Alcoa is infamous for having lousy numbers and missing its estimates, even Cramer came out today saying who cares about Alcoa, they have lousy numbers. Last quarter they had lousy numbers, but everyone else had great numbers, so what does this mean? To me, it means that Alcoa is the contrarian play since they beat their numbers and raised guidance. Although one analyst says he was not happy with the results as he thought they would guide higher and attributed last quarter’s beat to the airline and auto industries higher demand, basically he said the rest of the year would be weak. I have not looked through the company’s numbers because I do not own Alcoa and I do not want to own Alcoa, so why bother.
Alcoa had good earnings, at least good headline earnings, and CSX had good earnings, which is no surprise since the rail reports have been looking better, but I think we are in for some serious outlook shocks moving forward. All the initial signs are there as the economy is cooling off, frankly it was never that hot to begin with, as retail sales are not stellar, consumer credit is contracting and unemployment remains incredibly high. For some reason the unemployment aspect has become a new normal that most people are immune to, 454,000 initial claims last week was not good and a 466,000 4 week average is not good, in fact it is disturbing that more people are not concerned about this. Not to mention, unemployment benefits for some 3M people are about or have already ran out, not good at all for future earnings outlook, in my opinion, or maybe this fits into a V shaped recovery story somewhere along the way, I get confused nowadays.
One surprise last week was the news that Wells Fargo was closing down 638 stores that catered to non-prime, a.k.a. sub-prime, borrowers, I thought they got out of that business 2 years ago? The firm is expected to has a $.02 charge because of this closure which leads me to believe there may be more losses which led to the closure of the division, not a stretch, I know. Also considering that their pick-a-pay mortgage portfolio still looks terrible I think there is more to the story, but, frankly, with the suspension of mark-to-market accounting what does a bad loan really mean anymore? I will say even with the accounting gimmickry that a bad loan still impairs the balance sheet even if it ‘looks’ good in the reporting and over time a loss will catch up to the bank it is just a matter of how long. I also suspect that there is probably no more perfect quarters for the trading desks f Goldman and JP Morgan, my heart bleeds for them. What I am trying to say is that we might be shocked to find that financials do not perform as well as expectations and their outlook gets more cautious.
There is also technology which has been on fire for the past year, there is no denying that. Earnings have been fantastic and growth has been abundant for pretty much anyone in the technology arena, but will it continue? I fear, no. One of the dirty little secrets is the fact that for the bulk of the last years Asia has been the driving force of growth and these firms have had the benefits of a declining dollar which meant a lot of positive FX results. This is true for Google to Intel who all had several hundred million in earning kickers thanks to a depreciating dollar, but that trend stopped at the end of 1Q10 when Europe started to really catch on fire. I am sure 2Q earnings are going to be good, but guidance might not be as robust as many believe and there is now greater possibility for misses on the top or bottom line as well.
There is also Europe to contend with, I know, everyone says Europe is no big deal and the impact in the U.S. will be minimal. Well, the same people also said the sub-prime crisis was contained in 2007 as well, how did that work out for you? The fact of the matter is that 30% of the S&P 500 earnings are coming from Europe and they are going to stop spending as much, that is just a fact. This slow down will have an impact on earnings moving forward, how much? I do not know, no one knows which is why guidance will probably be more cautious this quarter. You may be saying, well Asia is growing like a weed and I will agree with you, but only somewhat.
I will say that the population in Asia will probably be more liberal with their wallets than businesses will be. China has a lot to contend with right now between property bubbles blowing up, banks worrying about capital requirements, loans becoming harder to come by, profit margins being squeezed by employees wanting higher pay, but their top importer, the EU, has a falling currency and the U.S. consumer is also not buying as much either. They probably are not going to be buying as much as they would be or had in the past. A good barometer of this is the Baltic Dry Index which has plummeted over the past few weeks. China is the reason why the BDI expands and contracts, for the most part, and it shows that China is importing less because they are uncertain or at the very least done stockpiling for now. I believe that means Chinese companies are not doing much capex right now, I could be wrong, but I just don’t see it happening.
The other thing I know people will rip me apart on is the $1.7T, or there about, in cash U.S. companies has on its balance sheets. Many believe all that money will be spent or used to hire, well, what planet are you living on? How long has that money been there for? 6 – 9 months maybe a year now? This is like the cash on the sideline argument, it doesn’t hold water. I agree that eventually that money will go to work somewhere, but not now there is simply too much uncertainty out there. These companies will not go out and hire people, why would they do that, they just fired them? They don’t hire people just to give people jobs, that what governments do. The bottom line is there is no end demand right now, all the evidence shows that as the consumer is deleveraging and so are companies.
That money is sitting on the balance sheet right now because firms are worried about what is going to happen. Most firms paid down debt and are preparing to hunker down for a bad business environment for a long period of time which is why they are not raising dividends to much higher levels or buying new equipment. There is simply no reason to invest right now when the current employee level and technology can met their needs which is the problem with deflationary depressions. Over time this may change, but given what we see right now and the sharp drop in the leading indicators, drop in retail sales, etc. companies are just going to hold that cash until they absolutely have to spend it. I hope I am wrong, but it doesn’t look that way.
I believe that we have plenty of reasons to be worried this earnings season. There has been tremendous technical damage done to the S&P and unless we get stellar earnings and good guidance I do not see the markets going higher. The headwinds are just too strong right now and there is little sign that things are getting better, the opposite is true. I believe we are heading for an immense P/E multiple compression and that is a good thing for value investors, bad for those who own AAPL though. Speaking of which, AAPL is also another reason to be weary of the market right now, it is the only alpha holding out there, take that bad boy out and it will be like trying to get an elephant through an eye of a needle. Plus, if AAPL broke the trust they have with their users who can the people trust? Look for lower guidance.
I have written about money velocity at length and what I think will eventually happen and much of my thesis is about to be put to the test. For whatever reason the market seems to think massively shrinking consumer credit is a good thing and that the Federal Reserve will be starting a new QE process very soon, which is the news this afternoon that coincided with the parabolic move late in the day. However, I cannot disagree with this more and believe that any quantitative easing will do nothing to help expand credit or increase the money supply to the public. We have at the very least disinflationary forced if not outright deflation and the Fed is already running negative real interest rates.
If you recall about a year ago there was a paper from a Fed of IMF official, the authors name escapes me, that recommended real interest rates to run at -5% annually. At the time everyone thought the man was nuts and he was/is in my opinion, but the only way to get real rates that low is through loose money policy and quantitative easing. The Fed has maintained, and will continue to maintain a zero interest rate policy forever as far as I can tell, a loose monetary policy and performed the only quantitative easing policy the U.S. has ever seen, $1.5T in agency and U.S. treasury paper. Unfortunately we still have no idea what the long-term impact of these policies will be, but they cannot be good. These policies are causing real rates to go negative and mortgage rates to plummet.
In order to get the target rate to -5% the Fed will need to buy much more paper than it owns now. My guess is another $2-3T in additional paper and, again, we will not know what the impact of this QE program will be to our economy or currency for some time, but it will not be good. I am not sure why the Fed or this President cannot figure out that interest rates really don’t matter and declining credit is actually a good thing. In fact, all of the “bad news” is really long-term good news as far as the consumer is concerned, not the employment or housing data, but consumer credit. This de-leveraging is just what is needed as we were all awash in debt and most people cannot or could not ever repay their debts. I have never seen a government so desperate to reignite indebtedness of the public like we are seeing right now, it makes no sense long-term.
So, the Fed will start QE again, what will this do? Nothing. Will it increase the money supply? Yes, but not the public’s money supply merely the banking sectors balance sheet which is supposedly flush with cash anyhow. Banks are not lending money because they know they will not get repaid, but borrowers simply do not want more debt either, a good thing! We have mortgage rates below 4.6% and there is no demand, it just doesn’t get much better than that right now, although I think mortgage rates go sub 3% soon. Quantitative easing will do nothing to improve that situation and it certainly will not boost the confidence in the USD which is more than likely the goal, remember, the only way to double exports in 5 years is to devalue the dollar, but it will not work.
The point is that all the QE in the world will not put money in your pocket or your employer’s bank account to give you a raise. Essentially, from a monetary point of view the Fed is done as it cannot get money into the system. QE will merely create inflation, but not the kind of inflation Ben wants, Ben wants wage inflation and QE will merely create dollar devaluation which is Weimar Republic type of inflation. The public also does not want more games or trickery from the government and it frightens me to think what could happen if Ben goes down this reckless path. Remember, just because there is not an impact from his current policies today does not mean there will not be negative implications from these idiotic policies a year or 5 years from now.
What Ben will tell Obama is to create a direct QE program, i.e. a Bush style stimulus, a big one. I do not believe this will go over very well nor do I think voters are in any mood to be bribed with their own money this year, but if one is unemployed and offered $2,000 could or would they say no? Probably not. This type of stimulus would create what Ben is looking for, wage inflation and money velocity, but make no mistake it will be a short-term boost only. We have a long time before we are out of this mess and we have much pain ahead of us. We need to suck it up and deal with it. Contrary to popular belief it is not Bush’s fault, it is all politicians fault going back 30 years and the only cure is pain.
We will still look for an easy way out and probably do QE with another stimulus, but make no mistake that will be suicide for our countries long-term financial health and our currency will be in major trouble if we choose that path. I hate to say it, I have friends who are unemployed, but we must take the pain as it will be shorter than looking for the quick fix. We are all credit junkies and we got to kick the habit.
Consumers are still deleveraging their balance sheets and reducing their debts which may cause a shock for retailers this holiday season. Today we saw credit contract in September by $12B compared to estimates of $10B which should be alarming considering all the green shoot talk and all the declarations of the recession being over. On the brighter side of things, the $21B in credit contraction reported in August was reduced to only $19B, but the forecast was still only for $10B in total reduction, so draw your own conclusions. When consumer spending is 70% of GDP and most of that consumption was done on credit, what do you think happens when to said GDP when credit contracts?
If you get rid of government payment transfers and all the funny business from the economic data the government puts out you will be rather shocked that those green shoots are nothing more than sleight of hand magic tricks. One must look beyond the headlines to get to the real numbers to see what I am talking about, like the employment report, I personally get a kick out the birth/death model, which you must go to the website to actually see because they are so proud of it they don’t actually include it in the report, but the numbers impact the unemployment data. In September the BLS created some 34K jobs out of thin air based on this data, which is less than usual actually, but when the employment report was really high the birth/death model was pumping out big time numbers folks.
In fact, the numbers were so skewed that the BLS announced that it inadvertently added some 825K jobs to the plus category that never existed in as of March of 2009. Even though they know they made this error, they will correct it in February 2010 almost a full year later. Let us not forget about the U-6 data which shows a healthy 17% of Americans are unemployed or underemployed, this is the number that they used to use during the Great Depression, just so you know. There are all sorts of little things that you need to look at, but essentially in September some 785,000 people are out of work if you look at the household survey.
There you have it. Data musings from consumer credit to the employment report, all equaling the same thing, no recovery. So far most of the earnings are showing very little to no top line earnings growth, except for those providing value for consumers and, surprisingly, Alcoa which shocked me frankly. I contend that if Yum Brands missed on the top line, even by a little, which is telling in my opinion.
The consumer credit contraction is now in its fifth month and shows no sign of slowing. In fact, the length and depth of the contraction has caught many analysts off guard and should weaken expectations of a consumer revival in the near-term.
According to Bloomberg, the credit contraction is the longest since 1991 and is a result of consumers not wanting to add to their already bulging debt burden. Consumer credit dropped $10.3 billion in June compared to $5.38 billion in May and there is little evidence to assume that this contraction will end anytime soon. While this certainly will impact consumer spending in the near-term it is better for Americans longer term as they will have less debt.
Economists had estimated that credit would contract by $5 billion, clearly the actual contraction was a surprising figure to most. Credit card fell by $5.25 billion while non-revolving debt, including auto loans and mobile-home loans, declined by $5.04 billion. Even though consumer credit has contracted government debt is sure to pick up the slack, to a degree.
I believe consumer spending declines have only just begun, but the current data shows a decline in spending by 1.2%. Personal incomes and real incomes have had steeper declines than most had expected and is probably a trend that will continue into the foreseeable future. Wages and salaries have also declines by 4.7% from June 2008 to June 2009, which is a record since the data has been collected.
With the markets and home values significantly lower Americans net worth has declined by $13.9 trillion which is just unbelievable. However, Fitch says defaults are falling for credit products and they believe we are close to a plateau on defaults. I have to disagree with that and believe that we will see higher than expected defaults in the near future, especially in the prime and jumbo mortgage area which has been trending higher lately. Not to mention that Fitch’s Prime Credit Card Index is 64% higher than it was just a year earlier at 10.79.
Consumers are stretched to the limit and that is bad news for GDP since we decided to become a consumer nation versus a manufacturing nation. While the rate of decent in credit defaults seems to be slowing I believe that it is the calm before the storm and the situation sill deteriorate. Based on what I see, which is beyond the headline numbers, there are growing, not shrinking, problems that have yet to come to light. Government spending will only create a short-term improvement before it is exhausted.
Another example of credit troubles that are plaguing our economy. This is why we need to get our act together and get a manufacturing base back to the US. Yes, we are the largest exporter of technology, weapons systems and large machines, i.e. excavators and dump trucks. However, we do not export hammers, nails or other useful products, China does.
Here is what the ABA, American Bankers Association, said about credit; “the rate of consumer loan payments at least 30 days late to rise to 3.23 percent in the January-to-March period from 3.22 percent in the 2008 fourth quarter, the American Bankers Association said. Credit Card swipe
Fallout from a still deteriorating housing market caused the rate of consumer loan payments at least 30 days late to rise to 3.23 percent in the January-to-March period from 3.22 percent in the 2008 fourth quarter, the American Bankers Association said.
Delinquencies were the highest since the ABA began tracking the data in 1974. Late payments on home equity borrowings set records, rising to 3.52 percent from 3.03 percent on loans and to 1.89 percent from 1.46 percent on lines of credit.
The overall delinquency rate actually understates consumer pain because it excludes bank-issued credit cards, where credit deterioration was severe.
Delinquencies on the value of all card debt soared to a record 6.60 percent from 5.52 percent in the fourth quarter.
The rate of delinquent accounts rose to 4.75 percent from 4.52 percent, near the record 4.81 percent in the spring of 2005.
U.S. consumers ended March with $939.6 billion of revolving credit outstanding, a rough approximation of credit card debt, according to Federal Reserve data.
Delinquencies rose to 3.01 percent from 2.03 percent on direct auto loans, to 3.70 percent from 2.96 percent on mobile home loans, to 3.47 percent from 2.88 percent on personal loans, and to 1.52 percent from 1.38 percent on recreational vehicle loans.
They fell to 3.42 percent from 3.53 percent on auto loans made through dealers, to 2.04 percent from 2.35 percent on marine loans, and to 1.46 percent from 1.75 percent on property improvement loans.”
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