick a can down a blind road, chances for other countries, namely the U.S. and longer term Japan, to perform in like manner diminish. Perhaps significantly. All due to progressing global weakness.

Hope of economic growth increasing government revenue to offset debt not only is looking bleak, but government debt is too large for realistic growth rates creating a meaningful offset on debt.  Austerity can't be avoided. Still, austerity's reach needs to be balanced, to avoid strangling growth. Historical analogies don’t really exist, certainly in an integrated global economy.

What is known, U.S. Congress needs to look more adult and less childish. Winning political party battles on scorched earth efforts, leaves a scorched America.

Fix For Fiscal Cliff

Times are heating with anticipation of a presidential election and associated congressional numbers. Where central banks have been making meaningful steps to move things, elections now tell of fiscal movement, or continued paralysis.

While editorial management at this establishment apparently frowns upon political commentary, I doubt if I will lose my job. With my hidden tablet, its just a man and his thoughts now.

After singing to myself "No Body Knows the Trouble I've Seen" for a few weeks, I also managed to get enough reception on my tablet to see a couple of views of Thomas Peterffy's ad. What I could see of it made sense.

Regardless of presidential results, I found a solution for Congress. Constitution doesn't have to be changed, nor any real voting process.

Necessary, however, is maintaining a two party system....but now with three choices for each party to vote upon as a party, and then present to the other party.

 It is called Rocks, Paper, Scissors. Best two out of three on any issue. Should reduce risk of inaction considerably.

QE 3 UNLIKELY AND WILL NOT SOLVE INFRASTRUCTURE DEFICITS

QE3 is now at zero hour for any announcement out of Jackson. Markets have been pricing in expectations and pundit positions are every where. Conversely, why should the Fed say yes to QE?

A presidential election is a few months off, and the Fed must sustain neutrality. Political neutrality is a major Fed mandate, which neutrality is also expected of those elected. A quid pro quo.  Also, equity prices haven't fallen over  time despite overall caution in company guidance and reductions in revenue. Earnings per share have been revised down over time which seems natural against overall economic developments. But declines in revenue were surprising. Declines in revenue tell of limits in sustaining earnings.

Noted cash with some companies and considerable excess reserves among banks tell of hesitancy to engage opportunity. Hesitancy of course arises from ultimate insecurity in fiscal policy and regulatory behavior.For the Fed, insecurity tells of cash hoarding and inflation potential once hoards are released.Especially with market advantages gained by M&A activity over a few years.

Progression in economic indicators have been touted. For July results reported in August, retail sales, industrial production and durable goods orders have shown an advance. But, after how many months of decline or teetering on loss. Do they now show a climb out of a hole or a developing hole? Regional Fed manufacturing results have been very weak and moving into trending decline for some time.

Crude and gasoline are in a new place with demand obviously having increased due to world development. Still, technology and price differentials have created supply opportunity and advantages. For such opportunity to be realized, infrastructure development needs to occur in order to move product to refining centers and then global markets. It's occurring, but at what cost both financially and in gross petroleum flow.

Can QE3 cure hesitations among companies and banks, and then bring cash to markets? No. Can QE3 solve petroleum infrastructure problems? No. Once infrastructure gets addressed, can QE3 open new markets? No.

Totality of consideration puts QE3 at not likely now. Should it happen later or even now, diminishing returns will be realized.

Expected by the Fed is a tale told similar to ECB's leader of how all will be protected, should the need arise.

  

FED MINUTES TELL MAJORITY WANTS QE3, BUT CONVICTION FOR QE3 REMAINS HESITANT

Speculation on a third round of Federal Reserve Bank quantitative easing, or QE3, found much more certainty in its occurrence. On Wednesday, Federal Open Market Committee (FOMC) minutes were released revealing existing Federal Reserve sentiment. Based on Fed discussions, QE3 looks to be a matter of time rather than “if”.

Quantitative easing amounts to the Fed increasing monetary supplies by buying government securities such as treasuries from banks. Banks thereby receive an infusion of cash. Then, expectations are for banks to lend their new cash. Past experiences have revealed, however, increases in commodity values and equities. Also realized in past QE is treasury prices decline and yields increase while the dollar falls due to flooding liquidity.

Oil prices, being driven in dollars, are fraught with a balance between cheapening U.S. dollars and increasing demand driven by comparatively cheap dollars.

With oil prices having been in decline for a considerable period, starting certainly last April, increases in U.S. dollar isn't a cause, U.S. dollar has increased but not to a degree explaining crude price declines. Rather, supplies have increased against a decline in global demand, simple. Implied is further QE might not ultimately drive up demand for oil, and thereby U.S. or global production. Rather, QE3 could raise petroleum prices through speculation driven by past pricing experience, only for economies to ultimately see a further decline in demand and production due to price.

Data also reveals QE's association with increases in GDP, here in the U.S. and abroad. It can have a positive influence. But that influence is experienced only during the period of exceptional easing operations. Once it ends, we return to what existed otherwise. Similarly, cash infusions brought by QE certainly create reserves to be used later, during better economic times. Suggested is potential inflation later once economies improve. However, when will economies improve. Recovery is now a new normal.

Saying this, FOMC minutes of Wednesday reveals QE3's likelihood, but not its conviction. Where minutes say “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” Other comments, apparently in the minority, point out QE3 risks.

According to FOMC minutes, “A few participants were concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or lead to a rise in longer-term inflation expectations.”

Through FOMC minutes, alternatives to QE3 were addressed but overall rejected. Namely was discussion on other central bank activities. ECB's zeroing of interest charged on deposits was considered, but rejected. ECB's efforts are conducted under different money market conditions from U.S. conditions. FOMC also looked at Bank of England's Funding for Lending Plan. Such plan looks interesting, but open to bank gaming. This plan was rejected because minutes say “importance of institutional differences between the two countries was noted.”

FOMC comments appear to tell of a majority seeing progressing weakness, as opposed to a soft patch. QE3 looks like a matter of time, with reservation of hesitancy among some members. Where will any substantial and sustainable data of economic growth come from?

AGAINST GLOBAL WEAKNESS, MACHINERY HOLDS SPECIAL STRENGTH

U.S. GDP BETTER THAN EXPECTED IMPLIES INFLUENCE OF OIL AND GAS

Q2 GDP did sound off better at 1.5% growth versus an expected rate of 1.2%. Though GDP shows sequential decline, it remains in growth. Caution  arises through a variety of more current data mentioned on this space yesterday.

Remarkable, however, is sustained pricing and production witnessed in machinery. Resilient strength is known in vehicle production (with sales flat or in decline). Also accounting for growth is a bottom in housing ownership which is renewing a rental market. With it comes increases in multi-occupant residential construction. We then have improved technologies demonstrating a renewed petroleum and natural gas industry here in the U.S.

All create positive business ramifications. From vehicles, structural construction and development of oil and gas fields, machinery is confirming a fundamental strength. But this strength is only as strong as its underlying causes.

INDUSTRIAL PRODUCTION RESULTS SHOW SUSTAINED STRENGTH IN NAICS 333, MACHINERY

North American Industrial Classification System (NAICS) is how the Fed and other economic data collectors classify data into groups. NAICS 333 is composed of real machine manufacturers, like Caterpillar and Deere, from there it goes into the manufacture of metal work machinery, engines, turbines, power transmission and industrial machinery which includes; saw mills, rubber and plastics, textiles and pipe production machinery. 

Last Industrial Production report from the Federal Reserve, dated July 17, tells a tale of overall weakness on a quarter over quarter basis for all items. For example, where manufacturing was up 5.6% Q4, and up 9.8% Q1….it was up only 1.4% for Q2. Keeping in mind Industrial Production is a lagging indicator, Q3 could show deeper weakness given more concurrent indicators reported on this site.

Optimism is found, however, in some fundamental items on the Industrial Production report. Machinery sales is chief in that Q4 saw an annual increase of 8.5%, up a giant 21.9% in Q1, and through a tough Q2, it was up 8.8%.

Machinery weighs heavily and significantly on the Industrial Production report at 5.41% of durable manufacturing, where motor vehicles are at 5.33%, computers and electronics at 6.25%, transportation equipment at 4.30%  and miscellaneous at 3.12% (all values are weighted against the overall index).

Sustained sales in machinery over quarters compare with noted and known strength of motor vehicles which were up 23.9% Q4, 41.0% Q1 and up 18.2% Q2. Miscellaneous Industrial Production is like autos with robust growth and sequentially up from a rise of 2.3% Q4, to 9.9% Q1 and up 13.5% Q2 (sequential Q2 growth, unheard of among indicators and shows outstanding performance).  

Computers and electronics saw a rise of 1.0% Q4, 8.8% Q1 and 5.1% Q2. For transportation equipment, data shows a progressing sequential decline from 17.7% Q4 all the way down to -.1% Q2.

From Industrial Production data over quarters, one can garner sustained strength in machinery, vehicles and miscellaneous production. Computer and electronics hang in there, but not to the degree of machinery, and other items. Transportation equipment is in sequential decline.

All told, machinery has proven itself for months to be consistent and sustained in production, as with automobiles. Next factor to look at is pricing durability over the period.

IMPORT/EXPORT PRICING OF MACHINERY HOLDS STRONG

Import/Export data from the Bureau of Labor Statistics provides this information. Dated July 12, 2012, information shows import machinery pricing up 2.4% and export pricing up 2.8% (Y/Y). Compare such result with other leads on manufacturing being computers and electronics for example. This area is down on imports  -1.8% and up some .4% on exports (Y/Y).

Versus other major items on the BLS import/export data set, machinery manufacturing especially with exports holds pricing strength. This along with sustained and continued demand tells of foundational economic strength.

Revealed in GDP is a base of resiliency. It appears vehicle and petroleum production in North America are proving to be anchors in filling what consumption exists. Consumption feeding car sales and petroleum are giving demand to machinery demand. 

Q2 GDP STRENGTH COULD TURN INTO PROGRESSING Q2 INDICATOR WEAKNESS FOR A Q3 DECLINE, OR SUSTAINING MODERATE GROWTH

Current situation is that retail sales show auto sales in decline, while data from car manufacturers show flat results. Compare this with industrial production data which shows cars still in a rate of good but reduced production. Oil and gas are in a serious issue of oil and gasoline declining globally with consumption, but consumer prices staying high due to refiner limits on end use product supplies. Housing is so infant, any growth is magical. 

Through what window are drivers of this economy looking, and perhaps seeing only their own reflection.  Chart below is the Dow Jones Industrial Machinery Index, an idea to be kicked around, especially after today.

Say China goes into deep easing and more spending on infrastructure, say Euro Zone goes into similar levels of bond purchases as known before or even more, say interest rates are generally relaxed among developing countries such that carry trades become a secure proposition.

Could we then be one step forward with global easing, but then learn at the end of easing we are really four steps back. At some point, fiscal policy aside from austerity alone must step to the plate and take a real swing.....good, bad, or indifferent, action matters. 

Fed Regional Indicators and Q2 GDP, Industrial Production and Importance of Numbers Now

Q2 GDP and Industrial Production introduce a new round of Fed regional indicators for July

Fed regional indicators for July demonstrate continuing weakening entering Q3, as they did entering Q2. Putting Fed regional data into perspective is Q2 GDP and June's Industrial Production results. Regional indicators proved over Q2 to ultimately become a lead on GDP and other indicators, suggesting decent correlation.

GDP ended Q4, 2011 at 4.1%, Q1 at 2.0% and initial Q2 data showing GDP down to an increase of 1.5%, but still higher than an expected decline to 1.2%. Nearly all areas showed quarter over quarter decline with personal consumption expenditure down to a 1.5% increase v. Q2's 2.4% increase. Personal expenditure on durable goods fell into decline, down a -1% against a Q1 increase of 11.5% and expenditure on nondurable goods was flat.

Telling is motor vehicls' contribution to GDP where output provided .72% in Q1, the number fell to  .13% in Q2. Motor vehicles have been a major force of economic growth. Such a result comports with the Retail Sales report as opposed to month over month car company reports.

Providing support to GDP was a slowing of the rate of decline in Federal government spending which declined to -4.2% in Q1, then to -0.4% in Q2. Where exports strengthened in Q2 to 5.3% v. Q1's 4.4%, the strength was offset by an increase in imports (which reduce GDP) to 6.0% in Q2 from 3.1% in Q1.

All told it appears that an uptick in government spending helped to support otherwise slowing production. Also a strong dollar encouraged import purchases offsetting positive increases in exports. Motor vehicles declined significantly while staying positive and....

June's Industrial Production results released on July 17 show a significant quarter over quarter decline in production. Total industrial production grew in Q2 by 2.2% against Q1's rate of 5.8%.  Manufacturing grew in Q2 by only 1.4% v. Q1 at 9.8%.

Breaking manufacturing down into durable and nondurable manufacturing, the durable side saw Q2 growth at 6.2% compared with Q1 at 16.3% with wood products, nonmetalic mineral products and primary metals falling into negative territory. Automobiles show continued strength but waning momentum. Q2 saw motor vehicle production grow at 18.2% against Q1's growth rate of 41.0%.

Nondurable manufacturing went from a Q1 advance of 3.5% to a Q2 contraction of -3.4%. In fact all items composing nondurable manufacturing went into significant contraction aside from printing/support and plastic/rubber products.

It appears that progressing weakness witnessed in Fed regional indicators month over month through Q2 did show up in GDP and industrial production. Concern is that where Fed regional indicators demonstrated volatile results which were inclined to weakness in Q2, such a trend might move into more consistent results inclined to consistent weakness. Implication could be deeper declines in GDP.

 Fed regional indicators are showing Q2 weakness with Q2 revisions and Q3 GDP implications

July's regional indicators are generally either in contraction, or if they happen to be up, they're not up by much. Empire State Manufacturing Survey has managed to keep its head above water. General business conditions improved a little in July going to 7.39 from June's 2.29. But one can't help notice how new orders fell into decline in May and progressed to July's -2.69 from June's 2.18.

Empire State does show improvement in shipments up to 10.28 from 4.81 in June, employees have increased, prices paid for raw materials continues in decline where prices received for finished goods ticked up a little from 1.03 in June to July's 3.70. Overall, the indicator is bouncing, but when it is bouncing up, the gains tend to be diminishing.

Kansas City Fed Manufacturing Index is like Empire, only stronger indications of weakness exist. Kansas City’s composite index showed a 3 in June and improved to 5 in July. Contrary to this 2 point improvement are continued declines in nearly all items. Production showed a decent 12 in June and down to 2 in July, for the same period volume of shipments were 12 and in July -3, new orders are in sequential but relaxing contraction with June at-7 and July -4, average employee workweek is sequentially in contraction, prices paid for raw materials are up substantially and prices received for finished goods are contracting or flat.

Advancing items for Kansas City Fed Index are inventories, perhaps a consequence of production overshooting demand; and employment, perhaps due to similar reasons as with inventories.

Philadelphia Fed Survey, which started contracting entering May, remains in relatively steep contraction, despite a modest July improvement from June’s-16.6 to July’s -12.9. Positives do exist with new order improving in July to -6.9 from June’s -18.8 and shipments show similar improvement as with unfilled orders. What is most encouraging is pricing strength returned to Philly suggesting return of demand. Namely, prices paid were up in July to 3.7 against a -2.8 for June and prices received a positive 1.6 from -6.9 in July.

Adding to significantly contracting Fed regions is Richmond Fed Manufacturing Survey. Its composite index puts July at a contraction of -17 v. a contraction of -1 in June. Real problem, and unlike Philadelphia is shipments, new orders, backlog orders and capacity utilization which are contracting from  -16 to -27 versus a mild June of contraction.

Dallas Fed Manufacturing Survey moved into a dichotomy of significant contraction against growing weakness. Dichotomy is in business activity contracting to -13.2 in July from June’s 5.8 and production sustaining at a positive 12.0 in July from a June strong result of 15.5. Where business activity is in contraction, production side items in contraction are growth rate of new orders at -3.1 v. June’s 1.6 and unfilled orders at -1.6 v. June’s 7.6. Also in contraction are inventories with materials’ inventories at -3.0 against a June 1.1 increase and finished goods’ inventories down -8.0 where June was down -7.7.

Appears to be a dirth of demand driven destocking in Dallas. Low demand destocking can be seemingly confirmed with prices paid for raw materials up sequentially, but prices received for finished goods down -5.5 for July and down -5.8 in June.

Looks like Empire is struggling to stay above water and Kansas City should be underwater, but bloated inventories are creating a false positive in Kansas City. Philadelphia remains in significant decline, but showing pricing strength and perhaps growth in demand. Richmond does not look healthy at all and looks anemic. Dallas, where is this dichotomy going? Could be destocking driven by demand declines.

Overall, Fed regional indicators remain volatile, but even more inclined to weakness.

 Advancing indicators are a minority against declining indicators, showing a real trend

Other indicators are in contraction. Namely, Chicago Fed National Activity Index in sequential decline with June down -.45 and July down -.15 but the 3 month moving average down for all four months sequentially. ISM Manufacturing Index is down sequentially June to July with June at 49.7 (below 50 tends to show contraction) and July an improved 49.8.

 Leading Indicators are also down for a first time in a long time. Results are down in July at -.3% v. June up .4%. Essential strength for Leading Indicators is spread in yields (for banks) between 10 year Treasuries and Fed Funds rate. (I tried to borrow at Fed Fund rates and buy Treasuries for the carry trade, got denied, they told me I’m not a bank, I had no choice but to agree)

Currently, it does look like indicators that can sustain positive territory are in a real minority. Even then, they have their ugly points. In majority are indicators in decline, with month over month dynamics continuing into July progressing into pattern weakness.

Fed Regional Indicators, Car Sales and Retail Sales: Third Quarter Will Be Challenged

First half of 2012 shows weakness bleeding into Q3 for U.S.

Q2 results look to be mirroring deterioration seen in Q1. Where Q1 signaled slowing against Q4, 2011, Q2 results demonstrate a trend of H1, 2012, perhaps bleeding into Q3. First half of 2012 is marked by volatility across all asset classes, but most noted is progressing decline in global economic performance. Apparent is U.S. influence on global propositions. Emerging markets previously supported divergence in growth between developed and developing countries.

Now, where emerging markets demonstrate signs of progressing weakness starting in Q4 2011, Q1 and Q2 slowed for U.S., which magnifies emerging market declines. Certainly associated with all slowing is the largest economy in the world, the European Union (EU).

Liquidity and collateral insecurity originates in Europe, highlighted by Dodd-Frank and Basil III, but is really pointed in EU’s resolve to address the issue. Friday, June 29, showed unexpected EU cooperation driving up equity values in dramatic fashion. With few details being provided, summit talk at least took a direction wanted by markets.

Steepening EU commitment to its struggle is certainly progressing U.S. economic sluggishness. Q1 GDP is settling in at 1.9% growth against Q4’s 3% advance. From all indicators discussed on this space, Q2 opened weak, and looks to be closing with progressing weakness.

Regional Fed indicators deteriorated through Q2, and now ISM Index

Regional Fed indicators show Empire State taking a nose dive for June down to 2.29 compared with May at 17.09 (above zero shows growth). Where shipments were volatile through April and May, new orders trended weak, but stable. In June, both considerably declined. Inventories fell into contraction at -5.15 versus May’s 4.82 growth. Prices paid and received declined through Q2 with June showing both at November 2011 levels. Overall, index last saw such depressed activity during the European banking freeze which ended with ECB’s LTRO.

Philadelphia Fed Survey reveals declines starting in March, deepening in April and actually contracting in May. May saw the index down -5.8 and June a much deeper -16.8. Concern now is Empire will follow Philadelphia. Empire has the indications, but Philadelphia’s potential for improvement is M&A activity with their refineries and narrowing Brent/WTI spreads. Still, Philadelphia manufacturing seems to have found a lead on global economic slowing.

Richmond Fed Manufacturing Index has also been on a Q2 decline. April found Richmond at 14, May at 4 and June in contraction down to -3. Component deterioration troubles when shipments are at 18 in April, 0 in May and -2 for June. New orders saw April at 13, May 1 and June a stark -12. Backlog of orders look bleak with April a nice 2, May a bad -18 and June -16. Prices also weakened. On the good side, six months out, business expectations remain very positive.

Kansas City Fed Manufacturing Index remains positive, but in decline. April produced a 3, May showed 9 and June 3. Overall, volatility is leaning toward weakness.  Confirming weakness are employment numbers. Sobering is Q2 work week showing April at -10, May -2 and June -4. In the same period, number of employees declined considerably with April at 12, May showing 8 and June settling at 3. New orders have been volatile and mostly in contraction with April -8, May 10 and June -7. Prices paid weakened through Q2 and prices received are at -4 for June.

Dallas Fed Manufacturing Survey is the only indicator showing health, surprisingly. Where its business activity index slumped to -5.1 in May, June is at 5.8. Production in May fell to 5.5 where June rose to 15.5. Components of the index look strong except for prices. Prices paid for raw materials fell from 20.2 in May to June’s 2.7 and prices received for finished goods fell from -.5 in May to -5.8 for June. Curious is how general pricing weakness, as seen in other regional indicators, isn’t translating into general economic weakness for the Dallas Survey.

Moving into contraction is the ISM Manufacturing Index. For a first time since July 2009, ISM data fell below 50 to 49.7. Numbers above 50 show growth, and numbers below show contraction. New orders are also underwater at 47.8, first time since April, 2009. This index has demonstrated resiliency to maintain above 50. From August 2008 through July 2009, results stayed well below 50 while economic recession weighed. Now, index shows numbers reminiscent of the down days.  

Prices are also in dramatic decline with the index. March and April saw prices paid for raw materials at 61.0 for both months. May pricing fell to 47.5 and June to 37.0, which is the index’s lowest since April 2009.

Generally, Q2 saw progressing weakness ending out June with weakness in prices and new orders, suggesting a slow July. Also suggested are upstream and downstream declines in demand demonstrated by price weakness.

Cars contrast against retail same store sales to show a contradiction

Contrasting with Fed regional indexes and the ISM index are auto sales for June. For the first four months of 2012, sales showed an annual sales rate of 14.5M units. May, however, witnessed a 4.4% decline to 13.8M units. Given consumer confidence having declined for four months and disappointing employment data, analysts expected June auto sales to remain flat at May’s numbers. Surprisingly, June posted an actual result of 14.1M units.

Providing perspective for auto sales is April 2009 when sales hit a recession low of only 6.9M units. Auto sales closed 2011 with an annual rate reported in December of 13.6M units. Last time auto sales have experienced such success was in August 2009 when the “cash for clunkers” program lifted sales to 14.1M units.

June’s increase returns sales to previously seen 2012 levels, but just shy of average 2012 rates. Still car sales lead lagging indicators such as U.S. Census Bureau’s July 3 release of factory order data showing May’s activity. For shipments, autos essentially have a lead with an increase of 26.9% over May 2011 levels. Contrasting is mining, oil and gas field machinery showing only an 8.4% gain. New orders are even more revealing with mining, oil and gas machinery down -31.6% where motor vehicle bodies, parts and trailers have a 5.8% increase. Reality shows factory orders in steady decline since last summer, but remaining positive and resilient. Industrial production also shows influence of autos in a similar fashion.

Same store sales reported today with general disappointment and lackluster performance. Costco, for example, came in with a 3% SSS increase which disappointed by being a tiny short of analyst expectations. Gap, Walgreen, Kohls and Macy all show slowed results.

Most telling are results from international operations among car companies and retailers. Declining demand and a strengthening U.S. dollar are weighing heavily on overall company performance. Strong dollar amid trends of the last few years tell of obvious insecurity.